UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

 

For the fiscal year ended December 31, 2016

 

OR

 

For the transition period from             to             

 

Commission file number 001-37805

Quality Care Properties, Inc.

(Exact name of registrant as specified in its charter)

 

 

7315 Wisconsin Avenue, Suite 250 West

Bethesda, Maryland 20814

(Address of principal executive offices)

 

(240) 223-4680

(Registrant’s telephone number, including area code)

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

 

 

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

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☐ No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ☐ No ☒

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).  Yes ☒ No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by referenct in Part III of this Form 10-K or any amendment to this Form 10-K.  ☒

 

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

 

 

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

 

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asking price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter:  Not applicable because the Spin-Off (defined within Part I of this Report) was not effective until October 31, 2016.

 

As of March 24, 2017, there were 93,597,519 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the registrant’s 2017 Annual Meeting of Stockholders have been incorporated by reference into Part III of this Report as noted herein.

 

ITEMS OMITTED SUBJECT TO RULE 12B-25

The following items are the subject of a Form 12b-25 and are not included herein: audited consolidated financial statements of HCR ManorCare, Inc. as of December 31, 2016 and 2015 and for the three years in the period ended December 31, 2016, and related auditor consent to be included in Part IV, Item 15, and the exhibit required by Item 601(b)(32) of Regulation S-K.

 

 

 

 

EXPLANATORY NOTE

 

In accordance with a position of the staff of the Division of Corporate Finance of the Securities and Exchange Commission (the “SEC”) with respect to the inclusion of audited consolidated financial statements of certain lessees under a triple net lease in the lessor’s annual report under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Quality Care Properties, Inc. (“QCP” or the “Company”) is required to include audited consolidated financial statements of HCR ManorCare, Inc. (“HCRMC”) as of December 31, 2016 and 2015 and for the three years in the period ended December 31, 2016 (the “Required Financial Statements”) in this Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (“Annual Report”). HCRMC has not provided us with the Required Financial Statements, and as a result, we are unable to include the Required Financial Statements in this Annual Report. Although we have filed a Form 12b-25 with respect to the omission of the Required Financial Statements in this Annual Report, we cannot assure you as to when (or if) HCRMC will deliver the Required Financial Statements to us. Pursuant to the Master Lease, HCRMC is required to deliver to us the Required Financial Statements within 120 days after the end of HCRMC’s fiscal year.  See Item 1A. “Risk Factors—Risks Related to Our Business—HCRMC’s audited consolidated financial statements as of December 31, 2016 and 2015 and for the three years in the period ended December 31, 2016 have not been provided to us, and therefore, we cannot assure you that the unaudited information with respect to HCRMC and the HCRMC Properties presented in this Annual Report is accurate and subsequent disclosures correcting any such inaccuracies may have a material adverse effect on the market price of our securities” and “—Risks Related to Our Common Stock—The failure to timely file the Required Financial Statements could expose us to liability under the Exchange Act, impair our ability to issue securities publicly or otherwise finance our operations, and at some point could adversely impact the continued listing of our common stock on the New York Stock Exchange” for risks associated with this omission.

 

We are currently in discussions with HCRMC with respect to the Required Financial Statements and other matters.

 

In addition, due to the omission of the Required Financial Statements from this Annual Report, QCP’s principal executive officer and principal financial officer are unable to provide the certification required by Item 601(b)(32) of Regulation S-K with this Annual Report.

 

We intend to file an amendment to this Annual Report to include the Required Financial Statements and related auditor consent and the certifications required by Item 601(b)(32) of Regulation S-K as soon as practicable following receipt of the Required Financial Statements from HCRMC.

 

QUALITY CARE PROPERTIES, INC.

Annual Report on Form 10-K

December 31, 2016

 

TABLE OF CONTENTS

 

 

Unless the context otherwise requires, references to “we,” “us,” “our,” and “the Company” refer to Quality Care Properties, Inc. (“QCP”) after giving effect to the transfer of assets and liabilities from HCP, Inc. (“HCP”) as well as to the QCP Business (defined below).

 

Cautionary Language Regarding Forward-Looking Statements

 

Statements in this Annual Report on Form 10-K (“Annual Report”) that are not historical statements of fact may be deemed “forward-looking statements.” We intend to have our forward-looking statements covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with those provisions. Forward-looking statements include, among other things, statements regarding our intent, belief or expectations, including, but not limited to, statements regarding: the anticipated structure, benefits and tax treatment of the Spin‑Off; future financing plans, business strategies, growth prospects and operating and financial performance; expectations regarding the making of distributions and the payment of dividends; and compliance with and changes in governmental regulations.

 

Words such as “anticipate(s),” “expect(s),” “intend(s),” “plan(s),” “believe(s),” “may,” “will,” “would,” “could,” “should,” “seek(s)” and similar expressions, or the negative of these terms, are intended to identify such forward‑looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of risks and uncertainties that could lead to actual results differing materially from those projected, forecasted or expected. Although we believe that the assumptions underlying the forward‑looking statements are reasonable, we can give no assurance that our expectations will be attained. Further, we cannot guarantee the accuracy of any such forward-looking statement contained in this Annual Report, and such forward-looking statements are subject to known and unknown risks and uncertainties that are difficult to predict. Factors which could have a material adverse effect on our operations and future prospects or which could cause actual results to differ materially from our expectations include, but are not limited to:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward‑looking statements speak only as of the date of this Annual Report. Except as may be required under the federal securities laws and the rules and regulations of the Securities and Exchange Commission (the “SEC”), we expressly disclaim any obligation to release publicly any updates or revisions to any forward‑looking statements to reflect any change in our expectations or any change in events, conditions or circumstances on which any statement is based.

 

 

Part I

 

Item 1.  Business

 

Overview

 

Quality Care Properties, Inc. (“QCP” or the “Company”) is a Maryland corporation that was formed in 2016 to hold the HCR ManorCare, Inc. (“HCRMC”) portfolio (“HCRMC Properties”), 28 other healthcare related properties (“non‑HCRMC Properties,” and, collectively with the HCRMC Properties, the “Properties”), a deferred rent obligation (“DRO”) due from HCRMC under a master lease (the “Tranche B DRO”) and an equity method investment in HCRMC (together, the “QCP Business”) previously held by HCP, Inc. (“HCP”). Prior to the separation from HCP, which was completed on October 31, 2016, QCP was a wholly owned subsidiary of HCP. In connection with the separation, HCP transferred to certain subsidiaries of QCP the equity of entities that hold the QCP Business. Pursuant to the separation agreement, HCP effected the separation by means of a pro rata distribution of substantially all of the outstanding shares of QCP common stock to HCP stockholders of record as of the close of business on October 24, 2016, the record date (the “Spin‑Off”). At the time of the Spin-Off, the Properties contributed to QCP consisted of 274 post‑acute/skilled nursing properties, 62 memory care/assisted living properties, one surgical hospital and one medical office building (“MOB”), including 18 properties held for sale.

 

Unless the context otherwise requires, references to “we,” “us,” “our,” and “the Company” refer to QCP after giving effect to the transfer of assets and liabilities from HCP as well as to the QCP Business prior to the date of the completion of the separation. Before the completion of the separation, the QCP Business was operated through subsidiaries of HCP, which operates as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). QCP expects to operate as a REIT under the applicable provisions of the Code, commencing with its initial taxable year ended December 31, 2016. REITs are generally not liable for federal corporate income taxes as long as they continue to distribute not less than 100% of their REIT taxable income. If we determine to maintain REIT status, we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gains.

 

As of December 31, 2016, the Properties consisted of 264 post‑acute/skilled nursing properties, 61 memory care/assisted living properties, one surgical hospital and one medical office building (“MOB”), including seven non‑strategic properties held for sale. The Properties are primarily located in Pennsylvania, Illinois, Ohio, Florida and Michigan. As of December 31, 2016, 299 of the 327 properties were leased to HCRMC under a master lease agreement (as amended and supplemented from time to time, the “Master Lease”). The Master Lease properties are leased to, and operated by, HCRMC through its wholly owned indirect subsidiary, HCR III Healthcare, LLC (“HCR III” or the “Lessee”). All of HCR III’s obligations under the Master Lease are guaranteed by HCRMC. The non‑HCRMC Properties are leased on a triple-net basis to other national and regional operators and other tenants unaffiliated with HCRMC.

 

The Master Lease is structured as a triple‑net lease, in which HCRMC, either directly or through its affiliates and sublessees, operates the properties and is responsible for all operating costs associated with the properties, including the payment of property taxes, insurance and repairs, and providing indemnities to us against liabilities associated with the operation of the properties. HCR III is required to expend a minimum amount during each lease year for capital projects (as defined in the Master Lease), which, as of December 31, 2016, is equal to approximately $30 million for all of the HCRMC Properties in the aggregate. Under the terms of the Master Lease, we are required through April 1, 2019 to, upon HCR III’s request, provide HCR III an amount to fund Capital Addition Costs (as defined in the Master Lease) approved by us, in our reasonable discretion, with such amount not to exceed $100 million in the aggregate, but we are not obligated to advance more than $50 million in any single lease year. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Capital Expenditures.”

 

Before the separation, QCP had not conducted any business as a separate company and had no material assets or liabilities. The operations of the business transferred to us by HCP on the Spin-Off date are presented as if the transferred business was our business for all historical periods described and at the carrying value of such assets and liabilities reflected in HCP’s books and records. Additionally, the financial statements reflect the common shares outstanding at the separation date as outstanding for all periods prior to the separation.

 

As a result of the Spin‑Off, QCP is a publicly‑traded company (NYSE: QCP) primarily engaged in the ownership and leasing of post‑acute/skilled nursing properties and memory care/assisted living properties. Our primary source of revenues is rent payable under the Master Lease. We expect HCR III will generate revenues primarily from patient fees and services. We also have the right to receive payment of the Tranche B DRO currently outstanding under the Master Lease. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Deferred Rent Obligation” for additional information regarding the Tranche B DRO.

 

We initially lack certain non‑management administrative capabilities, and accordingly, we have entered into an agreement pursuant to which HCP is providing certain administrative and support services to us on a transitional basis (the “Transition Services Agreement” or “TSA”), which is customary for a transaction such as the Spin‑Off, expiring on the earlier of October 31, 2017 or completion of all services to be provided by HCP under the agreemenet, unless extended or earlier terminated.

 

 

Strategy

 

QCP seeks to maximize stockholder value through:

 

 

 

 

 

HCRMC Overview

 

HCRMC, collectively with its subsidiaries, is a leading national healthcare services provider, with over 50,000 employees, that owns and operates skilled nursing and rehabilitation centers, assisted living facilities, memory care facilities, hospice and home health agencies, and outpatient rehabilitation clinics. As of December 31, 2016, its long‑term care business operated in 306 centers in 26 states, including seven non‑strategic properties held for sale, with

67% located in Pennsylvania, Ohio, Michigan, Florida and Illinois. As of December 31, 2016, HCRMC offered hospice and home health services through 108 offices located in 23 states, and offered rehabilitation therapy services in 49 outpatient therapy clinics and a variety of other settings, including skilled nursing centers, schools, and hospitals. HCRMC has invested over $325 million in capital expenditures during the four year period ended December 31, 2016.

 

For the year ended December 31, 2016, HCRMC generated $3.8 billion in total revenues consisting of 84% from long‑term care, including its post‑acute/skilled nursing and memory care/assisted living businesses, and 16% from hospice, home health and rehabilitation services.

 

HCRMC’s two primary business segments, as of December 31, 2016, were as follows:

 

Long‑Term Care

 

HCRMC’s long‑term care segment includes the operation of post‑acute/skilled nursing centers, memory care facilities and assisted living facilities. HCRMC focuses on providing high‑quality post‑acute care to patients. Post‑acute care patients often require intensive rehabilitation therapy in order to maximize their recoveries. Services rendered to them are typically reimbursed by Medicare, managed care or other insurance, which generally provide higher reimbursement rates than Medicaid.

 

As of December 31, 2016, the 239 HCRMC post‑acute/skilled nursing properties owned by QCP, including seven non‑strategic properties held for sale, were located across 25 states, and approximately 66% of the properties were located in Pennsylvania, Ohio, Michigan, Florida and Illinois. HCRMC operates its post‑acute/skilled nursing businesses under the Heartland and ManorCare Health Services brands.

 

HCRMC primarily operates its memory care/assisted living properties as stand‑alone properties, as well as separate units within some of the post‑acute/skilled nursing properties. These business lines are dedicated to providing residents with personal care services and assistance with activities of daily living as well as, if applicable, dementia care.

 

As of December 31, 2016, the 60 HCRMC memory care/assisted living properties owned by QCP were located across 12 states. Approximately 85% of these properties were stand‑alone memory care/assisted living properties, operated under the Arden Courts brand, providing care focused on residents who are suffering from Alzheimer’s disease and other forms of dementia. The remaining facilities provide assisted and independent living services.

 

Hospice and Home Health

 

As of December 31, 2016, HCRMC provided hospice and home health services in 108 offices in 23 states, covering many of the markets served by HCRMC’s post‑acute/skilled nursing properties. From 2013 to 2016, the revenues and operating margin from this segment have grown, on a compound annual basis, by 3.4% and 0.8%, respectively.

 

For a description of risks relating to HCRMC, including those related to long‑term care and hospice and home health, that could have a material adverse effect on our business, financial condition and results of operations, see Item 1A. “Risk Factors—Risks Related to Our Business” and “—Impact of Industry Trends on HCRMC and Recent Events Specific to HCRMC” below.

