ITEM 1. Business
BUSINESS
Overview
We are a healthcare REIT incorporated in Delaware in 1985. We own a geographically diverse portfolio of healthcare-related and seniors housing facilities in the United States. As of December 31, 2005, this portfolio consisted of 200 skilled nursing facilities, 41 hospitals and 139 seniors housing and other facilities in 42 states. Except with respect to our medical office buildings, we lease these facilities to healthcare operating companies under “triple-net” or “absolute-net” leases, which require the tenants to pay all property-related expenses. As of December 31, 2005, Kindred leased 225 of our facilities. We also had real estate loan investments relating to 30 healthcare-related and seniors housing facilities as of December 31, 2005.
We conduct substantially all of our business through our wholly owned subsidiaries, Ventas Realty, Limited Partnership (“Ventas Realty”), PSLT OP, L.P. (“PSLT OP”) and Ventas Finance I, LLC (“Ventas Finance”), and ETOP, in which we own substantially all of the partnership units. Our primary business consists of financing, owning and leasing healthcare-related and seniors housing facilities and leasing or subleasing those facilities to third parties.
We operate through one reportable segment: investment in real estate. See our Consolidated Financial Statements and the related notes, including “Note 2-Summary of Significant Accounting Policies,” included in Part II, Item 8 of this Annual Report on Form 10-K.
Our business strategy is comprised of two primary objectives: (1) diversifying our portfolio of properties and (2) increasing our earnings. We intend to continue to diversify our real estate portfolio by operator, facility type, geography and reimbursement source through investments in, and/or acquisitions or development of, additional healthcare-related and/or seniors housing assets across a wide spectrum.
Portfolio of Properties
As of December 31, 2005, Ventas Realty owned 314 of our facilities, consisting of 39 hospitals, 156 skilled nursing facilities and 119 seniors housing and other facilities (including 68 seniors housing and other facilities owned by PSLT OP), Ventas Finance owned 39 of our skilled nursing facilities, and ETOP owned seventeen of our facilities, consisting of five skilled nursing facilities and twelve seniors housing and other facilities. We and certain of our other subsidiaries owned the remaining ten facilities.
The following table provides an overview of our portfolio of properties and other real estate investments as of and for the year ended December 31, 2005:
(1) Includes (i) revenue of $2.3 million related to the amortization of deferred revenue recorded as a result of our receipt of Kindred common stock in connection with Kindred’s emergence from bankruptcy in April 2001 and the amortization of the deferred revenue recorded from the receipt of $4.5 million of additional future rent under our leases with Kindred and (ii) $0.1 million from subleases under our leases with Kindred.
(2) As of December 31, 2005, we owned healthcare properties located in 42 states operated by eighteen different operators.
(3) The remainder of our total revenues is interest and other income.
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Healthcare and Seniors Housing Facilities
Skilled Nursing Facilities. Our skilled nursing facilities typically provide nursing care services to the elderly and rehabilitation and restoration services, including physical, occupational and speech therapies, and other medical treatment for patients and residents who do not require the high technology, care-intensive setting of an acute care or rehabilitation hospital.
Hospitals. Our hospitals generally are long-term acute care hospitals that serve medically complex, chronically ill patients who require a high level of monitoring and specialized care, but whose conditions do not necessitate the continued services of an intensive care unit. The operator of these hospitals has the capability to treat patients who suffer from multiple systemic failures or conditions such as neurological disorders, head injuries, brain stem and spinal cord trauma, cerebral vascular accidents, chemical brain injuries, central nervous system disorders, developmental anomalies and cardiopulmonary disorders. Chronic patients are often dependent on technology for continued life support, such as mechanical ventilators, total parenteral nutrition, respiration or cardiac monitors and dialysis machines, and, therefore, due to their severe medical conditions, these patients generally are not clinically appropriate for admission to a nursing facility or rehabilitation hospital.
Seniors Housing Facilities. Our seniors housing facilities are comprised of assisted and independent living facilities that offer residential units on a month-to-month basis primarily to elderly individuals with various levels of assistance requirements. Residents of these facilities are provided meals in a central dining area and engage in group activities organized by the staff. Assisted living residents may also be provided personal supervision and daily assistance with eating, bathing, grooming and administering medication that make it possible for them to live independently.
Other Facilities. Our other facilities consist of medical office buildings, which offer office space primarily to physicians and other healthcare-related businesses, and personal care facilities, which provide specialized care, including supported living services, neurorehabilitation, neurobehavioral management and vocational programs, for persons with acquired or traumatic brain injury.
Other Real Estate Investments
As of December 31, 2005, our other real estate investments consisted of six first mortgage loans in the outstanding aggregate principal amount of $36.3 million and a mezzanine loan made to Trans Healthcare, Inc. (“THI”) in the outstanding principal amount of $4.0 million.
Each first mortgage loan accrues interest at a rate of nine percent per annum and provides for monthly amortization of principal with a balloon payment maturity date ranging between February and November 2010. Three of these loans were extended in conjunction with the buy-out of our $21.4 million investment in eight distressed mortgage loans and are guaranteed by a third party, unrelated to the borrower, and its two principals. The remaining three loans are guaranteed by an affiliate of the borrower and its two principals.
See “Note 7-Loans Receivable” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Geographic Diversification
Our portfolio of healthcare-related and seniors housing facilities is broadly diversified by geographic location in the United States, with facilities in two states comprising more than ten percent of our 2005 total revenues. The following table shows our rental income derived by geographic location for the year ended December 31, 2005:
(1) Includes (i) revenue of $2.3 million related to the amortization of deferred revenue recorded as a result of our receipt of Kindred common stock in connection with Kindred’s emergence from bankruptcy in April 2001 and the amortization of the deferred revenue recorded from the receipt of $4.5 million of additional future rent under our leases with Kindred and (ii) $0.1 million from subleases under our leases with Kindred.
(2) The remainder of our total revenues is interest from loans receivable and interest and other income.
Certificates of Need
A majority of our skilled nursing facilities and hospitals are located in states that have certificate of need (“CON”) requirements. A CON, which is issued by a governmental agency with jurisdiction over healthcare facilities, is at times required for expansion of existing facilities, construction of new facilities, addition of beds, acquisition of major items of equipment or introduction of new services. The CON rules and regulations may restrict an operator’s ability to expand our properties in certain circumstances.
The following table shows the percentage of our rental income derived by skilled nursing facilities and hospitals in states with and without CON requirements for the year ended December 31, 2005:
Provident Acquisition
On June 7, 2005, we completed the acquisition of Provident Senior Living Trust (“Provident”) in a transaction valued at approximately $1.2 billion. Provident was formed as a Maryland real estate investment trust in March 2004 and owned seniors living properties located in the United States. Pursuant to the Provident acquisition, we acquired 68 independent and assisted living facilities in nineteen states comprised of approximately 6,819 residential living units, all of which are leased to Brookdale and Alterra under triple-net leases with renewal options. In September 2005, Brookdale and Alterra were combined, through a series of mergers, under a new holding company, Brookdale Senior Living. During the fourth quarter of 2005, Brookdale Senior Living completed the initial public offering of its common stock.
We funded the cash portion of the purchase price for the Provident acquisition, which was approximately $231.0 million, and repaid all outstanding borrowings under Provident’s credit facility at closing from a combination of net proceeds from the sale $350.0 aggregate principal amount of senior notes and borrowings under our revolving credit facility. Additionally, we issued approximately 15.0 million shares of common stock and common stock equivalents to Provident equity holders as part of the purchase price for the Provident acquisition, and we assumed approximately $459.4 million of property-level mortgage debt.
Significant Tenants
As of December 31, 2005, approximately 33.6 percent and 45.8 percent of our properties, based on their original cost, were operated by Kindred and Brookdale Senior Living, respectively, and for the year ended December 31, 2005, Kindred and Brookdale Senior Living accounted for approximately 59.8 percent and 22.9 percent, respectively, of our total revenues. Our reliance on Kindred is a result of our spin off of Kindred in May 1998, pursuant to which we transferred to Kindred our previous hospital, nursing facility and ancillary services businesses and we retained substantially all of the real property which we leased to Kindred. Our reliance on Brookdale Senior Living is a result of our acquisition of Provident in June 2005 and the subsequent combination of Brookdale and Alterra described above.
Because Kindred and Brookdale Senior Living lease a substantial portion of our properties and are the primary sources of our total revenues, their financial condition and ability and willingness to satisfy their obligations under their respective leases and certain other agreements with us have a significant impact on our financial results and our ability to service our indebtedness and to make distributions to our stockholders. We cannot assure you that Kindred or Brookdale Senior Living will have sufficient assets, income and access to financing to enable it to satisfy these obligations, and any inability or unwillingness on its part to do so would have a material adverse effect on our business, financial condition, results of operation and liquidity. See “Risks Arising from Our Business-We are dependent on Kindred and Brookdale Senior Living; Kindred’s or Brookdale Senior Living’s inability or unwillingness to satisfy its obligations under its agreements with us could significantly harm us and our ability to service our indebtedness and other obligations and to make distributions to our stockholders as required to continue to qualify as a REIT” included in Item 1A
Item 1A of this Annual Report on Form 10-K.
Employees
As of December 31, 2005, we had 32 full-time employees. We consider the relationship with our employees to be good.
Insurance
We maintain and/or require in our existing leases that our tenants maintain liability and casualty insurance on the properties and their operations. For example, under the Kindred Master Leases, Kindred is required to maintain, at its expense, certain insurance coverage related to the properties under the Kindred Master Leases and Kindred’s operations at the related facilities. However, we cannot assure you that Kindred or our other tenants will maintain such insurance, and any failure by our tenants to do so could have a material adverse effect on our business, financial condition, results of operation and liquidity and on our ability to service our indebtedness and other obligations and to make distributions to our stockholders as required for us to continue to qualify as a REIT (a “Material Adverse Effect”). We believe that our tenants are in substantial compliance with the insurance requirements contained in their respective leases with us.
We believe that the amount and scope of insurance coverage provided by our own and our tenants’ policies are customary for similarly situated companies in our industry. We cannot assure you that in the future such insurance will be available at a reasonable price or that we will be able to maintain adequate levels of insurance coverage.
Due to the increase in the number and severity of professional liability claims against healthcare providers, the availability of professional liability insurance has been severely restricted and the premiums for such insurance coverage has increased dramatically. As a result, many healthcare providers may incur large funded and unfunded professional liability expense, which could have a material adverse effect on their liquidity, financial condition and results of operations. In addition, many healthcare providers are pursuing different organizational and corporate structures coupled with insurance programs that provide less insurance coverage. Therefore, we cannot assure you that our tenants will continue to carry the insurance coverage required under the terms of their leases with us or that we will continue to require the same levels of insurance under our leases.
Additional Information
We maintain a website at www.ventasreit.com. The information on our website is not incorporated by reference in this Annual Report on Form 10-K, and our web address is included as an inactive textual reference only.
We make available, free of charge, through our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Commission. In addition, our Guidelines on Governance, the charters for each of our Audit and Compliance, Nominating and Governance and Executive Compensation Committees and our Code of Ethics and Business Conduct are available on our website, and we will mail copies of the foregoing documents to stockholders, free of charge, upon request to Corporate Secretary, Ventas, Inc., 10350 Ormsby Park Place, Suite 300, Louisville, Kentucky 40223.
GOVERNMENTAL REGULATION
Healthcare Regulation
General
The operators of our properties derive a substantial portion of their revenues from third party payors, including the Medicare and Medicaid programs. Medicare is a federal program that provides certain hospital and medical insurance benefits to persons age 65 and over, certain disabled persons and persons with end-stage renal disease. Medicaid is a medical assistance program jointly funded by federal and state governments and administered by each state pursuant to which benefits are available to certain indigent patients. The Medicare and Medicaid statutory framework is subject to administrative rulings, interpretations and discretion that affect the amount and timing of reimbursement made under Medicare and Medicaid. The amounts of program payments received by our operators and tenants can be changed by legislative or regulatory actions and by determinations by agents for the programs. See “-Healthcare Reform.” In addition, private payors, including managed care payors, increasingly are demanding discounted fee structures and the assumption by healthcare providers of all or a portion of the financial risk. Efforts to impose greater discounts and more stringent cost controls upon operators by private payors are expected to continue. We cannot assure you that adequate reimbursement levels will continue to be available for services to be provided by the operators of our properties which currently are being reimbursed by Medicare, Medicaid and private payors. Significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on these operators’ liquidity, financial condition and results of operations, which could affect adversely their ability to make rental payments under their leases with us.
The operators of our properties are subject to other extensive federal, state and local laws and regulations including, but not limited to, laws and regulations relating to licensure, conduct of operations, ownership of facilities, addition of facilities, services, prices for services, billing for services, and the confidentiality and security of health-related information. These laws authorize periodic inspections and investigations, and identification of deficiencies that, if not corrected, can result in sanctions that include loss of licensure to operate and loss of rights to participate in the Medicare and Medicaid programs. Regulatory agencies have substantial powers to affect the actions of operators of our properties if the agencies believe that there is an imminent threat to patient welfare, and in some states these powers can include assumption of interim control over facilities through receiverships.
Skilled Nursing Facilities. The operators of our skilled nursing facilities generally are licensed on an annual or bi-annual basis and certified annually for participation in the Medicare and Medicaid programs through various regulatory agencies which determine compliance with federal, state and local laws. These legal requirements relate to the quality of the nursing care provided, qualifications of the administrative personnel and nursing staff, the adequacy of the physical plant and equipment and continuing compliance with the laws and regulations governing the operation of nursing facilities. A loss of licensure or certification could adversely affect a nursing facility’s ability to receive payments from the Medicare and Medicaid programs, which, in turn, could adversely impact the operator’s ability to make rental payments under its leases with us.
Long-Term Acute Care Hospitals. Substantially all of our hospitals are operated as long-term acute care hospitals, which are hospitals that have a Medicare average length of stay greater than 25 days. Our hospitals are freestanding facilities, and we do not own any “hospitals within hospitals.” In order to receive Medicare and Medicaid reimbursement, each hospital must meet the applicable conditions of participation set forth by United States Department of Health and Human Services (“HHS”) relating to the type of hospital, its equipment, personnel and standard of medical care, as well as comply with state and local laws and regulations. Hospitals undergo periodic on-site licensure surveys, which generally are limited if the hospital is accredited by the Joint Commission on Accreditation of Healthcare Organizations or other recognized accreditation organizations. A loss of licensure or certification could adversely affect a hospital’s ability to receive payments from the Medicare and Medicaid programs, which, in turn, could adversely impact the operator’s ability to make rental payments under its leases with us.
Assisted Living Facilities. Assisted living facilities provide services to aid in activities of daily living, such as bathing, meals, security, transportation, recreation, medication supervision and limited therapeutic programs. More intensive medical needs of the resident are often met within assisted living facilities by home health providers, close coordination with the resident’s physician and skilled nursing facilities. Assisted living facilities are subject to relatively few federal regulations. Instead, they are regulated mainly by state and local laws which govern the licensing of beds, the provision of services, staffing requirements and other operational matters. However, these state laws vary greatly from one state to another.
The recent increase in the number of assisted living facilities around the country has attracted the attention of various federal agencies which believe there should be more federal regulation of these facilities. To date, Congress has deferred to state regulation of assisted living facilities. As a result of the increased federal scrutiny along with the rapid increase in the number of these facilities, some states have revised and strengthened their regulation of assisted living facilities. More states are expected to do the same in the future.
Any significant expansion in the number or type of, or a violation of any of, these federal, state or local laws and regulations could have a material adverse effect on our operators’ liquidity, financial condition and results of operations, which, in turn, could adversely impact their ability to make rental payments under their leases with us.
Certificates of Need
Some states require state approval for development and expansion of healthcare facilities and services, including findings of need for additional or expanded healthcare facilities or services. A CON is issued by a
governmental agency with jurisdiction over healthcare facilities and is at times required for expansion of existing facilities, construction of new facilities, addition of beds, and acquisition of major items of equipment or introduction of new services. The CON rules and regulations may restrict an operator’s ability to expand our properties in certain circumstances.
In the last several years, in response to mounting Medicaid budget deficits, many states have begun to tighten CON controls, including the imposition of moratoriums on new nursing facilities and hospitals. Some states have also increased controls over licensing and change-of-ownership rules.
In the event that any operator of our properties fails to make rental payments to us or to comply with the applicable healthcare regulations, and, in either case, the operator or its lenders fail to cure the default prior to the expiration of the applicable cure period, our ability to evict that operator and substitute another operator or operators may be materially delayed or limited by various state licensing, receivership, CON or other laws, as well as by Medicare and Medicaid change-of-ownership rules. Such delays and limitations could have a material adverse effect on our ability to collect rent, to obtain possession of leased properties, or otherwise to exercise remedies for tenant default. In addition, we may also incur substantial additional expenses in connection with any such licensing, receivership or change-of-ownership proceedings.
Fraud and Abuse
There are extensive federal and state laws and regulations prohibiting fraud and abuse in the healthcare industry that can result in significant criminal and civil penalties that can materially affect the operators of our properties. The federal laws include:
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The anti-kickback statute (Section 1128B(b) of the Social Security Act), which prohibits certain business practices and relationships that might affect the provision and cost of healthcare services reimbursable under Medicare, Medicaid and other federal healthcare programs, including the payment or receipt of remuneration for the referral of patients whose care will be paid by Medicare or other governmental programs.
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The physician self-referral prohibition (Ethics in Patient Referral Act of 1989, commonly referred to as the “Stark Law”), which prohibits referrals by physicians of Medicare patients to providers of a broad range of designated healthcare services with which the physicians (or their immediate family members) or Medicaid have ownership interests or certain other financial arrangements.
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The False Claims Act, which prohibits any person from knowingly presenting false or fraudulent claims for payment to the federal government (including the Medicare and Medicaid programs).
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The Civil Monetary Penalties Law, which authorizes HHS to impose civil penalties administratively for fraudulent acts.
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The Health Insurance Portability and Accountability Act of 1996 (commonly referred to as “HIPAA”), which among other things, protects the privacy and security of individually identifiable health information by limiting its use and disclosure.
Sanctions for violating these federal laws include criminal and civil penalties that range from punitive sanctions, damage assessments, money penalties, imprisonment, denial of Medicare and Medicaid payments, and/or exclusion from the Medicare and Medicaid programs. These laws also impose an affirmative duty on operators to ensure that they do not employ or contract with persons excluded from the Medicare and other government programs.
Many states have adopted or are considering legislative proposals similar to the federal fraud and abuse laws, some of which extend beyond the Medicare and Medicaid programs to prohibit the payment or receipt of remuneration for the referral of patients and physician self-referrals regardless of whether the service was reimbursed by Medicare or Medicaid. Many states have also adopted or are considering legislative proposals to
increase patient protections, such as minimum staffing levels, criminal background checks, and limiting the use and disclosure of patient specific health information. These state laws also impose criminal and civil penalties similar to the federal laws.
In the ordinary course of their business, the operators of our properties have been and are subject regularly to inquiries, investigations and audits by federal and state agencies that oversee these laws and regulations. Recent federal and state legislation has greatly increased funding for investigations and enforcement actions which have increased dramatically over the past several years. This trend is expected to continue. Private enforcement of healthcare fraud also has increased due in large part to amendments to the civil False Claims Act in 1986 that were designed to encourage private individuals to sue on behalf of the government. These whistleblower suits by private individuals, known as qui tam relators, may be filed by almost anyone, including present and former patients or nurses and other employees. HIPAA also created a series of new healthcare related crimes.
As federal and state budget pressures continue, federal and state administrative agencies may also continue to escalate investigation and enforcement efforts to root out waste and to control fraud and abuse in governmental healthcare programs. A violation of any of these federal and state fraud and abuse laws and regulations could have a material adverse effect on our operators’ liquidity, financial condition and results of operations, which could affect adversely their ability to make rental payments to us.
Healthcare Reform
Healthcare is one of the largest industries in the United States and continues to attract much legislative interest and public attention. In an effort to reduce federal spending on healthcare, in 1997 the federal government enacted the Balanced Budget Act (“BBA”), which contained extensive changes to the Medicare and Medicaid programs, including substantial Medicare reimbursement reductions for healthcare operations. For certain healthcare providers, including hospitals and skilled nursing facilities, implementation of the BBA resulted in more drastic reimbursement reductions than had been anticipated. In addition to its impact on Medicare, the BBA also afforded states more flexibility in administering their Medicaid plans, including the ability to shift most Medicaid enrollees into managed care plans without first obtaining a federal waiver.
The following key legislative and regulatory changes have been made to the BBA to provide some relief from the drastic reductions in Medicare and Medicaid reimbursement resulting from implementation of the BBA:
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The Balanced Budget Refinement Act of 1999 (“BBRA”);
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The Medicare, Medicaid, and State Child Health Insurance Program Benefits Improvement and Protection Act of 2000 (“BIPA”);
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Beginning on October 1, 2003, the Center for Medicare & Medicaid Services (“CMS”) instituted a one-time “administrative fix” to increase SNF payment rates by 3.26 percent; and
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The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“Medicare Modernization Act”, sometimes referred to as the “Drug Bill”).
For the last several years, many states have announced actual or potential budget shortfalls. As a result of these budget shortfalls, many states have announced that they are implementing or considering implementing “freezes” or cuts in Medicaid rates paid to providers, including hospitals and nursing homes.
The Medicare and Medicaid programs, including payment levels and methods, are in a state of change and are less predictable following the enactment of BBA and the subsequent reform activities. We cannot assure you that future healthcare legislation or changes in the administration or implementation of governmental healthcare reimbursement programs will not have a material adverse effect on the liquidity, financial condition or results of operations of our operators and tenants, which could have a material adverse effect on their ability to make rental payments to us and which, in turn, could have a Material Adverse Effect on us.
Medicare Reimbursement; Long-Term Acute Care Hospitals
The BBA mandated the creation of a prospective payment system for long-term acute care hospitals (“LTAC PPS”), which became effective on October 1, 2002 for cost report periods commencing on or after October 1, 2002. Long-term acute care hospitals have transitioned or are currently transitioning to LTAC PPS, which classifies patients into distinct diagnostic groups based on clinical characteristics and expected resource needs.
Under LTAC PPS, long-term acute care hospitals are no longer reimbursed on a reasonable cost basis that reflects costs incurred, but rather on a predetermined rate. LTAC PPS requires payment for a Medicare beneficiary at a predetermined, per discharge amount for each defined patient category (called “Long-Term Care-Diagnosis Related Groups” or “LTC-DRGs”), adjusted for differences in area wage levels.
Updates to the LTAC PPS payment rates are published annually for the long-term acute care hospital rate year (July 1 through June 30). However, annual updates to the LTAC PPS classification system and its relative weighting system (LTC-DRGs) will continue to coincide with the federal fiscal year (October 1 to September 30) as with the prospective payment system for short-term acute care hospitals (DRGs). These updates are regulatorily established each year.
On January 19, 2006, CMS issued a proposed rule to update LTAC PPS payment rates for the 2007 rate year (July 1, 2006 through June 30, 2007). Under this proposed rule, long-term acute care hospitals will receive no market basket inflation increase in Medicare payments starting July 1, 2006. The proposed rule also adds new restrictions on payments for short-stay outlier cases, makes adjustments to the labor portion of the federal rate and increases the outlier fixed loss threshold, along with a slight increase in the budget neutrality adjustment. If this rule becomes final, the combined effective decrease in rate year 2007 Medicare revenues for long-term acute care hospitals would be $362 million, or 11.1 percent on the total historical patient mix and volume.
The January 19, 2006 proposed rule also discusses the research that was to be conducted by Research Triangle Institute (RTI) to determine the feasibility of implementing the recommendations of the Medicare Payment Advisory Commission (MedPac). They were asked to clearly define the role of long-term acute care hospitals in the inpatient continuum of care by establishing facility and patient criteria and for Medicare’s Quality Improvement Organizations (QIOs) to play a larger role in reviewing admissions for medical necessity and for compliance with any facility and patient criteria.