 

Impact of Industry Trends on HCRMC and Recent Events Specific to HCRMC

 

HCRMC, along with other post‑acute/skilled nursing operators, has been and continues to be adversely impacted by a challenging operating environment in the post‑acute/skilled nursing sector, which has put downward pressure on revenues and operating income. Ongoing trends in the post‑acute/skilled nursing sector include, but are not limited to the following:

 

 

 

 

 

In addition to the industry trends, HCRMC’s recent performance has been impacted by the following:

 

 

 

Due to the headwinds facing the broader post‑acute/skilled nursing industry and HCRMC, including the continued reduction in revenues per admission and shorter length of patient stays, HCRMC’s performance continued to deteriorate in 2016. As a result, despite revised Master Lease obligations from the lease amendment effective April 2015 reducing annual rent from $541 million to $473 million, reductions of contractual rent due under the Master Lease of $5 million for November 2016, $15 million for December 2016 and $10 million for January 2017, and non‑strategic property sales, HCRMC’s normalized fixed charge coverage stood at 1.01x for the 12‑month period ended December 31, 2016, compared to 1.07x for the 12‑month period ended December 31, 2015. HCRMC’s facility EBITDAR (defined as earnings before interest, taxes, depreciation and amortization, and rent) cash flow coverage ratio was 0.84x for the 12-month period ended December 31, 2016, compared to 0.86x for the 12-month period ended December 31, 2015. For additional information regarding the foregoing HCRMC data and their computations, as well as HCRMC’s exit from the 50 non‑strategic properties, the Master Lease amendment effective April 2015 and HCRMC’s recent performance, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—HCRMC Financial Information.” For additional information regarding the reductions of contractual rent due under the Master Lease for November 2016, December 2016 and January 2017, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Portfolio Overview.” For a more detailed description of risks to which we are subject due to our dependence on HCRMC, including adverse business and financial conditions and developments, see Item 1A. “Risk Factors—Risks Related to Our Business.”

 

While we expect the post‑acute/skilled nursing operating environment to remain challenging in the near‑term, we believe that healthcare service providers, such as HCRMC, and healthcare real estate owners, such as us, that are able to successfully navigate through the current challenges will benefit from the long‑term positive fundamentals of the post‑acute/skilled nursing sector, including: (i) an aging population, (ii) expected increases in aggregate skilled nursing expenditures and (iii) supply constraints in the skilled nursing sector due to certificate of need requirements and other barriers to entry. HCRMC also benefits from operating in the memory care/assisted living and hospice and home health sectors, which we believe have favorable near‑ and long‑term fundamentals, due in part to growing demand for Alzheimer’s and other dementia care services. See “—Post‑Acute/Skilled Nursing Industry Overview” and “—Memory Care/Assisted Living Industry Overview” for a discussion of healthcare trends in the post‑acute/skilled nursing and memory care/assisted living sectors.

 

Competition

 

Investing in real estate serving the healthcare industry is highly competitive. We face competition from other REITs (including HCP), investment companies, pension funds, private equity and hedge fund investors, sovereign funds, healthcare operators, lenders, developers and other institutional investors, some of whom may have greater flexibility (e.g., non‑REIT competitors), resources and lower costs of capital than we do. Increased competition makes it more challenging for us to identify and successfully capitalize on opportunities that meet our objectives. Our ability to compete may also be impacted by global, national and local economic trends, availability of investment alternatives, availability and cost of capital, construction and renovation costs, existing laws and regulations, new legislation and population trends, among other factors.

 

Rental and related revenues are dependent on the ability of HCRMC and our other existing and future tenants and operators to compete with other companies on a number of different levels, including: the quality of care provided, reputation, the physical appearance of a property, price and range of services offered, alternatives for healthcare delivery, the supply of competing properties, physicians, staff, referral sources, location, the size and demographics of the population in surrounding areas, and the financial condition of our tenants and operators. Private, federal and state payment programs, and government reimbursement, as well as the effect of laws and regulations, may also have a significant influence on the profitability of our tenants and operators. For a discussion of the risks associated with competitive conditions affecting our business, see Item 1A. “Risk Factors—Risks Related to Our Business.”

 

Employees

 

At December 31, 2016, we had nine employees (including our executive officers), none of whom were subject to a collective bargaining agreement.

 

Headquarters

 

Our corporate headquarters is located at 7315 Wisconsin Avenue, Suite 250 West, Bethesda, Maryland 20814, and our telephone number is (240) 223-4680.

 

Insurance

 

HCRMC and the lessees under the Leases for the non‑HCRMC Properties are required to provide various types of insurance, including, but not limited to, liability and property, including business interruption, coverage. Additionally, through the TSA, our properties are covered under HCP’s corporate general liability insurance program, and we expect to obtain a corporate general liability insurance program to extend coverage for all of our properties after expiration of the TSA. We have the right under the Master Lease and the Leases for the non‑HCRMC Properties to regularly review our lessees’ insurance coverages, and we intend to do so. There are, however, certain types of extraordinary losses, such as those due to acts of war or other events, that may be either uninsurable or not economically insurable. In addition, we have a large number of properties that are exposed to earthquake, hurricane, flood and windstorm occurrences for which the related insurances carry higher deductibles.

 

We believe that the amount and scope of insurance coverage provided by our lessees and operators are customary for similarly situated companies in our industry. We cannot, however, provide assurance that such insurance will be available at a reasonable cost in the future or that the insurance coverage provided will fully cover all losses on our properties upon the occurrence of a catastrophic event, nor can we provide assurance with regard to the future financial viability of the insurers.

 

Government Regulation, Licensing and Enforcement

 

Overview

 

HCRMC and our other existing tenants and operators are, and our future tenants and operators will be, typically subject to extensive and complex federal, state and local healthcare laws and regulations relating to quality of care, licensure and certificate of need, government reimbursement, fraud and abuse practices, and similar laws governing the operation of healthcare facilities, and we expect that the healthcare industry, in general, will continue to face increased regulation and pressure in the areas of fraud, waste and abuse, cost control, healthcare management and provision of services, among others. These regulations are wide ranging and can subject our tenants and operators to civil, criminal and administrative sanctions. Affected tenants and operators may find it increasingly difficult to comply with this complex and evolving regulatory environment because of a relative lack of guidance in many areas as certain of our healthcare properties are subject to oversight from several government agencies, and the laws may vary from one jurisdiction to another. Changes in laws, regulations, reimbursement enforcement activity and regulatory non‑compliance by our tenants and operators could have a significant effect on their operations and financial condition, which in turn may adversely impact us as detailed below and set forth under Item 1A. “Risk Factors—Risks Related to Our Business.”

 

The following is a discussion of certain laws and regulations generally applicable to our tenants and operators (including HCRMC), and in certain cases, to us:

 

Fraud and Abuse Enforcement

 

There are various extremely complex U.S. federal and state laws and regulations governing healthcare providers’ relationships and arrangements and prohibiting fraudulent and abusive practices by such providers. These laws include: (i) U.S. federal and state false claims acts, which, among other things, prohibit providers from filing false claims or making false statements to receive payment from Medicare, Medicaid or other U.S. federal or state healthcare programs; (ii) U.S. federal and state anti‑kickback and fee‑splitting statutes, including the Medicare and Medicaid anti‑kickback statute, which prohibit or restrict the payment or receipt of remuneration to induce referrals or recommendations of healthcare items or services; (iii) U.S. federal and state physician self‑referral laws (commonly referred to as the “Stark Law”), which generally prohibit referrals by physicians to entities with which the physician or an immediate family member has a financial relationship; (iv) the federal Civil Monetary Penalties Law, which prohibits, among other things, the knowing presentation of a false or fraudulent claim for certain healthcare services; and (v) U.S. federal and state privacy laws, including the privacy and security rules contained in the Health Insurance Portability and Accountability Act of 1996 (commonly referred to as “HIPAA”), which provide for the privacy and security of personal health information. Violations of U.S. healthcare fraud and abuse laws carry civil, criminal and administrative sanctions, including punitive sanctions, monetary penalties, imprisonment, denial of Medicare and Medicaid reimbursement and potential exclusion from Medicare, Medicaid or other federal or state healthcare programs. These laws are enforced by a variety of federal, state and local agencies and can also be enforced by private litigants through, among other things, federal and state false claims acts, which allow private litigants to bring qui tam or “whistleblower” actions.

 

Reimbursement

 

Sources of revenues for HCRMC and our other existing tenants and operators include, and for our future tenants and operators may include, among others, governmental healthcare programs, such as the federal Medicare programs and state Medicaid programs, and non‑governmental third‑party payors, such as insurance carriers and health maintenance organizations (“HMOs”). As federal and state governments focus on healthcare reform initiatives, and as the federal government and many states face significant current and future budget deficits, efforts to reduce costs by these payors will likely continue, which may result in reduced or slower growth in reimbursement for certain services provided by some of our tenants and operators. Additionally, new and evolving payor and provider programs in the United States, including but not limited to Medicare Advantage, Dual Eligible, Accountable Care Organizations, and Bundled Payments could adversely impact our tenants’ and operators’ liquidity, financial condition or results of operations.

 

Healthcare Licensure and Certificate of Need

 

Certain healthcare properties in our portfolio are subject to extensive federal, state and local licensure, certification and inspection laws and regulations. In addition, various licenses and permits are required to handle controlled substances (including narcotics), operate pharmacies, handle radioactive materials and operate equipment. Many states require certain healthcare providers to obtain a certificate of need, which requires prior approval for the construction or expansion of certain healthcare properties. The approval process related to state certificate of need laws may impact some of our tenants’ and operators’ abilities to expand or change their businesses.

 

Americans with Disabilities Act (the “ADA”)

 

Our properties must comply with the ADA, and any similar state or local laws, to the extent that such properties are “public accommodations” as defined in those statutes. The ADA may require removal of barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable. To date, we have not received any notices of noncompliance with the ADA that have caused us to incur substantial capital expenditures to address ADA concerns. Should barriers to access by persons with disabilities be determined to exist at any of our properties, we may be directly or indirectly responsible for additional costs that may be required to make properties ADA‑compliant. Noncompliance with the ADA could result in the imposition of fines or an award of damages to private litigants. The obligation to make readily achievable accommodations pursuant to the ADA is an ongoing one, and we continue to assess our properties and make modifications as appropriate in this respect.

 

Environmental Matters

 

A wide variety of federal, state and local environmental and occupational health and safety laws and regulations affect healthcare property operations. These complex federal and state statutes, and their enforcement, involve a myriad of regulations, many of which involve strict liability on the part of the potential offender. Some of these federal and state statutes may directly impact us. Under various federal, state and local environmental laws, ordinances and regulations, an owner of real property, such as us, may be liable for the costs of removal or remediation of hazardous or toxic substances at, under or disposed of in connection with such property, as well as other potential costs relating to hazardous or toxic substances (including government fines and damages for injuries to persons and adjacent property). The cost of any required remediation, removal, fines or personal or property damages and any related liability therefore could exceed or impair the value of the property. In addition, the presence of such substances, or the failure to properly dispose of or remediate such substances, may adversely affect the value of such property and the owner’s ability to sell or rent such property or to borrow using such property as collateral which, in turn, could reduce our earnings. See Item 1A. “Risk Factors—Risks Related to Our Business—Environmental compliance costs and liabilities associated with our real estate may be substantial and may have a materially adverse effect on our business, financial condition or results of operations.”

 

Available Information

 

We file this Annual Report on Form 10-K (“Annual Report”) and other periodic reports and statements electronically with the SEC. The SEC maintains an Internet site that contains reports, statements and proxy and information statements, and other information provided by users at www.sec.gov. Our reports and statements, including amendments, are also available free of charge on our website, www.qcpcorp.com, as soon as reasonably practicable after such documents are filed with the SEC. The information contained on our website is not incorporated by reference into this report and such information should not be considered a part of this report. You may also read and copy any materials we file with the SEC at the SEC’s public reference room at 100 F Street, N.E., Washington, DC 20549. You may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330.

 

Item 1A.  Risk Factors

 

The following risk factors, among others, could materially and adversely affect our business, financial condition or results of operations, and could, in turn, impact the trading price of our common stock. These risk factors may describe situations beyond our control and you should carefully consider them. Additional risks and uncertainties not presently known to us or that are currently not believed to be material could also materially and adversely affect us. We may update these risk factors in our future periodic reports and other filings.

 

RISKS RELATED TO OUR BUSINESS

 

We depend on a single tenant and operator for substantially all of our revenues.

 

Substantially all of our properties are operated by HCRMC through HCR III (either directly or indirectly through its affiliates and sublessees) pursuant to the terms of the Master Lease, consisting of 239 post‑acute/skilled nursing properties and 60 memory care/assisted living properties as of December 31, 2016. Thus, we depend on a single tenant and operator for substantially all of our revenues. HCRMC accounted for 94% of our total revenues during the year ended December 31, 2016. HCRMC is one of the largest providers of post‑acute, memory care and hospice services in the United States and relies heavily on government reimbursement programs such as Medicare and Medicaid.

 

The inability or other failure of HCR III or HCRMC under the Master Lease (or the guaranty thereof) to meet its obligations to us, whether or not HCRMC’s results of operations improve, would materially reduce our liquidity, cash flow, net operating income and results of operations, which would in turn reduce the amount of dividends we pay to our stockholders, cause our stock price to decline and have other materially adverse effects on our business, results of operations and financial condition.

 

In addition, any failure by HCRMC to effectively conduct its operations or to maintain and improve our properties could adversely affect its business reputation and its ability to attract and retain patients and residents in our properties, which could have a materially adverse effect on our business, results of operations and financial condition.