Comments on the January 19, 2006 proposed rule will be accepted until March 20, 2006, and a final rule is expected to be published later in the second quarter of 2006.
On August 12, 2005, CMS published a final rule updating the LTC-DRG categorization system for LTAC PPS for the 2006 federal fiscal year (October 1, 2005 through September 30, 2006). In the final rule, CMS, among other things, revised the relative weights for each LTC-DRG used to estimate the resource needs of patients classified in each LTC-DRG and revised the minimum average length of stay requirements for each LTC-DRG necessary to receive full payment under the system. CMS estimates that the combined effect of these changes will decrease federal fiscal year 2006 Medicare revenues for long-term acute care hospitals by approximately 4.2 percent.
On May 6, 2005, CMS published a final rule updating the LTAC PPS payment rates for the 2006 rate year (July 1, 2005 through June 30, 2006). Under this final rule, long-term acute care hospitals received a 3.4 percent increase in Medicare payments starting July 1, 2005. In the final rule, CMS, among other things, further increased LTAC PPS rates by reducing the negative budget neutrality adjustment. CMS estimates that the combined effect of these changes will increase rate year 2006 Medicare revenues for long-term acute care hospitals by approximately 5.3 percent.
We cannot assure you that future updates to the LTAC PPS system or Medicare reimbursement for long-term acute care hospitals will not materially adversely impact our operators, which, in turn, could have a
Material Adverse Effect on us. See “Risks Arising from Our Business-Changes in the reimbursement rates or methods of payment from third-party payors, including the Medicare and Medicaid programs, could have a material adverse effect on certain of our tenants” included in Item 1A of this Annual Report on Form 10-K.
Medicare Reimbursement; Skilled Nursing Facilities
BBA established a prospective payment system for skilled nursing facilities (“SNF PPS”) offering Part A covered services. Under the SNF PPS, payment amounts are based upon classifications determined through assessments of individual Medicare patients in the skilled nursing facility, rather than on the facility’s reasonable costs. The payments received under the SNF PPS are intended generally to cover all inpatient services for Medicare patients, including routine nursing care, most capital-related costs associated with the inpatient stay, and ancillary services, such as respiratory therapy, occupational and physical therapy, speech therapy and certain covered drugs. Under the SNF PPS, per diem payments are made to nursing home facilities for each resident.
In response to widespread healthcare industry concern about the reductions in payments under BBA, the federal government enacted BBRA on November 29, 1999. BBRA increased the per diem reimbursement rates for certain high acuity patients by 20 percent starting April 1, 2000 and continuing until case-mix refinements were implemented by CMS, as explained below. Under BBRA, outpatient rehabilitation therapy providers, including Part B nursing facilities, received a two-year moratorium on the annual cap on the amount of physical, occupational and speech therapy provided to a patient, which moratorium was subsequently extended until December 31, 2005.
During 2003, financial limitations on therapy services went into effect. For Part B nursing facility residents, a $1,500 limit was placed on the reimbursement level for physical therapy/speech language pathology services combined and a separate $1,500 limit for occupational therapy. As a result of administrative delays and litigation, this limitation was only effective from September 1, 2003 through December 8, 2003, the effective date of the Medicare Modernization Act, which included a two-year moratorium on the application of therapy caps until December 31, 2005. On January 1, 2006, the therapy limitations went into effect until the Deficit Reduction Act (“DRA”) was enacted. This new law retroactively established an exception process for the payment of all claims above the limits when such services are medically necessary.
On August 4, 2005, CMS announced an update to SNF PPS for the 2006 federal fiscal year (October 1, 2005 through September 30, 2006). In the final rule, CMS, among other things, refined the resource utilization groups (“RUGs”) by adding nine new payment categories which determine the daily payments for Medicare beneficiaries in skilled nursing facilities (“RUGs Refinement”). The result of this refinement was to eliminate the temporary add-on payments that Congress enacted as part of the BBRA. CMS also increased the case mix index for all of the RUGs categories. The increase in the index is equal to about half of the value of the temporary add-on payment that ended with the refinement of the previous system. CMS estimates that the increase in payments along with the RUGs Refinement, together with an annual inflation increase of 3.1 percent, will result in a small overall increase in skilled nursing facility Medicare payments in federal fiscal year 2006. The RUGs Refinement under the final rule was implemented on January 1, 2006 and the full market basket increase was implemented on October 1, 2005.
We cannot assure you that future updates to the SNF PPS system, therapy services or Medicare reimbursement for skilled nursing facilities will not materially adversely impact our operators, which, in turn, could have a Material Adverse Effect on us. See “Risks Arising from Our Business-Changes in the reimbursement rates or methods of payment from third-party payors, including the Medicare and Medicaid programs, could have a material adverse effect on certain of our tenants” included in Item 1A of this Annual Report on Form 10-K.
Medicaid Reimbursement; Skilled Nursing Facilities
Approximately two-thirds of all nursing home residents are dependent on Medicaid. Medicaid reimbursement rates, however, typically are less than the amounts charged by the operators of our properties.
BBA repealed the “Boren Amendment” federal payment standard for Medicaid payments to hospitals and nursing facilities effective October 1, 1997, giving states greater latitude in setting payment rates for these providers. Furthermore, federal legislation restricts a nursing facility operator’s ability to withdraw from the Medicaid Program by restricting the eviction or transfer of Medicaid residents.
For the last several years, many states have announced actual or potential budget shortfalls. As a result of these budget shortfalls, many states have announced that they are implementing or considering implementing “freezes” or cuts in Medicaid rates paid to skilled nursing facility providers.
In the DRA, Congress made changes to the Medicaid program that are estimated to result in $10 billion in savings to the federal government over the next five years primarily through the accounting practices some states use to calculate their matched payments and revising the qualifications for individuals who are eligible for Medicaid benefits. At this time, it is not possible to predict whether significant Medicaid rate freezes or cuts or other program changes will be adopted and if so, by how many states or whether the United States Government will revoke, reduce or stop approving “provider taxes” that have the effect of increasing Medicaid payments to the states, or the impact of such actions on our operators. However, severe and widespread Medicaid rate cuts or freezes could have a material adverse effect on our skilled nursing facility operators, which, in turn, could have a Material Adverse Effect on us.
Nursing Home Quality Initiative
In 2002, HHS launched the Nursing Home Quality Initiative program. This program, which is designed to provide consumers with comparative information about nursing home quality measures, rates nursing homes on various quality of care indicators. Since 2002, investigative and enforcement activities regarding nursing home quality compliance has intensified both on the federal and state administrative levels.
If the operators of our properties are unable to achieve quality of care ratings that are comparable or superior to those of their competitors, patients may choose alternate facilities, which could cause operating revenues to decline. In the event the financial condition or operating revenues of these operators are adversely affected, the operators’ ability to make rental payments to us could be adversely affected, which, in turn, could have a Material Adverse Effect on us.
Environmental Regulation
As an owner of real property, we are subject to various federal, state and local laws and regulations regarding environmental, health and safety matters. These laws and regulations address, among other things, asbestos, polychlorinated biphenyls, fuel oil management, wastewater discharges, air emissions, radioactive materials, medical wastes, and hazardous wastes. In certain cases, the costs of complying with these laws and regulations and the penalties for non-compliance can be substantial. For example, although we do not generally operate our properties, we may be held jointly and severally liable for costs relating to the investigation and cleanup of any property from which there is or has been a release or threatened release of a hazardous or toxic substance and any other affected properties, regardless of whether we knew of or caused the release. In addition to these costs, which are typically not limited by law or regulation and could exceed the property’s value, we could be liable for certain other costs, including governmental fines and injuries to persons or property. See “Risks Arising from Our Business-If any of our properties are found to be contaminated, or if we become involved in any environmental disputes, we could incur substantial liabilities and costs” included in Item 1A of this Annual Report on Form 10-K.
We are generally indemnified by the current operators of our properties for contamination caused by those operators. For example, under the Kindred Master Leases, Kindred has agreed to indemnify us against any environmental claims (including penalties and clean-up costs) resulting from any condition arising in, on or under, or relating to, the leased properties at any time on or after the lease commencement date for the applicable
leased property and from any condition permitted to deteriorate on or after such date (including as a result of migration from adjacent properties not owned or operated by us or any of our affiliates other than Kindred and its direct affiliates). However, we cannot assure you that Kindred or another operator will have the financial capability or the willingness to satisfy any such environmental claims, and in the event Kindred or another operator is unable or unwilling to do so, we may be required to satisfy the claims. See “Risks Arising from Our Business-We are dependent on Kindred and Brookdale Senior Living; Kindred’s or Brookdale Senior Living’s inability or unwillingness to satisfy its obligations under its agreements with us could significantly harm us and our ability to service our indebtedness and other obligations and to make distributions to our stockholders as required to continue to qualify as a REIT” included in Item 1A of this Annual Report on Form 10-K. We have also agreed to indemnify Kindred and certain of our other operators against any environmental claims (including penalties and clean-up costs) resulting from any condition arising on or under, or relating to, the leased properties at any time before the lease commencement date for the applicable leased property.
We did not make any material capital expenditures in connection with such environmental, health, and safety laws, ordinances and regulations in 2005 and do not expect that we will have to make any such material capital expenditures during 2006.
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following discussion of “Certain U.S. Federal Income Tax Considerations” is not exhaustive of all possible tax considerations and is not tax advice. Moreover, this summary does not deal with all tax aspects that might be relevant to a particular stockholder in light of such stockholder’s circumstances, nor does it deal with particular types of stockholders that are subject to special treatment under the Internal Revenue Code of 1986, as amended (the “Code”), such as insurance companies, financial institutions and broker-dealers. The Code provisions governing the federal income tax treatment of REITs are highly technical and complex, and this summary is qualified in its entirety by the applicable Code provisions, rules and Treasury regulations promulgated thereunder, and administrative and judicial interpretations thereof. The following discussion is based on current law, which could be changed at any time, possibly retroactively.
Federal Income Taxation of Ventas
We elected REIT status beginning with the year ended December 31, 1999. Beginning with the 1999 tax year, we believe that we have satisfied the requirements to qualify as a REIT, and we intend to continue to qualify as a REIT for federal income tax purposes. If we continue to qualify for taxation as a REIT, we generally will not be subject to federal corporate income tax on net income that we currently distribute to stockholders. This treatment substantially eliminates the “double taxation” (i.e., taxation at both the corporate and stockholder levels) that generally results from investment in a corporation.
Notwithstanding our qualification as a REIT, we will be subject to federal income tax on any undistributed taxable income, including undistributed net capital gains at regular corporate rates. In addition, we will be subject to a 4 percent excise tax if we do not satisfy specific REIT distribution requirements. See “-Requirements for Qualification as a REIT-Annual Distribution Requirements.” We may be subject to the “alternative minimum tax” on our undistributed items of tax preference. If we have (i) net income from the sale or other disposition of “foreclosure property” (see below) that is held primarily for sale to customers in the ordinary course of business or (ii) other non-qualifying income from foreclosure property, we will be subject to tax at the highest corporate rate on such income. See “-Requirements for Qualification as a REIT-Asset Tests.” In addition, if we have net income from “prohibited transactions” (which are, in general, certain sales or other dispositions of property (other than foreclosure property) held primarily for sale to customers in the ordinary course of business), that income will be subject to a 100 percent tax.
We may also be subject to “Built-in Gains Tax” on any appreciated asset that we own or acquire that was previously owned by a C corporation (i.e., a corporation generally subject to full corporate level tax). If we dispose
of any of these assets and recognize gain on the disposition of such asset during the ten-year period immediately after the assets were owned by a C corporation (either prior to our REIT election, through stock acquisition or merger), then we generally will be subject to regular corporate income tax on the gain equal to the lower of (i) the recognized gain at the time of the disposition or (ii) the built-in gain in that asset as of the date it became a REIT asset. In connection with the sale of any assets, all or a portion of such gain could be treated as ordinary income instead of capital gain and be subject to taxation and/or the minimum REIT distribution requirements.
See “-Requirements for Qualification as a REIT” below for other circumstances in which we may be required to pay federal taxes.
Requirements for Qualification as a REIT
To continue to qualify as a REIT, we must continue to meet the requirements discussed below, relating to our organization, sources of income, nature of assets and distributions of income to stockholders.
Organizational Requirements
The Code defines a REIT as a corporation, trust or association: (i) that is managed by one or more directors or trustees; (ii) the beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest; (iii) that would be taxable as a domestic corporation, but for Sections 856 through 859 of the Code; (iv) that is neither a financial institution nor an insurance company subject to certain provisions of the Code; (v) the beneficial ownership of which is held by 100 or more persons during at least 335 days of a taxable year of twelve months, or during a proportionate part of a shorter taxable year (the “100 Shareholder Rule”); (vi) not more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) during the last half of each taxable year (the “5/50 Rule”); (vii) that makes an election to be a REIT (or has made such election for a previous taxable year) and satisfies all relevant filing and other administrative requirements established by the Internal Revenue Service (“IRS”) that must be met in order to elect and to maintain REIT status; (viii) that uses a calendar year for federal income tax purposes; and (ix) that meets certain other tests, described below, regarding the nature of its income and assets.
We believe, but we cannot assure you, that we have satisfied and will continue to satisfy the organizational requirements. In order to prevent a concentration of ownership of our stock that would cause us to fail the 5/50 Rule or the 100 Shareholder Rule, we have placed certain restrictions on the transfer of our shares that are intended to prevent further concentration of share ownership. However, such restrictions may not prevent us from failing to meet these requirements, and thereby failing to qualify as a REIT.
In addition, to qualify as a REIT, a corporation may not have (as of the end of the taxable year) any earnings and profits that were accumulated in periods before it elected REIT status. We believe we have not had any accumulated earnings and profits that are attributable to non-REIT periods, although the IRS would be entitled to challenge that determination.
Gross Income Tests
To continue to qualify as a REIT, we must satisfy two annual gross income requirements. First, at least 75 percent of our gross income (excluding gross income from prohibited transactions) for each taxable year must consist of defined types of income derived directly or indirectly from investments relating to real property or mortgages on real property (including pledges of equity interest in certain entities holding real property and also including “rents from real property” (as defined in the Code)) and, in certain circumstances, interest on certain types of temporary investment income. Second, at least 95 percent of our gross income (excluding gross income from prohibited transactions) for each taxable year must be derived from such real property or temporary investments, dividends, interest and gain from the sale or disposition of stock or securities, or from any combination of the foregoing.
We believe, but we cannot assure you, that we have been and will continue to be in compliance with the gross income tests. If we fail to satisfy one or both gross income tests for any taxable year, we may nevertheless qualify as a REIT for the year under certain relief provisions of the Code. If we were eligible to qualify under the relief provisions, a 100 percent tax would be imposed with respect to the income exceeding one or both of the gross income tests.
If we fail to satisfy one or both of the gross income tests and the relief provisions for any year, we will no longer qualify as a REIT. If we lose our REIT status, it would have a Material Adverse Effect on us.
Asset Tests
At the close of each quarter of our taxable year, we must satisfy two tests relating to the nature of our assets. First, at least 75 percent of the value of our total assets must be represented by cash or cash items (including certain receivables), government securities, “real estate assets” or, in cases where we raise new capital through stock or long-term (maturity of at least five years) debt offerings, temporary investments in stock or debt instruments during the one-year period following our receipt of such capital (the “75 percent asset test”). Second, of the investments not meeting the requirements of the 75 percent asset test, the value of any one issuer’s debt and equity securities owned by us (other than our interest in any entity classified as a partnership for federal income tax purposes, the stock of a taxable REIT subsidiary (as defined below) or the stock of a qualified REIT subsidiary) may not exceed five percent of the value of our total assets (the “five percent asset test”), and we may not own more than ten percent of any one issuer’s outstanding voting securities or ten percent of the value of any one issuer’s outstanding securities (the “ten percent securities test”), subject to limited “safe harbor” exceptions. In addition, no more than 20 percent of the value of our assets can be represented by securities of taxable REIT subsidiaries.
If we fail to satisfy the asset tests at the end of any quarter other than our first quarter, we may nevertheless continue to qualify as a REIT and maintain our REIT status if (i) we satisfied all of the asset tests at the close of the preceding calendar quarter and (ii) the discrepancy between the value of our assets and the asset test requirements arose from changes in the market values of our assets and was not wholly or partly caused by an acquisition of nonqualifying assets. As a result of the enactment of the American Jobs Creation Act of 2004, if the conditions described in clauses (i) and (ii) above were not satisfied, we still could avoid disqualification by eliminating any discrepancy within six months after the last day of the quarter in which we identify the asset test failure. A penalty up to $50,000 may be assessed for such failure. We intend to maintain adequate records of the value of our assets to ensure compliance with the asset tests and to take such other actions as may be required to comply with those tests.
We believe, but we cannot assure you, that we have been and will continue to be in compliance with the ten percent securities test and the five percent asset test. If we fail to satisfy either of these tests, we would lose our REIT status, which would have a Material Adverse Effect on us.
Foreclosure Property
The foreclosure property rules permit us (by our election) to foreclose or repossess properties without being disqualified as a result of receiving income that does not qualify under the gross income tests; however, a corporate tax is imposed upon net income from “foreclosure property” that is not otherwise “good REIT” income. Detailed rules specify the calculation of the tax, and the after-tax amount would increase the dividends we would be required to distribute to stockholders each year. See “-Annual Distribution Requirements” below.
Foreclosure property treatment will end on the first day on which we enter into a lease of the property that will give rise to income that is not “good REIT” income under Section 856(c)(3) of the Code. In addition, foreclosure property treatment will end if any construction takes place on the property (other than completion of a building, or other improvement more than ten percent complete before default became imminent). Foreclosure
property treatment is available for an initial period of three years and may be extended up to six years. Foreclosure property treatment for qualified healthcare property is available for an initial period of two years and may be extended up to six years.
Taxable REIT Subsidiaries
We are permitted to own up to 100 percent of a “taxable REIT subsidiary” or a “TRS.” Tax legislation implemented TRS rules to allow REITs to have greater flexibility in engaging in activities, which previously had been prohibited by REIT rules. TRSs are corporations subject to tax as a regular “C” corporation. Generally, a TRS can own assets that cannot be owned by a REIT and can perform otherwise impermissible tenant services (excluding the direct or indirect operation or management of a lodging or healthcare facility) which would otherwise disqualify the REIT’s rental income under the REIT income tests. In enacting the TRS rules, Congress intended that the arrangements between a REIT and its TRSs be structured to ensure that a TRS will be subject to an appropriate level of federal income taxation. As a result, there are certain limits on the ability of a TRS to deduct interest payments made to us. In addition, we will be obligated to pay a 100 percent penalty tax on some payments that we receive or on certain expenses deducted by the TRS if the economic arrangements between the REIT, the REIT’s tenants and the TRS are not comparable to similar arrangements among unrelated parties.
On March 26, 2002, we formed Ventas Capital Corporation, a Delaware corporation and TRS. On November 8, 2002, we formed another TRS, Ventas TRS, LLC, a Delaware limited liability company. Both companies are owned 100 percent by Ventas Realty. As of December 31, 2005, neither Ventas Capital Corporation nor Ventas TRS, LLC owned any of our assets.
As a result of our acquisition of ElderTrust on February 5, 2004, we also own substantially all of ET Capital Corporation, a Delaware corporation and TRS. ET Capital Corporation is 100 percent owned by ETOP. As of December 31, 2005, ET Capital Corporation’s only assets were intercompany loans.
Annual Distribution Requirements
In order to be taxed as a REIT, we are required to distribute dividends (other than capital gain dividends) to our stockholders in an amount at least equal to (i) the sum of (A) 90 percent of our “REIT taxable income” (computed without regard to the dividends paid deduction and our net capital gain) and (B) 90 percent of the net income (after tax), if any, from foreclosure property, minus (ii) the sum of certain items of non-cash income. Such distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for such year and if paid on or before the first regular dividend payment after such declaration. To the extent that we do not distribute all of our net capital gain or distribute at least 90 percent, but less than 100 percent, of our “REIT taxable income,” as adjusted, we will be subject to tax on the undistributed amount at regular capital gains and ordinary corporate tax rates except to the extent of net operating loss or capital loss carryforwards. If any taxes are paid in connection with the Built-in Gains Tax rules, these taxes will be deductible in computing REIT taxable income. Furthermore, if we fail to distribute during each calendar year at least the sum of (i) 85 percent of our REIT ordinary income for such year, (ii) 95 percent of our REIT capital gain net income for such year (other than long-term capital gain we elect to retain and treat as having been distributed to stockholders), and (iii) any undistributed taxable income from prior periods, we will be subject to a four percent nondeductible excise tax on the excess of such required distribution over the amounts actually distributed.
We believe, but we cannot assure you, that we have satisfied the annual distribution requirements for the year of our REIT election and each year thereafter. Although we intend to continue meeting the annual distribution requirements to qualify as a REIT for federal income tax purposes for the year ended December 31, 2005 and subsequent years, it is possible that economic, market, legal, tax or other considerations may limit our ability to meet such requirements. As a result, if we were not able to meet the annual distribution requirement, we would fail to qualify as a REIT.
Failure to Continue to Qualify
If our election to be taxed as a REIT is revoked or terminated (e.g., due to a failure to meet the REIT qualification tests), we will be subject to tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates except to the extent of net operating loss and capital loss carryforwards. Distributions to stockholders will not be deductible by us, nor will they be required to be made. To the extent of current and accumulated earnings and profits, all distributions to stockholders will be taxable as ordinary income, and, subject to certain limitations in the Code, corporate stockholders may be eligible for the dividends received deduction. In addition, we would be prohibited from re-electing REIT status for the four taxable years following the year during which we ceased to qualify as a REIT, unless certain relief provisions of the Code applied. It is impossible to predict whether we would be entitled to such statutory relief.
Federal Income Taxation of U.S. Stockholders
As used herein, the term “U.S. Stockholder” means a holder of our common stock that for U.S. federal income tax purposes is (i) a citizen or resident of the United States, (ii) a corporation, partnership or other entity created or organized in or under the laws of the United States or of any political subdivision thereof, (iii) an estate whose income from sources without the United States is includible in gross income for U.S. federal income tax purposes regardless of its connection with the conduct of a trade or business within the United States or (iv) any trust with respect to which (A) a U.S. court is able to exercise primary supervision over the administration of such trust and (B) one or more U.S. persons have the authority to control all substantial decisions of the trust.
As long as we qualify as a REIT, distributions made to our taxable U.S. Stockholders out of current or accumulated earnings and profits (and not designated as capital gain dividends) will be taken into account by such U.S. Stockholders as ordinary income and will not be eligible for the capital gains tax rate (i.e., qualified dividends rate) generally available to individuals or for the dividends received deduction generally available to corporations. Distributions that are designated as capital gain dividends will be taxed as a capital gain (to the extent such distributions do not exceed our actual net capital gain for the taxable year) without regard to the period for which the stockholder has held its shares. The tax rates applicable to such capital gains are discussed below. Distributions in excess of current and accumulated earnings and profits will not be taxable to a stockholder to the extent that they do not exceed the adjusted basis of the stockholder’s shares, but rather will reduce the adjusted basis of such shares. To the extent that distributions in excess of current and accumulated earnings and profits exceed the adjusted basis of a stockholder’s shares, such distributions will be included in income as capital gains assuming the shares are capital assets in the hands of the stockholder. The tax rate applicable to such capital gain will depend on the stockholder’s holding period for the shares. In addition, any distribution declared by us in October, November or December of any year and payable to a stockholder of record on a specified date in any such month shall be treated as both paid by us and received by the stockholder on December 31 of such year, provided that the distribution is actually paid by us during January of the following calendar year.
We may elect to treat all or a part of our undistributed net capital gain as if it had been distributed to our stockholders (including for purposes of the four percent excise tax discussed above under “-Requirements for Qualification as a REIT-Annual Distribution Requirements”). If we make such an election, our stockholders would be required to include in their income as long-term capital gain their proportionate share of our undistributed net capital gain, as designated by us. Each such stockholder would be deemed to have paid its proportionate share of the income tax imposed on us with respect to such undistributed net capital gain, and this amount would be credited or refunded to the stockholder. In addition, the tax basis of the stockholder’s shares would be increased by its proportionate share of undistributed net capital gains included in its income, less its proportionate share of the income tax imposed on us with respect to such gains.
Stockholders may not include in their individual income tax returns any of our net operating losses or capital losses. Instead, such losses would be carried over by us for potential offset against our future income (subject to certain limitations). Taxable distributions from us and gain from the disposition of our common stock
will not be treated as passive activity income and, therefore, stockholders generally will not be able to apply any “passive activity losses” (such as losses from certain types of limited partnerships in which the stockholder is a limited partner) against such income. In addition, taxable distributions from us generally will be treated as investment income for purposes of the investment interest limitations.
We will notify stockholders after the close of our taxable year as to the portions of the distributions attributable to that year that constitute ordinary income, return of capital and capital gain. To the extent a portion of the distribution is designated as a capital gain dividend, we will notify stockholders as the portion that is a “fifteen percent rate gain distribution” and the portion that is an unrecaptured Section 1250 distribution. A fifteen percent rate gain distribution are those capital gain distributions to domestic shareholders that are individuals, estates or trusts at a maximum of fifteen percent. An unrecaptured Section 1250 gain distribution would be taxable to taxable domestic shareholders that are individuals, estates or trusts at a maximum rate of 25 percent.
Treatment of Tax-Exempt Stockholders
Tax-exempt organizations, including qualified employee pension and profit sharing trusts and individual retirement accounts (collectively, “Exempt Organizations”), generally are exempt from federal income taxation. However, they are subject to taxation on their unrelated business taxable income (“UBTI”). While many investments in real estate generate UBTI, the IRS has issued a published ruling that dividend distributions by a REIT to an exempt employee pension trust do not constitute UBTI, provided that the shares of the REIT are not otherwise used in an unrelated trade or business of the exempt employee pension trust. Based on that ruling, and subject to the exceptions discussed below, amounts distributed by us to Exempt Organizations generally should not constitute UBTI. However, if an Exempt Organization finances its acquisition of our common stock with debt, a portion of its income from us will constitute UBTI pursuant to the “debt-financed property” rules. Furthermore, social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans that are exempt from taxation under paragraphs (7), (9), (17) and (20), respectively, of Section 501(c) of the Code are subject to different UBTI rules, which generally will require them to characterize distributions from us as UBTI. In addition, in certain circumstances, a pension trust that owns more than 10 percent of our stock is required to treat a percentage of the dividends from us as UBTI.
Special Tax Considerations for Non-U.S. Stockholders
The rules governing U.S. federal income taxation of nonresident alien individuals, foreign corporations, foreign partnerships and other foreign stockholders (collectively, “Non-U.S. Stockholders”) are complex, and the following is no more than a brief summary of those rules. Non-U.S. stockholders should consult with their own tax advisors to determine the impact of federal, state and local income tax laws with regard to their ownership of our common stock, including any reporting requirements.
For purposes of this discussion, the term “Non-U.S. Stockholder” does not include any foreign stockholder whose investment in our stock is “effectively connected” with the conduct of a trade or business in the United States. Such a foreign stockholder, in general, will be subject to U.S. federal income tax with respect to its investment in our stock in the same manner as a U.S. Stockholder is taxed (subject to applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals). In addition, a foreign corporation receiving income that is treated as effectively connected with a U.S. trade or business also may be subject to an additional 30 percent “branch profits tax,” unless an applicable tax treaty provides a lower rate or an exemption. Certain certification requirements must be satisfied in order for effectively connected income to be exempt from withholding.
Distributions to Non-U.S. Stockholders that are not attributable to gain from sales or exchanges by us of U.S. real property interests and are not designated by us as capital gain dividends (or deemed distributions of retained capital gains) will be treated as dividends of ordinary income to the extent that they are made out of our current or accumulated earnings and profits. Such distributions ordinarily will be subject to a withholding tax
equal to 30 percent of the gross amount of the distribution unless an applicable tax treaty reduces or eliminates that tax. Distributions in excess of our current and accumulated earnings and profits will not be taxable to a stockholder to the extent that such distributions do not exceed the adjusted basis of the stockholder’s shares, but rather will reduce the adjusted basis of such shares. To the extent that distributions in excess of current and accumulated earnings and profits exceed the adjusted basis of a Non-U.S. Stockholder’s shares, such distributions will give rise to tax liability if the Non-U.S. Stockholder would otherwise be subject to tax on any gain from the sale or disposition of its shares, as described below.
For any year in which we qualify as a REIT, distributions that are attributable to gain from sales or exchanges by us of U.S. real property interests will be taxed to a Non-U.S. Stockholder under the provisions of the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”). Under FIRPTA, distributions attributable to gain from sales of U.S. real property interests are taxed to a Non-U.S. Stockholder as if such gain were effectively connected with a U.S. business. Non-U.S. Stockholders thus would be taxed at the normal capital gain rates applicable to U.S. Stockholders (subject to applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals). Distributions subject to FIRPTA also may be subject to 30 percent branch profits tax in the hands of a foreign corporate stockholder not entitled to treaty relief or exemption.
We expect to withhold U.S. tax at the rate of 30 percent on the gross amount of any dividends, other than dividends treated as attributable to gain from sales or exchanges of U.S. real property interests and capital gain dividends, paid to a Non-U.S. Stockholder, unless (i) a lower treaty rate applies and the required form evidencing eligibility for that reduced rate is filed with us or the appropriate withholding agent or (ii) the Non-U.S. Stockholder files an IRS Form W-8ECI or a successor form with us or the appropriate withholding agent claiming that the distributions are effectively connected with the Non-U.S. Stockholder’s conduct of a U.S. trade or business.
Under FIRPTA, we are required to withhold 35 percent of any distribution that is designated as a capital gain dividend or which could be designated as a capital gain dividend. Thus, if we designate previously made distributions as capital gain dividends, subsequent distributions (up to the amount of such prior distributions) will be treated as capital gain dividends for purposes of FIRPTA withholding.
For so long as our common stock continues to be regularly traded on an established securities market, the sale of such stock by any Non-U.S. Stockholder who is not a Five Percent Non-U.S. Stockholder (as defined below) generally will not be subject to U.S. federal income tax (unless the Non-U.S. Stockholder is a nonresident alien individual who was present in the United States for more than 182 days during the taxable year of the sale and certain other conditions apply, in which case such gain will be subject to a 30 percent tax on a gross basis). A “Five Percent Non-U.S. Stockholder” is a Non-U.S. Stockholder who, at some time during the five-year period preceding such sale or disposition, beneficially owned (including under certain attribution rules) more than five percent of the total fair market value of our common stock (as outstanding from time to time) or owned shares of another class of our stock that represented value greater than five percent of our common stock (measured at the time such shares were acquired).
In general, the sale or other taxable disposition of our common stock by a Five Percent Non-U.S. Stockholder also will not be subject to U.S. federal income tax if we are a “domestically controlled REIT.” A REIT is a “domestically controlled REIT” if, at all times during the five-year period preceding the relevant testing date, less than 50 percent in value of its shares is held directly or indirectly by Non-U.S. Stockholders (taking into account those persons required to include the REIT’s dividends in income for U.S. federal income tax purposes). Although we believe that we currently qualify as a domestically controlled REIT because our common stock is publicly traded, we cannot assure you that we will qualify as a domestically controlled REIT at any time in the future. If we do not constitute a domestically controlled REIT, a Five Percent Non-U.S. Stockholder will be taxed in the same manner as a U.S. Stockholder with respect to gain on the sale of our common stock (subject to applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals).
Information Reporting Requirements and Backup Withholding Tax
We will report to our U.S. Stockholders and to the IRS the amount of distributions paid during each calendar year and distributions required to be treated as so paid during a calendar year, and the amount of tax withheld, if any. Under the backup withholding rules, a stockholder may be subject to backup withholding at the applicable rate (currently 28 percent) with respect to distributions paid unless such holder (i) is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact or (ii) provides a taxpayer identification number, certifies as to no loss of exemption from backup withholding and otherwise complies with the applicable requirements of the backup withholding rules. A stockholder who does not provide us with its correct taxpayer identification number also may be subject to penalties imposed by the IRS. In addition, we may be required to withhold a portion of capital gain distributions to any stockholders who fail to certify their non-foreign status to us.
U.S. Stockholders should consult their own tax advisors regarding their qualifications for an exemption from backup withholding and the procedure for obtaining such an exemption. Backup withholding is not an additional tax. Rather, the amount of any backup withholding with respect to a payment to a U.S. Stockholder will be allowed as a credit against the U.S. Stockholder’s U.S. federal income tax liability and may entitle the U.S. Stockholder to a refund, provided that the required information is furnished to the IRS.
Other Tax Considerations
We and our stockholders may be subject to state and local tax in states and localities in which we do business or own property. The tax treatment of us and our stockholders in such jurisdictions may differ from the federal income tax treatment described above. Consequently, stockholders should consult their own tax advisors regarding the effect of state and local tax laws on their ownership of shares of our common stock.
ITEM 1A. Risk Factors
Our business, operations and financial condition are subject to various risks. Some of these risks are described below. However, this section does not describe all risks applicable to us, our industry or our business, and it is intended only as a summary of certain material factors. If any of the following risks actually occur, we could be materially adversely affected.
We have grouped these risk factors into three general categories:
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risks arising from our business;
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risks arising from our capital structure; and
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risks arising from our status as a REIT.
Risks Arising from Our Business
We are dependent on Kindred and Brookdale Senior Living; Kindred’s or Brookdale Senior Living’s inability or unwillingness to satisfy its obligations under its agreements with us could significantly harm us and our ability to service our indebtedness and other obligations and to make distributions to our stockholders as required to continue to qualify as a REIT.
We are dependent on Kindred and Brookdale Senior Living in a number of ways:
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we lease a substantial portion of our properties to Kindred under the Kindred Master Leases, and therefore Kindred was the source of a significant majority of our total revenues in 2005 and 2004 and continues to be a majority source of our revenues;
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as a result of the Provident acquisition, subsidiaries of Brookdale Senior Living, Brookdale and Alterra, the operators of the Provident properties, now account for a significant portion of our revenues; and
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since the Kindred Master Leases and our leases with Brookdale and Alterra are triple-net leases, we depend on Kindred, Brookdale and Alterra to pay insurance, taxes, utilities and maintenance and repair expenses required in connection with the leased properties.
We cannot assure you that Kindred or Brookdale Senior Living will have sufficient assets, income, access to financing and insurance coverage to enable it to satisfy its obligations under its agreements with us. In addition, any failure by Kindred or Brookdale Senior Living to effectively conduct its operations could have a material adverse effect on its business reputation or on its ability to enlist and maintain patients in its facilities. Any inability or unwillingness by Kindred or Brookdale Senior Living to satisfy its obligations under its agreements with us could have a Material Adverse Effect on us.
We may be unable to find another lessee/operator for our properties if we have to replace Kindred, Brookdale, Alterra or our other operators.
We may have to find another lessee/operator for the properties covered by one or more of the Kindred Master Leases or the leases with Brookdale, Alterra or our other operators upon the expiration of the terms of the applicable lease or upon a default by Kindred, Brookdale, Alterra or our other operators. During any period that we are attempting to locate one or more lessees/operators, there could be a decrease or cessation of rental payments by Kindred, Brookdale or Alterra or our other operators. We cannot assure you that we will be able to locate another suitable lessee/operator or, if we are successful in locating such an operator, that the rental payments from the new operator would not be significantly less than the existing rental payments. Our ability to locate another suitable lessee/operator may be significantly delayed or limited by various state licensing, receivership, CON or other laws, as well as by Medicare and Medicaid change-of-ownership rules. In addition, we may also incur substantial additional expenses in connection with any such licensing, receivership or change-of-ownership proceedings. Such delays, limitations and expenses could materially delay or impact our ability to collect rent, to obtain possession of leased properties or otherwise to exercise remedies for tenant default and could have a Material Adverse Effect on us.
We may encounter certain risks when implementing our business strategy to pursue investments in, and/or acquisitions or development of, additional healthcare-related and/or seniors housing assets.
We intend to continue to pursue investments in, and/or acquisitions or development of, additional healthcare-related and/or seniors housing assets domestically and internationally, subject to the contractual restrictions contained in our revolving credit facility and the indentures governing our outstanding senior notes. Investments in and acquisitions of these properties entail general investment risks associated with any real estate investment, including risks that the investment will fail to perform in accordance with expectations, the estimates of the cost of improvements necessary for acquired properties will prove inaccurate or the lessee/operator will fail to meet performance expectations. In addition, investments in and acquisitions of properties outside the United States would subject us to legal, economic and market risks associated with operating in foreign countries, such as currency and tax risks. If we pursue new development projects, these projects would be subject to numerous risks, including risks of construction delays or cost overruns that may increase project costs, new project commencement risks such as receipt of zoning, occupancy and other required governmental approvals and permits and the risk of incurring development costs in connection with projects that are not pursued to completion. In addition, we may borrow to finance any investments in, and/or acquisitions or development of, healthcare-related, seniors housing and/ or other properties, which would increase our leverage.
We compete for investment or acquisition opportunities with entities that have substantially greater financial resources than we do. Our ability to compete successfully for these opportunities is affected by many factors, including our cost of obtaining debt and equity capital at rates comparable to or better than our competitors. Competition generally may reduce the number of suitable investment or acquisition opportunities available to us and increase the bargaining power of property owners seeking to sell, thereby impeding our investment, acquisition or development activities. See “Business-Competition” included in Item 1 of this Annual Report on Form 10-K.
Even if we are successful at identifying and competing for investment or acquisition opportunities, these opportunities involve a number of risks. These risks include diversion of management’s attention, the risk that the value of the properties or businesses we invest in or acquire could decrease substantially after such investment or acquisition and the risk that we will be unable to accurately assess the value of properties or businesses that are not of the type we currently own, some or all of which could have a Material Adverse Effect on us.
Additionally, if we are successful in continuing to implement our business strategy to pursue investments in, and/or acquisitions or development of, additional healthcare-related and/or seniors housing assets or businesses, we intend to increase the number of operators of our properties and, potentially, our business segments. We cannot assure you that we will have the capabilities to successfully monitor and manage a portfolio of properties with a growing number of operators and/or manage such businesses.
Our investments are concentrated in healthcare-related and seniors housing properties, making us more vulnerable economically than if our investments were diversified.
We invest primarily in real estate-in particular, healthcare-related and seniors housing properties. Accordingly, we are exposed to the risks inherent in concentrating investments in real estate, and these risks become even greater due to the fact that all of our investments are in properties used in the healthcare or seniors housing industries. A downturn in the real estate industry could adversely affect the value of our properties. A downturn in the healthcare or seniors housing industries could negatively impact our operators’ ability to make rental payments to us, which, in turn, could have a Material Adverse Effect on us.
Furthermore, the healthcare industry is highly regulated, and changes in government regulation and reimbursement in the past have had material adverse consequences on the industry in general, which may not even have been contemplated by lawmakers and regulators. We cannot assure you that future changes in government regulation of healthcare will not have a material adverse effect on the healthcare industry, including our lessees/operators. Our ability to invest in non-healthcare, non-healthcare-related or non-seniors housing properties is restricted by the terms of our revolving credit facility, so these adverse effects may be more pronounced than if we diversified our investments outside of real estate or outside of healthcare and seniors housing.
Our tenants, including Kindred, may be adversely affected by increasing healthcare regulation and enforcement.
We believe that the regulatory environment surrounding the long-term healthcare industry has intensified both in the amount and type of regulations and in the efforts to enforce those regulations. This is particularly true for large for-profit, multi-facility providers like Kindred.
The extensive federal, state and local laws and regulations affecting the healthcare industry include, but are not limited to, laws and regulations relating to licensure, conduct of operations, ownership of facilities, addition of facilities and equipment, allowable costs, services, prices for services, quality of care, patient rights, fraudulent or abusive behavior, and financial and other arrangements which may be entered into by healthcare providers. Federal and state governments have intensified enforcement policies, resulting in a significant increase in the number of inspections, citations of regulatory deficiencies and other regulatory sanctions, including terminations from the Medicare and Medicaid programs, bars on Medicare and Medicaid payments for new admissions, civil monetary penalties and even criminal penalties. See “Governmental Regulation-Healthcare Regulation” included in Item 1 of this Annual Report on Form 10-K.
If Kindred or our other tenants and operators fail to comply with the extensive laws, regulations and other requirements applicable to their businesses, they could become ineligible to receive reimbursement from governmental and private third-party payor programs, suffer civil and/or criminal penalties and/or be required to make significant changes to their operations. Kindred and our other tenants also could be forced to expend
considerable resources responding to an investigation or other enforcement action under applicable laws or regulations. In addition, as part of a settlement agreement Kindred entered into with the federal government, Kindred agreed to comply with the terms of a corporate integrity agreement. Kindred could incur additional expenses in complying with the corporate integrity agreement, and any failure to comply with the corporate integrity agreement could have a material adverse effect on its results of operations, financial condition and its ability to make rental payments to us, which, in turn, could have a Material Adverse Effect on us.
We are unable to predict the future course of federal, state and local regulation or legislation, including the Medicare and Medicaid statutes and regulations. Changes in the regulatory framework could have a material adverse effect on Kindred and our other operators, which, in turn, could have a Material Adverse Effect on us.
Changes in the reimbursement rates or methods of payment from third-party payors, including the Medicare and Medicaid programs, could have a material adverse effect on certain of our tenants.
Kindred and certain of our other tenants and operators rely on reimbursement from third-party payors, including the Medicare and Medicaid programs, for substantially all of their revenues. There continue to be various federal and state legislative and regulatory proposals to implement cost-containment measures that limit payments to healthcare providers, such as the proposed rule issued by CMS on January 19, 2006 updating LTAC PPS payment rates for the 2007 rate year. See “Governmental Regulation-Healthcare Regulation” included in Item 1 of this Annual Report on Form 10-K. In addition, private third-party payors have continued their efforts to control healthcare costs. We cannot assure you that adequate reimbursement levels will be available for services to be provided by Kindred and other tenants which are currently being reimbursed by Medicare, Medicaid or private payors. Significant limits by governmental and private third-party payors on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on the liquidity, financial condition and results of operations of Kindred and certain of our other operators and tenants, which, in turn, could have a Material Adverse Effect on us.
Significant legal actions could subject our operators to increased operating costs and substantial uninsured liabilities, which could materially adversely affect our operators’ liquidity, financial condition and results of operation.
Although claims and costs of professional liability insurance seem to be growing at a slower pace, our skilled nursing facility operators have experienced substantial increases in both the number and size of professional liability claims in recent years. In addition to large compensatory claims, plaintiffs’ attorneys continue to seek significant punitive damages and attorneys’ fees.
Due to the high level in the number and severity of professional liability claims against healthcare providers, the availability of professional liability insurance has been severely restricted and the premiums on such insurance coverage have increased dramatically. As a result, the insurance coverage of our operators might not cover all claims against them or continue to be available to them at a reasonable cost. If our operators are unable to maintain adequate insurance coverage or are required to pay punitive damages, they may be exposed to substantial liabilities.
Kindred insures its professional liability risks in part through a wholly-owned, limited purpose insurance company. The limited purpose insurance company insures initial losses up to specified coverage levels per occurrence with no aggregate coverage limit. Coverage for losses in excess of those per occurrence levels is maintained through unaffiliated commercial insurance carriers up to an aggregate limit. The limited purpose insurance company then insures all claims in excess of the aggregate limit for the unaffiliated commercial insurance carriers. Kindred maintains general liability insurance and professional malpractice liability insurance in amounts and with deductibles which Kindred management has indicated that it believes are sufficient for its operations.
Operators that insure their professional liability risks through their own captive limited purpose entities generally estimate the future cost of professional liability through actuarial studies which rely primarily on historical data. However, due to the increase in the number and severity of professional claims against healthcare providers, these actuarial studies may underestimate the future cost of claims, and we cannot assure you that these operators’ reserves for future claims will be adequate to cover the actual cost of those claims. If the actual cost of claims is significantly higher than the operators’ reserves, it could have a material adverse effect on the liquidity, financial condition and results of operation of our operators and their ability to make rental payments to us, which, in turn, could have a Material Adverse Effect on us.
Our operators may be sued under a federal whistleblower statute.
Our operators who engage in business with the federal government may be sued under a federal whistleblower statute designed to combat fraud and abuse in the healthcare industry. See “Governmental Regulation-Healthcare Regulation” included in Item 1 of this Annual Report on Form 10-K. These lawsuits can involve significant monetary damages and award bounties to private plaintiffs who successfully bring these suits. If any of these lawsuits were to be brought against our operators, such suits combined with increased operating costs and substantial uninsured liabilities could have a material adverse effect on the liquidity, financial condition and results of operation of our operators and their ability to make rental payments to us, which, in turn, could have a Material Adverse Effect on us.
If any of our properties are found to be contaminated, or if we become involved in any environmental disputes, we could incur substantial liabilities and costs.
Under federal and state environmental laws and regulations, a current or former owner of real property may be liable for costs related to the investigation, removal and remediation of hazardous or toxic substances or petroleum that are released from or are present at or under, or that are disposed of in connection with such property. Owners of real property may also face other environmental liabilities, including government fines and penalties imposed by regulatory authorities and damages for injuries to persons, property or natural resources. Environmental laws and regulations often impose liability without regard to whether the owner was aware of, or was responsible for, the presence, release or disposal of hazardous or toxic substances or petroleum. In certain circumstances, environmental liability may result from the activities of a current or former operator of the property. Although we are generally indemnified by the current operators of our properties for contamination caused by such operators, these indemnities may not adequately cover all environmental costs. See “Governmental Regulation-Environmental Regulation” included in Item 1 of this Annual Report on Form 10-K.
We have assumed substantially all of Provident’s liabilities, including contingent liabilities; if these liabilities are greater than expected, or if there are unknown Provident obligations, our business could be materially adversely affected.
As a result of the Provident acquisition, we have assumed substantially all of Provident’s liabilities, including contingent liabilities to which Provident succeeded when it acquired the ownership interests in the properties that are currently leased to Brookdale and Alterra. We may learn additional information about Provident’s business and liabilities that adversely affects us, such as:
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liabilities for clean-up or remediation of undisclosed environmental conditions;
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unasserted claims of vendors or other persons dealing with Provident or the former property owners;
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liabilities, whether or not incurred in the ordinary course of business, relating to periods prior to the Provident acquisition, including periods prior to the acquisition of the Brookdale and Alterra properties by Provident;
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claims for indemnification by general partners, directors, officers and others indemnified by Provident or the former property owners; and
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liabilities for taxes relating to periods prior to the Provident acquisition, including taxes associated with the acquisition or prior ownership of the Brookdale and Alterra properties.
As a result, we cannot assure you that the Provident acquisition will be successful or will not, in fact, harm our business. Among other things, if Provident’s liabilities are greater than expected, or if there are obligations of Provident of which we were not aware at the time of completion of the acquisition, or if the Provident acquisition fails to qualify as a “reorganization” within the meaning of Section 368(a) of the Code, it could have a Material Adverse Effect on us.
Risks Arising from Our Capital Structure
We may become more leveraged.
As of December 31, 2005, we had approximately $1.8 billion of indebtedness. Our revolving credit facility and the indentures governing our outstanding senior notes permit us to incur substantial additional debt, and we may borrow additional funds, which may include secured borrowings. A high level of indebtedness may have the following consequences:
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a substantial portion of our cash flow from operations must be dedicated to the payment of debt service, thus reducing the funds available for our business strategy and for distributions to stockholders;
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potential limits on our ability to adjust rapidly to changing market conditions and vulnerability in the event of a downturn in general economic conditions or in the real estate and/or healthcare industries;
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a potential impairment of our ability to obtain additional financing for our business strategy; and
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a potential downgrade in the rating of our debt securities by one or more rating agencies which could have the effect of, among other things, increasing our cost of borrowing.