Furthermore, HCRMC faces an increasingly competitive labor market for skilled management personnel and nurses, which can cause operating costs to increase. While HCR III and HCRMC are generally obligated to indemnify, defend and hold the lessor under the Master Lease (which consists of certain of our subsidiaries) harmless from and against various claims, litigation and liabilities arising in connection with the operation, repair and maintenance of the HCRMC Properties (which obligation is guaranteed by HCRMC), HCR III and HCRMC may have insufficient assets, income, access to financing and/or insurance coverage to enable them to satisfy their indemnification obligations.

 

Since substantially all of our real estate portfolio is leased to a single tenant, the risks described herein and in “—The real estate portfolio that is leased to HCR III accounts for substantially all of our assets and revenues. Adverse regulatory, operational and litigation developments in HCRMC’s business and financial condition have had, and continue to have, an adverse effect on us” and “—Adverse changes in the financial condition as well as the bankruptcy or insolvency of any of our tenants, particularly HCRMC, and rejection of the Leases, would materially adversely affect our business, results of operations and financial condition” below would be more significant to us than such risks may be to other companies with more diversified portfolios. These risks could have a material adverse effect on our business, liquidity, results of operations and financial condition and such a material adverse effect would likely limit our ability to meet our obligations under our financing arrangements and other contractual obligations and therefore result in, among other adverse events, acceleration of our indebtedness, impairment of our access to capital, the enforcement of default remedies by our counterparties, or the commencement of insolvency proceedings by or against us under the U.S. Bankruptcy Code.

 

HCRMC’s audited consolidated financial statements as of December 31, 2016 and 2015 and for the three years in the period ended December 31, 2016 have not been provided to us, and therefore, we cannot assure you that the unaudited information with respect to HCRMC and the HCRMC Properties presented in this Annual Report is accurate and subsequent disclosures correcting any such inaccuracies may have a material adverse effect on the market price of our securities.

 

As of the date of this Annual Report, we have not received audited consolidated financial statements of HCRMC as of December 31, 2016 and 2015 and for the three years in the period ended December 31, 2016 (the “Required Financial Statements”) from HCRMC.  Accordingly, we have prepared the information regarding HCRMC included in this Annual Report based upon 2016 unaudited information of HCRMC. It is possible that the information included in the Required Financial Statements could differ materially and adversely from the unaudited information previously provided to us by HCRMC and included herein.  Following the receipt of the Required Financial Statements and related auditor consent, we will amend this Annual Report to include the Required Financial Statements as an exhibit to this Annual Report and, to the extent we deem necessary or appropriate, supplement or amend the information contained herein.  Although we filed a Form 12b-25 with the SEC with respect to the omission of the Required Financial Statements in this Annual Report, we cannot assure you as to when (or if) HCRMC will deliver the Required Financial Statements and related auditor consent to us.  In particular, our ability to file an amendment to this Annual Report that includes the Required Financial Statements as an exhibit on or prior to April 17, 2017 pursuant to Rule 12b-25 under the Exchange Act, is subject to the receipt from HCRMC of the Required Financial Statements reasonably in advance of that date.  Pursuant to the Master Lease, HCRMC is required to deliver to us the Required Financial Statements within 120 days after the end of HCRMC’s fiscal year.   Our stock price may fluctuate due to the failure of HCRMC to provide the Required Financial Statements and the resulting uncertainty regarding the accuracy or completeness of HCRMC’s unaudited financial information included in this Annual Report, and any corrective disclosure we may need to take in the future may materially and adversely affect the market price of our securities.

 

The real estate portfolio that is leased to HCR III accounts for substantially all of our assets and revenues. Adverse regulatory, operational and litigation developments in HCRMC’s business and financial condition have had, and continue to have, an adverse effect on us.

 

HCRMC, one of the nation’s largest providers of post‑acute, memory care and hospice services, is obligated under the Master Lease, through HCR III (either directly or indirectly through its affiliates and sublessees), to operate and manage substantially all of our properties. These properties represented 94% of our total assets as of December 31, 2016. All of HCR III’s obligations under the Master Lease are guaranteed by HCRMC.

 

Due to the headwinds facing the broader post‑acute/skilled nursing industry and HCRMC, including the continued reduction in revenues per admission and shorter length of patient stays, HCRMC’s performance continued to deteriorate in 2016. As a result, despite revised Master Lease obligations from the lease amendment effective April 2015

reducing annual rent from $541 million to $473 million, reductions of contractual rent due under the Master Lease of $5 million for November 2016, $15 million for December 2016 and $10 million for January 2017, and non‑strategic property sales, HCRMC’s normalized fixed charge coverage stood at 1.01x for the 12‑month period ended December 31, 2016, compared to 1.07x for the 12‑month period ended December 31, 2015. HCRMC’s facility EBITDAR (defined as earnings before interest, taxes, depreciation and amortization, and rent) cash flow coverage ratio was 0.84x for the 12-month period ended December 31, 2016, compared to 0.86x for the 12-month period ended December 31, 2015. For additional information regarding the foregoing HCRMC data and their computations, as well as HCRMC’s exit from the 50 non‑strategic properties, the Master Lease amendment effective April 2015 and HCRMC’s recent performance, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—HCRMC Financial Information.” For additional information regarding the reductions of contractual rent due under the Master Lease for November 2016, December 2016 and January 2017, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Portfolio Overview.”

 

Continued deterioration or the failure of HCRMC to improve its operating performance, business or financial condition, or adverse regulatory developments, would likely lead to amendments to or defaults under the Master Lease that further reduce the revenues we earn from the HCRMC Properties, reduce the value of the HCRMC Properties under the Master Lease, or result in, among other adverse events, acceleration of HCRMC’s indebtedness, impairment of its continued access to capital, the enforcement of default remedies by us or other of its counterparties, or the commencement of insolvency proceedings by or against it under the U.S. Bankruptcy Code, any one or a combination of which would have a materially adverse effect on our results of operations, financial condition and cash flows.

 

On April 20, 2015, the DOJ unsealed a previously filed complaint in the U.S. District Court for the Eastern District of Virginia against HCRMC and certain of its affiliates in three consolidated cases following a civil investigation arising out of three lawsuits filed by former employees of HCRMC under the qui tam provisions of the federal False Claims Act. The DOJ’s complaint in intervention is captioned United States of America, ex rel. Ribik, Carson, and Slough v. HCR ManorCare, Inc., ManorCare Inc., HCR ManorCare Services, LLC and Heartland Employment Services, LLC (Civil Action Numbers: 1:09cv13; 1:11cv1054; 1:14cv1228 (CMH/TCB)). The complaint alleges that HCRMC submitted claims to Medicare for therapy services that were not covered by the skilled nursing facility benefit, were not medically reasonable and necessary, and were not skilled in nature, and therefore not entitled to Medicare reimbursement. The DOJ is seeking treble damages (in an unspecified amount); civil penalties (in an unspecified amount); compensation for alleged unjust enrichment; recovery of certain payments the government made to HCRMC; and costs, pre‑judgment interest, and expenses. In June 2016, the court approved the parties’ joint discovery plan, which provides for discovery to be completed by February 2017, which deadline was extended by the court to June 2017 on the joint motion of the parties. The court has not yet issued a scheduling order setting forth dates for summary judgment motions, other pre‑trial motions or a trial date. While this litigation is at an early stage and HCRMC has indicated that it believes the claims are unjust and it will vigorously defend against them, the ultimate outcome is uncertain and could, among other things, cause HCRMC to: (i) incur substantial additional time and costs to respond to and defend HCRMC’s actions in the litigation with the DOJ and any other third‑party payors; (ii) refund or adjust amounts previously paid for services under governmental programs and to change business operations going forward in a manner that negatively impacts future revenue; (iii) pay substantial fines and penalties and incur other administrative sanctions, including having to conduct future business operations pursuant to a corporate integrity agreement, which may be with the Office of Inspector General of the Department of Health and Human Services; (iv) lose the right to participate in the Medicare or Medicaid programs; and (v) suffer damage to HCRMC’s reputation. In addition, any settlement in the DOJ litigation, with or without an admission of wrongdoing, may include a substantial monetary component resulting in a materially adverse effect on HCRMC’s liquidity and financial condition. A significant adverse judgment against, or a significant settlement obligation agreed to by, HCRMC could impact HCRMC’s ability to make contractual rent and Tranche B DRO payments due under the Master Lease.

 

Adverse changes in the financial condition as well as the bankruptcy or insolvency of any of our tenants, particularly HCRMC, and rejection of the Leases, would materially adversely affect our business, results of operations and financial condition.

 

We depend on the rent payable by our tenants pursuant to the Leases, particularly the rent payable by HCRMC pursuant to the Master Lease, which accounted for 94% of our total revenues for the year ended December 31, 2016. Although the Leases, including the Master Lease, generally provide us with the right under specified circumstances to terminate the lease, evict the tenant or operator, or demand immediate repayment of certain obligations to us, the bankruptcy and insolvency laws afford certain rights to a party that has filed for bankruptcy or reorganization that may

render certain of these remedies unenforceable, or, at the least, delay our ability to pursue such remedies and realize any recoveries in connection therewith. Such delays could result in our failure to comply with covenants governing the senior secured credit facilities, resulting in an event of default that, if not cured or waived, would result in the acceleration of substantially all of our indebtedness. For example, we cannot evict a tenant or operator solely because of its bankruptcy filing. A debtor has the right to assume, or to assume and assign to a third party, or to reject its executory contracts and unexpired leases in a bankruptcy proceeding. If a debtor were to reject its leases with us, and in particular, if HCRMC were to reject the Master Lease or any portion thereof to the extent permitted, obligations under such rejected leases would cease and the claim against the rejecting debtor would be an unsecured claim, which would be limited by the statutory cap set forth in the U.S. Bankruptcy Code, which would be substantially less than the remaining rent actually owed under the lease. In addition, debtors have also asserted in bankruptcy proceedings that leases should be re‑characterized as financing arrangements, in which case a lender’s rights and remedies, as compared to a landlord’s, would be materially different.

 

Furthermore, if a debtor‑tenant seeks bankruptcy protection, the automatic stay provisions of the U.S. Bankruptcy Code would preclude us from enforcing our remedies against the manager unless relief is first obtained from the court having jurisdiction over the bankruptcy case. In any of these events, we would likely be required to fund certain expenses and obligations (e.g., real estate taxes, insurance, debt costs and maintenance expenses) to preserve the value of our properties, avoid the imposition of liens on our properties or transition our properties to a new tenant, operator or manager. Additionally, since many of our properties are used by our tenants to provide long‑term custodial care to the elderly, evicting such tenant for failure to pay rent while the property is occupied may involve specific regulatory requirements and may not be successful. Because HCRMC accounts for substantially all of our portfolio, the impact of these risks to us would be magnified in the event of an HCRMC bankruptcy and would have a material adverse effect on our business and results of operations including but not limited to possibly causing us to fail to comply with covenants governing the senior secured credit facilities, resulting in an event of default that, if not cured or waived, would result in the acceleration of substantially all of our indebtedness.

 

Although we granted a temporary rent reduction to HCR III in response to HCRMC’s continuing financial deterioration and its request for partial relief, we cannot be certain that a comprehensive economic restructuring of the Master Lease will occur, or if it does occur, that it would not have a material adverse effect on us.

 

In November 2016, we provided to HCR III reductions of contractual rent due under the Master Lease as follows: a $5 million reduction for the month of November 2016, a $15 million reduction for the month of December 2016 and a $10 million reduction for the month of January 2017. HCR III paid in full the contractual rent due for the months of February 2017 and March 2017. The above reductions in the amounts of rent are not indications of future contractual rent modifications, if any, that might result from our discussions and negotiations with HCRMC. Any actual reductions in future contractual rent due from HCR III under the Master Lease may materially exceed the amounts of the November 2016, December 2016 and January 2017 rent reductions. We cannot be certain that a comprehensive economic restructuring of the Master Lease will occur, or if it does occur, it would not result in a material adverse effect on us. There can be no assurance that we will be able to enhance the value of the Master Lease in the future, nor can there be any assurance that we and HCRMC will reach agreement on any amendments or modifications to the Master Lease. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Portfolio Overview.”

 

We and our tenants and operators may from time to time face litigation and are likely to experience rising liability and insurance costs, which could have a material adverse effect on our financial condition.

 

In some states, advocacy groups have been created to monitor the quality of care at healthcare facilities, and these groups have brought litigation against the operators of such facilities. Also, in several instances, private litigation by patients has resulted in large damage awards for alleged abuses. The effect of such litigation and other potential litigation may materially increase the costs incurred by HCRMC and our other existing and future tenants and operators for monitoring and reporting quality of care compliance. In addition, their cost of liability and medical malpractice insurance can be significant and may increase or not be available at a reasonable cost so long as the present healthcare litigation environment continues. Cost increases could cause HCRMC and our other existing and future tenants and operators to be unable to purchase the appropriate liability and malpractice insurance, potentially decreasing our revenues and increasing our collection and litigation costs. In addition, as a result of our ownership of healthcare properties, we may be named as a defendant in lawsuits arising from the alleged actions of HCRMC or our other existing or future tenants or operators, for which claims we expect to be indemnified, but which may require unanticipated

expenditures on our part. See “—We depend on a single tenant and operator for substantially all of our revenues” and “—The real estate portfolio that is leased to HCR III accounts for substantially all of our assets and revenues. Adverse regulatory, operational and litigation developments in HCRMC’s business and financial condition have had, and continue to have, an adverse effect on us.”

 

In addition, from time to time, we or our tenants may be involved in certain other legal proceedings, lawsuits and other claims. An unfavorable resolution of any such legal proceedings, lawsuits or other claims could have a materially adverse effect on our business, results of operations and financial condition. Regardless of the outcome, any such legal proceedings, lawsuits or other claims may result in substantial costs, disruption of our normal business operations and the diversion of management attention. We may be unable to prevail in, or achieve a favorable settlement of, any pending or future legal action against us.