We may be unable to raise additional capital necessary to continue to implement our business plan and to meet our debt payments.
In order to continue to implement our business plan and to meet our debt payments, we may need to raise additional capital. Our ability to incur additional indebtedness is restricted by the terms of our revolving credit facility and the indentures governing our outstanding senior notes. In addition, adverse economic conditions could cause the terms on which we can obtain additional borrowings to become unfavorable. In such circumstances, we may be required to raise additional equity in the capital markets or liquidate one or more investments in properties at times that may not permit realization of the maximum return on the investments and that could result in adverse tax consequences to us. In addition, certain healthcare regulations may constrain our ability to sell assets. We cannot assure you that we will be able to meet our debt service obligations, and the failure to do so could have a Material Adverse Effect on us.
We have now, and may have in the future, exposure to floating interest rates, which can have the effect of reducing our profitability.
We receive revenue primarily by leasing our assets under long-term triple-net leases in which the rental rate is generally fixed with annual rent escalations, subject to certain limitations. Certain of our debt obligations are floating rate obligations with interest rate and related payments that vary with the movement of LIBOR or other indexes. The generally fixed rate nature of our revenues and the variable rate nature of certain of our obligations create interest rate risk and can have the effect of reducing our profitability or making our lease and other revenue insufficient to meet our obligations. We are not limited in the amount of floating rate debt we may incur.
Risks Arising from Our Status as a REIT
Loss of our status as a REIT would have significant adverse consequences to us and the value of our common stock.
If we lose our status as a REIT, we will face serious tax consequences that will substantially reduce the funds available for satisfying our obligations and for distribution to our stockholders for each of the years involved because:
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we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to federal income tax at regular corporate rates;
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we also could be subject to the federal alternative minimum tax and possibly increased state and local taxes; and
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unless we are entitled to relief under statutory provisions, we could not elect to be subject to tax as a REIT for four taxable years following the year during which we were disqualified.
In addition, if we fail to qualify as a REIT, all distributions to stockholders would continue to be treated as dividends to the extent of our current and accumulated earning and profits, although corporate stockholders may be eligible for the dividends received deduction and individual stockholders may be eligible for taxation at the rates generally applicable to long-term capital gains (currently at a maximum rate of fifteen percent) with respect to distributions. We would no longer be required to pay dividends to maintain REIT status.
As a result of all these factors, our failure to qualify as a REIT also could impair our ability to implement our business strategy and would adversely affect the value of our common stock.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The determination of various factual matters and circumstances not entirely within our control may affect our ability to remain qualified as a REIT. In addition, new legislation, regulations, administrative interpretations or court decisions may adversely affect our investors or our ability to remain qualified as a REIT for tax purposes. Although we believe that we qualify as a REIT, we cannot assure you that we will continue to qualify or remain qualified as a REIT for tax purposes.
See “Certain U.S. Federal Income Tax Considerations-Federal Income Taxation of Ventas” and “-Requirements for Qualification as a REIT” included in Item 1 of this Annual Report on Form 10-K.
The 90 percent distribution requirement will decrease our liquidity and may limit our ability to engage in otherwise beneficial transactions.
To comply with the 90 percent distribution requirement applicable to REITs and to avoid the nondeductible excise tax, we must make distributions to our stockholders. See “Certain U.S. Federal Income Tax Considerations-Requirements for Qualification as a REIT-Annual Distribution Requirements” included in Item 1 of this Annual Report on Form 10-K. The indentures governing our outstanding senior notes permit us to make annual distributions to our stockholders in an amount equal to the minimum amount necessary to maintain our REIT status so long as the ratio of our Debt to Adjusted Total Assets (as each term is defined in the indentures) does not exceed 60 percent and to make additional distributions if we pass certain other financial tests. However, distributions may limit our ability to rely upon rental payments from our properties or subsequently acquired properties to finance investments, acquisitions or new developments.
Although we anticipate that we generally will have sufficient cash or liquid assets to enable us to satisfy the REIT distribution requirement, it is possible that, from time to time, we may not have sufficient cash or other liquid assets to meet the 90 percent distribution requirement or we may decide to retain cash or distribute such greater amount as may be necessary to avoid income and excise taxation. This may be due to the timing differences between the actual receipt of income and actual payment of deductible expenses, on the one hand,
and the inclusion of that income and deduction of those expenses in arriving at our taxable income, on the other hand. In addition, non-deductible expenses such as principal amortization or repayments or capital expenditures in excess of non-cash deductions also may cause us to fail to have sufficient cash or liquid assets to enable us to satisfy the 90 percent distribution requirement.
In the event that timing differences occur or we deem it appropriate to retain cash, we may borrow funds, issue additional equity securities (although we cannot assure you that we will be able to do so), pay taxable stock dividends, if possible, distribute other property or securities or engage in a transaction intended to enable us to meet the REIT distribution requirements. This may require us to raise additional capital to meet our obligations; however, see “-Risks Arising from Our Capital Structure-We may be unable to raise additional capital necessary to continue to implement our business plan and to meet our debt payments.” The terms of our revolving credit facility and the indentures governing our outstanding senior notes restrict our ability to engage in some of these transactions.
We may still be subject to corporate level taxes.
Following our REIT election, we are considered to be a former C corporation for income tax purposes. Therefore, we remain potentially subject to corporate level taxes for any Kindred asset dispositions occurring between January 1, 1999 and December 31, 2008. Also, as a consequence of the Provident acquisition, we remain potentially subject to corporate level taxes if we dispose of any of the Brookdale properties before November 2014.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2.
ITEM 2. Properties
Healthcare and Seniors Housing Facilities
As of December 31, 2005, we owned 200 skilled nursing facilities, 41 hospitals and 139 seniors housing facilities and other facilities in 42 states. We believe that the geographic diversity of the properties makes our portfolio less susceptible to adverse changes in state reimbursement and regulation and regional economic downturns.
Ventas Realty has granted mortgage liens on certain of its properties to secure borrowings under our revolving credit facility, and certain of our other subsidiaries have mortgage loan obligations in the aggregate principal amount of $622.3 million outstanding at December 31, 2005 secured by those subsidiaries’ facilities.
The following table sets forth select information regarding the facilities we owned as of December 31, 2005 for each state in which we own property:
Other Real Estate Investments
As of December 31, 2005, our other real estate investments consisted of six first mortgage loans and a mezzanine loan in the outstanding aggregate principal amount of $40.3 million.
Each first mortgage loan accrues interest at a rate of nine percent per annum and provides for monthly amortization of principal with a balloon payment maturity date ranging between February and December 2010. Three of these loans were extended in conjunction with the buy-out of our $21.4 million investment in eight distressed mortgage loans and are guaranteed by a third party, unrelated to the borrower, and its two principals. The remaining three loans are guaranteed by an affiliate of the borrower and its two principals.
See “Note 7-Loans Receivable” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.
Corporate Offices
We lease our corporate offices in Louisville, Kentucky and Chicago, Illinois.
ITEM 3.
ITEM 3. Legal Proceedings
The information contained in “Note 14-Litigation” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K is incorporated by reference into this Item 3. Except as set forth therein, we are not a party to, nor is any of our property the subject of, any material pending legal proceedings.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
ITEM 5.
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock, par value $0.25 per share, is listed and traded on the New York Stock Exchange (the “NYSE”) under the symbol “VTR.” The following table sets forth, for the periods indicated, the high and low sales prices of our common stock as reported on the NYSE and the dividends declared per share.
As of February 24, 2006, there were 103,810,735 shares of our common stock outstanding held by approximately 3,408 stockholders of record.
Dividend Policy
On February 23, 2006, we declared the first quarterly installment of our 2006 dividend in an amount of $0.395 per share payable on March 30, 2006 to stockholders of record on March 7, 2006. We expect to distribute 100 percent or more of our taxable net income to our stockholders for 2006.
A number of factors are considered by our Board of Directors when making the final determination regarding the frequency and amount of our dividends. These decisions regarding dividends are normally made quarterly. Therefore, we cannot assure you that we will maintain the policy stated above. Please see “Cautionary Statements” and the risk factors included in Part I, Item 1A of this Annual Report on Form 10-K for a description of other factors that may affect our distribution policy.
Our stockholders may reinvest all or a portion of any cash distribution on their shares of our common stock by participating in our Distribution Reinvestment and Stock Purchase Plan, subject to the terms of the plan. See “Note 15-Capital Stock” of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Director and Employee Stock Sales
Certain of our directors, executive officers and other employees may, from time to time, adopt non-discretionary, written trading plans that comply with Rule 10b5-1 under the Exchange Act, or otherwise monetize their equity-based compensation.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table summarizes information with respect to our equity compensation plans as of December 31, 2005:
(1) These plans consist of (i) the 1987 Incentive Compensation Program (Employee Plan); (ii) the 1987 Stock Option Plan for Non-Employee Directors; (iii) the TheraTx, Incorporated 1996 Stock Option/Stock Issuance Plan; (iv) the 2000 Incentive Compensation Plan (Employee Plan) (formerly known as the 1997 Incentive Compensation Plan); (v) the 2004 Stock Plan for Directors (which amended and restated the 2000 Stock Option Plan for Directors (formerly known as the 1997 Stock Option Plan for Non-Employee Directors)); and (vi) the Employee and Director Stock Purchase Plan.
(2) These plans consist of (i) the Common Stock Purchase Plan for Directors, under which our non-employee directors may receive common stock in lieu of directors’ fees, (ii) the Nonemployee Director Deferred Stock Compensation Plan, under which our non-employee directors may receive units convertible on a one-for-one basis into common stock in lieu of director fees, and (iii) the Executive Deferred Stock Compensation Plan, under which our executive officers may receive units convertible on a one-for-one basis into common stock in lieu of compensation.
Stock Repurchases
During the fourth quarter ended December 31, 2005, no purchases of our common stock were made by or on behalf of us or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act).
ITEM 6.
ITEM 6. Selected Financial Data
You should read the following selected financial data in conjunction with our Consolidated Financial Statements and the notes thereto included in Item 8 of this Annual Report on Form 10-K.
(1) We consider funds from operations (“FFO”) an appropriate measure of performance of an equity REIT, and we use the National Association of Real Estate Investment Trusts (“NAREIT”) definition of FFO. NAREIT defines FFO as net income (computed in accordance with GAAP, excluding gains or losses from sales of real estate property, plus real estate depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. FFO presented herein is not necessarily comparable to FFO presented by other
real estate companies due to the fact that not all real estate companies use the same definition. FFO should not be considered as an alternative to net income (determined in accordance with GAAP) as an indicator of our financial performance or as an alternative to cash flow from operating activities (determined in accordance with GAAP) as a measure of our liquidity, nor is FFO indicative of sufficient cash flow to fund all of our needs. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations-Funds from Operations” included in Item 7
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the consolidated results of operations and financial condition of Ventas, Inc. (together with its subsidiaries, unless otherwise indicated or except where the context otherwise requires, “we,” “us” or “our”). You should read this discussion in conjunction with our Consolidated Financial Statements and the notes thereto included in Item 8 of this Annual Report on Form 10-K. This Management’s Discussion and Analysis will help you understand:
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Key transactions that we completed in 2005;
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Our critical accounting policies and estimates;
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Accounting policies that we adopted in 2005, 2004 and 2003;
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Our results of operations for the last three years;
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Our liquidity and capital resources; and
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Our funds from operations.
Key Transactions in 2005
During 2005, we completed the following key transactions:
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We acquired all of the outstanding common shares of Provident Senior Living Trust (“Provident”) in a transaction valued at approximately $1.2 billion, which added 68 seniors housing facilities to our portfolio.
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We acquired seven seniors housing facilities from a new tenant who is a publicly traded seniors housing operator in two transactions valued at $104.5 million.
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We acquired eight seniors housing facilities from an existing tenant in five transactions valued at $104.0 million.
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We issued six first mortgage loans bearing interest at an annual rate of nine percent in the aggregate principal amount of $36.4 million.
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We issued $200.0 million of 6 1/2% unsecured senior notes, maturing on June 1, 2016; $175.0 million of 6 3/4% unsecured senior notes, maturing on June 1, 2010; $175.0 million of 7 1/8% unsecured senior notes, maturing on June 1, 2015 and an additional $50.0 million of our existing 6 5/8% unsecured senior notes, maturing on October 15, 2014.
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We repaid all obligations under our commercial mortgage backed securitization (“CMBS”) loan, which had an outstanding principal balance of $209.8 million at the time of the payoff.
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We raised $97.0 million in net proceeds through the sale of 3,247,000 shares of our common stock in an underwritten public offering.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), which requires us to make estimates and judgments about future events that
affect the reported amounts in the financial statements and the related disclosures. We believe that the following critical accounting policies, among others, affect our more significant estimates and judgments used in the preparation of our financial statements. For more information regarding our critical accounting policies, please see “Note 2-Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Long-Lived Assets
Investments in real estate properties are recorded at cost. We account for acquisitions using the purchase method. The cost of the properties acquired is allocated among tangible land, buildings and equipment and recognized intangibles based upon estimated fair values in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” We estimate fair values of the components of assets acquired as of the acquisition date or engage a third party appraiser as necessary. Recognized intangibles, if any, include the value of acquired lease contracts and related customer relationships.
Our method for determining fair value varies with the categorization of the asset acquired. We estimate the fair value of buildings on an as-if-vacant basis, and depreciate the building value over the estimated remaining life of the building. We determine the allocated value of other fixed assets based upon the replacement cost and depreciate such value over their estimated remaining useful lives. We determine the value of land either based on real estate tax assessed values in relation to the total value of the asset, internal analyses of recently acquired and existing comparable properties within our portfolio or third party appraisals. The fair value of in-place leases, if any, reflects (i) above and below market leases, if any, determined by discounting the difference between the estimated current market rent and the in-place rentals, the resulting intangible asset of which is amortized to rental revenue over the remaining life of the associated lease plus any fixed rate renewal periods, if applicable, (ii) the estimated value of the cost to obtain tenants, including tenant allowances, tenant improvements and leasing commissions, which is amortized over the remaining life of the associated lease, and (iii) an estimated value of the absorption period to reflect the value of the rents and recovery costs foregone during a reasonable lease-up period, as if the acquired space was vacant, which is amortized over the remaining life of the associated lease. We also estimate the value of tenant or other customer relationships acquired by considering the nature and extent of existing business relationships with the tenant, growth prospects for developing new business with such tenant, such tenant’s credit quality, expectations of lease renewals with such tenant, and the potential for significant, additional future leasing arrangements with such tenant. We amortize such value, if any, over the expected term of the associated arrangements or leases, which would include the remaining lives of the related leases and any expected renewal periods.
Impairment of Long-Lived Assets
We periodically evaluate our long-lived assets, primarily consisting of our investments in real estate, for impairment indicators. If indicators of impairment are present, we evaluate the carrying value of the related real estate investments in relation to the future undiscounted cash flows of the underlying operations and adjust the net book value of leased properties and other long-lived assets to fair value if the sum of the expected future cash flow or sales proceeds is less than book value. An impairment loss is recognized at the time we make any such adjustment. Future events could occur which would cause us to conclude that impairment indicators exist and an impairment loss is warranted.
Loans and Other Amounts Receivable from Third Parties
We evaluate the collectibility of loans and other amounts receivable from third parties based on a number of factors including, (i) corporate and facility level financial and operations reports, (ii) compliance with the financial covenants set for the in the borrowing or lease agreement, (iii) the financial stability of the applicable borrow or tenant and any guarantor and (iv) the payment history of the borrower or tenant. Our level of reserves, if any, for loans and other amounts receivable from third parties fluctuates depending upon all of the factors previously mentioned.
Revenue Recognition
Certain of our leases, excluding our master lease agreements (the “Kindred Master Leases”) with Kindred Healthcare, Inc. and certain of its affiliates (collectively, “Kindred”), provide for periodic and determinable increases in base rent. Base rental revenues under these leases are recognized on a straight-line basis over the term of the applicable lease. Certain of our other leases, including the Kindred Master Leases, provide for an annual increase in rental payments only if certain revenue parameters or other contingencies are met. We recognize the increased rental revenue under these leases only if the revenue parameters or other contingencies are met rather than on a straight-line basis over the term of the applicable lease. We recognize income from rent, lease termination fees and other income once all of the following criteria are met in accordance with Securities and Exchange Commission (the “Commission”) Staff Accounting Bulletin 104: (i) the agreement has been fully executed and delivered; (ii) services have been rendered; (iii) the amount is fixed or determinable; and (iv) the collectibility is reasonably assured.
Fair Value of Derivative Instruments
The valuation of derivative instruments requires us to make estimates and judgments that affect the fair value of the instruments. Fair values for our derivatives are verified with a third party consultant. Such amounts and the recognition of such amounts in the financial statements are subject to significant estimates which may change in the future.
Results of Operations
The tables below show our results of operations for each year and the absolute and percentage change in those results from year to year.
Years Ended December 31, 2005 and 2004
nm - not meaningful
Revenues
The increase in our 2005 rental income reflects (i) the recognition of $85.9 million in additional rent relating to the properties acquired during 2005 ($59.5 million relates to the Provident acquisition), the full year effect in 2005 of properties acquired during 2004 (see “Note 5-Acquisitions” of the Notes to Consolidated Financial Statements) and (ii) a $6.7 million increase resulting from the 3.5 percent annual escalator under the Kindred Master Leases effective May 1, 2005. The rental income from Kindred includes $2.3 million related to the amortization of deferred revenue recorded as a result of our receipt of (a) Kindred common stock and (b) $4.5 million of additional future rent under the Kindred Master Leases in connection with Kindred’s emergence from bankruptcy in 2001.
Interest income from loans receivable, which includes amortization of deferred fees, represents $2.0 million of interest income in connection with a $17.0 million mezzanine loan made to Trans Healthcare, Inc. (“THI”) in 2002, of which $4.0 million remained outstanding at December 31, 2005, and $2.0 million of interest income on the six first mortgage loans made in 2005. During 2005, we invested $21.4 million in a portfolio of eight distressed mortgage loans, on which we earned interest of $1.0 million. As of December 31, 2005, the balance on the distressed mortgage loans portfolio had been repaid in its entirety.
The increase in interest and other income primarily relates to $1.3 million of fees associated with our investment in the portfolio of eight distressed mortgage loans described above and $0.8 million related to the recovery in 2005 of a previously written-off receivable.
Expenses
Interest expense includes $3.9 million of amortized deferred financing costs for each of the years ended December 31, 2005 and 2004. Interest expense included in discontinued operations was $0.6 million and $1.1 million for the years ended December 31, 2005 and 2004, respectively. Total interest expense, including interest allocated to discontinued operations, increased $39.0 million in 2005 over 2004, primarily due to a $49.9 million increase from increased debt to fund acquisitions made during 2005, partially offset by a $10.9 million decrease from lower effective interest rates. Our effective interest rate decreased to 7.6 percent for the year ended December 31, 2005 from 8.4 percent for the year ended December 31, 2004.
Depreciation expense increased primarily due to the properties acquired during 2005. See “Note 5-Acquisitions” of the Notes to Consolidated Financial Statements.
The increase in property-level operating expenses relates solely to a full year of activity for the seven medical office buildings acquired during 2004 and the acquisition of two medical office buildings in the first quarter of 2005.
The increase in general, administrative and professional fees is attributable to costs associated with growth in our asset base, our initiative to develop and market our strategic diversification program, engage in comprehensive asset management, comply with regulatory requirements such as the Sarbanes-Oxley Act of 2002, and to attract and retain appropriate personnel to achieve our business objectives.
In December 2005, we paid off our CMBS loan and incurred a loss from extinguishment of debt of $1.4 million primarily related to the write-off of unamortized deferred financing costs. In September 2004, we refinanced indebtedness under our prior credit agreement at lower interest rates and incurred a loss from extinguishment of debt of $1.4 million related to the write-off of unamortized deferred financing costs.
As a result of anticipated lower variable rate debt balances due to the payoff of our CMBS loan in December 2005, we entered into an agreement with the counterparty to our interest rate swap to reduce the notional amount of the swap to $100.0 million from $330.0 million for its remaining term in exchange for a payment to the counterparty of approximately $2.3 million. In addition, we recognized $3.3 million of a previously deferred gain recorded in connection with our 1999 transaction to shorten the maturity of a separate interest rate swap.
During the fourth quarter of 2005, we settled our previously disclosed litigation against Sullivan & Cromwell LLP and received net proceeds of $15.9 million, after payment of expenses in connection with the settlement. See “Note 14-Litigation” of the Notes to Consolidated Financial Statements.
With $2.0 million of the net proceeds received from the litigation settlement, we established and funded the Ventas Charitable Foundation, Inc. (the “Foundation”). The Foundation will be used to support charitable and philanthropic causes important to the communities in which we operate and to our employees.
Discontinued Operations
The decrease in discontinued operations is a result of a lower net gain on the sale of properties in 2005. Discontinued operations in 2004 includes the net income of two properties sold, whereas the discontinued operations in 2005 includes only the net income from one property sold.
In 2005, we completed the sale of one facility for $9.9 million in net cash proceeds and recognized a net gain on the sale of $5.1 million. In addition, the tenant paid us lease termination fees approximately $0.2 million. In 2004, we completed the sale of two facilities for $21.1 million in net cash proceeds and recognized a net gain on the sale of $19.4 million. In addition, the tenant paid us lease termination fees approximating $0.5 million. The net gains and lease termination fees are included in discontinued operations for the respective years in which the dispositions occurred. See “Note 6-Dispositions” of the Notes to Consolidated Financial Statements.
Years Ended December 31, 2004 and 2003
nm - not meaningful
Revenues
The increase in our 2004 rental income reflects (i) a $10.4 million increase resulting from the 3.5 percent annual escalator under the Kindred Master Leases effective May 1, 2004, and the rent increase from the July 1, 2003 amendment to the Kindred Master Leases, and (ii) the recognition of $32.1 million in additional rent relating to the properties acquired during 2004. See “Note 5-Acquisitions” of the Notes to Consolidated Financial Statements. The rental income from Kindred includes $2.3 million related to the amortization of deferred revenue recorded as a result of our receipt of Kindred common stock in connection with Kindred’s emergence from bankruptcy in 2001 and the receipt of $4.5 million of additional future rent under the Kindred Master Leases.
Interest income from loans receivable represents interest income in connection with the loan to THI.
The decrease in interest and other income is primarily attributable to the recovery in 2003 of a previously written-off receivable.
Expenses
Interest expense includes $3.9 million and $4.1 million of amortized deferred financing costs for the years ended December 31, 2004 and 2003, respectively. Interest expense included in discontinued operations was $1.1 million and $3.5 million for the years ended December 31, 2004 and 2003, respectively. Total interest expense, excluding interest on our 2000 settlement with the United States Department of Justice but including interest allocated to discontinued operations, increased $2.0 million in 2004 over 2003, due primarily to a $6.6 million increase related to the debt assumed in connection with our 2004 acquisitions of ElderTrust and certain facilities from Brookdale Living Communities, Inc., partially offset by (i) a $3.2 million decrease from lower effective interest rates, (ii) a $0.8 million decrease from the amortization of a deferred gain recorded in connection with our 1999 transaction to shorten the maturity of our previous interest rate swap, (iii) a $0.3 million decrease from reduced principal balances of our existing debt and (iv) a $0.3 million decrease in amortization of deferred financing costs
Depreciation expense increased primarily due to the properties acquired during 2004. See “Note 5-Acquisitions” of the Notes to Consolidated Financial Statements.
The increase in general, administrative and professional fees is primarily attributable to costs associated with our initiative to develop and market our strategic diversification program, engage in comprehensive asset management, comply with regulatory requirements such as the Sarbanes-Oxley Act of 2002, and to attract and retain appropriate personnel to achieve our business objectives.
In September 2004, we refinanced indebtedness under our prior credit agreement at lower interest rates and incurred a loss from extinguishment of debt of $1.4 million related to the write-off of unamortized deferred financing costs.