 

Pursuant to a separation and distribution agreement that QCP and HCP entered into in connection with the completion of the Spin‑Off: (i) any liability arising from or relating to QCP’s business has been assumed by QCP and QCP has indemnified HCP and its subsidiaries (and its respective directors, officers, employees and agents and certain other related parties) against any losses arising from or relating to such liability, and (ii) HCP has indemnified QCP (including its subsidiaries, directors, officers, employees and agents and certain other related parties) for any liability arising from or relating to legal proceedings involving HCP’s real estate investment business prior to the Spin‑Off and its retained properties. HCP is currently a party to various legal actions and administrative proceedings, including various claims arising in the ordinary course of its business, which are subject to the indemnities provided by HCP to QCP, including the actions described below.

 

HCP has reported that, on May 9, 2016, a purported stockholder of HCP filed a putative class action complaint, Boynton Beach Firefighters’ Pension Fund v. HCP, Inc., et al., Case No. 3:16‑cv‑01106‑JJH, in the U.S. District Court for the Northern District of Ohio against HCP, certain of its officers, HCRMC, and certain of its officers, asserting violations of the federal securities laws. The suit asserts claims under section 10(b) and 20(a) of the Exchange Act and alleges that HCP made certain false or misleading statements relating to the value of and risks concerning its investment in HCRMC by allegedly failing to disclose that HCRMC had engaged in billing fraud, as alleged by the DOJ in a pending suit against HCRMC arising from the False Claims Act. The plaintiff in the suit demands compensatory damages (in an unspecified amount), costs and expenses (including attorneys’ fees and expert fees), and equitable, injunctive, or other relief as the Court deems just and proper. The DOJ lawsuit against HCRMC is described in greater detail in Note 12 to the combined consolidated financial statements included in Part IV, Item 15 of this Annual Report. As the Boynton Beach action is in its early stages and a lead plaintiff has not yet been named, the defendants have not yet responded to the complaint. HCP has reported that it believes the suit to be without merit and intends to vigorously defend against it.

 

HCP as also reported that, on June 16, 2016 and July 5, 2016, purported stockholders of HCP filed two derivative actions, respectively Subodh v. HCR ManorCare Inc., et al., Case No. 30‑2016‑00858497‑CU‑PT‑CXC and Stearns v. HCR ManorCare, Inc., et al., Case No. 30‑2016‑00861646‑CU‑MC‑CJC, in the Superior Court of California, County of Orange, against certain of HCP’s current and former directors and officers and HCRMC. The Stearns action was subsequently consolidated by the Court with the Subodh action. HCP is named as a nominal defendant. The consolidated derivative action alleges that the defendants engaged in various acts of wrongdoing, including, among other things, breaching fiduciary duties by publicly making false or misleading statements of fact regarding HCRMC’s finances and prospects, and failing to maintain adequate internal controls. The plaintiffs demand damages (in an unspecified amount), pre‑judgment and post‑judgment interest, a directive that HCP and the individual defendants improve HCP’s corporate governance and internal procedures (including putting resolutions to amend the bylaws or charter to a stockholder vote), restitution from the individual defendants, costs (including attorneys’ fees, experts’ fees, costs, and expenses), and further relief as the Court deems just and proper. As the Subodh action is in the early stages, the defendants are in the process of evaluating the suit and have not yet responded to the complaint.

 

HCP has also reported that, on June 9, 2016, and on August 25, 2016, HCP received letters from a private law firm, acting on behalf of its clients, purported stockholders of HCP, each asserting substantially the same allegations made in the Subodh and Stearns matters discussed above. Each letter demands that HCP’s Board of Directors take action to assert HCP’s rights. The Board of Directors of HCP is in the process of evaluating the demand letters.

 

An unfavorable resolution of any such litigation could have a material adverse effect on HCP’s business, financial position or results of operations, which, in turn, could have a materially adverse effect on our business, results of operations and financial condition if HCP is unable to meet its indemnification obligations.

 

The requirements of, or changes to, governmental reimbursement programs such as Medicare or Medicaid may adversely affect our tenants’ and operators’ ability to meet their financial and other contractual obligations to us.

 

HCRMC and certain of our other existing and future tenants and operators are or will be affected, directly or indirectly, by an extremely complex set of federal, state and local laws and regulations pertaining to governmental reimbursement programs. Such laws and regulations are subject to frequent and substantial changes that are sometimes applied retroactively. See Item 1. “Business—Government Regulation, Licensing and Enforcement.” For the year ended December 31, 2016, our tenants and operators generated approximately 66% of their revenues from governmental payors, primarily Medicare and Medicaid. Tenants and operators that generate revenues from governmental payors are generally subject to, among other things:

 

 

 

 

 

 

 

 

 

 

If our tenants or operators directly or indirectly fail to comply with the extensive laws, regulations and other requirements applicable to their business and the operation of our properties, they could become ineligible to receive reimbursement from governmental reimbursement programs, face bans on admissions of new patients or residents, suffer civil or criminal penalties or be required to make significant changes to their operations. These laws and regulations are enforced by a variety of federal, state and local agencies and can also be enforced by private litigants through, among other things, federal and state false claims acts, which allow private litigants to bring qui tam or “whistleblower” actions. Our tenants and operators would be adversely affected by the resources required to respond to an investigation or other enforcement action. See “—The real estate portfolio that is leased to HCR III accounts for substantially all of our assets and revenues. Adverse regulatory, operational and litigation developments in HCRMC’s business and financial condition have had, and continue to have, an adverse effect on us.” In such event, the results of operations and financial condition of our tenants and operators, including HCRMC, and the results of operations of our properties operated by those entities could be materially adversely affected, resulting, in turn, in a materially adverse effect on us. We are unable to predict future federal, state and local regulations and legislation, including the Medicare and Medicaid statutes and regulations, or the intensity of enforcement efforts with respect to such regulations and legislation, and any changes in the regulatory framework could have a materially adverse effect on our tenants and operators, which, in turn, would have a materially adverse effect on us.

 

Sometimes governmental payors freeze or reduce payments to healthcare providers, or provide annual reimbursement rate increases that are smaller than expected, due to budgetary and other pressures. Healthcare reimbursement will likely continue to be of significant importance to federal and state authorities. We cannot make any assessment as to the ultimate timing or the effect that any future legislative reforms may have on our tenants’ and operators’ costs of doing business and on the amount of reimbursement by government and other third‑party payors. The failure of any of our tenants or operators to comply with these laws and regulations, and significant limits on the scope

of services reimbursed and on reimbursement rates and fees, could materially adversely affect their ability to meet their financial and contractual obligations to us.

 

Legislation to address federal government operations and administration decisions affecting the Centers for Medicare and Medicaid Services could have a materially adverse effect on our tenants’ and operators’ liquidity, financial condition or results of operations.

 

Congressional consideration of legislation pertaining to the federal debt ceiling, the Patient Protection and Affordable Care Act, along with the Health Care and Education Reconciliation Act of 2010 (collectively, the “Affordable Care Act”), tax reform and entitlement programs, including reimbursement rates for physicians, could have a materially adverse effect on HCRMC’s and our other existing and future tenants’ and operators’ liquidity, financial condition or results of operations. In particular, reduced funding for entitlement programs such as Medicare and Medicaid may result in increased costs and fees for programs such as Medicare Advantage plans and additional reductions in reimbursements to providers. Additionally, amendments to the Affordable Care Act, implementation of the Affordable Care Act and decisions by the Centers for Medicare and Medicaid Services could impact the delivery of services and benefits under Medicare, Medicaid or Medicare Advantage plans and could affect our tenants and operators and the manner in which they are reimbursed by such programs. Furthermore, the future of the Affordable Care Act, including its repeal, replacement or modification, is uncertain. Any such changes could have a materially adverse effect on our tenants’ and operators’ liquidity, financial condition or results of operations, which could adversely affect their ability to satisfy their obligations to us and could have a materially adverse effect on us.

 

Furthermore, the U.S. Supreme Court’s decision upholding the constitutionality of the individual healthcare mandate while striking down the provisions linking federal funding of state Medicaid programs with a federally mandated expansion of those programs has contributed to the uncertainty regarding the impact that the law will have on healthcare delivery systems over the next decade.

 

Tenants and operators that fail to comply with federal, state and local laws and regulations, including licensure, certification and inspection requirements, may cease to operate or be unable to meet their financial and other contractual obligations to us.

 

HCRMC and our other existing tenants and operators are, and our future tenants and operators will be, subject to or impacted by extensive, frequently changing federal, state and local laws and regulations. These laws and regulations include, among others: laws protecting consumers against deceptive practices; laws relating to the operation of our properties and how our tenants and operators conduct their business, such as fire, health and safety and privacy laws; federal and state laws affecting hospitals, clinics and other healthcare communities that participate in both Medicare and Medicaid that mandate allowable costs, pricing, reimbursement procedures and limitations, quality of services and care, food service and physical plants; resident rights laws (including abuse and neglect laws) and fraud laws; anti‑kickback and physician referral laws; the Americans with Disabilities Act of 1990, as amended (the “ADA”), and similar state and local laws; and safety and health standards set by the Occupational Safety and Health Administration or similar state and local agencies. Certain of our properties may also require a license, registration and/or certificate of need to operate. See “—We depend on a single tenant and operator for substantially all of our revenues” and “—The real estate portfolio that is leased to HCR III accounts for substantially all of our assets and revenues. Adverse regulatory, operational and litigation developments in HCRMC’s business and financial condition have had, and continue to have, an adverse effect on us.”

 

Our tenants’ and operators’ failure to comply with any of these laws, regulations or requirements could result in loss of accreditation, denial of reimbursement, imposition of fines, suspension or decertification from government healthcare programs, loss of license or closure of the facility and/or the incurrence of considerable costs arising from an investigation or regulatory action, which would have an adverse effect on properties owned by us, and therefore would materially adversely impact us. See Item 1. “Business—Government Regulation, Licensing and Enforcement.”

 

If we must replace HCRMC or any of our other tenants or operators, we might be unable to reposition the properties on as favorable terms, or at all, and required regulatory approvals can delay or prohibit transfers of our healthcare properties.

 

Substantially all of our properties are leased to HCRMC, consisting of 239 of our post‑acute/skilled nursing properties and 60 of our memory care/assisted living properties as of December 31, 2016, which lease terms expire over

time in accordance with the terms of the Master Lease. We cannot predict whether HCRMC or our other existing tenants will renew existing leases beyond their current terms. However, we believe that HCRMC’s lease payment will continue to be in excess of its post‑acute/skilled nursing business’ operating performance and, consequently, HCRMC will be incentivized to forego renewal of the Master Lease. Following expiration of a lease term or if we exercise our right to replace a tenant or operator in default, rental payments on the related properties would likely decline or cease altogether while we reposition the properties with a suitable replacement tenant or operator. A replacement tenant or operator may require different features in a property, depending on that tenant’s or operator’s particular business. We may incur substantial expenditures to modify a property before we are able to secure a replacement tenant or operator or to accommodate multiple tenants or operators. In addition, transfers of healthcare properties to replacement tenants or operators are generally subject to regulatory approvals or ratifications, including, but not limited to, change of ownership approvals under certificate of need laws and Medicare and Medicaid provider arrangements that are not required for transfers of other types of commercial operations and other types of real estate. The replacement of any tenant or operator could be delayed by the regulatory approval process of any federal, state or local government agency necessary for the transfer of the property or the replacement of the operator licensed to manage the property. If we are unable to find a suitable replacement tenant or operator upon favorable terms, or at all, we may take possession of a property, which would expose us to successor liability, require us to indemnify subsequent operators to whom we might transfer the operating rights and licenses, or require us to spend substantial time and funds to preserve the value of the property and adapt the property to other uses, all of which would likely materially adversely affect our business, results of operations and financial condition. In addition, delays or inability in finding a suitable replacement tenant or operator could result in our failure to comply with covenants governing the senior secured credit facilities, resulting in an event of default that, if not cured or waived, would result in the acceleration of substantially all of our indebtedness.

 

We rely on external sources of capital to fund future capital needs, and if access to such capital is unavailable on acceptable terms or at all, it would have a materially adverse effect on our ability to meet commitments as they become due or make future investments necessary to grow our business.

 

We may not be able to fund all of our capital needs through our senior secured revolving credit facility, our unsecured revolving credit facility and cash retained from operations. If we are unable to generate enough internal capital or obtain borrowings under the senior secured revolving credit facility and the unsecured revolving credit facility, we may need to rely on external sources of capital (including debt and equity financing) to fulfill our capital requirements.

 

Our access to capital depends upon a number of factors, some of which we have little or no control over, including but not limited to:

 

 

 

 

 

 

 

 

 

 

 

Under the terms of the Master Lease, we are required through April 1, 2019 to, upon HCR III’s request, provide HCR III an amount to fund Capital Addition Costs (as defined in the Master Lease) approved by us, in our reasonable discretion, with such amount not to exceed $100 million in the aggregate, but we are not obligated to advance more than $50 million in any single lease year. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Capital Expenditures.”

 

If access to capital is unavailable on acceptable terms or at all, it would materially and adversely impact our ability to fund operations, repay or refinance our debt obligations, fund dividend payments, acquire properties and make the investments needed to grow our business.

 

Our substantial indebtedness could materially and adversely affect our financial position, including reducing funds available for other business purposes and reducing our operational flexibility, and we may have future capital needs and may not be able to obtain additional financing on acceptable terms.

 

We are a highly levered company. As of December 31, 2016, we had approximately $1.8 billion principal amount of outstanding indebtedness, in addition to having $75 million available under a senior secured revolving credit facility and amounts available under an unsecured revolving credit facility (which amounts may only be drawn subject to certain limitations, including the unavailability of borrowings under the senior secured revolving credit facility), with approximately $36 million available as of February 28, 2017. Although the related debt agreements restrict the aggregate amount of our indebtedness, we may incur additional indebtedness in the future to refinance our existing indebtedness, to finance newly‑acquired properties or for other purposes. Our governing documents do not contain any limitations on the amount of debt we may incur, and we do not have a formal policy limiting the amount of debt we may incur in the future. Subject to the restrictions set forth in our debt agreements, our board of directors may establish and change our leverage policy at any time without stockholder approval. Any significant additional indebtedness could negatively affect the credit ratings of our debt and could require a substantial portion of our cash flow to make interest and principal payments due on our indebtedness, thereby reducing funds available to us for other purposes. Our substantial indebtedness has important consequences, including: reducing funds available to us to pay dividends and for our working capital, capital expenditures, debt service requirements, strategic initiatives and other purposes. Our substantial indebtedness also limits our flexibility in planning for, or reacting to, changes in our operations or business, makes us more highly leveraged than some of our competitors, which places us at a competitive disadvantage, makes us more vulnerable to downturns in our business, the post‑acute/skilled nursing sector or the economy, restricts us from making strategic acquisitions, engaging in development activities, expanding our properties or exploiting business opportunities, causes us to make non‑strategic divestitures, and exposes us to the risk of increased interest rates, as certain of our borrowings, including borrowings under the senior secured credit facilities, are at variable rates of interest.

 

Moreover, our ability to satisfy our financial obligations under our indebtedness outstanding from time to time will depend upon our future financial and operating performance, which is subject to then prevailing economic, industry, competitive and credit market conditions, including interest rate levels and the availability of credit generally, and financial, business, legislative, regulatory and other factors, many of which are beyond our control. We cannot assure you that our business will generate cash flow from operations, or that we will be able to draw under the senior secured revolving credit facility or the unsecured revolving credit facility or otherwise, in an amount sufficient to fund our future liquidity needs.

 

If our cash flows and capital resources are insufficient to service our indebtedness, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. We may be unable to obtain additional financing or financing on favorable terms or our operating cash flow may be insufficient to satisfy our financial obligations under our indebtedness outstanding from time to time. Among other things, the absence of an investment grade credit rating or any credit rating downgrade or a worsening of credit market conditions could increase our financing costs and could

limit our access to financing sources. If financing is not available when needed, or is available on unfavorable terms, we may be unable to take advantage of business opportunities or respond to competitive pressures, any of which could materially and adversely affect our business, financial condition and results of operations.

 

Covenants in our debt agreements may limit our operational flexibility, and a covenant breach or default could materially and adversely affect our business, financial position or results of operations.

 

Our debt agreements contain customary covenants that, among other things, restrict, subject to certain exceptions, our ability to sell assets, pay dividends and make other distributions, redeem or repurchase our capital stock, incur additional debt and issue capital stock, create liens, consolidate, merge or sell substantially all of our assets, enter into certain transactions with our affiliates, make loans, investments or advances, repay subordinated indebtedness or undergo a change in control. The debt agreements also: (i) have a financial covenant requiring us to comply with certain levels of debt service coverage, (ii) constrain our ability to modify the Master Lease, and (iii) contain customary events of default. Breaches of certain covenants may result in defaults and cross‑defaults under certain of our other indebtedness, even if we satisfy our payment obligations to the respective obligee.

 

As a result of these covenants, we are limited in the manner in which we conduct our business, and we may be unable to engage in favorable business activities or finance future operations or capital needs. A failure to comply with these covenants or the covenants under any of our future indebtedness could result in an event of default, which, if not cured or waived, could have a material adverse effect on our business, financial condition and results of operations. A default could also cause cross defaults under our other indebtedness. If we were unable to repay those amounts, the lenders under the senior secured credit facilities could proceed against the collateral granted to them to secure that indebtedness. We have pledged substantially all of our assets as collateral under the senior secured credit facilities and the senior secured notes. If any of our outstanding indebtedness under the senior secured credit facilities, senior secured notes or our other indebtedness were to be accelerated, there can be no assurance that our assets would be sufficient to repay such indebtedness in full. We do not have sufficient working capital to satisfy our debt obligations in the event of an acceleration of all or a significant part of our outstanding indebtedness.

 

Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly and could adversely affect our stock price.

 

Borrowings under the senior secured credit facilities and the unsecured revolving credit facility are at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on certain of our variable rate indebtedness would increase even if the amount borrowed remained the same, and our net income and cash flows, including cash available for servicing our indebtedness, would correspondingly decrease. A 0.125% change to the interest rate of the variable rate indebtedness, including the senior secured term loan and the senior secured revolving credit facility, but excluding the undrawn unsecured revolving credit facility, would change annual interest expense by approximately $1.3 million, based on the outstanding debt as of December 31, 2016. We may enter into interest rate swaps that involve the exchange of floating for fixed rate interest payments in order to reduce interest rate volatility. However, we may not maintain interest rate swaps with respect to all of our variable rate indebtedness, and any swaps we enter into may not fully mitigate our interest rate risk, may prove disadvantageous or may create additional risks.

 

If interest rates increase, so could our interest costs for any new debt and our variable rate debt obligations we incurred in connection with the Spin‑Off. This increased cost could make future financing by us more costly, as well as lower our current period earnings. Rising interest rates could limit our ability to refinance existing debt when it matures or cause us to pay higher interest rates upon refinancing.

 

In addition, an increase in interest rates could decrease the access third parties have to credit, thereby decreasing the amount they are willing to pay to lease our properties and consequently limiting our ability to reposition our portfolio promptly in response to changes in economic or other conditions. Further, the dividend yield on our common stock, as a percentage of the price of such common stock, will influence the price of such common stock. Thus, an increase in market interest rates may lead prospective purchasers of our common stock to expect a higher dividend yield, which could adversely affect the market price of our common stock.

 

We do not have an investment grade rating, which negatively affects our ability to access capital and increases the cost of any new debt compared to companies with an investment grade rating.

 

Credit ratings assigned to our business and financial obligations have a significant impact on our cost of capital. We do not have an investment grade rating, which negatively affects our ability to access new debt at acceptable interest rates or at all. In addition, there can be no assurance that any rating assigned will remain for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency, if, in that rating agency’s judgment, future circumstances relating to the basis of the rating, such as adverse changes, so warrant. A lowering or withdrawal of a rating may further increase our borrowing costs and reduce our access to capital.

 

Volatility, disruption or uncertainty in the financial markets may impair our ability to raise capital, obtain new financing or refinance existing obligations.

 

The global financial markets have experienced and may continue to undergo periods of significant volatility, disruption and uncertainty. While economic conditions have improved since the economic downturn in 2008 and 2009, economic growth has at times been slow and uneven and the strength and sustainability of an economic recovery is challenging and uncertain. Increased or prolonged market disruption, volatility or uncertainty could materially adversely impact our ability to raise capital, obtain new financing or refinance our existing obligations as they mature.

 

Market volatility could also lead to significant uncertainty in the valuation of our investments, which may result in a substantial decrease in the value of our properties. As a result, we may be unable to recover the carrying amount of such investments and the associated goodwill, if any, which may require us to recognize impairment charges in earnings.

 

Ongoing trends in the healthcare industry, including a shift away from a traditional fee‑for‑service model and increased penetration of government reimbursement programs with lower reimbursement rates and length of stay, and increased competition in the industry may result in lower revenues and may affect the ability of our tenants/operators to meet their financial and other contractual obligations to us.

 

Post‑acute/skilled nursing operators, including HCRMC, have been and continue to be impacted by a challenging operating environment, which has put downward pressure on revenues and operating income. Ongoing trends in the post‑acute/skilled nursing sector that are causing operators to adjust their business models include, but are not limited to, (i) a shift away from a traditional fee‑for‑service model towards new managed care models, which base reimbursement on patient outcome measures; (ii) increased penetration of Medicare Advantage plans (i.e., managed Medicare), which has reduced reimbursement rates, average length of stay and average daily census, particularly for higher acuity patients; (iii) increased competition from alternative healthcare services such as home health agencies, life care at home, community‑based service programs, retirement communities and convalescent centers; and (iv) increased regulatory scrutiny on government reimbursements.

 

We are unable at this time to predict how these trends will affect the revenues and profitability of our existing or future tenants and operators; however, if these trends continue, they may reduce the profitability of our tenants and operators, which in turn could negatively affect their ability and willingness to comply with the terms of their leases with us and/or renew those leases upon expiration, which would materially and adversely affect our business, results of operations and financial condition.

 

The healthcare industry in which we operate is also highly competitive. The occupancy levels at, and fee income from, our properties are dependent on our ability and the ability of HCRMC and any of our other existing and future tenants or operators to compete with other tenants and operators on a number of different levels, including the quality of care provided, reputation, the physical appearance of a property, price, the range of services offered, family preference, alternatives for healthcare delivery, the supply of competing properties, physicians, staff, referral sources, location, and the size and demographics of the population in the surrounding area. In addition, HCRMC and our other existing tenants and operators face, and our future tenants or operators will face, an increasingly competitive labor market for skilled management personnel and nurses. An inability to attract and retain skilled management personnel and nurses and other trained personnel could negatively impact the ability of HCRMC or any of our other existing or future tenants or operators to meet their obligations to us. A shortage of nurses or other trained personnel or general inflationary pressures on wages may force HCRMC and any of our other existing or future tenants or operators to enhance pay and benefits packages to compete effectively for skilled personnel, or to use more expensive contract personnel, but they may be unable to offset these added costs by increasing the rates charged to residents. Any increase

in labor costs and other property operating expenses or any failure by HCRMC or any of our other existing or future tenants or operators to attract and retain qualified personnel would likely adversely affect our cash flow and have a materially adverse effect on our business, results of operations and financial condition.

 

HCRMC and our other existing and future tenants or operators also compete with numerous other companies providing similar healthcare services or alternatives such as home health agencies, life care at home, community‑based service programs, senior housing, retirement communities and convalescent centers. We cannot be certain that HCRMC and our other existing or future tenants or operators will be able to achieve occupancy and rate levels, and to manage their expenses, in a way that will enable them to meet all of their obligations to us. Further, many competing companies may have resources and attributes that are superior to those of HCRMC and our other existing and future tenants or operators. HCRMC and our other existing and future tenants or operators may encounter increased competition that could limit their ability to maintain or attract residents or expand their businesses or to manage their expenses, either of which could materially adversely affect their ability to meet their financial and other contractual obligations to us, potentially decreasing our revenues and impairing our assets and/or increasing collection and dispute costs.

 

Economic and other conditions that negatively affect geographic areas from which a greater percentage of our revenues is recognized could materially adversely affect our business, results of operations and financial condition.

 

For the year ended December 31, 2016, 61% of our revenues were derived from properties located in Pennsylvania, Ohio, Michigan, Florida and Illinois. We may continue to be subject to increased exposure to adverse conditions affecting these regions, including downturns in the local economies or changes in local real estate conditions, increased competition or decreased demand, changes in state‑specific legislation and local climate events and natural disasters (such as earthquakes, wildfires and hurricanes), which could adversely affect our business and results of operations.

 

Our properties may experience uninsured or underinsured losses, which could result in a significant loss of the capital we have invested in a property, decrease anticipated future revenues or cause us to incur unanticipated expense.

 

HCRMC and our other tenants subject to triple‑net leases are required to provide various types of insurance covering the properties they lease from us, including, but not limited to, liability and property, including business interruption, coverage. Additionally, through the TSA, our properties are covered under HCP’s corporate general liability insurance program, and we expect to obtain a corporate general liability insurance program to extend coverage for all of our properties after expiration of the TSA. We believe that the one property that is not subject to a triple‑net lease is adequately protected under our comprehensive insurance program. However, many of our properties are located in areas exposed to earthquake, hurricane, windstorm, flood and other natural disasters and may be subject to other losses. While we expect our tenants and operators will purchase insurance coverage for earthquake, hurricane, windstorm, flood and other natural disasters that they believe is adequate in light of current industry practice, and we will have, under our leases, the right to request that lessees provide additional insurance against such other hazards commonly insured against by similar property in the region, such insurance may not fully cover such losses. These losses can result in decreased anticipated revenues from a property and the loss of all or a portion of our investment in a property. Following these events, we may remain liable for any other financial obligations related to the property. The insurance market for such exposures can be very volatile, and our tenants and operators may be unable to purchase the limits and terms we desire on a commercially reasonable basis in the future. In addition, there are certain exposures for which we and our tenants and operators do not purchase insurance because we and they do not believe it is economically feasible to do so or where there is no viable insurance market.

 

The Properties are located in 30 states, and if one of our properties experiences a loss that is uninsured or that exceeds policy coverage limits, we could lose our investment in the damaged property as well as the anticipated future cash flows from such property. If the damaged property is subject to recourse indebtedness, we could continue to be liable for the indebtedness even if the property is irreparably damaged.

 

In addition, even if damage to our properties is covered by insurance, a disruption of business caused by a casualty event may result in loss of revenues for us. Any business interruption insurance may not fully compensate them or us for such loss of revenues.

 

Loss of our key personnel could temporarily disrupt our operations and adversely affect us.

 

We are dependent on the efforts of our executive officers, and competition for these individuals is intense. Although we have entered into employment agreements with our Chief Executive Officer, our President and Chief Investment Officer, and our Chief Financial Officer, we cannot assure you that they will remain employed with us. The loss or limited availability of the services of any of our executive officers, or our inability to recruit and retain qualified personnel in the future, could, at least temporarily, have a materially adverse effect on our business, results of operations and financial condition and the value of our common stock.

 

Environmental compliance costs and liabilities associated with our real estate may be substantial and may have a materially adverse effect on our business, financial condition or results of operations.

 

Federal, state and local laws, ordinances and regulations may require us, as a current or previous owner of real estate, to investigate and clean up certain hazardous or toxic substances or petroleum released at a property. We may be held liable to a governmental entity or to third parties for property damage and for investigation and cleanup costs incurred by the third parties in connection with the contamination. The costs of cleanup and remediation could be substantial. In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and the costs it incurs in connection with the contamination.

 

With regard to the Master Lease with HCRMC and our other Leases with other tenants, environmental insurance is only required for certain specified HCRMC Properties. The Master Lease and certain other Leases do, however, require HCRMC and certain of our other tenants to indemnify us for environmental liabilities they cause. While we have indemnity rights from HCRMC and certain of our other tenants with respect to environmental liabilities they cause, such liabilities could exceed the coverage limits of the applicable tenant’s insurance, if any, or the financial ability of the tenant to indemnify us under the applicable leases. As the owner of a site, we may also be held liable to third parties for damages and injuries resulting from environmental contamination emanating from the site, including the release of asbestos‑containing materials into the air. We may also experience environmental liabilities arising from conditions not known to us. The cost of defending against these claims, complying with environmental regulatory requirements, conducting remediation of any contaminated property or paying personal injury or other claims or fines could be substantial and could have a materially adverse effect on our business, results of operations and financial condition.

 

In addition, the presence of contamination or the failure to remediate contamination may materially adversely affect our ability to use, sell or lease the property or to borrow using the property as collateral.

 

Our charter restricts the ownership and transfer of our outstanding stock, which may have the effect of delaying, deferring or preventing a transaction or change of control of our company.

 

We will elect to be treated as a REIT commencing with our initial taxable year ended December 31, 2016. In order for us to qualify as a REIT, not more than 50% in value of our outstanding shares of stock may be owned, beneficially or constructively, by five or fewer individuals at any time during the last half of each taxable year after the first year for which we elect to be subject to tax and qualify as a REIT. Additionally, at least 100 persons must beneficially own our stock during at least 335 days of a taxable year (other than the first taxable year for which we elect to be subject to tax and qualify as a REIT). Our charter, with certain exceptions, authorizes our board of directors to take such actions as are necessary or advisable to preserve our qualification as a REIT. Our charter also provides that, unless exempted by the board of directors, no person may own more than 9.8% in value or in number, whichever is more restrictive, of the outstanding shares of our common stock or more than 9.8% in value of the aggregate of the outstanding shares of all classes and series of our stock. For purposes of our ownership limit, a person includes a group as that term is used for purposes of Section 13(d)(3) of the Exchange Act. The constructive ownership rules are complex and may cause shares of stock owned directly or constructively by a group of related individuals or entities to be constructively owned by one individual or entity. These ownership limits could delay or prevent a transaction or a change in control of us that might involve a premium price for shares of our stock or otherwise be in the best interests of our stockholders. The acquisition of less than 9.8% of our outstanding stock by an individual or entity could cause that individual or entity to own constructively in excess of 9.8% in value of our outstanding stock, and thus violate our charter’s ownership limit. Our charter also prohibits any person from owning shares of our stock that would result in our being “closely held” under Section 856(h) of the Code or otherwise cause us to fail to qualify as a REIT. In addition, our charter provides that (i) no person shall beneficially own shares of stock to the extent such beneficial ownership of stock

would result in us failing to qualify as a “domestically controlled qualified investment entity” within the meaning of Section 897 (h) of the Code, and (ii) no person shall beneficially or constructively own shares of stock to the extent such beneficial or constructive ownership would cause us to own, beneficially or constructively, more than a 9.9% interest (as set forth in Section 856(d)(2)(B) of the Code) in a tenant of our real property. Any attempt to own or transfer shares of our stock in violation of these restrictions may result in the transfer being automatically void. Our charter also provides that shares of our capital stock acquired or held in excess of the ownership limit will be transferred to a trust for the benefit of a charitable beneficiary that we designate, and that any person who acquires shares of our capital stock in violation of the ownership limit will not be entitled to any dividends on the shares or be entitled to vote the shares or receive any proceeds from the subsequent sale of the shares in excess of the lesser of the market price on the day the shares were transferred to the trust or the amount realized from the sale. We or our designee will have the right to purchase the shares from the trustee at this calculated price as well. A transfer of shares of our capital stock in violation of the limit may be void under certain circumstances. Our 9.8% ownership limitation may have the effect of delaying, deferring or preventing a change in control, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for our stockholders.

 

Maryland law and provisions in our charter and bylaws may delay or prevent takeover attempts by third parties and therefore inhibit our stockholders from realizing a premium on their stock.

 

The Maryland Business Combination Act provides that unless exempted, a Maryland corporation may not engage in business combinations, including a merger, consolidation, share exchange or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities with an “interested stockholder” or an affiliate of an interested stockholder for five years after the most recent date on which the interested stockholder became an interested stockholder, and thereafter unless specified criteria are met. An interested stockholder is generally a person owning or controlling, directly or indirectly, 10% or more of the voting power of the outstanding voting stock of a Maryland corporation. Unless our board of directors takes action to exempt us, generally or with respect to certain transactions, from this statute in the future, the Maryland Business Combination Act will be applicable to business combinations between us and other persons.

 

In addition to the restriction on business combinations contained in the Maryland Business Combination Act, our charter and bylaws contain provisions that are intended to deter coercive takeover practices and inadequate takeover bids and to encourage prospective acquirors to negotiate with our board of directors rather than to attempt a hostile takeover. For example, our board of directors has the exclusive power to adopt, alter or repeal any provisions of our bylaws or make new bylaws. In addition, our directors may be removed only for cause by the affirmative vote of holders of two‑thirds of the outstanding shares of our voting stock. Our charter also requires the vote of two‑thirds of the shares entitled to vote on the matter to amend the provisions of our charter related to the removal of directors.

 

Our bylaws require, subject to certain proxy access rules, advance notice for director nominations and proposals of new business to be considered at a stockholder meeting and that stockholders may only call a special meeting upon the written request of the stockholders entitled to cast not less than a majority of all the votes entitled to be cast on the business proposed to be transacted at such meeting. Our bylaws also provide that, unless we consent in writing to the selection of an alternative forum, the Circuit Court for Baltimore City, Maryland, or, if that Court does not have jurisdiction, the United States District Court for the District of Maryland, Baltimore Division, shall be the sole and exclusive forum for derivative actions brought on behalf of us and certain claims and other actions against us and our directors, officers and employees.

 

The restrictions on business combinations provided under Maryland law and contained in our charter may delay, defer or prevent a change of control or other transaction even if such transaction involves a premium price for our common stock or our stockholders believe that such transaction is otherwise in their best interests.

 

We rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could harm our business.

 

We rely on information technology networks and systems, including the Internet, to process, transmit and store electronic information and to manage or support a variety of business processes, including financial transactions and records and maintaining personal identifying information and tenant and lease data. We purchase some of our information technology from vendors, on whom our systems depend. We will rely on commercially available systems, software, tools and monitoring to provide security for the processing, transmission and storage of confidential tenant and

customer data, including individually identifiable information relating to financial accounts. Although we have taken steps to protect the security of our information systems and the data maintained in those systems, it is possible that our safety and security measures will not prevent the systems’ improper functioning or damage, or the improper access or disclosure of personally identifiable information such as in the event of cyber‑attacks. Security breaches, including physical or electronic break‑ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns or unauthorized disclosure of confidential information. The risk of security breaches has generally increased as the number, intensity and sophistication of attacks have increased. In some cases, it may be difficult to anticipate or immediately detect such incidents and the damage they cause. Any failure to maintain proper function, security and availability of our information systems could interrupt our operations, damage our reputation, subject us to liability claims or regulatory penalties and could have a materially adverse effect on our business, financial condition and results of operations.

 

RISKS RELATED TO OUR SPIN‑OFF FROM HCP

 

The historical financial information included in this Annual Report may not be a reliable indicator of future results.

 

Our combined consolidated historical financial data included in this Annual Report may not reflect our business, financial position or results of operations had we been an independent, publicly‑traded company during all periods presented, or what our business, financial position or results of operations will be in the future as an independent, publicly‑traded company. Prior to the Spin‑Off, our business was operated by HCP as part of its corporate organization and not operated as a stand‑alone company.

 

For additional information about the past financial performance of our business and the basis of presentation of our combined consolidated historical financial data, see Item 6. “Selected Financial Data,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical financial statements and accompanying notes included in Part IV, Item 15 of this Annual Report.

 

We may be unable to achieve some or all of the benefits that we expect to achieve from the Spin‑Off.

 

We are a publicly‑traded, self‑managed and self‑administered company, independent from HCP. However, we may not be able to achieve some or all of the benefits that we expect to achieve as a company independent from HCP in the time we expect, if at all. For instance, it may take longer than anticipated for us to, or we may never, succeed in growing our revenues through our active management strategies or successfully take advantage of positive long‑term healthcare industry trends.

 

The Spin‑Off could give rise to disputes or other unfavorable effects, which could materially and adversely affect our business, financial position or results of operations.

 

The Spin‑Off may lead to increased operating and other expenses, of both a nonrecurring and a recurring nature, and to changes to certain operations, which expenses or changes could arise pursuant to arrangements made between HCP and us or could trigger contractual rights of, and obligations to, third parties. Disputes with third parties could also arise out of these transactions, and we could experience unfavorable reactions to the Spin‑Off from employees, lenders, ratings agencies, regulators or other interested parties. These increased expenses, changes to operations, disputes with third parties, or other effects could materially and adversely affect our business, financial position or results of operations. In addition, disputes with HCP could arise in connection with the Separation and Distribution Agreement dated as of October 31, 2016 (the “Separation and Distribution Agreement”), the Tax Matters Agreement dated as of October 31, 2016 (the “Tax Matters Agreement”) and the Transition Services Agreement or other agreements.

 

Potential indemnification obligations to HCP pursuant to the separation and distribution agreement may subject us to substantial liabilities.

 

The Separation and Distribution Agreement with HCP provides for, among other things, provisions governing our relationship with HCP with respect to and following the Spin‑Off. Among other things, the Separation and Distribution Agreement provides for indemnification obligations designed to make us financially responsible for substantially all liabilities that may exist relating to our business activities, whether incurred prior to or after the Spin‑Off, as well as those obligations of HCP that we will assume pursuant to the Separation and Distribution

Agreement. If we are required to indemnify HCP or its related parties under the circumstances set forth in this agreement, we may be subject to substantial liabilities. For additional information on our potential indemnification obligations, see Note 12. “Commitments and Contingencies—Legal Proceedings” to the combined consolidated financial statements included in Part IV, Item 15 of this Annual Report.

 

The Spin‑Off may expose us to potential liabilities arising out of state and federal fraudulent conveyance laws.

 

A court could deem the Spin‑Off of our common stock or certain internal restructuring transactions undertaken by HCP in connection therewith to be a fraudulent conveyance or transfer. Fraudulent conveyances or transfers are defined to include transfers made or obligations incurred with the actual intent to hinder, delay or defraud current or future creditors or transfers made or obligations incurred for less than reasonably equivalent value when the debtor‑transferor was insolvent, or that rendered the debtor‑transferor insolvent, inadequately capitalized or unable to pay its debts as they become due.

 

If a court were to find that the Spin‑Off was a fraudulent transfer or conveyance, a court could void the Spin‑Off or impose substantial liabilities upon us, which could adversely affect our financial condition and our results of operations. Among other things, the court could require us to fund liabilities of other companies involved in the Spin-Off and related transactions for the benefit of creditors, or require stockholders to return any dividends previously paid by us. Moreover, a court could void certain elements of the Spin‑Off or we could be awarded monetary damages for the difference between the consideration paid to HCP or its stockholders and the fair market value of the transferred property at the time of the Spin‑Off. Whether a transaction is a fraudulent conveyance or transfer will vary depending upon the jurisdiction whose law is being applied.

 

Our agreements with HCP may not reflect terms that would have resulted from arm’s‑length negotiations with unaffiliated third parties.

 

The agreements related to the Spin‑Off, including the Separation and Distribution Agreement, the Tax Matters Agreement, the Transition Services Agreement and the agreement governing our unsecured revolving credit facility, were entered into in the context of the Spin‑Off while we were still controlled by HCP. As a result, they may not reflect terms that would have resulted from arm’s‑length negotiations between unaffiliated third parties. The terms of the agreements entered into in the context of the Spin‑Off concern, among other things, transition services, allocation of assets and liabilities attributable to periods prior to the Spin‑Off and the rights and obligations, including certain indemnification obligations, of HCP and us after the Spin‑Off. In addition, as the sole lender under our unsecured revolving credit facility, HCP or one of its subsidiaries will have certain rights with respect to our ability to incur additional indebtedness and amend the terms of the documents governing our outstanding indebtedness. For a more detailed description, see “Liquidity and Capital Resources” within Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

We may be unable to make, on a timely or cost‑effective basis, the changes necessary to operate as an independent, publicly‑traded, self‑managed and self‑administered company primarily focused on real property utilized in the healthcare industry.

 

Prior to the Spin-Off, we had no significant historical operations as an independent company and currently do not have the infrastructure and personnel necessary to operate as an independent, publicly‑traded, self‑managed and self‑administered company without relying on HCP to provide certain services on a transitional basis. HCP is obligated to provide such transition services pursuant to the terms of the Transition Services Agreement that we entered into with HCP, to allow us the time, if necessary, to build the infrastructure and retain the personnel necessary to operate as a separate publicly‑traded company without relying on such services. Following the expiration of the Transition Services Agreement on October 31, 2017, unless extended or earlier terminated, HCP will be under no obligation to provide further assistance to us. As a separate public entity, we are subject to, and responsible for, regulatory compliance, including periodic public filings with the SEC and compliance with NYSE continued listing requirements as well as compliance with generally applicable tax and accounting rules. Because our business had not been operated as an independent, publicly‑traded, self‑managed and self‑administered company prior to the Spin-Off, we cannot assure you that we will be able to successfully implement the infrastructure or retain the personnel necessary to operate as an independent, publicly‑traded, self‑managed and self‑administered company or that we will not incur costs in excess of anticipated costs to establish such infrastructure and retain such personnel.

 

RISKS RELATED TO OUR STATUS AS A REIT

 

Our failure to qualify as, or election to not continue to be, a REIT would result in higher taxes and reduced cash available for distribution to our stockholders. HCP’s failure to qualify as a REIT could cause us to lose our REIT status.

 

We intend to operate in a manner that will enable us to qualify as a REIT for U.S. federal income tax purposes to the extent consistent with maximizing stockholder value. Our compliance with the REIT income and quarterly asset requirements depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. Moreover, the proper classification of one or more of our investments may be uncertain in some circumstances, which could affect the application of the REIT qualification requirements. In addition, we hold substantially all of our assets through certain subsidiary REITs, and any failure of such a subsidiary to qualify as a REIT could cause us to fail to satisfy the REIT requirements. Accordingly, there can be no assurance that the IRS will not contend that our investments violate the REIT requirements. In addition, our board of directors may determine that maintaining our REIT status would no longer be in the best interest of us or our stockholders, which may result from, for example, other business opportunities that we may wish to pursue or from opportunities arising from our relationship with HCRMC, and we may elect to discontinue our REIT status.

 

We received an opinion of Skadden, Arps, Slate, Meagher & Flom LLP (“Skadden, Arps”), counsel to us and HCP, with respect to our qualification to be subject to tax as a REIT in connection with the Spin‑Off (the “REIT Tax Opinion”). Investors should be aware, however, that opinions of counsel are not binding on the IRS or any court. The REIT Tax Opinion represents only the view of Skadden, Arps, based on its review and analysis of existing law and on certain representations as to factual matters and covenants made by HCP and us, including representations relating to the values of our assets and the sources of our income. The opinion was expressed as of the date issued, October 31, 2016. Skadden, Arps has no obligation to advise HCP, us or the holders of our common stock of any subsequent change in the matters stated, represented or assumed or of any subsequent change in applicable law. Furthermore, both the validity of the REIT Tax Opinion and our qualification as a REIT depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis, the results of which will not be monitored by Skadden, Arps. Our ability to satisfy the asset tests depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals.

 

If we were to fail to qualify as a REIT in any taxable year for which the statute of limitations remains open, or elect not to qualify as a REIT in any taxable year, we would be subject to U.S. federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of, and trading price for, our stock. Unless entitled to relief under certain provisions of the Code, we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we initially ceased to qualify as a REIT.

 

The rule against re‑electing REIT status following a loss of such status could also apply to us or to REIT subsidiaries of ours if it were determined that HCP or certain REIT subsidiaries of HCP failed to qualify as REITs for certain taxable years and we or one of our REIT subsidiaries were treated as a successor to any such entity for U.S. federal income tax purposes. Although HCP, in the Tax Matters Agreement, in connection with the Spin-Off covenanted to use its reasonable best efforts to maintain the REIT status of HCP and its REIT subsidiaries for each taxable year ended on or before December 31, 2016 (unless HCP obtains an opinion from a nationally recognized tax counsel or a private letter ruling from the IRS to the effect that such failure to maintain REIT status will not cause us to fail to qualify as a REIT under the successor REIT rule referred to above), no assurance can be given that such covenant would prevent us from failing to qualify as a REIT. Although, in the event of a breach, we may be able to seek damages from HCP, there can be no assurance that such damages, if any, would appropriately compensate us. In addition, if HCP or any of the relevant subsidiaries were to fail to qualify as a REIT despite its reasonable best efforts, we would have no claim against HCP. If we fail to qualify as a REIT due to a predecessor’s failure to qualify as a REIT, we would be subject to corporate income tax as described in the preceding paragraph.

 

Qualifying as a REIT involves highly technical and complex provisions of the Code.

 

Qualification as a REIT involves the application of highly technical and complex Code provisions for which only limited judicial and administrative authorities exist. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership, and other requirements on a continuing basis. In addition, our ability to satisfy the requirements to qualify as a REIT may depend in part on the actions of third parties over which we have no control or only limited influence.

 

We could fail to qualify as a REIT if income we receive from our tenants is not treated as qualifying income.

 

Under applicable provisions of the Code, we will not be treated as a REIT unless we satisfy various requirements, including requirements relating to the sources of our gross income. Rents received or accrued by us from any of our tenants will not be treated as qualifying rent for purposes of these requirements if the applicable Lease is not respected as a true lease for U.S. federal income tax purposes and is instead treated as a service contract, joint venture or some other type of arrangement. If any of the Leases are not respected as true leases for U.S. federal income tax purposes, we may fail to qualify as a REIT.

 

In addition, subject to certain exceptions, rents received or accrued by us from any of our tenants will not be treated as qualifying rent for purposes of the REIT gross income requirements if we or a beneficial or constructive owner of 10% or more of our stock beneficially or constructively owns 10% or more of the total combined voting power of all classes of such tenant’s stock entitled to vote or 10% or more of the total value of all classes of such tenant’s stock. Our charter provides for restrictions on ownership and transfer of our shares of stock, including restrictions on such ownership or transfer that would cause the rents received or accrued by us from our tenants to be treated as non‑qualifying rent for purposes of the REIT gross income requirements. Nevertheless, these restrictions may be ineffective at ensuring that rents received or accrued by us from our tenants will be treated as qualifying rent for purposes of REIT qualification requirements.

 

REIT distribution requirements could adversely affect our liquidity and our ability to execute our business plan.

 

We generally must distribute annually at least 90% of our REIT taxable income in order for us to qualify as a REIT (assuming that certain other requirements are also satisfied) so that U.S. federal corporate income tax does not apply to earnings that we distribute. To the extent that we satisfy this distribution requirement and qualify for taxation as a REIT but distribute less than 100% of our REIT taxable income, we will be subject to U.S. federal corporate income tax on our undistributed net taxable income. Moreover, if a REIT distributes less than 85% of its taxable income to its stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then it is required to pay an excise tax on 4% of any shortfall between the required 85% and the amount that was actually distributed. We intend to make distributions to our stockholders to comply with the REIT requirements of the Code.

 

Initially our taxable income will be generated primarily by rents paid under the Leases. From time to time, we may generate taxable income greater than our cash flows as a result of differences in timing between the recognition of taxable income and the actual receipt of cash or the effect of nondeductible capital expenditures, the creation of reserves or required debt or amortization payments. If we do not have other funds available in these situations, we could be required to borrow funds on unfavorable terms, sell assets at disadvantageous prices or distribute amounts that would otherwise be invested to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase our costs or reduce our equity or adversely impact our ability to raise short‑ and long‑term debt. Furthermore, the REIT distribution requirements may increase the financing needed to fund capital expenditures, further growth and expansion initiatives, which would increase our total leverage. Thus, compliance with the REIT requirements may hinder our ability to grow, which could adversely affect the value of our common stock.

 

Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.

 

Even if we remain qualified for taxation as a REIT, we may be subject to certain U.S. federal, state, and local taxes on our income and assets, including taxes on any undistributed income and state or local income, property and transfer taxes. For example, we hold some of our assets or conduct certain of our activities through one or more TRSs or

other subsidiary corporations that are subject to U.S. federal, state, and local corporate‑level income taxes as regular C corporations. In addition, we may incur a 100% excise tax on transactions with a TRS if they are not conducted on an arm’s‑length basis. Any of these taxes would decrease cash available for distribution to our stockholders.

 

Complying with the REIT requirements may cause us to forgo otherwise attractive acquisition and business opportunities or liquidate otherwise attractive investments.

 

To qualify as a REIT for U.S. federal income tax purposes, we must ensure that, at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and “real estate assets” (as defined in the Code). The remainder of our investments (other than government securities, qualified real estate assets and securities issued by a TRS) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our total assets (other than government securities, qualified real estate assets and securities issued by a TRS) can consist of the securities of any one issuer, and no more than 25% (or, for 2018 and subsequent taxable years, 20%) of the value of our total assets can be represented by securities of one or more TRSs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate or forgo otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.

 

In addition to the asset tests set forth above, to qualify as a REIT we must continually satisfy tests concerning, among other things, the sources of our income, the amounts we distribute to our stockholders and the ownership of our stock. We may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source‑of‑income or asset‑diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make certain attractive investments.

 

Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.

 

Dividends payable to domestic stockholders that are individuals, trusts and estates are generally taxed at reduced tax rates. Dividends payable by REITs, however, generally are not eligible for the reduced rates. Although these rules do not adversely affect the taxation of REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non‑REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock.

 

Complying with the REIT requirements may limit our ability to hedge effectively.

 

The REIT provisions of the Code substantially limit our ability to hedge our assets and liabilities. Income from certain hedging transactions that we may enter into to, including transactions to manage risk of interest rate changes with respect to borrowings made or to be made to acquire or carry real estate assets, does not constitute “gross income” for purposes of the 75% or 95% gross income tests that apply to REITs, provided that certain identification requirements are met. To the extent that we enter into other types of hedging transactions or fail to properly identify such transaction as a hedge, the income is likely to be treated as non‑qualifying income for purposes of both of the gross income tests. As a result of these rules, we may be required to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because the TRS may be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in the TRS will generally not provide any tax benefit, except that such losses could theoretically be carried back or forward against past or future taxable income in the TRS.

 

The tax on prohibited transactions limits our ability to engage in certain transactions which would be treated as prohibited transactions for U.S. federal income tax purposes.

 

Net income that we derive from a prohibited transaction is subject to a 100% tax. The term “prohibited transaction” generally includes a sale or other disposition of property that is held primarily for sale to customers in the ordinary course of our trade or business. We might be subject to this tax if we were to dispose of our property in a manner that was treated as a prohibited transaction for U.S. federal income tax purposes.

 

We intend to conduct our operations so that no asset that we own (or that we treat as being owned) will be treated as, or as having been, held for sale to customers, and that a sale of any such asset will not be treated as having been in the ordinary course of our business. As a result, we may choose not to engage in certain sales at the REIT level, even though the sales might otherwise be beneficial to us. In addition, whether property is held “primarily for sale to customers in the ordinary course of a trade or business” depends on the particular facts and circumstances. No assurance can be given that any property that we sell will not be treated as property held for sale to customers, or that we can comply with certain safe‑harbor provisions of the Code that would prevent such treatment. The 100% prohibited transaction tax does not apply to gains from the sale of property that is held through a TRS or other taxable corporation, although such income will be subject to tax in the hands of the corporation at regular corporate rates. We intend to structure our activities to prevent prohibited transaction characterization.

 

Legislative or other actions affecting REITs could have a negative effect on us.

 

The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury (the “Treasury”). Changes to the tax laws or interpretations thereof, with or without retroactive application, could materially and adversely affect our investors or us. New legislation, Treasury regulations promulgated under the Code (“Treasury Regulations”), administrative interpretations or court decisions could significantly and negatively affect our ability to qualify as a REIT or the U.S. federal income tax consequences to our investors and us of such qualification. In particular, changes in policy positions by the new presidential administration may impact our business, and potential changes in proposed tax reforms (such as the denial of net interest deductibility) could adversely affect results. In addition, even changes that do not impose greater taxes on us could potentially result in adverse consequences to our shareholders. For example, a decrease in corporate tax rates could decrease the attractiveness of the REIT structure relative to companies that are not organized as REITs. There can be no guarantee that we will be able to adapt our business to any new policy positions, and any such process may have an adverse effect on our business, financial condition and results of operations.

 

Liquidation of assets may jeopardize our REIT qualification or create additional tax liability for us.

 

If we determine to continue to qualify as a REIT, we must comply with requirements regarding the composition of our assets and our sources of income. If we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.

 

REIT ownership limitations may restrict or prevent you from engaging in certain transfers of our common stock.

 

In order to satisfy the requirements for REIT qualification, no more than 50% in value of all classes or series of our outstanding shares of stock may be owned, actually or constructively, by five or fewer individuals (as defined in the Code to include certain entities) at any time during the last half of each taxable year after our first taxable year. As described above, subject to certain exceptions, rents received or accrued by us from our tenants will not be treated as qualifying rent for purposes of the REIT gross income requirements if we or a beneficial or constructive owner of 10% or more of our stock beneficially or constructively owns 10% or more of the total combined voting power of all classes of such tenant’s stock entitled to vote or 10% or more of the total value of all classes of such tenant’s stock. To assist us in satisfying the REIT requirements, our charter contains certain ownership and transfer restrictions on our stock. More specifically, our charter provides that shares of our capital stock acquired or held in excess of the ownership limit will be transferred to a trust for the benefit of a designated charitable beneficiary, and that any person who acquires shares of our capital stock in violation of the ownership limit will not be entitled to any dividends on such shares or be entitled to vote such shares or receive any proceeds from the subsequent sale of such shares in excess of the lesser of the price paid for such shares or the amount realized from the sale (net of any commissions and other expenses of sale). A transfer of shares of our capital stock in violation of the ownership limit will be void ab initio under certain circumstances. Under applicable constructive ownership rules, any shares of stock owned by certain affiliated owners generally would be added together for purposes of the common stock ownership limits, and any shares of a given class or series of preferred stock owned by certain affiliated owners generally would be added together for purposes of the ownership limit on such class or series. Our 9.8% ownership limitation may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for our stockholders. See “—Risks Related to Our Business—Our charter

restricts the ownership and transfer of our outstanding stock, which may have the effect of delaying, deferring or preventing a transaction or change of control of our company.”

 

RISKS RELATED TO OUR COMMON STOCK

 

The market price and trading volume of our common stock may fluctuate widely.

 

The market price of our common stock may fluctuate significantly. In addition, the trading volume of our common stock may fluctuate and cause significant price variations to occur. If the market price of our common stock declines significantly, stockholders may be unable to resell their shares at or above the price at which they traded when they acquired them. We cannot provide assurance that the market price of our common stock will not fluctuate or decline significantly in the future.

 

Additionally, any disposition by a significant stockholder of our common stock, or the perception in the market that such dispositions could occur, may cause the price of our common stock to fall. Any such decline could impair our ability to raise capital through future sales of our common stock. Further, our common stock may not qualify for certain investment indices, including indices specific to REITs, and any such failure may discourage new investors from investing in our common stock.

 

The market price and trading volume of our common stock may fluctuate significantly, depending upon many factors, some of which may be beyond our control, including, but not limited to:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations may adversely affect the trading price of our common stock.

 

The failure to timely file the Required Financial Statements could expose us to liability under the Exchange Act, impair our ability to issue securities publicly or otherwise finance our operations, and at some point could adversely impact the continued listing of our common stock on the New York Stock Exchange.

 

Our inability to file an amendment to this Annual Report on or prior to April 17, 2017 to include the Required Financial Statements could expose us to liability under the Exchange Act, impair our ability to issue securities publicly or otherwise finance our operations, and at some point could adversely impact the continued listing of our common stock on the New York Stock Exchange.

 

Our shares of common stock rank junior to all of our consolidated liabilities and preferred stock.

 

In the event of a bankruptcy, liquidation, dissolution or winding up, our assets would be available to pay obligations on the common stock only after all of our consolidated liabilities have been paid. In the event of a bankruptcy, liquidation, dissolution or winding up, there may not be sufficient assets remaining, after paying our and our subsidiaries’ liabilities, to pay any amounts with respect to the common stock then outstanding. Additionally, no distribution of our assets may be made to holders of our common stock until we have paid to holders of our Class A Preferred Stock a liquidation preference. We also have a significant amount of indebtedness, which amounted to $1.8 billion face value as of December 31, 2016, with availability of $75 million under the senior secured revolving credit facility and availability under the unsecured revolving credit facility, with approximately $36 million available as of February 28, 2017, subject to certain conditions. We may also take on additional long‑term debt and working capital lines of credit to meet future financing needs, subject to certain restrictions under the terms of our existing indebtedness.

 

Your percentage of ownership in our company may be diluted in the future.

 

In the future, your percentage ownership in us may be diluted because of equity issuances for acquisitions, capital market transactions or otherwise. We also anticipate granting compensatory equity awards to directors, officers, employees, advisors and consultants who provide services to us. Such awards will have a dilutive effect on our earnings per share, which could adversely affect the market price of our common shares.

 

In addition, our articles of incorporation authorize us to issue, without the approval of our stockholders, one or more additional classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over our common stock respecting dividends and distributions, as our board of directors generally may determine. The terms of one or more such classes or series of preferred stock could dilute the voting power or reduce the value of our common stock. For example, we could grant the holders of preferred stock the right to elect some number of our directors in all events or on the occurrence of specified events, or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we could assign to holders of preferred stock could affect the residual value of the common stock.

 

We may be unable to pay dividends.

 

If we determine to maintain REIT status, we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income. Our ability to pay dividends may be adversely affected by a number of factors, including the risk factors described in this Annual Report. Dividends will be authorized by our board of directors and declared by us based upon a number of factors, including actual results of operations, restrictions under Maryland law or applicable debt covenants, our financial condition, our taxable income, the annual distribution requirements under the REIT provisions of the Code, our operating expenses and other factors our directors deem relevant. We may fail to achieve investment results that will allow us to make a specified level of cash dividends or year‑to‑year increases in cash dividends. In addition, no dividends may be declared or paid on our common stock unless dividends have been paid or set aside for payment on all outstanding shares of preferred stock that have a preference on distributions, including the Class A Preferred Stock.

 

Furthermore, while we are required to pay dividends in order to maintain our REIT status (as described above under “—Risks Related to Our Status as a REIT—REIT distribution requirements could adversely affect our liquidity and our ability to execute our business plan”), we may elect not to maintain our REIT status, in which case we would no longer be required to pay such dividends. Moreover, even if we do elect to maintain our REIT status, after completing various procedural steps, we may elect to comply with the applicable distribution requirements by distributing, under certain circumstances, a portion of the required amount in the form of shares of our common stock in lieu of cash. If we

elect not to maintain our REIT status or to satisfy any required distributions in shares of common stock in lieu of cash, such action could negatively affect our business and financial condition as well as the market price of our common stock. We cannot assure you that we will pay any dividends on shares of our common stock.

 

We may choose to pay dividends in our own stock, in which case you could be required to pay income taxes in excess of the cash dividends you receive.

 

We may distribute taxable dividends that are payable in cash and shares of our common stock where up to only 20% of such a dividend is made in cash. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of our current and accumulated earnings and profits for U.S. federal income tax purposes. As a result, stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. If a U.S. holder sells the stock that it receives as a dividend in order to pay this tax, the sale proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non‑U.S. holders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock.

 

It is unclear whether and to what extent we will be able to pay taxable dividends in cash and stock in future years. Moreover, various aspects of such a taxable cash/stock dividend are uncertain and have not yet been addressed by the IRS. The IRS may impose additional requirements with respect to taxable cash/stock dividends, including on a retroactive basis, or assert that the requirements for such taxable cash/stock dividends have not been met.

 

Item 1B.  Unresolved Staff Comments

 

None.

 

Item 2.  Properties

 

Properties Summary

 

Below is a summary of the Properties as of December 31, 2016:

 

 

 

Geographic Distribution

 

Below is a summary of the geographic distribution of the Properties, as of December 31, 2016, by number of properties:

 

Below is a graphical representation of our state‑by‑state revenues for the year ended December 31, 2016:

 

By State (% of Revenues)

 

 

Master Lease with HCRMC

 

Substantially all of our properties are leased to HCR III, as the lessee, under the Master Lease on a triple‑net lease basis (and guaranteed by HCRMC), consisting of 239 post‑acute/skilled nursing properties and 60 memory care/assisted living properties as of December 31, 2016, including seven non‑strategic properties held for sale as of December 31, 2016, for the remainder of the initial fixed terms for the four pools (based on asset class) described in the Master Lease, which pools expire on March 31, 2029, March 31, 2030, March 31, 2032 and March 31, 2033, respectively. Each of the pools of properties is further divided into sub‑pools, and each sub‑pool has two renewal options. The first renewal option for each sub‑pool ranges from five to 17 years (with a limited number less than five years). The second renewal option for each sub‑pool is five years. With respect to the applicable first renewal term, if exercised, the applicable pool must be renewed in its entirety. With respect to the applicable second renewal term, if exercised, a pool may be renewed on a sub‑pool basis, but any such sub‑pool, if renewed, must be renewed in its entirety.

 

Under the Master Lease, HCR III is responsible for operating, repairing and maintaining the HCRMC Properties in compliance with all applicable legal requirements. The maintenance and repair responsibilities include, among others things, maintaining every portion of each property, HCR III’s personal property and all private roadways, sidewalks and curbs appurtenant to the HCRMC Properties. During each of the 10th (beginning April 2021) and 20th (beginning April 2031) lease years, we have the right to obtain updated property condition assessments (each a “PCA”) for each of the properties. Based on the PCAs, we have the right to identify to HCR III items of deferred maintenance that HCR III will be required to complete during the following two lease years. HCR III is required to expend during each lease year, no less than the Annual Minimum Capital Project Amount for Capital Projects (as defined in the Master Lease), which, as of the date hereof, is equal to $824 per bed per year (subject to increase each lease year as required under the Master Lease) for all of the HCRMC Properties in the aggregate, but allocated among the properties at HCRMC’s discretion. Promptly following the expiration of each lease year, HCR III is required to furnish to us reasonable documentary evidence as to the completion of all capital projects for such lease year, together with the costs thereof. As of December 31, 2016, HCR III has provided documentary evidence that it has maintained compliance with the capital project expenditure requirements under the Master Lease. If HCR III fails to expend during any lease year the applicable Annual Minimum Capital Project Amount for Capital Projects, then HCR III is required to deposit with us a repair and replacement reserve in the amount required under the Master Lease.

 

In addition to maintenance requirements, HCR III is also responsible for insurance required to be carried under the Master Lease, taxes levied on or with respect to the HCRMC Properties and all utilities and other services necessary or appropriate for the HCRMC Properties and the business conducted on the HCRMC Properties and all licenses and permits therefor. HCR III also provides indemnities in favor of lessor against liabilities associated with the operation of the HCRMC Properties.

 

HCR III and HCRMC are required to submit periodic reports to us upon request on operational and other financial matters to enable us to confirm that HCR III and HCRMC are in compliance with their obligations under the Master Lease and guaranty thereof, respectively.

 

Subject to certain exceptions set forth in the Master Lease, none of HCR III and related parties (i) directly or indirectly, is permitted to operate, own, manage or have any ownership interest in any other property or institution providing services or similar goods to those provided in connection with any HCRMC Property, within a 5 mile radius of such property, and (ii) during the last year of the applicable fixed initial term and during any renewal term under the Master Lease and for a period of two years following expiration of the term under the Master Lease, is permitted to hire, engage or otherwise employ any property level management or supervisory personnel working on or in connection with any HCRMC Property. In addition, during the last three years of the applicable fixed initial term and of any renewal term under the Master Lease, with respect to any or all of the HCRMC Properties, HCR III shall not recommend or solicit the removal or transfer of more than 3% of the total residents or patients at any property to any other property or institution (including, without limitation, any other property that is subject to the Master Lease).

 

If at any time during the term of the Master Lease, HCRMC, HCR III or any of their respective wholly‑owned subsidiaries (each, a “Covered Party”), desires to finance (whether the same is acquisition financing, refinancing or development financing and including, without limitation, through any sale‑leaseback or similar transaction) or to sell all or any portion of its interest in any memory care/assisted living property or skilled nursing property asset owned or currently leased by a Covered Party or in development pipeline set forth in the Master Lease, then we (directly or through our affiliates) will have a right of first refusal with respect to any such transaction (unless it is with an affiliate of a Covered Party).

 

Because we lease the HCRMC Properties to HCRMC through its wholly‑owned subsidiary, HCR III as lessee under the Master Lease, HCRMC is the source of substantially all of our revenues, and HCRMC’s financial condition and ability and willingness to satisfy its obligations under the Master Lease, and its willingness to renew the Master Lease upon expiration of the initial fixed term thereof, significantly impact our revenues and our ability to service our indebtedness and to make distributions to our stockholders. There can be no assurance that HCRMC will have sufficient assets, income and access to financing to enable it to satisfy its obligations under the Master Lease, and any inability or unwillingness on 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 other obligations, and on our ability to pay dividends to our stockholders, as required for us to qualify, and maintain our status, as a REIT. We also cannot assure you that HCRMC or its subsidiaries will elect to renew the lease arrangements with us upon expiration of the initial fixed terms or any renewal terms thereof, or, if such leases are not renewed, that we can reposition the affected properties on the same or better terms. See “Risk Factors—Risks Related to Our Business—We depend on a single tenant and operator for substantially all of our revenues” and “Risk Factors—Risks Related to Our Business—The real estate portfolio that is leased to HCR III accounts for substantially all of our assets and revenues. Adverse regulatory, operational and litigation developments in HCRMC’s business and financial condition have had, and continue to have, an adverse effect on us.”

 

For additional information regarding the Master Lease, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—HCRMC Financial Information” and Note 4 to the combined consolidated financial statements included in Part IV, Item 15 of this Annual Report.

 

Occupancy and Annual Rent Trends

 

The following table summarizes occupancy and average annual rent paid to us for our portfolio for the periods presented (square feet in thousands):

 

 

 

 

 

Lease Expirations

 

Below is a summary, as of December 31, 2016, of the lease expirations for the next 10 years and thereafter at our leased properties, assuming that none of the renewal or purchase options are exercised and excluding seven non‑strategic properties held for sale (dollars and square feet in thousands):

 

 

Item 3.  Legal Proceedings

 

From time to time, the Company is a party to legal proceedings, lawsuits and other claims that arise in the ordinary course of the Company’s business. Except as contained in Note 12. “Commitments and Contingencies—Legal Proceedings” to the combined consolidated financial statements included in Part IV, Item 15 of this Annual Report, the Company is not aware of any legal proceedings or claims that it believes may have, individually or taken together, a material adverse effect on the Company’s business, prospects, financial condition, results of operations or cash flows. The Company’s policy is to record a liability when a loss is considered probable and the amount can be reasonably estimated and to expense legal costs as they are incurred. The information contained in Note 12. “Commitments and Contingencies—Legal Proceedings” to the combined consolidated financial statements included in Part IV, Item 15 of this Annual Report is incorporated by reference in this Item 3.

 

Item 4.  Mine Safety Disclosures

 

Not applicable.