As a result of anticipated lower variable rate debt balances due to the sale of ten facilities in December 2003, we entered into an agreement with the counterparty to our interest rate swap to break $120.0 million of the then $450.0 million notional amount in exchange for a payment to the counterparty of approximately $8.6 million. In addition, we recognized $3.4 million of a previously deferred gain recorded in connection with the 1999 transaction to shorten the maturity of a separate interest rate swap. The $5.2 million net expense, which was previously reported in accumulated other comprehensive income on the Consolidated Balance Sheet, was recognized as a net expense in the Consolidated Statement of Income for the year ended December 31, 2003.
During the year ended December 31, 2003, we reported an increase of approximately $20.2 million to our operating results, reflecting the reversal of a previously recorded contingent liability. See “Note 11-Income Taxes” of the Notes to Consolidated Financial Statements.
No interest expense was incurred with respect to the United States settlement in 2004, as compared to $4.9 million in 2003, due to full prepayment in 2003. See “Note 12-Commitments and Contingencies” of the Notes to Consolidated Financial Statements.
Gain on Sale of Kindred Common Stock
During the year ended December 31, 2003, we disposed of 920,814 shares of Kindred common stock and recognized a gain of $9.0 million. Since the sale, we have not owned any shares of Kindred common stock.
Discontinued Operations
The decrease in discontinued operations is a result of a lower net gain on the sale of properties in 2004. Discontinued operations in 2003 includes the net income of 27 properties sold, whereas discontinued operations in 2004 includes only the net income of two properties sold.
In 2004, we completed the sale of two facilities for $21.1 million in net cash proceeds and recognized a net gain on the sale of $19.4 million. In addition, the tenant paid us lease termination fees approximating $0.5 million. In 2003, we completed the sale of 27 facilities for $139.2 million in net cash proceeds and recognized a net gain on the sale of $51.8 million. In addition, the tenant paid us lease termination fees approximating $10.1 million. The net gains and lease termination fees are included in discontinued operations for the respective years in which the dispositions occurred. See “Note 6-Dispositions” of the Notes to Consolidated Financial Statements.
Funds from Operations
Our funds from operations (“FFO”) for the five years ended December 31, 2005 are summarized in the following table:
Historical cost accounting for real estate assets implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. To overcome this problem, we consider FFO an appropriate measure of performance of an equity REIT, and we use the National Association of Real Estate Investment Trusts (“NAREIT”) definition of FFO. NAREIT defines FFO as net income (computed in accordance with GAAP), excluding gains (or losses) from sales of real estate property, plus real estate depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.
FFO presented herein is not necessarily comparable to FFO presented by other real estate companies due to the fact that not all real estate companies use the same definition. FFO should not be considered as an alternative to net income (determined in accordance with GAAP) as an indicator of our financial performance or as an alternative to cash flow from operating activities (determined in accordance with GAAP) as a measure of our liquidity, nor is FFO necessarily indicative of sufficient cash flow to fund all of our needs. We believe that in
order to facilitate a clear understanding of our consolidated historical operating results, FFO should be examined in conjunction with net income as presented in the Consolidated Financial Statements and data included elsewhere in this Annual Report on Form 10-K.
Asset/Liability Management
Asset/liability management is a key element of our overall risk management program. The objective of asset/liability management is to support the achievement of business strategies while maintaining appropriate risk levels. The asset/liability management process focuses on a variety of risks, including market risk (primarily interest rate risk) and credit risk. Effective management of these risks is an important determinant of the absolute levels and variability of FFO and net worth. The following discussion addresses our integrated management of assets and liabilities, including the use of derivative financial instruments. We do not use derivative financial instruments for speculative purposes.
Market Risk
We receive revenue primarily by leasing our assets under long-term triple-net leases in which the rental rate is generally fixed with annual escalators, subject to certain limitations. We also earn revenue from our mortgage loans. Our obligations under our revolving credit facility are floating rate obligations whose interest rate and related monthly interest payments vary with the movement in LIBOR. The general fixed nature of our assets and the variable nature of our obligations create interest rate risk. If interest rates were to rise significantly, our lease and other revenue might not be sufficient to meet our debt obligations. In order to mitigate this risk, in September 2001, we entered into an interest rate swap agreement in the notional amount of $450.0 million to hedge floating rate debt for the period between July 1, 2003 and June 30, 2008 (the “Swap”). The Swap is treated as a cash flow hedge for accounting purposes and is with a highly rated counterparty on which we pay a fixed rate of 5.385 percent and receive LIBOR from the counterparty. In December 2003, due to our lower expected future variable rate debt balances as a result of the sale of ten facilities, we reduced the notional amount of the Swap for the period from December 11, 2003 through June 29, 2006 from $450.0 million to $330.0 million. In December 2005, due to our lower expected future variable rate debt balances as a result of our payoff of the CMBS loan, we further reduced the notional amount of the swap to $100.0 million for the remaining term of the Swap. See “Note 8-Borrowing Arrangements” of the Notes to Consolidated Financial Statements. There are no collateral requirements under the Swap. As of December 31, 2005, the notional amount of the Swap was $100.0 million, which is scheduled to expire on June 30, 2008.
To highlight the sensitivity of the Swap and our fixed rate debt to changes in interest rates, the following summary shows the effects of a hypothetical instantaneous change of 100 basis points (BPS) in interest rates as of December 31, 2005 and 2004:
(1) The change in fair value of the Swap was due to the reduction of notional amount in December 2005 and a general increase in interest rates. The change in fair value of fixed rate debt was due to the issuance of approximately $600.0 million of fixed rate senior notes and the assumption of approximately $427.3 million of fixed rate debt as a result of our acquisitions during the year ended December 31, 2005, partially offset by a general increase in interest rates.
N/A Not applicable.
We paid $6.9 million under the Swap during the year ended December 31, 2005. Assuming that interest rates do not change, we estimate that we will pay approximately $0.6 million on the Swap during the year ending December 31, 2006.
We had approximately $208.2 million and $260.9 million of variable rate debt outstanding as of December 31, 2005 and 2004, respectively. The decrease in our outstanding variable rate debt from December 31, 2004 is primarily attributable to the refinancing of our CMBS loan with fixed rate senior notes, offset by additional mortgages assumed in connection with the Provident acquisition. The Swap currently effectively hedges $100.0 million of our outstanding variable rate debt. Any amounts of variable rate debt in excess of $100.0 million are subject to interest rate changes. However, pursuant to the terms of certain leases with one of our tenants, if interest rates increase on certain debt that we have totaling $109.7 million as of December 31, 2005, our tenant is required to pay us additional rent (on a dollar-for-dollar basis) in an amount equal to the increase in interest expense resulting from the increased interest rates. Therefore, the increase in interest expense related to this debt is equally offset by an increase in additional rent due to us from the tenant. As of December 31, 2005, there was minimal cash flow impact from the fluctuation of interest rates on variable rate debt since we effectively hedged nearly all of our variable rate debt. The fair value of our fixed and variable rate debt is based on current interest rates at which similar borrowings could be made by us.
We may engage in additional hedging strategies in the future, depending on management’s analysis of the interest rate environment and the costs and risks of such strategies. Our market risk sensitive instruments are not entered into for trading purposes.
Credit Risk
As a result of our spin off of Kindred in May 1998 and the Provident acquisition in June 2005, we have a significant concentration of credit risk with Kindred and Brookdale Senior Living Inc. (together with its subsidiaries, “Brookdale Senior Living”). For the years ended December 31, 2005 and 2004, Kindred accounted for $199.1 million, or 59.8 percent of our total revenues, and $192.4 million, or 81.5 percent of our total revenues, respectively, and Brookdale Senior Living accounted for $76.2 million, or 22.9 percent of our total revenues, for the year ended December 31, 2005. Accordingly, the financial condition of Kindred and Brookdale Senior Living and their ability to meet our rent obligations will largely determine our rental revenues and our ability to make distributions to our stockholders. In addition, any failure by Kindred or Brookdale Senior Living to effectively conduct its operations could have a material adverse effect on its business reputation or on its ability to enlist and maintain patients in its facilities. See “Risk Factors-Risks Arising from Our Business-We are dependent on Kindred and Brookdale Senior Living; Kindred’s or Brookdale Senior Living’s inability or unwillingness to satisfy its obligations under its agreements with us could significantly harm us and our ability to service our indebtedness and other obligations and to make distributions to our stockholders as required to continue to qualify as a REIT” included in Part I, Item 1A of this Annual Report on Form 10-K and “Note 4-Concentration of Credit Risk” of the Notes to Consolidated Financial Statements. We monitor our credit risk under our lease agreements with our tenants by, among other things, (i) reviewing and analyzing information regarding the healthcare industry generally, publicly available information regarding tenants, and information provided by the tenants and borrowers under our lease and other agreements, and (ii) having periodic discussions with tenants, borrowers and their representatives.
Liquidity and Capital Resources
During 2005, our principal sources of liquidity were proceeds from equity and debt issuances, cash flow from operations, borrowings under our revolving credit facility, disposition of real estate assets, proceeds from stock option exercises, and proceeds from the Distribution Reinvestment and Stock Purchase Plan. We anticipate that cash flow from operations over the next twelve months will be adequate to fund our business operations, dividends to stockholders and debt amortization. Capital requirements for acquisitions may require funding from borrowings, assumption of debt from the seller, issuance of secured or unsecured long-term debt or other securities or equity offerings.
We intend to continue to fund future investments through cash flow from operations, borrowings under our revolving credit facility, disposition of assets and issuance of secured or unsecured long-term debt or other securities. As of December 31, 2005, we had cash and cash equivalents of $1.6 million, escrow deposits and restricted cash of $59.7 million, and unused availability of $210.6 million under our revolving credit facility.
CMBS Transaction
In December 2001, we raised $225.0 million in gross proceeds from the completion of the CMBS transaction. In December 2005, we repaid all of our outstanding indebtedness under the CMBS loan in the outstanding principal amount of $209.8 million at the payoff date with the net proceeds from our sale of the 2016 Senior Notes (as defined below) and borrowings under our revolving credit facility.
Revolving Credit Facility
In September 2004, we entered into a new $300.0 million revolving credit facility that replaced our previous revolving credit facility. The revolving credit facility bears interest at LIBOR plus a percentage ranging from 1.05 percent to 1.75 percent, depending on our consolidated leverage ratio. As of December 31, 2005, borrowings under the revolving credit facility bore interest at LIBOR plus 1.45 percent, resulting in a borrowing rate of approximately 5.83 percent. We also incur an annual facility fee of 25 basis points payable in quarterly installments. Initial borrowings under the revolving credit facility were used to refinance all revolver balances and pay off the $60.0 million term loan outstanding under our previous revolving credit facility. The revolving credit facility matures in September 2007, but may be extended at our option and subject to the satisfaction of certain conditions, for a period of one year.
The outstanding aggregate principal balance of the revolving credit facility may not exceed either (i) the borrowing base (as described below) or (ii) $300.0 million. As of December 31, 2005, the outstanding principal balance under the revolving credit facility (excluding outstanding letters of credit of $0.2 million) was $89.2 million. Subject to the terms of the revolving credit facility, we have the option to increase our borrowing capacity (in the form of additional revolving loans and/or a term loan) to an amount not to exceed $450.0 million.
As of December 31, 2005, the borrowing base under the revolving credit facility was $300.0 million. The borrowing base is the sum of (i) 65 percent of the aggregate appraised property value of the borrowing base properties, plus (ii) 100 percent of amounts on deposit in certain cash collateral or pledged accounts. The borrowing base properties are currently comprised of 52 owned or leased real properties, which are also mortgaged to secure the revolving credit facility. As of December 31, 2005, the borrowing base properties had a net book value of $114.3 million and were leased to Kindred pursuant to the Kindred Master Leases.
The revolving credit facility imposes various restrictive covenants on us. See “Note 8-Borrowing Arrangements” of the Notes to Consolidated Financial Statements.
Senior Notes Offerings
In December 2005, we completed the offerings of $200.0 million aggregate principal amount of 6 1/2% Senior Notes due 2016 (the “2016 Senior Notes”) of our subsidiaries, Ventas Realty, Limited Partnership and Ventas Capital Corporation (collectively, the “Issuers”) at a half percent discount to par value.
In June 2005, we completed the offering of 6 3/4% Senior Notes due June 1, 2010 of the Issuers, in the aggregate principal amount of $175.0 million (the “2010 Senior Notes”), and 7 1/8% Senior Notes due June 1, 2015 of the Issuers, in the aggregate principal amount of $175.0 million (the “2015 Senior Notes”).
In June 2005, we also completed the offering of $50.0 million aggregate principal amount of 6 5/8% Senior Notes due 2014 (the “2014 Senior Notes”) of the Issuers, which was in addition to the $125.0 million aggregate
principal amount of 2014 Senior Notes originally issued in October 2004. The additional $50.0 million aggregate principal amount of the 2014 Senior Notes was issued at a one percent discount to par value. The additional $50.0 million aggregate principal amount and the original $125.0 million aggregate principal amount of the 2014 Senior Notes are governed by the same indenture.
In April 2002, we completed the offering of 8 3/4% Senior Notes due May 1, 2009 of the Issuers, in the aggregate principal amount of $175.0 million (the “2009 Senior Notes”), and 9% Senior Notes due May 1, 2012 of the Issuers, in the aggregate principal amount of $225.0 million (the “2012 Senior Notes”). On December 31, 2002, we purchased $0.8 million principal amount of 2009 Senior Notes and $33.2 million principal amount of 2012 Senior Notes in open market transactions.
As of December 31, 2005, $174.2 million principal amount of 2009 Senior Notes, $175.0 million principal amount of 2010 Senior Notes, $191.8 million principal amount of 2012 Senior Notes, $175.0 million principal amount of 2014 Senior Notes, $175.0 million principal amount of 2015 Senior Notes and $200.0 million principal amount of 2016 Senior Notes (collectively, the “Senior Notes”) were outstanding. We and certain of our subsidiaries have fully and unconditionally guaranteed the Senior Notes.
The Senior Notes are subject to a number of restrictive covenants. See “Note 8-Borrowing Arrangements” of the Notes to Consolidated Financial Statements.
Pursuant to registration rights agreements entered into in connection with the 2010 Senior Notes, 2015 Senior Notes and additional 2014 Senior Notes offerings, on October 28, 2005, we completed offers to exchange the 2010 Senior Notes, 2015 Senior Notes and additional 2014 Senior Notes with new series of notes that are registered under the Securities Act of 1933, as amended (the “Securities Act”), and are otherwise substantially identical to the original 2010 Senior Notes, 2015 Senior Notes and 2014 Senior Notes, except that certain transfer restrictions, registration rights and liquidated damages do not apply to the new notes. We did not receive any additional proceeds in connection with the exchange offers.
Pursuant to the registration rights agreements entered into in connection with the 2016 Senior Notes offerings, on January 27, 2006, we filed a registration statement with respect to an offer to exchange the 2016 Senior Notes with a new series of notes that are registered under the Securities Act and are otherwise substantially identical to the original 2016 Senior Notes, except that certain transfer restrictions, registration rights and liquidated damages do not apply to the new notes. We will not receive any additional proceeds in connection with the exchange offer.
Dividends
In order to continue to qualify as a REIT, we must make annual distributions to our stockholders of at least 90 percent of REIT taxable income (excluding net capital gain). We declared dividends greater than 100 percent of estimated taxable income for 2005 and intend to pay a dividend greater than 100 percent of taxable income for 2006.
We expect that REIT taxable income will be less than cash flow due to the allowance of depreciation and other non-cash deductions in computing REIT taxable income. Although we anticipate that we generally will have sufficient cash or liquid assets to enable us to satisfy the 90 percent distribution requirement, it is possible that from time to time we may not have sufficient cash or other liquid assets to meet the 90 percent distribution requirement or we may decide to retain cash or distribute such greater amount as may be necessary to avoid income and excise taxation. If we do not have sufficient cash or liquid assets to enable us to satisfy the 90 percent distribution requirement, or if we desire to retain cash, we may borrow funds, issue additional equity securities, pay taxable stock dividends, if possible, distribute other property or securities or engage in a transaction intended to enable us to meet the REIT distribution requirements.
Capital Expenditures and Property Acquisitions
Except with respect to our medical office buildings, capital expenditures to maintain and improve our leased properties generally will be incurred by our tenants. Accordingly, we do not believe that we will incur any major expenditures in connection with these leased properties. After the terms of the leases expire, or in the event that the tenants are unable or unwilling to meet their obligations under the leases, we anticipate that any expenditures relating to the maintenance of leased properties for which we may become responsible will be funded by cash flows from operations or through additional borrowings. To the extent that unanticipated expenditures or significant borrowings are required, our liquidity may be affected adversely. Our ability to borrow funds may be restricted in certain circumstances by the terms of our revolving credit facility and the indentures governing the Senior Notes.
Equity Offerings
In 2002, we filed and the Commission declared effective a universal shelf registration statement on Form S-3 with the Commission relating to $750.0 million aggregate offering price of common stock, preferred stock, subsidiary debt securities and related guarantees, depository shares and warrants.
In July 2005, we completed the sale of 3,247,000 shares of our common stock in an underwritten public offering pursuant to our universal shelf registration statement. We received $97.0 million in net proceeds from the sale, which we used to repay indebtedness under our revolving credit facility and for general corporate purposes, including the funding of acquisitions.
In March 2004, we completed the sale of 2,000,000 shares of our common stock in an underwritten public offering pursuant to our shelf registration statement. We received $51.1 million in net proceeds from the sale, which we used to repay indebtedness under our revolving credit facility and for general corporate purposes, including the funding of acquisitions.
As of December 31, 2005, approximately $501.0 million of securities remained available for offering under the shelf registration statement.
Other
During 2005 and 2004, we assumed facility-level mortgage debt in connection with certain property acquisitions, including the Provident and ElderTrust acquisitions. See “Note 5-Acquisitions” of the Notes to Consolidated Financial Statements. Outstanding facility-level mortgage debt was approximately $622.3 million and $100.5 million as of December 31, 2005 and 2004, respectively.
The 2003 Consolidated Statement of Income includes a $4.9 million expense related to our early repayment of a prior year settlement agreement with the United States Department of Justice.
We received proceeds on the exercises of stock options in the amounts of $6.8 million and $17.7 million for the years ended December 31, 2005 and 2004, respectively. Future proceeds on the exercises of stock options are primarily affected by the future performance of our stock price and the number of options outstanding. Options outstanding have decreased to 1.3 million as of December 31, 2005, from 1.6 million and 2.6 million as of December 31, 2004 and 2003, respectively.
We generated net proceeds from our Distribution Reinvestment and Stock Purchase Plan of $5.0 million and $13.1 million for the years ended December 31, 2005 and 2004, respectively. In March 2005, we began offering a one percent discount on the purchase price of our stock to shareholders who reinvest their dividends and/or make optional cash purchases of common stock through the plan. During 2004, we offered a two percent discount. Each month or quarter, as applicable, we may lower or eliminate the discount without prior notice, thereby affecting the future proceeds that we receive from this plan.
We have outstanding loans to certain current and former executive officers in the aggregate principal amount of approximately $2.8 million as of December 31, 2005, down from $3.2 million at December 31, 2004. The loans are payable over ten years beginning, in each case, on the date such loan was made. See “Note 16-Related Party Transactions” of the Notes to Consolidated Financial Statements.
Cash Flows
Cash Flows from Operating Activities
Net cash provided by operating activities totaled $223.8 million and $150.0 million for the years ended December 31, 2005 and 2004, respectively. The increase in 2005 cash flows is primarily a result of increases due to rent escalators and additional rent, net of interest expense, relating to the properties acquired during 2005.
Cash Flows from Investing Activities
Net cash used in investing activities for the year ended December 31, 2005 was $615.0 million. We invested $589.6 million in real property, which was financed through borrowings under our revolving credit facility, the issuance of Senior Notes and cash on hand, and proceeds of $11.3 million from the sale of facilities, of which $9.9 million is being held in escrow for use in an Internal Revenue Code Section 1031 exchange. Additionally, we invested $47.3 million in real estate loans and received proceeds from our real estate loans of $20.3 million. Net cash used in investing activities for the year ended December 31, 2004 was $298.7 million. We invested $323.9 million in real property, which was financed through borrowings under our revolving credit facility and cash on hand, and sold two facilities for proceeds of $21.1 million. Net cash provided by investing activities for the year ended December 31, 2003 was $159.7 million. We received $139.2 million in proceeds from the disposal of real estate properties and $20.2 million in proceeds from the sale of the Kindred common stock.
Cash Flows from Financing Activities
Net cash provided by financing activities totaled $389.6 million for the year ended December 31, 2005. The proceeds included (i) $600.0 million from the issuance of Senior Notes, (ii) $102.0 million from the issuance of common stock, (iii) $50.2 million from net borrowings under our revolving credit facility and (iv) $6.8 million from the issuance of common stock upon the exercise of stock options. The uses primarily included (i) an aggregate principal payment of $212.6 million on the CMBS loan to fulfill this debt obligation, (ii) aggregate principal payments on other mortgage obligations of $19.4 million, (iii) $125.8 million of cash dividend payments and (iv) a cash payment for the swap break of $2.3 million.
Net cash provided by financing activities totaled $70.0 million for the year ended December 31, 2004. The proceeds included (i) $125.0 million from the issuance of Senior Notes, (ii) $64.2 million from the issuance of common stock, (iii) $39.0 million from net borrowings under our revolving credit facility and (iv) $17.7 million from the issuance of common stock upon the exercise of stock options. The uses included (i) an aggregate principal payment of $67.0 million on our previous term loan, the CMBS loan and other mortgage loans and (ii) $103.5 million of cash dividend payments.
Net cash used in financing activities totaled $217.4 million for the year ended December 31, 2003. The uses included (i) an aggregate principal payment of $67.1 million on our revolving credit facility and the CMBS loan, (ii) a $37.4 million cash payment in 2003 to settle the repurchase of Senior Notes that occurred on December 31, 2002, (iii) $8.6 million in swap breakage fees, (iv) full repayment on the United States settlement of $46.6 million and (v) $80.2 million of cash dividend payments. The uses were offset by $22.6 million of proceeds from the issuance of common stock upon the exercise of stock options.
Contractual Obligations
The following table summarizes the effect that minimum debt (which includes principal and interest payments) and other material noncancelable commitments are expected to have on our cash flow in the future periods.
(1) Amounts represent contractual amounts due, including interest.
(2) Interest on variable rate debt and obligations under the Swap were based on forward rates obtained as of December 31, 2005.
(3) Includes outstanding principal amounts of $174.2 million of the 2009 Senior Notes and $175.0 million of the 2010 Senior Notes.
(4) Includes outstanding principal amounts of $191.8 million of the 2012 Senior Notes, $175.0 million of the 2014 Senior Notes, $175.0 million of the 2015 Senior Notes, and $200.0 million of the 2016 Senior Notes.
In connection with the Kindred spin off, we assigned our former third-party lease obligations and third-party guarantee agreements to Kindred. As of December 31, 2005, we believe that the aggregate exposure under our third-party lease obligations was approximately $21.6 million and that we have no material exposure under the third-party guarantee agreements. Kindred has agreed to indemnify and hold us harmless from and against all claims against us arising out of the third-party leases, and we do not expect to incur any liability under those leases. However, we cannot assure you that Kindred will have sufficient assets, income and access to financing to enable it to satisfy, or that it will continue to honor its obligations under the indemnity agreement relating to the third-party leases. See “Note 12-Commitments and Contingencies” of the Notes to Consolidated Financial Statements.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
The information set forth in Item 7 of this Annual Report on Form 10-K under “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Asset/Liability Management” is incorporated by reference into this Item 7A.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
Ventas, Inc.
Index to Consolidated Financial Statements and Financial Statement Schedule
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Ventas, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external reporting purposes in accordance with generally accepted accounting principles in the United States.
Management, under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2005 was effective. All internal control systems, no matter how well designed, have inherent limitations. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Therefore, the Company’s internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation and presentation and may not prevent or detect misstatements.
Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report included herein, which expresses an unqualified opinion on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
Ventas, Inc.
We have audited the accompanying consolidated balance sheets of Ventas, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index. These financial statements and schedule are the responsibility of management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ventas, Inc. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Ventas, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 16, 2006, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Chicago, Illinois
February 16, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Stockholders and Board of Directors
Ventas, Inc.
We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that Ventas, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Ventas, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Ventas, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Ventas, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005, and our report dated February 16, 2006, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Chicago, Illinois
February 16, 2006
VENTAS, INC.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2005 and 2004
(In thousands, except per share amounts)
See accompanying notes.
VENTAS, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands, except per share amounts)
See accompanying notes.
VENTAS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2005, 2004, and 2003
(In thousands, except per share amounts)
See accompanying notes.
VENTAS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands)
See accompanying notes.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1-Description of Business
Ventas, Inc. (together with its subsidiaries, unless otherwise indicated or except where the context otherwise requires, “we,” “us” or “our”) is a healthcare real estate investment trust (“REIT”) with a geographically diverse portfolio of healthcare-related and seniors housing facilities in the United States. As of December 31, 2005, this portfolio consisted of 200 skilled nursing facilities, 41 hospitals, 139 seniors housing facilities and other facilities in 42 states. Except with respect to our medical office buildings, we lease these facilities to healthcare operating companies under “triple-net” or “absolute net” leases. Kindred Healthcare, Inc. and its subsidiaries (collectively, “Kindred”) leased 225 of our facilities as of December 31, 2005. We also have real estate loan investments relating to 30 healthcare-related and seniors housing facilities as of December 31, 2005.
We conduct substantially all of our business through our wholly owned subsidiaries, Ventas Realty, Limited Partnership (“Ventas Realty”), PSLT OP, L.P. (“PSLT OP”) and Ventas Finance I, LLC (“Ventas Finance”), and ElderTrust Operating Partnership (“ETOP”), in which we own substantially all of the partnership units.
Note 2-Summary of Significant Accounting Policies
Impact of Recently Issued Accounting Standards
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), which is a revision to SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). SFAS No. 123(R) supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”). We have accounted for share-based payments to employees using the intrinsic value method under APB Opinion No. 25 and, as such, generally recognize no compensation cost for employee stock options. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123, except that 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 under SFAS No. 123(R).
As required under Securities and Exchange Commission (the “Commission”) Release No. 33-8568, we adopted the provisions of this accounting standard on January 1, 2006. We will apply the modified prospective method of adoption in which compensation cost is recognized beginning on the date we adopt the accounting standard for all share-based payments granted after the adoption date and for all awards granted to employees prior to the adoption date that remain unvested on the adoption date. See “Note 10-Compensation Plans” regarding the effect the adoption of SFAS No. 123(R) will have on our consolidated financial statements.
Basis of Presentation
The consolidated financial statements include the accounts of Ventas, Inc. and all of its direct and indirect wholly and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Accounting Estimates
The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of rental revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Segment Reporting
We operate through one reportable segment: investment in real estate. Our primary business consists of financing, owning and leasing healthcare-related and seniors housing facilities and leasing or subleasing those facilities to third parties. Substantially all of our leases are triple-net leases, which require the tenants to pay all property-related expenses. With the exception of our medical office buildings, we do not operate our facilities nor do we allocate capital to maintain the properties. Substantially all depreciation and interest expenses, except for interest expense relating to the United States Settlement (as defined in “Note 12-Commitments and Contingencies-Settlement of United States Claims”), reflected in the Consolidated Statements of Income relate to the ownership of our investment in real estate.
Discontinued Operations
The results of operations and gain/(loss) on real estate properties sold or held for sale are reflected in the Consolidated Statements of Income as “discontinued operations” for all periods presented. Interest expense allocated to discontinued operations has been estimated based on a proportional allocation of rental income among all of our facilities.
Long-Lived Assets
Investments in real estate properties are recorded at cost. We account for acquisitions using the purchase method. The cost of the properties acquired is allocated among tangible land, buildings and equipment and recognized intangibles based upon estimated fair values in accordance with the provisions of SFAS No. 141, “Business Combinations.” We estimate fair values of the components of assets acquired as of the acquisition date or engage a third-party appraiser as necessary. Recognized intangibles, if any, include the value of acquired lease contracts and related customer relationships.
Our method for determining fair value varies with the categorization of the asset acquired. We estimate the fair value of our buildings on an as-if-vacant basis, and depreciate the building value over the estimated remaining life of the building. We determine the allocated value of other fixed assets based upon the replacement cost and depreciate such value over their estimated remaining useful lives. We determine the value of land either based on real estate tax assessed values in relation to the total value of the asset, internal analyses of recently acquired and existing comparable properties within our portfolio or third-party appraisals. The fair value of in-place leases, if any, reflects (i) above and below market leases, if any, determined by discounting the difference between the estimated current market rent and the in-place rentals, the resulting intangible asset of which is amortized to rental revenue over the remaining life of the associated lease plus any fixed rate renewal periods, if applicable, (ii) the estimated value of the cost to obtain tenants, including tenant allowances, tenant improvements and leasing commissions, which is amortized over the remaining life of the associated lease, and (iii) an estimated value of the absorption period to reflect the value of the rents and recovery costs foregone during a reasonable lease-up period, as if the acquired space was vacant, which is amortized over the remaining life of the associated lease. We also estimate the value of tenant or other customer relationships acquired by considering the nature and extent of existing business relationships with the tenant, growth prospects for developing new business with such tenant, such tenant’s credit quality, expectations of lease renewals with such tenant, and the potential for significant, additional future leasing arrangements with such tenant. We amortize such value, if any, over the expected term of the associated arrangements or leases, which would include the remaining lives of the related leases and any expected renewal periods.
Fixtures and equipment totaling $151.3 million and $12.2 million at December 31, 2005 and 2004, respectively, is included in buildings and improvements in the Consolidated Balance Sheets. Depreciation is
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
recorded on the straight-line basis, using estimated useful lives ranging from 20 to 50 years for buildings and improvements and three to ten years for fixtures and equipment.
Impairment of Long-Lived Assets
We periodically evaluate our long-lived assets, primarily consisting of our investments in real estate, for impairment indicators. If indicators of impairment are present, we evaluate the carrying value of the related real estate investments in relation to the future undiscounted cash flows of the underlying operations. We adjust the net book value of leased properties and other long-lived assets to fair value, if the sum of the expected future cash flow or sales proceeds is less than book value. An impairment loss is recognized at the time we make any such adjustment. Future events could occur which would cause us to conclude that impairment indicators exist and an impairment loss is warranted.
During the year ended December 31, 2003, we recorded a $0.8 million impairment on one non-operating skilled nursing facility. During the years ended December 31, 2005 and 2004, we did not recognize an impairment loss.
Loans Receivable
Loans receivable are stated at the unpaid principal balance net of any deferred origination fees. Net deferred origination fees are comprised of loan fees collected from the borrower net of certain direct costs. Net deferred origination fees are amortized over the contractual life of the loan using the level yield method. Interest income on the loans receivable is recorded as earned. We evaluate the collectibility of the loan receivable based on, among other things, (i) corporate and facility level financial and operational reports, (ii) compliance with the financial covenants set forth in the applicable loan documents and (iii) the financial stability of the applicable borrower and any guarantor.
Cash Equivalents
Cash equivalents consist of highly liquid investments with a maturity date of three months or less when purchased. These investments are stated at cost which approximates fair value.
Escrow Deposits and Restricted Cash
Escrow deposits primarily consist of amounts held by lenders to provide for future real estate tax and insurance expenditures and tenant improvements, earnest money deposits on acquisitions and net proceeds from property sales that were executed as a tax-deferred disposition. Restricted cash represents amounts committed for various utility deposits and security deposits paid to us by third parties.
Deferred Financing Costs
Deferred financing costs are amortized as a component of interest expense over the terms of the related borrowings using a method that approximates a level yield, and are net of accumulated amortization of approximately $5.9 million and $7.3 million at December 31, 2005 and 2004, respectively.
Derivative Instruments
As discussed in “Note 8-Borrowing Arrangements,” we use derivative instruments to protect against the risk of interest rate movements on future cash flows under our variable rate debt agreements. Derivative instruments are reported at fair value on the Consolidated Balance Sheets. Changes in the fair value of
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
derivatives deemed to be eligible for hedge accounting are reported in accumulated other comprehensive income exclusive of ineffectiveness amounts which are reported in interest expense. As of December 31, 2005, a $0.1 million net unrealized loss on the derivatives is included in accumulated other comprehensive loss. Changes in fair value of derivative instruments that are not eligible for hedge accounting are reported in the Consolidated Statements of Income. See “Note 9-Fair Values of Financial Instruments.” Fair values of derivative instruments are verified with a third-party consultant.
Fair Values of Financial Instruments
The following methods and assumptions were used in estimating fair value disclosures for financial instruments.
•
Cash and cash equivalents: The carrying amount of cash and cash equivalents reported in the Consolidated Balance Sheets approximates fair value because of the short maturity of these instruments.
•
Loans receivable: The fair value of loans receivable is estimated by discounting the future cash flows using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
•
Notes receivable-related parties: The fair value of the notes receivable-related parties is estimated using a discounted cash flow analysis, using interest rates being offered for similar loans to borrowers with similar credit ratings.
•
Interest rate swap agreement: The fair value of the interest rate swap agreement is based on rates being offered for similar arrangements which consider forward yield curves and discount rates.
•
Senior notes payable and other debt: The fair values of borrowings under fixed rate agreements are estimated by discounting the future cash flows using current interest rates at which similar borrowings could be made by us.
Comprehensive Income
Comprehensive income includes net income and all other non-owner changes in stockholders’ equity during a period including unrealized fair value adjustments on certain derivative instruments.
Revenue Recognition
Certain of our leases, excluding the Kindred Master Leases (as defined below), provide for periodic and determinable increases in base rent. Base rental revenues under these leases are recognized on a straight-line basis over the terms of the applicable lease. Certain of our other leases, including the Kindred Master Leases, provide for an annual increase in rental payments only if certain revenue parameters or other contingencies are met. We recognize the increased rental revenue under these leases only if the revenue parameters or other contingencies are met rather than on a straight-line basis over the term of the applicable lease. We recognize income from rent, lease termination fees and other income once all of the following criteria are met in accordance with Commission Staff Accounting Bulletin 104: (i) the agreement has been fully executed and delivered; (ii) services have been rendered; (iii) the amount is fixed or determinable; and (iv) the collectibility is reasonably assured.
Federal Income Tax
As we have elected to be treated as a real estate investment trust under the applicable provisions of the Internal Revenue Code, no provision has been made from federal income tax purposes. See “Note 11-Income taxes.”
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 3-Revenues from Properties
Approximately 59.8 percent and 81.5 percent of our total revenues for the years ended December 31, 2005 and 2004, respectively, were derived from our master lease agreements with Kindred (the “Kindred Master Leases”). Each Kindred Master Lease is a “triple-net lease” pursuant to which Kindred is required to pay all insurance, taxes, utilities, maintenance and repairs related to the properties. There are several renewal bundles of properties under each Kindred Master Lease, with each bundle containing a varying number of properties. All properties within a bundle have primary terms ranging from 10 to 15 years from May 1, 1998 and, provided certain conditions are satisfied, are subject to three five-year renewal terms.
On June 7, 2005, we completed the acquisition of Provident Senior Living Trust (“Provident”) (see “Note 5-Acquisitions”), which leased all of its properties to affiliates of Brookdale Living Communities, Inc. (together with its subsidiaries, “Brookdale”) and Alterra Healthcare Corporation (together with its subsidiaries, “Alterra”). In September 2005, Brookdale was combined, through a series of mergers, with Alterra under a new holding company, Brookdale Senior Living Inc. (together with its subsidiaries, “Brookdale Senior Living”). As a result of this acquisition, Brookdale Senior Living became a significant source of our total revenues. Approximately 22.9 percent of our total revenues for the year ended December 31, 2005 was derived from our lease agreements with Brookdale Senior Living.
Kindred is subject to the reporting requirements of the Commission and is required to file with the Commission annual reports containing audited financial information and quarterly reports containing unaudited financial information. During the fourth quarter of 2005, Brookdale Senior Living completed the initial public offering of its common stock and, as a result, is now subject to the reporting requirements of the Commission and also required to file with the Commission annual reports containing audited financial information and quarterly reports containing unaudited financial information. The information related to Kindred and Brookdale Senior Living contained or referred to in this Annual Report on Form 10-K is derived from filings made by Kindred or Brookdale Senior Living, as the case may be, with the Commission or other publicly available information, or has been provided to us by Kindred or Brookdale Senior Living. We have not verified this information either through an independent investigation or by reviewing Kindred’s or Brookdale Senior Living’s public filings. We have no reason to believe that this information is inaccurate in any material respect, but we cannot assure you that all of this information is accurate. Kindred’s and Brookdale Senior Living’s filings with the Commission can be found at the Commission’s website at www.sec.gov. We are providing this data for informational purposes only, and you are encouraged to obtain Kindred’s and Brookdale Senior Living’s publicly available filings from the Commission.
Kindred Master Leases
Each Kindred Master Lease is a triple-net lease pursuant to which Kindred is required to pay all insurance, taxes, utilities, maintenance and repairs related to the properties. The properties leased to Kindred pursuant to each Kindred Master Lease are grouped into renewal bundles, with each bundle containing a varying number of properties. All properties within a bundle have primary terms ranging from ten to fifteen years, commencing May 1, 1998, and, provided certain conditions are satisfied, are subject to three five-year renewal terms.
Under each Kindred Master Lease, the aggregate annual rent is referred to as Base Rent (as defined in each Kindred Master Lease). Base Rent escalates on May 1 of each year at an annual rate of 3.5 percent over the prior period Base Rent if certain Kindred revenue parameters are met.
We have a one-time right under each Kindred Master Lease (the “Reset Right”), exercisable by notice (the “Reset Notices”) given on or after January 20, 2006 and on or before July 19, 2007, to increase the rent to a then fair market rental rate for a total fee of $4.6 million payable on a pro-rata basis at the time of exercise under the applicable Kindred Master Lease. If we deliver the Reset Notices prior to July 19, 2006, the increased rent, if
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
any, would be effective on July 19, 2006, and if we deliver the Reset Notices after July 19, 2006, the increased rent, if any, would be effective on the date the Reset Notices are delivered. The Reset Right applies to the original Kindred Master Leases on a lease-by-lease basis. If the Reset Right is exercised for any Kindred Master Lease, the annual escalations currently applicable to that particular Kindred Master lease may be altered or reduced, depending on market conditions at the time.
On July 1, 2003, we amended the Kindred Master Leases to increase rent on certain facilities leased to Kindred by $8.6 million per year on an annualized basis (May 1, 2003 through April 30, 2004), for approximately seven years. Subject to any adjustment resulting from our exercise of the Reset Right, this amount will escalate 3.5 percent annually in accordance with the Kindred Master Leases.
Brookdale Senior Living Leases
Each of our leases with subsidiaries of Brookdale Senior Living is a triple-net lease pursuant to which the tenant is required to pay all insurance, taxes, utilities, maintenance and repairs related to the properties. In addition, the tenants are required to comply with the terms of the mortgage financing documents affecting the properties. Our leases with Brookdale have primary terms of fifteen years, commencing either January 28, 2004 (in the case of fifteen “Grand Court” facilities we acquired in early 2004) or October 19, 2004 (in the case of the facilities we acquired in connection with the Provident acquisition), and, provided certain conditions are satisfied, are subject to two ten-year renewal terms. Our leases with Alterra also have primary terms of fifteen years, commencing either October 20, 2004 or December 16, 2004 (both in the case of facilities we acquired in connection with the Provident acquisition), and, provided certain conditions are satisfied, are subject to two five-year renewal terms.
Under the terms of the Brookdale leases assumed in connection with the Provident acquisition, Brookdale is obligated to pay base rent, which escalates on January 1 of each year, by an amount equal to the lesser of (i) four times the percentage increase in the Consumer Price Index during the immediately preceding year or (ii) three percent. Under the terms of the Brookdale leases with respect to the “Grand Court” facilities, Brookdale is obligated to pay base rent, which escalates on February 1 of each year, by an amount equal to the greater of (i) two percent or (ii) 75 percent of the increase in the Consumer Price Index during the immediately preceding year. Under the terms of the Alterra leases, Alterra is obligated to pay base rent, which escalates either on January 1 or November 1 of each year by an amount equal to the lesser of (i) four times the percentage increase in the Consumer Price Index during the immediately preceding year or (ii) 2.5 percent. See “Note 12-Commitments and Contingencies.”
The future contracted minimum rentals, excluding rent escalations and excluding the amortization of the value of the Kindred common stock and the $4.5 million in cash received on April 20, 2001, the date on which Kindred emerged from bankruptcy, but with straight-line rents where applicable, for all of our leases are as follows:
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 4-Concentration of Credit Risk
As of December 31, 2005, approximately 33.6 percent and 45.8 percent of our properties, based on their original cost, were operated by Kindred and Brookdale Senior Living, respectively, and approximately 59.5 percent and 27.5 percent of our properties, based on their original cost, were seniors housing facilities and skilled nursing facilities, respectively. Our remaining properties consist of hospitals, medical office buildings and other facilities. Our facilities are located in 42 states, with facilities in two states accounting for more than ten percent of total revenues for the year ended December 31, 2005. For the years ended December 31, 2004 and 2003, facilities in only one state accounted for more than ten percent of total revenue.
Because we lease a substantial portion of our properties to Kindred and Brookdale Senior Living and Kindred and Brookdale Senior Living are the primary source of our total revenues, their financial condition and ability and willingness to satisfy their obligations under their respective leases and certain other agreements with us will significantly impact our revenues and our ability to service our indebtedness and to make distributions to our stockholders. We cannot assure you that Kindred or Brookdale Senior Living will have sufficient assets, income and access to financing to enable it to satisfy its obligations under its respective leases and other agreements with us, and any inability or unwillingness or its part to do so would have a material adverse effect on our business, financial condition, results of operations and liquidity, on our ability to service our indebtedness and on our ability to make distributions to our stockholders as required to maintain our status as a REIT.
Note 5-Acquisitions
The following is a summary of our more significant acquisitions in 2005 and 2004. The primary reason for these acquisitions was to invest in healthcare and seniors housing properties with an expected yield on investment, as well as to diversify our properties and revenue base and reduce our dependence on Kindred for rental revenue.
Provident
On June 7, 2005, we completed the acquisition of Provident in a transaction valued at approximately $1.2 billion. Provident was formed as a Maryland real estate investment trust in March 2004 and owned seniors living properties located in the United States. Pursuant to the Provident acquisition, we acquired 68 independent and assisted living facilities in nineteen states comprised of approximately 6,819 residential living units, all of which are leased to affiliates of Brookdale and Alterra pursuant to triple-net leases with renewal options. As of December 31, 2005, the aggregate annualized contractual cash rent expected from the Provident properties was approximately $85.7 million.
We funded the cash portion of the purchase price for the Provident acquisition, which was approximately $231.0 million, and repaid all outstanding borrowings under Provident’s credit facility at closing from a combination of net proceeds from the sale of $350.0 million aggregate principal amount of senior notes issued by Ventas Realty and a wholly owned subsidiary, Ventas Capital Corporation (collectively, the “Issuers”), and borrowings under our revolving credit facility. Additionally, we issued approximately 15.0 million shares of our common stock and share equivalents to Provident equity holders as part of the purchase price for the Provident acquisition. We also assumed approximately $459.4 million of property-level mortgage debt.
Other 2005 Acquisitions
During 2005, we acquired 23 seniors housing facilities, an adjacent parcel of land and one hospital for an aggregate purchase price of $278.2 million, including assumed debt of $74.4 million at the time of the
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
acquisitions. The seniors housing facilities and the hospital are leased under triple-net leases, each having initial terms ranging from ten to fifteen years and initially providing aggregate, annual cash base rent of approximately $23.9 million, subject to escalation as provided in the leases.
Also during 2005, we acquired three medical office buildings for an aggregate purchase price of $13.0 million, including assumed debt of $7.3 million at the time of the acquisitions. These buildings are leased to various tenants under leases having various remaining terms and initially providing aggregate, annual cash base rent of approximately $1.7 million, subject to escalation as provided in the leases. We have engaged third parties to manage the operations of the medical office buildings.
2004 Acquisitions
In February 2004, we acquired all of the outstanding common shares of ElderTrust in an all-cash transaction valued at $184.0 million. At the close of the ElderTrust transaction, ElderTrust had approximately $33.5 million in unrestricted and restricted cash. After transaction costs, the net investment of the ElderTrust transaction was approximately $160.0 million. The ElderTrust transaction added eighteen facilities to our portfolio. The ElderTrust properties are leased to various operators under leases having remaining terms primarily ranging from four to eleven years and initially providing aggregate, annual cash base rent of approximately $16.4 million, subject to escalation as provided in the leases. Concurrent with the consummation of the ElderTrust transaction, we also purchased all of the limited partnership units in ETOP, then held by third parties at $12.50 per unit, other than 31,455 Class C Units in ETOP (which remain outstanding). ETOP owns directly or indirectly all of the ElderTrust properties.
During 2004, we acquired fifteen independent living or assisted living facilities for an aggregate purchase price of $157.4 million. These facilities are leased by us to affiliates of Brookdale pursuant to a master lease containing ten properties and five separate single facility leases, all of which are triple-net leases guaranteed by Brookdale having an initial term of fifteen years and initially providing aggregate, annual cash base rent of approximately $14.5 million, subject to escalation as provided in the leases.
Additionally, during 2004 we acquired four seniors housing facilities and two skilled nursing facilities for an aggregate purchase price of $93.3 million. The facilities are leased under triple-net leases, having initial terms of ten to fifteen years and providing aggregate, annual cash base rent of approximately $8.9 million, subject to escalation as provided in the leases.
Also during 2004, we acquired five medical office buildings, for an aggregate purchase price of $15.9 million. These buildings are leased to various tenants under leases having remaining terms ranging from four to six years and initially providing for aggregate, annual cash base rent of approximately $1.9 million, subject to escalation as provided in the leases. We have engaged third parties to manage the operations of the medical office buildings.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Estimated Fair Value
The transactions completed during the year ended December 31, 2005 were accounted for under the purchase method. The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. Such estimates are subject to refinement as additional valuation information is received.
Unaudited Pro Forma
The following table illustrates the effect on net income and earnings per share as if we had consummated our 2005 and 2004 acquisitions and our 2005 and 2004 equity offerings as of the beginning of each of the three years ended December 31, 2005:
Note 6-Dispositions
In 2005, we completed the sale of one seniors housing facility for approximately $9.9 million in net cash proceeds and recognized a net gain on sale of approximately $5.1 million. In addition, the tenant paid us a lease termination fee of approximately $0.2 million. These net proceeds are being held in escrow for use in an Internal
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Revenue Code Section 1031 exchange. In 2004, we completed the sale of two facilities for $21.1 million in net cash proceeds and recognized a net gain on the sale of $19.4 million. In addition, the tenant paid us lease termination fees approximating $0.5 million. In 2003, we completed the sale of 27 facilities for $139.2 million in net cash proceeds and recognized a net gain on the sale of $51.8 million. In addition, the tenants paid us lease termination fees approximating $10.1 million. The net gains and lease termination fees are included in discontinued operations for the respective years in which the dispositions occurred.
As of December 31, 2004, 2003 and 2002, the net book value of the facilities sold and held for sale during 2005, 2004 and 2003 was $5.3 million, $3.2 million and $91.7 million, respectively.
Set forth below is a summary of the results of operations of the sold and held for sale facilities during the years ended December 31, 2005, 2004 and 2003:
Note 7-Loans Receivable
During 2005, we extended three first mortgage loans in the aggregate principal amount of $25.9 million. The loans accrue interest at a rate of 9.0 percent per annum and provide for monthly amortization of principal with balloon payment maturity dates ranging from February to April 2010. Each loan is guaranteed by an affiliate of the borrower and its two principals.
Also during 2005, we invested in a portfolio of eight distressed mortgage loans with eight separate borrowers for an aggregate purchase price of $21.4 million. As of December 31, 2005, our investment in the portfolio was satisfied by the buy-out of the applicable distressed mortgage loans in an amount equal to our investment in these loans. In conjunction with these buy-outs, we extended three first mortgage loans in an aggregate principal amount of $10.5 million. The new first mortgage loans accrue interest at a rate of nine percent per annum and provide for monthly amortization of principal with balloon payment maturity dates ranging from July to December 2010. These three first mortgage loans are also guaranteed by a third party and its two principals.
Our six first mortgage loans have a one percent exit fee that was paid at the date of issuance and is being deferred and amortized over the term of the loan. The aggregate unamortized balance of these deferred fees as of December 31, 2005 was $0.3 million.
During 2002, we completed a $120.0 million transaction with Trans Healthcare, Inc. (“THI”), a privately owned long-term care and hospital company. The transaction was structured as a $53.0 million sale-leaseback
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
transaction and a $67.0 million loan, comprised of a $50.0 million first mortgage loan and a $17.0 million mezzanine loan. Following a sale of the first mortgage loan in December 2002, our investment in THI was $70.0 million.
As part of the THI sale-leaseback, we purchased five properties and are leasing them back to THI under a triple-net master lease. The properties subject to the sale-leaseback are four skilled nursing facilities and one continuing care retirement community. The THI master lease, which has an initial term of ten years, provides for initial annual base rent of $6.0 million, subject to annual escalation if THI meets specified revenue parameters.
As of December 31, 2005, the balance of the mezzanine loan receivable was approximately $4.0 million. The THI mezzanine loan bears interest, inclusive of upfront fees, at eighteen percent per annum and is secured by equity pledges in entities that own and operate certain healthcare facilities, plus liens on other healthcare properties, and interests in certain additional properties. In November 2005, THI sold the physical therapy business also securing the THI mezzanine loan and the approximately $5.4 million of proceeds from the sale were applied to repayment of the loan. The THI mezzanine loan matured on November 15, 2005. We have entered into a series of forbearance agreements with THI regarding terms in the THI mezzanine loan documents and the THI master lease. The current forbearance agreement with THI expires on February 28, 2006 and the principal balance of the mezzanine loan as of February 28, 2006 is less than $3.0 million. THI remains current on all lease payments under its lease and has made continuous monthly principal and interest payments under the mezzanine loan. We cannot assure you that we will enter into additional forbearance agreements with THI or that THI will pay us all amounts due under the mezzanine loan or will continue to make all lease payments under the THI master lease.
Note 8-Borrowing Arrangements
The following is a summary of our long-term debt and certain interest rate and maturity information as of December 31, 2005 and 2004:
CMBS Loan
During 2001, we raised $225.0 million in gross proceeds from the completion of the CMBS transaction.
In December 2005, we repaid all of our outstanding indebtedness under the CMBS loan in the outstanding principal amount of $209.8 million at the payoff date with the net proceeds from our sale of the 2016 Senior Notes (as defined below) and borrowings under our revolving credit facility.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Revolving Credit Facility
In September 2004, we entered into a $300.0 million senior secured revolving credit facility, which replaced our previous revolving credit facility. The revolving credit facility expires in September 2007. Subject to the satisfaction of certain conditions, we may extend the revolving credit facility for one year and increase our borrowing capacity to an amount not to exceed $450.0 million. Generally, borrowings outstanding under the revolving credit facility bear interest at a fluctuating LIBOR-based rate per annum plus an applicable percentage ranging from 1.05 percent to 1.75 percent depending on our consolidated leverage ratio. The applicable percentage was 1.45 percent at December 31, 2005. The previous credit facility included revolving borrowings bearing interest at a fluctuating LIBOR-based rate and a term loan. The term loan bore interest at LIBOR plus 2.50 percent and was scheduled to mature in April 2007. Ventas Realty is the borrower and we are the guarantor under the revolving credit facility.
Obligations under the revolving credit facility are secured by liens on certain of Ventas Realty’s real property assets and any related leases, rents and personal property, and, at Ventas Realty’s option, may be secured by certain cash collateral. Currently, 52 real properties owned or leased by Ventas Realty are mortgaged to secure the revolving credit facility. As of December 31, 2005, the net book value of these properties was $114.3 million. As of December 31, 2005, the borrowing base under the revolving credit facility was $300.0 million, the aggregate principal balance of outstanding obligations (excluding outstanding letters of credit of $0.2 million) was $89.2 million and the remaining availability was $210.6 million.
We incurred losses on extinguishment of debt in the amount of $1.4 million for each of the years ended December 31, 2005 and 2004, representing the write-off of unamortized deferred financing costs related to the CMBS loan and our previous revolving credit facility.
The revolving credit facility imposes various restrictions on us, including restrictions pertaining to: (i) the incurrence of additional indebtedness; (ii) liens; (iii) certain dividends, distributions and other payments (the sum of all restricted payments made by us after April 17, 2002 cannot exceed 95 percent of our aggregate cumulative funds from operations (“FFO”)); (iv) mergers, sales of assets and other transactions; (v) the maintenance of minimum consolidated adjusted net worth and certain consolidated leverage and fixed charge coverage ratios; (vi) transactions with affiliates; (vii) permitted business and development activities and uses of loan proceeds; and (viii) changes to material agreements. The revolving credit facility contains usual and customary events of default and is, among other things, cross-defaulted with certain other indebtedness and obligations of Ventas Realty.
Senior Notes
In December 2005, we completed the offerings of $200.0 million aggregate principal amount of 6 1/2% Senior Notes due 2016 (the “2016 Senior Notes”) of the Issuers at a half percent discount to par value.
In June 2005, we completed the offering of 6 3/4% Senior Notes due 2010 of the Issuers, in the aggregate principal amount of $175.0 million (the “2010 Senior Notes”), and 7 1/8% Senior Notes due 2015 of the Issuers, in the aggregate principal amount of $175.0 million (the “2015 Senior Notes”). In June 2005, we also completed the offering of $50.0 million aggregate principal amount of 6 5/8% Senior Notes due 2014 (the “2014 Senior Notes”) of the Issuers, which was in addition to the $125.0 million aggregate principal amount of 2014 Senior Notes originally issued in October 2004. The additional $50.0 million aggregate principal amount of the 2014 Senior Notes was issued at a one percent discount to par value. The additional $50.0 million aggregate principal amount and the original $125.0 million aggregate principal amount of the 2014 Senior Notes are governed by the same indenture.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
In April 2002, we completed the offering of 8 3/4% Senior Notes due 2009 of the Issuers, in the aggregate principal amount of $175.0 million (the “2009 Senior Notes”), and 9% Senior Notes due 2012 of the Issuers, in the aggregate principal amount of $225.0 million (the “2012 Senior Notes”). On December 31, 2002, we purchased $0.8 million principal amount of 2009 Senior Notes and $33.2 million principal amount of 2012 Senior Notes in open market transactions.
The 2016 Senior Notes, 2010 Senior Notes, 2015 Senior Notes, 2014 Senior Notes, 2009 Senior Notes, and 2012 Senior Notes (collectively, the “Senior Notes”) are unconditionally guaranteed, jointly and severally, on a senior unsecured basis by us and by certain of our current and future subsidiaries as described in their respective indentures (collectively, the “Guarantors”). The Senior Notes are part of our general unsecured obligations, rank equal in right of payment with all of our existing and future senior obligations and rank senior to all of our existing and future subordinated indebtedness. However, the Senior Notes are effectively subordinated to all borrowings under our revolving credit facility with respect to the assets securing obligations under the facility.
The Issuers may redeem the 2016 Senior Notes, in whole at any time or in part from time to time, (i) prior to June 1, 2011 at a redemption price equal to 100 percent of the principal amount thereof, plus a make-whole premium as described in the applicable indenture and (ii) on or after June 1, 2011 at varying redemption prices set forth in the applicable indenture, plus, in each case, accrued and unpaid interest thereon to the redemption date. In addition, at any time prior to June 1, 2009, the Issuers may redeem up to 35 percent of the aggregate principal amount of the 2016 Senior Notes with the net cash proceeds from certain equity offerings at a redemption price equal to 106.500 percent of the principal amount thereof, plus accrued and unpaid interest thereon to the redemption date.
The Issuers may redeem the 2010 Senior Notes and the 2015 Senior Notes, in whole at any time or in part from time to time, prior to June 1, 2010 at a redemption price equal to 100 percent of the principal amount thereof, plus accrued and unpaid interest thereon to the redemption date and a make-whole premium as described in the applicable indenture. The Issuers may also redeem the 2015 Senior Notes, in whole at any time or in part from time to time, on or after June 1, 2010 at varying redemption prices set forth in the applicable indenture, plus accrued and unpaid interest thereon to the redemption date. In addition, at any time prior to June 1, 2008, the Issuers may redeem up to 35 percent of the aggregate principal amount of either or both of the 2010 Senior Notes and 2015 Senior Notes with the net cash proceeds from certain equity offerings at redemption prices equal to 106.750 percent and 107.125 percent, respectively, of the principal amount thereof, plus, in each case, accrued and unpaid interest thereon to the redemption date.
The Issuers may redeem the 2014 Senior Notes, in whole at any time or in part from time to time, (i) prior to October 15, 2009 at a redemption price equal to 100 percent of the principal amount thereof, plus a make-whole premium as described in the applicable indenture and (ii) on or after October 15, 2009 at varying redemption prices set forth in the applicable indenture, plus, in each case, accrued and unpaid interest thereon to the redemption date. In addition, at any time prior to October 15, 2007, the Issuers may redeem up to 35 percent of the aggregate principal amount of the 2014 Senior Notes with the net cash proceeds from certain equity offerings at a redemption price equal to 106.625 percent of the principal amount thereof, plus accrued and unpaid interest thereon to the redemption date.
The Issuers may redeem the 2009 Senior Notes and the 2012 Senior Notes, in whole at any time or in part from time to time, at a redemption price equal to 100 percent of the principal amount thereof, plus accrued and unpaid interest thereon to the redemption date and a make-whole premium as described in the applicable indenture.
If we experience certain kinds of changes of control, the Issuers must make an offer to repurchase the Senior Notes, in whole or in part, at a purchase price in cash equal to 101 percent of the principal amount of the Senior
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Notes, plus any accrued and unpaid interest to the date of purchase; provided, however, that in the event Moody’s and S&P have confirmed their ratings at Ba3 or higher and BB- or higher on the Senior Notes and certain other conditions are met, this repurchase obligation will not apply.
The indentures governing the Senior Notes contain covenants that limit our ability and the ability of certain of our subsidiaries (collectively, the “Restricted Group”) to, among other things: (i) incur debt; (ii) incur secured debt; (iii) make certain dividends, distributions and investments (the sum of all restricted payments made by us cannot exceed 95 percent of our aggregate cumulative FFO from April 2002); (iv) enter into certain transactions, including transactions with affiliates; (v) subject our subsidiaries to restrictions on dividends or other payments to us; (vi) merge, consolidate or transfer all or substantially all of the Restricted Group’s assets; and (vii) sell assets. The Restricted Group is also required to maintain total unencumbered assets of at least 150 percent of the Restricted Group’s unsecured debt.
Other Mortgages
At December 31, 2005, we had outstanding 50 mortgage loans that we assumed in connection with various acquisitions. Outstanding principal balances on these loans ranged from $0.4 million to $60.9 million as of December 31, 2005. The loans bear interest at fixed rates ranging from 5.6 percent to 8.5 percent per annum, except with respect to nine loans with outstanding principal balances ranging from $4.5 million to $32.0 million, which bear interest at the lender’s variable rates, ranging from 3.52 percent to 7.25 percent per annum at of December 31, 2005. The fixed rate debt bears interest at a weighted average annual rate of 7.09 percent and the variable rate debt bears interest at a weighted average annual rate of 4.11 percent as of December 31, 2005. The loans had a weighted average maturity of ten years as of December 31, 2005.
Scheduled Maturities of Borrowing Arrangements
As of December 31, 2005, our indebtedness has the following maturities (in thousands):
Derivatives and Hedging
In the normal course of business, we are exposed to the effect of interest rate changes. We limit these risks by following established risk management policies and procedures including the use of derivatives. For interest rate exposures, derivatives are used primarily to fix the rate on debt based on floating-rate indices and to manage the cost of borrowing obligations. We currently have an interest rate swap to manage interest rate risk (the “2003-2008 Swap”). We prohibit the use of derivative instruments for trading or speculative purposes. Further, we have a policy of only entering into contracts with major financial institutions based upon their credit ratings and other factors. When viewed in conjunction with the underlying and offsetting exposure that the derivative is designed to hedge, we do not anticipate any material adverse effect on our net income or financial position in the future from the use of derivatives.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
In 1998, we entered into an interest rate swap in the notional amount of $800.0 million (the “1998 Swap”) that was treated as a cash flow hedge. In 1999, we shortened the maturity of the 1998 Swap in exchange for a payment to us of $21.6 million, which was recorded as other comprehensive income. We began amortizing this deferred gain out of accumulated other comprehensive income in July 2003, the amended expiration date of the 1998 Swap, and will continue such amortization through December 2007, the original expiration date of the 1998 Swap.
In 2001, we entered into the 2003-2008 Swap in the notional amount of $450.0 million to hedge floating-rate debt for the period between July 1, 2003 and June 30, 2008, under which we pay a fixed rate at 5.385 percent and receive LIBOR from the counterparty to the agreement. The 2003-2008 Swap is treated as a cash flow hedge. In December 2003, we received unanticipated cash proceeds from the sale of various facilities to Kindred, thereby reducing our expected future variable rate debt balances. Accordingly, we entered into an agreement with the counterparty to reduce the notional amount of the 2003-2008 Swap to $330.0 million in exchange for a payment from us of approximately $8.6 million. This partial swap breakage cost and $3.4 million of the deferred gain were recognized as a net expense of $5.2 million in the Consolidated Statement of Income for the year ended December 31, 2003.
In December 2005, we refinanced our existing variable rate CMBS loan with the issuance of fixed rate 2016 Senior Notes, thereby reducing our expected future variable rate debt balances. Accordingly, we entered into an agreement with the counterparty to further reduce the notional amount of the 2003-2008 Swap to $100.0 million for its remaining term in exchange for a payment from us of approximately $2.3 million. This partial swap breakage cost and $3.3 million of the deferred gain were recognized as a net gain of approximately $1.0 million in the Consolidated Statement of Income for the year ended December 31, 2005.
Amortization of the deferred gain in accumulated other comprehensive income was $2.2 million and $2.3 million for the years ended December 31, 2005 and 2004, respectively. As of December 31, 2005, the remaining deferred gain in accumulated other comprehensive income was $1.4 million which will continue to be amortized through December 2007.
Unrealized gains and losses on the 2003-2008 Swap are recorded as other comprehensive income. The amounts reclassified into interest expense due to the swaps for the years ended December 31, 2005, 2004 and 2003 were $6.9 million, $13.3 million and $19.2 million, respectively. Assuming no changes in interest rates, we estimate that approximately $0.6 million of the current balance recorded in accumulated other comprehensive income will be recognized as interest expense within the next twelve months consistent with historical reporting. For the years ended December 31, 2004 and 2003, $0.5 million and $0.3 million, respectively, of the unrealized loss on the swaps previously reported in accumulated other comprehensive income was reclassified to interest expense to reflect the excess of the notional amount of the swaps over the anticipated variable rate debt balances in the future. No amount was reflected as interest expense for the year ended December 31, 2005 as we anticipated our variable rate debt balances to approximate the $100.0 million notional amount of the 2003-2008 Swap.
There are no collateral requirements under the 2003-2008 Swap. We are exposed to credit loss in the event of the non-performance by the counterparty to an interest rate swap agreement. However, we do not anticipate non-performance by the counterparty. The notional amount of the 2003-2008 Swap at December 31, 2005 was $100.0 million and is scheduled to expire on June 30, 2008.
At December 31, 2005, the 2003-2008 Swap was reported at its fair value of $1.6 million in the liabilities section of the Consolidated Balance Sheet. The offsetting entry is reported as a deferred loss in accumulated other comprehensive loss.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 9-Fair Values of Financial Instruments
As of December 31, 2005 and 2004, the carrying amounts and fair values of our financial instruments were as follows:
Fair value estimates are subjective in nature and depend on a number of important assumptions, including estimates of future cash flows, risks, discount rates and relevant comparable market information associated with each financial instrument. The use of different market assumptions and estimation methodologies may have a material effect on the reported estimated fair value amounts. Accordingly, the estimates presented above are not necessarily indicative of the amounts we would realize in a current market exchange.
Note 10-Compensation Plans
Stock Options and Restricted Stock
We have five plans under which options to purchase common stock and/or shares of restricted stock have been, or may be, granted to officers, employees and non-employee directors, one plan under which executive officers may receive common stock in lieu of compensation and two plans under which certain directors may receive common stock in lieu of director fees (the following are collectively referred to as the “Plans”): (1) the 1987 Incentive Compensation Program (Employee Plan); (2) the 2000 Incentive Compensation Plan (Employee Plan); (3) the 1987 Stock Option Plan for Non-Employee Directors; (4) the 2004 Stock Plan for Directors; (5) the TheraTx, Incorporated 1996 Stock Option/Stock Issuance Plan; (6) the Executive Deferred Stock Compensation Plan; (7) the Common Stock Purchase Plan for Directors (the “Directors Stock Purchase Plan”); and (8) the Nonemployee Director Deferred Stock Compensation Plan.
Under the Plans (other than the Executive Deferred Stock Compensation Plan, the Directors Stock Purchase Plan and the Nonemployee Director Deferred Stock Compensation Plan), options are exercisable at the market price on the date of grant, expire ten years from the date of grant, and vest over varying periods ranging from one to four years. As of December 31, 2005, options for 1,303,420 shares had been granted to eligible participants and remained outstanding under the Plans.
We have also granted options and restricted stock to certain officers, employees and non-employee directors outside of the Plans. These options and shares of restricted stock vest over varying periods, and the options are exercisable at the market price on the date of grant and expire ten years from the date of grant. As of December 31, 2005, options for 38,000 shares had been granted outside of the Plans to certain employees and non-employee directors and remained outstanding.
We granted 70,127, 68,271 and 157,934 shares of restricted stock during the years ended December 31, 2005, 2004 and 2003, respectively. The market value of these shares on the date of the award has been recorded as unearned compensation on restricted stock, with the unamortized balance shown as a separate component of stockholders’ equity. Unearned compensation is amortized to expense over the vesting period, with charges to operations of approximately $1.2 million in 2005 and 2004 and $1.3 million in 2003.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
New option and restricted stock grants and stock issuances may only be made under the 2000 Incentive Compensation Plan (Employee Plan), the Executive Deferred Stock Compensation Plan, the 2004 Stock Plan for Directors, the Directors Stock Purchase Plan and the Nonemployee Director Deferred Stock Compensation Plan. The number of shares reserved and the number of shares available for future grants or issuance under these plans as of December 31, 2005 are as follows:
•
2000 Incentive Compensation Plan (Employee Plan)-5,620,000 shares are reserved for grants to be issued to employees and, as of December 31, 2005, 883,248 shares were available for future grants. The 2000 Incentive Compensation Plan (Employee Plan) expires on December 31, 2006 and no additional grants thereunder will be permitted after that date.
•
Executive Deferred Stock Compensation Plan-500,000 shares are reserved for issuance to our executive officers in lieu of the payment of all or a portion of their salary, at their option, and, as of December 31, 2005, 500,000 shares were available for future issuance.
•
2004 Stock Plan for Directors-200,000 shares are reserved for grants or issuance to the chairman of the board and non-employee directors and, as of December 31, 2005, 176,750 shares were available for future grants or issuance. The 2004 Stock Plan for Directors expires on December 31, 2006 and no additional grants thereunder will be permitted after that date.
•
Directors Stock Purchase Plan-200,000 shares are reserved for issuance to the chairman of the board and non-employee directors in lieu of the payment of all or a portion of their retainer and meeting fees, at their option, and, as of December 31, 2005, 164,278 shares were available for future issuance.
•
Nonemployee Director Deferred Stock Compensation Plan-500,000 shares are reserved for issuance to nonemployee directors in lieu of the payment of all or a portion of their retainer and meeting fees, at their option, and, as of December 31, 2005, 488,512 shares were available for future issuance.
No additional grants are permitted under the 1987 Incentive Compensation Program (Employee Plan), the 1987 Stock Option Plan for Non-Employee Directors or the TheraTx, Incorporated 1996 Stock Option/Stock Issuance Plan. As a result, the shares reserved under these three Plans equal the options outstanding under such Plans. As of December 31, 2005, we had reserved 65,159 shares for issuance under these Plans.
The following is a summary of stock option activity in 2005, 2004 and 2003:
A. 2005 Activity
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
B. 2004 Activity
C. 2003 Activity
A summary of stock options outstanding at December 31, 2005 follows:
In 1995, FASB issued SFAS No. 123. This standard prescribes a fair value based method of accounting for employee stock options or similar equity instruments and requires certain pro forma disclosures. For purposes of the pro forma disclosures required under SFAS No. 123, the estimated fair value of the options granted during the years ended December 31, 2005, 2004 and 2003 was $854,300, $824,700 and $235,500, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to all stock-based employee compensation.
In determining the estimated fair value of our stock options as of the date of grant, we used the Black-Scholes option pricing model with the following assumptions:
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because our employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our employee stock options.
In December 2004, FASB issued SFAS No. 123(R), which is a revision to SFAS No. 123 and requires all share-based payments to employees, including stock option grants, to be recognized in the income statement based on their fair values. On January 1, 2006, we adopted SFAS No. 123(R) and are now recognizing compensation cost for all share-based payments to employees granted after that date and for all awards previously granted that remained unvested on that date. While the effect of adoption cannot be predicted at this time because it will depend on levels of share-based payments granted in the future, the effect of this accounting standard on our prior operating results would approximate the effect of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share set forth above.
Employee and Director Stock Purchase Plan
During 2005, we implemented the Ventas Employee and Director Stock Purchase Plan (“ESPP”) under which our employees and directors may purchase shares of our common stock at a discount. Pursuant to the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
terms of the ESPP, on each purchase date, participants may purchase shares of common stock at a price not less than 90 percent of the market price on that date, with respect to the employee tax-favored portion of the plan, and not less than 95 percent of the market price on that date, with respect to the additional employee and director portion of the plan. We have reserved 2,500,000 shares for issuance under the ESPP. As of December 31, 2005, 4,530 shares had been purchased under the ESPP and 2,495,470 shares were available for future issuance.
Employee Benefit Plan
We maintain a 401(K) plan that allows for eligible employees to defer compensation subject to certain limitations imposed by the Internal Revenue Code. We make a contribution for each qualifying employee of up to 3 percent of his or her salary, subject to limitations, regardless of the employee’s individual contribution. During 2005, 2004 and 2003, our contributions were approximately $78,000, $62,000 and $62,000, respectively.
Note 11-Income Taxes
We have elected to be taxed as a REIT under the Internal Revenue Code commencing with the year ended December 31, 1999. We intend to continue to operate in such a manner as to enable us to qualify as a REIT. Our actual qualification and taxation as a REIT depends upon our ability to meet, on a continuing basis, distribution levels, stock ownership, and the various qualification tests. During the years ended December 31, 2005, 2004 and 2003, our tax treatment of distributions was as follows:
No net provision for income taxes has been recorded in the Consolidated Financial Statements for the years ended December 31, 2005 and 2004 due to our belief that we qualified as a REIT and the distribution of more than 100 percent of our 2005 and 2004 taxable income as a dividend.
We believe we have met the annual distribution requirement by payment of at least 90 percent of our estimated taxable income for 2005, 2004 and 2003.
Net taxable income for federal income tax purposes results from net income for financial reporting purposes adjusted for the differences between the financial reporting and tax bases of assets and liabilities, including depreciation, prepaid rent, impairment losses on real estate, the United States Settlement liability, and the interest rate swap agreement. The net difference between tax bases and the reported amount of our assets and liabilities for federal income tax purposes was approximately $489.5 million less than the book bases of those assets and liabilities for financial reporting purposes for the year ended December 31, 2005. For the year ended December 31, 2004, the net difference between tax bases and the reported amount of our assets and liabilities for federal income tax purposes was $91.9 million more than the book bases of those assets and liabilities for financial reporting purposes.
We made no income tax payments for the years ended December 31, 2005, 2004 and 2003.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
We potentially remain subject to corporate level taxes for any asset dispositions during the ten-year period immediately after the assets were owned by a C corporation (either prior to our REIT election, through stock acquisition or merger) (“built-in gains tax”). The amount of income potentially subject to this special corporate level tax is generally equal to the lesser of (i) the excess of the fair value of the asset over its adjusted tax basis as of the date it became a REIT asset or (ii) the actual amount of gain. Some but not all future gains could be offset by available net operating losses. The deferred income tax liability of $30.4 million at December 31, 2005 and 2004 reflects a previously established liability to be utilized for any built-in gains tax incurred.
In 2003, we reported an increase of approximately $20.2 million to our operating results, reflecting the reversal of a previously recorded contingent liability. This contingent liability was previously recorded on the Consolidated Balance Sheet to take into account the uncertainties surrounding the outcome of the IRS audit for our 1997 and 1998 tax periods as well as other federal, state, local, franchise and miscellaneous tax items. As in certain prior periods, the IRS is currently reviewing our federal income tax return for the year ended December 31, 2001. As of December 31, 2005 and 2004, the total contingent liability was $1.8 million.
We have a net operating loss carryforward of $86.2 million at December 31, 2005. This amount can be used to offset future taxable income (and/or taxable income for prior years if audits of any prior year’s return determine that amounts are owed), if any, remaining after the dividends paid deduction. We will be entitled to utilize NOLs and tax credit carryforwards only to the extent that REIT taxable income exceeds our deduction for dividends paid. The NOL carryforwards begin to expire in 2018. The availability of the carryforwards are subject to the results of the ongoing IRS examination for the prior tax years.
As a result of the uncertainties relating to the ultimate utilization of favorable tax attributes described above, no net deferred tax benefit has been ascribed to net operating loss carryforwards as of December 31, 2005 and 2004. The IRS may challenge our entitlement to these tax attributes during its review of the tax returns for the previous tax years. We believe we are entitled to these tax attributes, but we cannot assure you as to the outcome of these matters.
Note 12-Commitments and Contingencies
Assumption of Certain Operating Liabilities and Litigation
In connection with our spin off of Kindred in 1998, Kindred agreed, among other things, to assume all liabilities and to indemnify, defend and hold us harmless from and against certain losses, claims and litigation arising out of the ownership or operation of the healthcare operations or any of the assets transferred to Kindred in the spin off, including without limitation all claims arising out of the third-party leases and third-party guarantees assigned to and assumed by Kindred at the time of the spin off. Under Kindred’s plan of reorganization, Kindred assumed and agreed to fulfill these obligations. The total aggregate remaining minimum rental payments under the third-party leases was approximately $21.6 million as of December 31, 2005 and we believe that we had no material exposure under the third-party guarantees.
Similarly, in connection with Provident’s acquisition of certain Brookdale-related and Alterra-related entities in 2004 and our subsequent acquisition of Provident, Brookdale and Alterra agreed, among other things, to indemnify and hold Provident (and, as a result of the Provident acquisition, us) harmless from and against certain liabilities arising out of the ownership or operation of such entities prior to their acquisition by Provident.
There can be no assurance that Kindred, Brookdale and Alterra will have sufficient assets, income and access to financing to enable them to satisfy, or that they will be willing to satisfy, their respective obligations under these arrangements. If Kindred, Brookdale or Alterra does not satisfy or otherwise honor its obligations to
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
indemnify, defend and hold us harmless under its respective contractual arrangements with us, then we may be liable for the payment and performance of such obligations and may have to assume the defense of such claims or litigation, which could have a material adverse effect on our business, financial condition, results of operation and liquidity, on our ability to service our indebtedness and on our ability to make distributions to our stockholders as required to maintain our status as a REIT.
Kindred Common Stock
In connection with Kindred’s emergence from bankruptcy in April 2001, we received 1,498,500 shares of Kindred common stock, representing not more than 9.99 percent of the then issued and outstanding common stock of Kindred. Based on applicable laws, regulations, advice from experts, an appraisal, the trading performance of Kindred common stock at the time and other appropriate facts and circumstances, the illiquidity and lack of registration of the Kindred common stock when received and our lack of significant influence over Kindred, we determined the value of the Kindred common stock to be $18.2 million on the date of issuance. The Kindred common stock was issued to us as additional future rent in consideration of our agreement to charge the base rent as provided in the Kindred Master Leases.
Prior to 2003, we sold 577,686 shares of our Kindred common stock. During the year ended December 31, 2003, we sold the remaining 920,814 shares of Kindred common stock that we held and recognized a gain of $9.0 million. We have not held any Kindred common stock since 2003.
Settlement of United States Claims
The 2003 Consolidated Statement of Income includes a $4.9 million expense related to our early repayment of the obligations due under our prior year settlement agreement with the United States Department of Justice.
Brookdale Leases
Subject to certain limitations and restrictions, if during the first six years of the initial term of our Brookdale leases assumed in connection with the Provident acquisition we, either voluntarily or at Brookdale’s request, obtain new mortgage debt or refinance existing mortgage debt on property covered by a Brookdale lease, then we may be required to pay Brookdale the net proceeds from any such mortgage debt financing or refinancing. Also, subject to certain limitations and conditions, Brookdale may request that we obtain new mortgage debt or refinance existing mortgage debt on the property covered by the Brookdale leases, and we have agreed to use commercially reasonable efforts to pursue any such financing or refinancing from the holder of the then existing mortgage debt on the applicable Brookdale property. In connection with any such financing or refinancing, the rent for the applicable Brookdale property will be increased using a recomputed lease basis increased by an amount equal to the net financed proceeds paid to Brookdale plus any fees, penalties, premiums or other costs related to such financing or refinancing. In addition, if the monthly debt service on any financed or refinanced proceeds paid to Brookdale exceeds the rent increase attributable to those financed or refinanced proceeds, then Brookdale is required to pay the excess. In addition, under certain circumstances, Brookdale will also be required to pay additional amounts relating to increases in debt service and other costs relating to any such financing or refinancing.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 13-Earnings Per Share
The following table shows the amounts used in computing basic and diluted earnings per share:
There were no anti-dilutive options outstanding for the years ended December 31, 2005 and 2004. Options to purchase 1.1 million shares of common stock at exercise prices ranging from $15.69 to $24.47 were outstanding at December 31, 2003, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares for the year ended December 31, 2003 and, therefore, the effect would be anti-dilutive.
Note 14-Litigation
Legal Proceedings Presently Defended and Indemnified by Third Parties
The following litigation and other matters arose from our operations prior to the time of our spin off of Kindred in May 1998 or relate to assets or liabilities transferred to Kindred in connection with the spin off. Under the agreements we entered into with Kindred at the time of the spin off, Kindred assumed the defense, on our behalf, of the matters described below, among others, and has indemnified us for any fees, costs, expenses and liabilities related to these matters (the “Indemnification”). Under Kindred’s plan of reorganization, Kindred assumed and agreed to abide by the Indemnification and to defend us in these and other matters as required under the spin agreements. However, there can be no assurance that Kindred will continue to defend us in these matters or that Kindred will have sufficient assets, income and access to financing to enable it to satisfy such obligations
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
or its obligations incurred in connection with the spin off. In addition, the following descriptions are based primarily on information included in Kindred’s public filings and information provided to us by Kindred. There can be no assurance that Kindred has included in its public filings and provided us complete and accurate information in all instances.
A stockholder derivative suit entitled Thomas G. White on behalf of Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98 C103669 was filed in June 1998 in the Circuit Court of Jefferson County, Kentucky. The complaint alleges, among other things, that certain former officers and directors damaged our company by engaging in breaches of fiduciary duty, insider trading, fraud and securities fraud and damaging our reputation. The suit seeks unspecified damages, interest, punitive damages, reasonable attorneys’ fees, other costs, and any extraordinary equitable and/or injunctive relief permitted by law or equity to assure the plaintiff has an effective remedy. We believe the allegations in the complaint are without merit. In September 2003, Kindred filed a motion to dismiss this action as to all defendants, including us, based on plaintiff’s failure to make demand for remedy upon the appropriate Board of Directors. On July 26, 2005, the Court granted Kindred’s motion and dismissed this action in its entirety. The plaintiff has appealed to the Kentucky Court of Appeals, and the parties are completing their briefing. Kindred has indicated that it intends to continue to defend this action vigorously on our behalf. We are unable at this time to estimate the possible loss or range of loss for this action and, therefore, no provision for liability, if any, resulting from this litigation has been made in the Consolidated Financial Statements as of December 31, 2005.
Kindred, Brookdale and Alterra are parties to certain legal actions and regulatory investigations arising in the normal course of their business. There can be no assurance that the resolution of any litigation or investigations, either individually or in the aggregate, would not have a material adverse effect on Kindred’s, Brookdale’s or Alterra’s liquidity, financial position or results of operations, which in turn could have a material adverse effect on us.
Other Litigation
We are a plaintiff in an action seeking a declaratory judgment and damages entitled Ventas Realty, Limited Partnership et al. v. Black Diamond CLO 1998-1 Ltd., et al., Case No. 99 C107076, filed November 22, 1999 in the Circuit Court of Jefferson County, Kentucky. Two of the three defendants in that action, Black Diamond International Funding, Ltd. and BDC Finance, LLC (collectively “Black Diamond”), have asserted counterclaims against us under theories of breach of contract, tortious interference with contract and abuse of process. We dispute the material allegations contained in Black Diamond’s counterclaims and we intend to continue to pursue its claims and defend the counterclaims vigorously. We are unable at this time to estimate the possible loss or range of loss for the counterclaims in this action, and therefore, no provision for liability, if any, resulting from this litigation has been made in our Consolidated Financial Statements as of December 31, 2005.
During the fourth quarter of 2005, we settled the action entitled Ventas, Inc. v. Sullivan & Cromwell, Case No. 02-5232, filed by us on June 27, 2002 in the Superior Court of the District of Columbia. The complaint asserted claims of legal malpractice and breach of fiduciary duty by Sullivan & Cromwell in connection with its legal representation of us in our spin off of Kindred. Under the terms of the settlement, a $25.5 million payment was made to us on behalf of Sullivan & Cromwell in the fourth quarter of 2005. After payment of expenses for this action, including the contingent fee for our outside legal counsel, we received approximately $15.9 million in net proceeds from the settlement, which we used to establish a charitable foundation, to repay debt and for other corporate purposes.
We are party to various other lawsuits arising in the normal course of our business. It is the opinion of management that, except as set forth in this Note 14, the disposition of these lawsuits will not, individually or in
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
the aggregate, have a material adverse effect on us. If management’s assessment of our liability with respect to these actions is incorrect, such lawsuits could have a material adverse effect on us.
No provision for liability, if any, resulting from the aforementioned litigation has been made in our Consolidated Financial Statements as of December 31, 2005.
Note 15-Capital Stock
The authorized capital stock at December 31, 2005, 2004 and 2003 consisted of 180,000,000 shares of common stock, par value of $0.25 per share, and 10,000,000 shares of preferred stock, par value $1.00 per share, of which 65,000 shares have been designated as Series A Preferred Stock and 300,000 shares have been designated Series A Participating Preferred Stock.
We have an effective registration statement on Form S-3 relating to the sale from time to time of up to $750.0 million aggregate offering price of common stock, preferred stock, subsidiary debt securities and related guarantees, depository shares and warrants. As of December 31, 2005, approximately $501.0 million of securities remained available for offering under the shelf registration statement.
In July 2005, we completed the sale of 3,247,000 shares of our common stock in an underwritten public offering pursuant to the shelf registration statement. We received $97.0 million in net proceeds from the sale, which we used to repay indebtedness under our revolving credit facility and for general corporate purposes, including the funding of acquisitions.
In March 2004, we completed the sale of 2,000,000 shares of our common stock in an underwritten public offering pursuant to the shelf registration statement. We received $51.1 million in net proceeds from the sale, which we used to repay indebtedness under the revolving credit facility and for general corporate purposes, including the funding of acquisitions.
Excess Share Provision
In order to preserve our ability to maintain REIT status, our certificate of incorporation provides that if a person acquires beneficial ownership of greater than nine percent of our outstanding common stock or 9.9 percent of our outstanding preferred stock, the shares that are beneficially owned in excess of such limit are deemed to be excess shares. These shares are automatically deemed transferred to a trust for the benefit of a charitable institution or other qualifying organization selected by our Board of Directors. The trust is entitled to all dividends with respect to the shares and the trustee may exercise all voting power over the shares.
We have the right to buy the excess shares for a purchase price equal to the lesser of (i) the price per share in the transaction that created the excess shares, or (ii) the market price on the date we buy the shares, and we may defer payment of the purchase price for the excess shares for up to five years. If we do not purchase the excess shares, the trustee of the trust is required to transfer the excess shares at the direction of the Board of Directors. The owner of the excess shares is entitled to receive the lesser of the proceeds from the sale of the excess shares or the original purchase price for such excess shares; any additional amounts are payable to the beneficiary of the trust.
The Board of Directors is empowered to grant waivers from the excess share provisions of our Certificate of Incorporation. In June 2003, we granted a waiver (the “C&S Waiver”) from the nine percent ownership limitation provisions of our Certificate of Incorporation to Cohen & Steers Capital Management, Inc. (“C&S”). Under the C&S Waiver, C&S may beneficially own, in the aggregate, up to fourteen percent in number of shares or value of our common stock.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Distribution Reinvestment and Stock Purchase Plan
We have a Distribution Reinvestment and Stock Purchase Plan. Under the plan’s terms, existing stockholders may purchase shares of common stock by reinvesting all or a portion of the cash distribution on their shares of our common stock. In addition, existing stockholders, as well as new investors, may purchase shares of common stock by making optional cash payments. In March 2005, we began offering a one percent discount on the purchase price of our stock to shareholders who reinvest their dividends and/or make optional cash purchases of common stock through the plan. In 2004, we offered a two percent discount on the purchase price of our stock to shareholders that participated in the plan. The availability of a market discount is at our discretion. The granting of a discount for one month or quarter, as applicable, will not insure the availability of a discount or the same discount in future months or quarters, respectively. Each month or quarter, as applicable, we may lower or eliminate the discount without prior notice. We may also, without prior notice, change our determination as to whether common shares will be purchased by the plan administrator directly from us or in the open market.
Note 16-Related Party Transactions
At December 31, 2005 and 2004, we had receivables of approximately $2.8 million and $3.2 million, respectively, due from certain current and former executive officers. The loans include interest provisions (with a 4.9 percent average annual interest rate) and were to finance the income taxes payable by the executive officers resulting from: (i) our 1998 spin off of Kindred and (ii) vesting of restricted shares. The loans are payable over a period of ten years. Interest on a note relating to the spin off in the principal amount of $1.1 million at December 31, 2005 (the “Spin Off Note”), is paid on a quarterly basis. The payee of the Spin Off Note resigned as an employee and director of Ventas in January 2003. In the event of a change in control, as defined in our previous 1997 Incentive Compensation Plan, accrued interest on and the principal balance of the Spin Off Note is forgiven. Interest on the note relating to taxes paid for the vested portion of restricted shares (the “Restricted Share Note”) is payable annually out of and only to the extent of dividends from the vested restricted shares. In the event of a change in control (as defined in the relevant employment agreement) or upon termination of the officer without cause (as defined in the relevant employment agreement), the principal balance of the Restricted Share Note is forgiven. The Restricted Share Note is secured by a pledge of all of the restricted shares to which the Restricted Share Note relates and the Restricted Share Note is otherwise non-recourse. The Spin Off Note is not secured.
During 1998, we acquired eight personal care facilities and related facilities for approximately $7.1 million from Tangram Rehabilitation Network, Inc. (“Tangram”). Tangram is a wholly owned subsidiary of Res-Care, Inc. (“Res-Care”) of which a member of our Board of Directors is the Chairman, President and Chief Executive Officer. We lease the Tangram facilities to Tangram pursuant to a master lease agreement which is guaranteed by Res-Care. For the years ended December 31, 2005, 2004 and 2003, Tangram has paid us approximately $863,000, $834,000 and $816,000, respectively, in base rent payments.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 17-Quarterly Financial Information (Unaudited)
Summarized unaudited consolidated quarterly information for the years ended December 31, 2005 and 2004 is provided below.
(1) The amounts presented for the three months ended March 31, 2005, June 30, 2005 and September 30, 2005 are not equal to the same amounts previously reported in our quarterly reports on Form 10-Q for each period as a result of discontinued operations consisting of properties sold in fourth quarter 2005. The following is a reconciliation to the amounts previously reported in the Form 10-Q:
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(1) The amounts presented for the three months ended March 31, 2004, June 30, 2004 and September 30, 2004 are not equal to the same amounts previously reported in our quarterly reports on Form 10-Q for each period as a result of discontinued operations consisting of properties sold in fourth quarter 2004. The following is a reconciliation to the amounts previously reported in the Form 10-Q:
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 18-Condensed Consolidating Information
We and certain of our direct and indirect wholly owned subsidiaries (the “Wholly Owned Subsidiary Guarantors”) have fully and unconditionally guaranteed, on a joint and several basis, the obligation to pay principal and interest with respect to the Senior Notes of the Issuers. ETOP, of which we own substantially all of the partnership units, and certain of its wholly owned subsidiaries (the “ETOP Subsidiary Guarantors” and collectively, with the Wholly Owned Subsidiary Guarantors, the “Guarantors”), have also provided a guarantee, on a joint and several basis, of the Senior Notes. We have other subsidiaries (“Non-Guarantor Subsidiaries”) that are not included among the Guarantors, and such subsidiaries are not obligated with respect to the Senior Notes. Contractual and legal restrictions, including those contained in the instruments governing certain Non-Guarantor Subsidiaries’ outstanding indebtedness, may under certain circumstances restrict our ability to obtain cash from our Non-Guarantor Subsidiaries for the purpose of meeting our debt service obligations, including our guarantee of payment of principal and interest on the Senior Notes. Additionally, as of December 31, 2005, approximately $114.3 million of the net assets of Ventas Realty were mortgaged to secure our revolving credit facility. Certain of our real estate assets are also subject to mortgages. The following summarizes our condensed consolidating information as of December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005:
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING BALANCE SHEET
As of December 31, 2005
(a) Ventas Capital is a wholly owned direct subsidiary of Ventas Realty that was formed to facilitate the offering of the Senior Notes and has no assets or operations.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING BALANCE SHEET
As of December 31, 2004
(a) Ventas Capital is a wholly owned direct subsidiary of Ventas Realty that was formed to facilitate the offering of the Senior Notes and has no assets or operations.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the year ended December 31, 2005
(a) Ventas Capital is a wholly owned direct subsidiary of Ventas Realty that was formed to facilitate the offering of the Senior Notes and has no assets or operations.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the year ended December 31, 2004
(a) Ventas Capital is a wholly owned direct subsidiary of Ventas Realty that was formed to facilitate the offering of the Senior Notes and has no assets or operations.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the year ended December 31, 2003
(a) Ventas Capital is a wholly owned direct subsidiary of Ventas Realty that was formed to facilitate the offering of the Senior Notes and has no assets or operations.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2005
(a) Ventas Capital is a wholly owned direct subsidiary of Ventas Realty that was formed to facilitate the offering of the Senior Notes and has no assets or operations.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2004
(a) Ventas Capital is a wholly owned direct subsidiary of Ventas Realty that was formed to facilitate the offering of the Senior Notes and has no assets or operations.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2003
(a) Ventas Capital is a wholly owned direct subsidiary of Ventas Realty that was formed to facilitate the offering of the Senior Notes and has no assets or operations.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Note 19-ETOP Condensed Consolidating Information
ETOP, of which we own substantially all of the partnership interests, and the ETOP Subsidiary Guarantors have provided full and unconditional guarantees, on a joint and several basis with us and certain of our direct and indirect wholly owned subsidiaries, of the obligation to pay principal and interest with respect to the Senior Notes. See “Note 18-Condensed Consolidating Information.” Certain of ETOP’s other direct and indirect wholly owned subsidiaries (the “ETOP Non-Guarantor Subsidiaries”) that have not provided the Guarantee of the Senior Notes are therefore not directly obligated with respect to the Senior Notes.
Contractual and legal restrictions, including those contained in the instruments governing certain of the ETOP Non-Guarantor Subsidiaries’ outstanding indebtedness, may under certain circumstances restrict ETOP’s (and therefore our) ability to obtain cash from the ETOP Non-Guarantor Subsidiaries for the purpose of satisfying ETOP’s and our debt service obligations, including ETOP’s and our guarantee of payment of principal and interest on the Senior Notes. See “Note 8-Borrowing Arrangements.” Certain of the ETOP Subsidiary Guarantors’ properties are subject to mortgages.
For comparative purposes, the ETOP Condensed Consolidating Financial Statements for the periods prior to the ElderTrust merger are presented as “Predecessor Company” financial statements and are not included as part of our Condensed Consolidating Financial Statements for those periods.
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING BALANCE SHEET
As of December 31, 2005
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING BALANCE SHEET
As of December 31, 2004
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the year ended December 31, 2005
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the period from February 5, 2004 through December 31, 2004
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
PREDECESSOR COMPANY CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the period from January 1, 2004 through February 4, 2004
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
PREDECESSOR COMPANY CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the year ended December 31, 2003
(unaudited)
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2005
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the period from February 5, 2004 through December 31, 2004
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
PREDECESSOR COMPANY CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the period from January 1, 2004 through February 4, 2004
VENTAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
PREDECESSOR COMPANY CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2003
(unaudited)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(Dollars in Thousands)
VENTAS, INC.
SCHEDULE III
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(In thousands)
ITEM 9.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Not applicable.
ITEM 9A.
ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure that material information relating to us is timely communicated to the officers who certify our financial reports and to other members of our management and Board of Directors.
Based upon their evaluation as of December 31, 2005, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are effective to ensure that information required to be disclosed by us in our Exchange Act filings is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.
Internal Control Over Financial Reporting
The information set forth under “Management Report on Internal Control over Financial Reporting” and “Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting” included in Part II, Item 8 of this Annual Report on Form 10-K is incorporated by reference into this Item 9A.
During the fourth quarter of 2005, there were no changes in our internal control over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, those controls.
ITEM 9B.
ITEM 9B. Other Information
Not applicable.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant
The information required by this Item 10 is incorporated by reference to our definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which we will file with the Commission not later than April 30, 2006.
ITEM 11.
ITEM 11. Executive Compensation
The information required by this Item 11 is incorporated by reference to our definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which we will file with the Commission not later than April 30, 2006.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information set forth under “Securities Authorized for Issuance Under Equity Compensation Plans” included in Part II, Item 5 of this Annual Report on Form 10-K is incorporated by reference into this Item 12. The information relating to security ownership of certain beneficial owners and management required by this Item 12 is incorporated by reference to our definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which we will file with the Commission not later than April 30, 2006.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions
The information required by this Item 13 is incorporated by reference to our definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which we will file with the Commission not later than April 30, 2006.
ITEM 14.
ITEM 14. Principal Accountant Fees and Services
The information required by this Item 14 is incorporated by reference to our definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which we will file with the Commission not later than April 30, 2006.
PART IV
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules
Financial Statements and Financial Statement Schedules
The following documents have been included in Part II, Item 8 of this Annual Report on Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003
Notes to Consolidated Financial Statements
Consolidated Financial Statement Schedule
Schedule III-Real Estate and Accumulated Depreciation
All other schedules have been omitted because they are inapplicable, not required or the information is included elsewhere in the Consolidated Financial Statements or notes thereto.
Exhibits
* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 15(c) of Form 10-K
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: February 28, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX