NATIONAL HEALTHCARE CORP - Quarter Report: 2019 March (Form 10-Q)

 

 

Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
OR
☐   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to ____________
Commission file number    001–13489
(Exact name of registrant as specified in its Charter)
Delaware		52–2057472
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization		Identification No.)
100 E. Vine Street
Murfreesboro, TN 37130
(Address of principal executive offices)
(Zip Code)
(615) 890–2020
Registrant's telephone number, including area code
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 [x] No [  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated filer [X ]	Accelerated filer  [  ]
Non–accelerated filer  [  ]	Smaller reporting company [  ]
	Emerging growth company [  ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  [  ]
Indicate by check mark whether the registrant is a shell company (as is defined in Rule 12b–2 of the Exchange Act). Yes [  ]   No [x]
15,306,290 shares of common stock of the registrant were outstanding as of May 1, 2019.

 

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

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common	NHC	NYSE American

 

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TABLE OF CONTENTS

 

 

 

 

PART I. FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements	3
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	37
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	38
Item 1A	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 3.	Defaults Upon Senior Securities	38
Item 4.	Mine Safety Disclosures	38
Item 5.	Other Information	38
Item 6.	Exhibits	39

 

 

 

		Three Months Ended March 31
		2019				2018
Revenues:
Net patient revenues		$	236,111			$	231,692
Other revenues			12,174				11,269
Net operating revenues			248,285				242,961
Cost and expenses:
Salaries, wages and benefits			141,388				140,095
Other operating			69,432				65,172
Facility rent			10,238				10,229
Depreciation and amortization			10,517				10,342
Interest			926				1,240
Total costs and expenses			232,501				227,078
Income from operations			15,784				15,883
Other income (expense):
Non–operating income (expense)			6,001				(3,065	)
Unrealized gains (losses) on marketable equity securities			6,838				(15,517	)
Income (loss) before income taxes			28,623				(2,699	)
Income tax provision			(7,392	)			(200	)
Net income (loss)			21,231				(2,899	)
Net loss attributable to noncontrolling interest			38				108
Net income (loss) attributable to National HealthCare Corporation		$	21,269			$	(2,791	)
Earnings (loss) per share attributable to National HealthCare Corporation stockholders:
Basic		$	1.39			$	(0.18	)
Diluted		$	1.39			$	(0.18	)
Weighted average common shares outstanding:
Basic			15,256,189				15,216,635
Diluted			15,324,125				15,216,635
Dividends declared per common share		$	0.50			$	0.48

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		Three Months Ended March 31
		2019				2018
Net income (loss)		$	21,231			$	(2,899	)
Other comprehensive income (loss):
Unrealized gains (losses) on investments in restricted marketable debt securities			3,225				(2,798	)
Reclassification adjustment for realized gains on sale of securities			-				(11	)
Income tax (expense) benefit related to items of other comprehensive income (loss)			(677	)			590
Other comprehensive gain (loss), net of tax			2,548				(2,219	)
Net loss attributable to noncontrolling interest			38				108
Comprehensive income (loss) attributable to National HealthCare Corporation		$	23,817			$	(5,010	)

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		March 31, 2019				December 31, 2018
		unaudited
Assets
Current Assets:
Cash and cash equivalents		$	38,194			$	43,247
Restricted cash and cash equivalents, current portion			14,785				9,967
Marketable equity securities			147,061				140,223
Restricted marketable debt securities, current portion			13,486				18,676
Accounts receivable			100,619				97,274
Inventories			6,953				7,470
Prepaid expenses and other assets			4,598				3,863
Notes receivable, current portion			1,417				1,289
Total current assets			327,113				322,009
Property and Equipment:
Property and equipment, at cost			987,763				979,088
Accumulated depreciation and amortization			(454,959	)			(444,438	)
Net property and equipment			532,804				534,650
Other Assets:
Restricted cash and cash equivalents, less current portion			1,720				1,706
Restricted marketable securities, less current portion			159,321				153,917
Deposits and other assets			5,895				5,602
Operating lease right-of-use assets			220,134				-
Goodwill			20,995				20,995
Notes receivable, less current portion			9,538				9,707
Investments in unconsolidated companies			34,777				32,362
Total other assets			452,380				224,289
Total assets		$	1,312,297			$	1,080,948

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		March 31, 2019				December 31, 2018
		unaudited
Liabilities and Stockholders’ Equity
Current Liabilities:
Trade accounts payable		$	19,318			$	19,759
Finance lease obligations, current portion			6,780				3,924
Operating lease liabilities, current portion			23,353				--
Accrued payroll			45,888				67,618
Amounts due to third party payors			16,293				16,108
Accrued risk reserves, current portion			28,271				28,643
Other current liabilities			22,407				14,249
Dividends payable			7,652				7,623
Total current liabilities			169,962				157,924
Long–term debt			55,000				55,000
Finance lease obligations, less current portion			18,110				19,128
Operating lease liabilities, less current portion			196,781				--
Accrued risk reserves, less current portion			70,271				67,381
Refundable entrance fees			8,078				8,078
Obligation to provide future services			2,172				2,172
Deferred income taxes			20,830				18,550
Other noncurrent liabilities			15,306				15,204
Deferred revenue			5,072				3,054
Total liabilities			561,582				346,491
Equity:
Common stock, $.01 par value; 45,000,000 shares authorized; 15,303,990 and 15,255,002 shares, respectively, issued and outstanding			153				153
Capital in excess of par value			219,566				219,435
Retained earnings			530,052				516,435
Accumulated other comprehensive loss			(197	)			(2,745	)
Total National HealthCare Corporation stockholders’ equity			749,574				733,278
Noncontrolling interest			1,141				1,179
Total equity			750,715				734,457
Total liabilities and equity		$	1,312,297			$	1,080,948

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		Three Months Ended March 31
		2019				2018
Cash Flows From Operating Activities:
Net income (loss)		$	21,231			$	(2,899	)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			10,517				10,342
Equity in (earnings) losses of unconsolidated investments			(2,321	)			6,586
Distributions from unconsolidated investments			31				2,254
Unrealized (gains) losses on marketable equity securities			(6,838	)			15,517
Gains on sale of restricted marketable debt securities			-				(11	)
Deferred income taxes			1,603				(5,206	)
Stock–based compensation			424				428
Changes in operating assets and liabilities:
Accounts receivable			(3,345	)			1,761
Income tax receivable			-				3,938
Inventories			517				(113	)
Prepaid expenses and other assets			(1,008	)			(631	)
Trade accounts payable			(441	)			737
Accrued payroll			(21,730	)			(22,619	)
Amounts due to third party payors			185				(234	)
Accrued risk reserves			2,498				2,971
Other current liabilities			8,158				(1,882	)
Other noncurrent liabilities			102				337
Deferred revenue			2,018				2,030
Net cash provided by operating activities			11,601				13,306
Cash Flows From Investing Activities:
Additions to property and equipment			(5,874	)			(7,100	)
Investments in notes receivable			(312	)			-
Investments in unconsolidated companies			(125	)			-
Collections of notes receivable			353				431
Purchase of restricted marketable debt securities			(3,565	)			(2,694	)
Sale of restricted marketable debt securities			6,576				3,535
Net cash used in investing activities			(2,947	)			(5,828	)
Cash Flows From Financing Activities:
Principal payments under finance lease obligations			(959	)			(903	)
Dividends paid to common stockholders			(7,623	)			(7,297	)
Issuance of common shares			579				1,067
Repurchase of common shares			(872	)			(867	)
Entrance fee refunds			-				(159	)
Net cash used in financing activities			(8,875	)			(8,159	)
Net Decrease in Cash, Cash Equivalents, Restricted Cash, and Restricted Cash Equivalents			(221	)			(681	)
Cash, Cash Equivalents, Restricted Cash, and Restricted Cash Equivalents, Beginning of Period			54,920				67,421
Cash, Cash Equivalents, Restricted Cash, and Restricted Cash Equivalents, End of Period		$	54,699			$	66,740
Balance Sheet Classifications:
Cash and cash equivalents		$	38,194			$	54,962
Restricted cash and cash equivalents			16,505				11,778
Total Cash, Cash Equivalents, Restricted Cash, and Restricted Cash Equivalents		$	54,699			$	66,740

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		Common Stock								Capital in Excess of				Retained Earnings				Accumulated Other Comprehensive				Non- controlling				Total Stockholders’
		Shares				Amount				Par Value				Earnings				Income				Interest				Equity
Balance at January 1, 2018			15,212,133			$	152			$	215,659			$	419,423			$	67,504			$	694			$	703,432
Reclassification due to new accounting standards			–				–				–				68,201				(68,201	)			–				–
Net loss attributable to National HealthCare Corporation			–				–				–				(2,791	)			–				–				(2,791	)
Net loss attributable to noncontrolling interest			–				–				–				–				–				(108	)			(108	)
Other comprehensive loss			–				–				–				–				(2,219	)			–				(2,219	)
Stock–based compensation			–				–				428				–				–				–				428
Shares sold – options exercised			21,906				–				1,067				–				–				–				1,067
Repurchase of common shares			(14,506	)			–				(867	)			–				–				–				(867	)
Dividends declared to common stockholders ($0.48 per share)			–				–				–				(7,305	)			–				–				(7,305	)
Balance at March 31, 2018			15,219,533			$	152			$	216,287			$	477,528			$	(2,916	)		$	586				691,637
Balance at January 1, 2019			15,255,002			$	153			$	219,435			$	516,435			$	(2,745	)		$	1,179			$	734,457
Net income attributable to National HealthCare Corporation			–				–				–				21,269				–				–				21,269
Net loss attributable to noncontrolling interest			–				–				–				–				–				(38	)			(38	)
Other comprehensive income			–				–				–				–				2,548				–				2,548
Stock–based compensation			–				–				424				–				–				–				424
Shares sold – options exercised			59,384				–				579				–				–				–				579
Repurchase of common shares			(10,396	)			–				(872	)			–				–				–				(872	)
Dividends declared to common stockholders ($0.50 per share)			–				–				–				(7,652	)			–				–				(7,652	)
Balance at March 31, 2019			15,303,990			$	153			$	219,566			$	530,052			$	(197	)		$	1,141				750,715

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Note 1 – Description of Business

 

National HealthCare Corporation (“NHC” or the “Company”) is a leading provider of senior health care services. As of March 31, 2019, we operate or manage, through certain affiliates, 75 skilled nursing facilities with a total of 9,510 licensed beds, 25 assisted living facilities, five independent living facilities, one behavioral health hospital, and 35 homecare programs. We operate specialized care units within certain of our healthcare centers such as Alzheimer's disease care units and sub-acute nursing units. We also have a noncontrolling ownership interest in a hospice care business that services NHC owned skilled nursing facilities and others. In addition, we provide insurance services, management and accounting services, and we lease properties to operators of skilled nursing and assisted living facilities. We operate in 10 states and are located primarily in the southeastern United States.

 

 

 

Note 2 – Summary of Significant Accounting Policies

 

The listing below is not intended to be a comprehensive list of all our significant accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles (“GAAP”), with limited need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited December 31, 2018 consolidated financial statements and notes thereto which contain accounting policies and other disclosures required by GAAP. Our audited December 31, 2018 consolidated financial statements are available at our web site: www.nhccare.com.

 

Basis of Presentation

 

The unaudited interim condensed consolidated financial statements to which these notes are attached include all normal, recurring adjustments which are necessary to fairly present the financial position, results of operations and cash flows of NHC. All significant intercompany transactions and balances have been eliminated in consolidation. The consolidated financial statements include the accounts of all entities controlled by NHC. The Company presents noncontrolling interest within the equity section of its consolidated balance sheets. The Company presents the amount of consolidated net income that is attributable to NHC and the noncontrolling interest in its consolidated statements of operations.

 

We assume that users of these interim financial statements have read or have access to the audited December 31, 2018 consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies, may be determined in that context. Accordingly, footnotes and other disclosures which would substantially duplicate the disclosure contained in our most recent annual report to stockholders have been omitted. This interim financial information is not necessarily indicative of the results that may be expected for a full year for a variety of reasons.

 

Estimates and Assumptions

 

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and could cause our reported net income to vary significantly from period to period.

 

 

Recently Adopted Accounting Guidance

 

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, "Leases (Topic 842)." The objective of this update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those annual periods and is to be applied either retrospectively to each prior reporting period presented in the financial statements or retrospectively at the beginning of the period of adoption.

 

The Company adopted the standard as of January 1, 2019, electing the transition method that allows it to apply the standard as of the adoption date and record a cumulative adjustment in retained earnings, if applicable. We did not have a cumulative adjustment to retained earnings. The interim condensed consolidated financial statements for the period ending March 31, 2019, are presented under the new standard, while comparative years presented are not adjusted and continue to be reported in accordance with our historical accounting policy.

 

On June 20, 2018, the FASB issued ASU No. 2018-07, “Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-based Payment Accounting.” ASU No. 2018-07 simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under the ASU, most of the guidance on such payments to nonemployees is aligned with the requirements for share-based payments granted to employees. On January 1, 2019, the Company early adopted the provisions of ASU No. 2018-07 and this standard did not have an impact on our consolidated financial statements.

 

On August 28, 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.” ASU No. 2018-13 changes the fair value measurement disclosure requirements of Accounting Standards Codification (“ASC”) 820. Entities are no longer required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but they will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. On January 1, 2019, the Company early adopted the provisions of ASU No. 2018-13 and this standard did not have a material impact on our consolidated financial statements.

 

Recent Accounting Guidance Not Yet Adopted 

     

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments.” ASU No. 2016-13 adds to U.S. GAAP an impairment model that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. The ASU is also intended to reduce the complexity of U.S. GAAP by decreasing the number of credit impairment models that entities use to account for debt instruments. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those annual periods, with early adoption permitted for fiscal years beginning after December 15, 2018. We are currently evaluating the impact this standard will have on our policies and procedures and internal control framework.

 

Net Patient Revenues and Accounts Receivable

 

Net patient revenues are derived from services rendered to patients for skilled and intermediate nursing, rehabilitation therapy, assisted living and independent living, and home health care services. Net patient revenue is reported at the amount that reflects the consideration to which the Company expects to be entitled in exchange for providing patient services. These amounts are due from patients, governmental programs, and other third-party payors, and include variable consideration for retroactive revenue adjustments due to settlement of audits, reviews, and investigations.

 

The Company recognizes revenue as its performance obligations are completed. Routine services are treated as a single performance obligation satisfied over time as services are rendered. These routine services represent a bundle of services that are not capable of being distinct. The performance obligations are satisfied over time as the patient simultaneously receives and consumes the benefits of the healthcare services provided. Additionally, there may be ancillary services which are not included in the daily rates for routine services, but instead are treated as separate performance obligations satisfied at a point in time when those services are rendered.

 

 

The Company determines the transaction price based on established billing rates reduced by contractual adjustments provided to third party payors. Contractual adjustments are based on contractual agreements and historical experience. The Company considers the patient's ability and intent to pay the amount of consideration upon admission. Subsequent changes resulting from a patient’s ability to pay are recorded as bad debt expense, which is included as a component of other operating expenses in the interim condensed consolidated statements of operations. Bad debt expense was $1,047,000 and $959,000 for the three months ended March 31, 2019 and 2018, respectively. As of March 31, 2019, and December 31, 2018, the Company has recorded allowance for doubtful accounts of $5,169,000 and $4,610,000, respectively, as our best estimate of probable losses inherent in the accounts receivable balance.

 

Other Revenues

 

Other revenues include revenues from the provision of insurance services, management and accounting services to other long–term care providers, and rental income. Our insurance revenues consist of premiums that are generally paid in advance and then amortized into income over the policy period. We charge for management services based on a percentage of net revenues. We charge for accounting services based on a monthly fee or a fixed fee per bed of the healthcare center under contract. We record other revenues as the performance obligations are satisfied based on the terms of our contractual arrangements.

 

Segment Reporting

 

In accordance with the provisions of ASC 280, “Segment Reporting”, the Company is required to report financial and descriptive information about its reportable operating segments. The Company has two reportable operating segments: (1) inpatient services, which includes the operation of skilled nursing facilities, assisted and independent living facilities, and one behavioral health hospital, and (2) homecare services. The Company also reports an “all other” category that includes revenues from rental income, management and accounting services fees, insurance services, and costs of the corporate office. See Note 6 for further disclosure of the Company’s operating segments.

 

Other Operating Expenses

 

Other operating expenses include the costs of care and services that we provide to the residents of our facilities and the costs of maintaining our facilities. Our primary patient care costs include drugs, medical supplies, purchased professional services, food, and professional liability insurance and licensing fees. The primary facility costs include utilities and property insurance.

 

General and Administrative Costs

 

With the Company being a healthcare provider, the majority of our expenses are "cost of revenue" items. Costs that could be classified as "general and administrative" by the Company would include its corporate office costs, excluding stock-based compensation, which were $5,144,000 and $6,678,000 for the three months ended March 31, 2019 and 2018, respectively.

 

Property and Equipment

 

Property and equipment are recorded at cost. Depreciation is provided by the straight-line method over the expected useful lives of the assets estimated as follows: buildings and improvements, 20-40 years and equipment and furniture, 3-15 years. Leasehold improvements are amortized over periods that do not exceed the non-cancelable respective lease terms using the straight-line method.

 

Finance leases are recorded at cost. Finance leases are amortized in accordance with the provision codified within ASC 842, Leases. Amortization of finance lease assets is included in depreciation and amortization expense.

 

 

Accrued Risk Reserves  

 

We are self–insured for risks related to health insurance and have wholly–owned limited purpose insurance companies that insure risks related to workers’ compensation and general and professional liability insurance claims. The accrued risk reserves include a liability for reported claims and estimates for incurred but unreported claims. Our policy is to engage an external, independent actuary to assist in estimating our exposure for claims obligations (for both asserted and unasserted claims). We reassess our accrued risk reserves on a quarterly basis.

 

Professional liability remains an area of particular concern to us. The long-term care industry has seen an increase in personal injury/wrongful death claims based on alleged negligence by skilled nursing facilities and their employees in providing care to residents. As of March 31, 2019, we and/or our managed centers are defendants in 63 such claims. It remains possible that those pending matters plus potential unasserted claims could exceed our reserves, which could have a material adverse effect on our consolidated financial position, results of operations and cash flows. It is also possible that future events could cause us to make significant adjustments or revisions to these reserve estimates and cause our reported net income to vary significantly from period to period.

 

We are principally self-insured for incidents occurring in all centers owned or leased by us. The coverages include both primary policies and excess policies. In all years, settlements, if any, in excess of available insurance policy limits and our own reserves would be expensed by us.

 

Continuing Care Contracts and Refundable Entrance Fee

 

We have one continuing care retirement center (“CCRC”) within our operations. Residents at this retirement center may enter into continuing care contracts with us. The contracts provide that 10% of the resident entry fee becomes non-refundable upon occupancy, and the remaining refundable portion of the entry fee is calculated using the lessor of the price at which the apartment is re-assigned or 90% of the original entry fee, plus 40% of any appreciation if the apartment exceeds the original resident’s entry fee.

 

Non-refundable fees are included as a component of the transaction price and are amortized into revenue over the actuarily determined remaining life of the resident, which is the expected period of occupancy by the resident. We pay the refundable portion of our entry fees to residents when they relocate from our community and the apartment is re-occupied. Refundable entrance fees are not included as part of the transaction price and are classified as non-current liabilities in our consolidated balance sheets. As of March 31, 2019, and December 31, 2018, we have recorded a refundable entrance fee in the amount of $8,078,000.

 

Obligation to Provide Future Services

 

We annually estimate the present value of the cost of future services and the use of facilities to be provided to the current CCRC residents and compare that amount with the balance of non-refundable deferred revenue from entrance fees received. If the present value of the cost of future services exceeds the related anticipated revenues, a liability is recorded (obligation to provide future services) with a corresponding charge to income. As of March 31, 2019, and December 31, 2018, we have recorded a future service obligation in the amount of $2,172,000.

 

Other Noncurrent Liabilities

 

Other noncurrent liabilities include reserves primarily related to various uncertain income tax positions.

 

Deferred Revenue

 

Deferred revenue includes the deferred gain on the sale of assets to National Health Corporation (“National”), the non-refundable portion (10%) of CCRC entrance fees being amortized over the remaining life expectancies of the residents, and premiums received within our workers’ compensation and professional liability companies in which the performance obligations have not been satisfied.

 

Noncontrolling Interest

 

The noncontrolling interest in a subsidiary is presented within total equity in the Company's interim condensed consolidated balance sheets. The Company presents the noncontrolling interest and the amount of consolidated net income attributable to NHC in its interim condensed consolidated statements of operations. The Company’s earnings per share is calculated based on net income attributable to NHC’s stockholders. The carrying amount of the noncontrolling interest is adjusted based on an allocation of subsidiary earnings based on ownership interest.

 

 

Variable Interest Entities

 

We have equity interests in unconsolidated limited liability companies that operate various post-acute and senior healthcare businesses. We analyze our investments in these limited liability companies to determine if the company is considered a variable interest entity (“VIE”) and would require consolidation. To the extent that we own interests in a VIE and we (i) are the sole entity that has the power to direct the activities of the VIE and (ii) have the obligation or rights to absorb the VIE's losses or receive its benefits, then we would be determined to be the primary beneficiary and would consolidate the VIE. To the extent we own interests in a VIE, then at each reporting period, we re-assess our conclusions as to which, if any, party within the VIE is considered the primary beneficiary.

 

The Company's maximum exposure to losses in its investments in unconsolidated VIEs cannot be quantified and may or may not be limited to its investment in the unconsolidated VIE. The investments in unconsolidated VIEs are classified as “investments in limited liability companies” in the consolidated balance sheets.

 

 

Note 3 – Net Patient Revenues

 

The Company disaggregates revenue from contracts with customers by service type and by payor.

 

Revenue by Service Type

 

The Company’s net patient services can generally be classified into the following two categories: (1) inpatient services, which includes the operation of skilled nursing facilities, assisted and independent living facilities, and a behavioral health hospital, and (2) homecare services.

 

 

For inpatient services, revenue is recognized on a daily basis as each day represents a separate contract and performance obligation. For homecare, revenue is recognized when services are provided based on the number of days of service rendered in the episode or on a per-visit basis. Typically, patients and third-party payors are billed monthly after services are performed or the patient is discharged, and payments are due based on contract terms.

 

As our performance obligations relate to contracts with a duration of one year or less, the Company is not required to disclose the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period. The Company has minimal unsatisfied performance obligations at the end of the reporting period as our patients are typically under no obligation to remain admitted in our facilities or under our care.  As the period between the time of service and time of payment is typically one year or less, the Company did not adjust for the effects of a significant financing component.

 

 

Revenue by Payor

 

Certain groups of patients receive funds to pay the cost of their care from a common source. The following table sets forth sources of net patient revenues for the periods indicated:

 

 

Medicare covers skilled nursing services for beneficiaries who require nursing care and/or rehabilitation services following a hospitalization of at least three consecutive days. For each eligible day a Medicare beneficiary is in a skilled nursing facility, Medicare pays the facility a daily payment, subject to adjustment for certain factors such as a wage index in the geographic area. The payment covers all services provided by the skilled nursing facility for the beneficiary that day, including room and board, nursing, therapy and drugs, as well as an estimate of capital–related costs to deliver those services.

 

For homecare services, Medicare pays based on the acuity level of the patient and based on episodes of care. An episode of care is defined as a length of care up to 60 days with multiple continuous episodes allowed. The services covered by the episode payment include all disciplines of care, in addition to medical supplies, within the scope of the home health benefit. We are allowed to make a request for anticipated payment at the start of care equal to 60% of the expected payment for the initial episode. The remaining balance due is paid following the submission of the final claim at the end of the episode. Deferred revenue is recorded for payments received for which the related services have not yet been provided.

 

Medicaid is operated by individual states with the financial participation of the federal government. The states in which we operate currently use prospective cost–based reimbursement systems. Under cost–based reimbursement systems, the skilled nursing facility is reimbursed for the reasonable direct and indirect allowable costs it incurred in a base year in providing routine resident care services as defined by the program.

 

Private pay, managed care, and other payment sources include commercial insurance, individual patient funds, managed care plans and the Veterans Administration. Private paying patients, private insurance carriers and the Veterans Administration generally pay based on the healthcare center's charges or specifically negotiated contracts. For private pay patients in skilled nursing, assisted living and independent living facilities, the Company bills for room and board charges, with the remittance being due on receipt of the statement and generally by the 10th day of the month the services are performed.

 

Certain managed care payors for homecare services pay on a per-visit basis. This non-episodic based revenue is recorded on an accrual basis based upon the date of services at amounts equal to its established or estimated per-visit rates.     

 

Third Party Payors

 

Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. Noncompliance with such laws and regulations can be subject to regulatory actions including fines, penalties, and exclusion from the Medicare and Medicaid programs. We believe that we are following all applicable laws and regulations.

 

Medicare and Medicaid program revenues, as well as certain Managed Care program revenues, are subject to audit and retroactive adjustment by government representatives or their agents. The Medicare PPS methodology requires that patients be assigned to Resource Utilization Groups ("RUGs") based on the acuity level of the patient to determine the amount paid to us for patient services. The assignment of patients to the various RUG categories is subject to post–payment review by Medicare intermediaries or their agents. Settlements with third-party payors for retroactive adjustments due to audits, reviews or investigations are considered variable consideration and are included in the determination of the estimated transaction price for providing patient care. These settlements are estimated based on the terms of the payment agreement with the payor, correspondence from the payor and the Company’s historical settlement activity, including an assessment to ensure that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the retroactive adjustment is subsequently resolved. Estimated settlements are adjusted in future periods as adjustments become known, or as years are settled or are no longer subject to such audits, reviews, and investigations. We believe that any differences between the net revenues recorded and final determination will not materially affect the consolidated financial statements. We have made provisions of approximately $16,293,000 and $16,108,000 as of March 31, 2019 and December 31, 2018, respectively, for various Medicare, Medicaid, and Managed Care claims reviews and current and prior year cost reports.

 

 

 

Note 4 – Other Revenues

 

Other revenues are outlined in the table below. Revenues from insurance services include premiums for workers’ compensation and professional liability insurance policies that our wholly–owned insurance subsidiaries have written for certain healthcare operators to which we provide management or accounting services. Revenues from management and accounting services include fees provided to manage and provide accounting services to other healthcare operators. Revenues from rental income include health care real estate properties owned by us and leased to third party operators. "Other" revenues include miscellaneous health care related earnings.

 

 

Insurance Services

 

For workers’ compensation insurance services, the premium revenues reflected in the interim condensed consolidated statements of operations for the three months ended March 31, 2019 and 2018 were $847,000 and $1,019,000, respectively. Associated losses and expenses are reflected in the interim condensed consolidated statements of operations as "Salaries, wages and benefits."

 

For professional liability insurance services, the premium revenues reflected in the interim condensed consolidated statements of operations for the three months ended March 31, 2019 and 2018 were $677,000 and $673,000, respectively. Associated losses and expenses including those for self–insurance are included in the interim condensed consolidated statements of operations as "Other operating costs and expenses".

 

Management Fees from National

 

We manage five skilled nursing facilities owned by National. For the three months ended March 31, 2019 and 2018, we recognized management fees and interest on management fees of $1,854,000 and $1,014,000 from these centers, respectively.

 

Rental Income

 

The Company leases real estate assets consisting of skilled nursing facilities and assisted living facilities to third party operators. Additionally, we sublease four Florida skilled nursing facilities included in our lease from National Health Investors (“NHI”) as noted in Note 7 – Long Term Leases.

 

 

 

The following table sets forth the undiscounted cash flows for future minimum lease payments receivable for leases in effect at March 31, 2019 (in thousands):

 

 

 

 

 

Note 5 – Non–Operating Income

 

Non–operating income includes equity in earnings of unconsolidated investments, dividends and other realized gains and losses on sales of marketable securities, and interest income.

 

Our most significant equity method investment is a 75.1% non–controlling ownership interest in Caris HealthCare L.P. (“Caris”), a business that specializes in hospice care services. For the three months ended March 31, 2018, Caris’ equity in earnings were negatively impacted by $8,228,000 for the settlement of a Qui Tam legal matter and legal fees related to the settlement.

 

 

 

 

Note 6 – Business Segments

 

The Company has two reportable operating segments: (1) inpatient services, which includes the operation of skilled nursing facilities, assisted and independent living facilities, and our behavioral health hospital; and (2) homecare services. These reportable operating segments are consistent with information used by the Company’s Chief Executive Officer, as chief operating decision maker (“CODM”), to assess performance and allocate resources.

 

The Company also reports an “all other” category that includes revenues from rental income, management and accounting services fees, insurance services, and costs of the corporate office. For additional information on these reportable segments see Note 2 – Summary of Significant Accounting Policies.

 

 

The Company’s CODM evaluates performance and allocates capital resources to each segment based on an operating model that is designed to improve the quality of patient care and profitability of the Company while enhancing long-term shareholder value. The CODM does not review assets by segment in his resource allocation and therefore, assets by segment are not disclosed below.

 

The following table sets forth the Company’s unaudited interim condensed consolidated statements of operations by business segment (in thousands):

 

 

 

 

 

 

 

Note 7 – Long-Term Leases

 

The Company’s lease portfolio primarily consists of finance and operating real estate leases for certain skilled nursing facilities, assisted and independent living facilities, homecare offices, and pharmacy warehouses. The original terms of the leases typically range from two to fifteen years. Several of the real estate leases include renewal options which vary in length and may not include specific rent renewal amounts. We determine if an arrangement is a lease at inception of a contract. We determine the lease term by assuming exercise of renewal options that are reasonably certain.

 

On January 1, 2019, the Company recorded right-of-use assets and liabilities on the condensed consolidated balance sheets for non-cancelable real estate operating leases with original or remaining lease terms in excess of one year. Leases with a lease term of 12 months or less at inception are not recorded on our condensed consolidated balance sheets and are expensed on a straight-line basis over the lease term in our condensed consolidated statement of operations. Finance leases remain on the condensed consolidated balance sheets as required by previous accounting guidance.

 

Operating lease right-of-use assets and liabilities are recorded at the present value of the lease payments over the lease term. The present value of the lease payments are discounted using the incremental borrowing rate associated with each lease. As most of our leases do not provide implicit rates, we have used incremental borrowing rates that were calculated based on information available at the later of the lease commencement date or the adoption date, January 1, 2019. The variable components of the lease payment that fluctuate with the operations of a health facility are not included in determining the right-of-use assets and lease liabilities. Rather, these variable components are expensed as incurred.

 

Accounting Policy Elections

 

The Company has elected the package of practical expedients offered in the transition guidance which allows management not to reassess lease identification, lease classification, and initial direct costs. The Company has elected the accounting policy practical expedient to exclude recording short-term leases, for all asset classes, as right-of-use assets and lease liabilities on the condensed consolidated balance sheets. Finally, the Company has elected the accounting policy practical expedient to recognize lease components and non-lease components together and not as separate parts of a lease for real estate leases.

 

 

Operating Leases with NHI

 

At March 31, 2019, we leased from NHI the real property of 35 skilled nursing facilities, seven assisted living centers and three independent living centers under two separate lease agreements. As part of the first lease agreement, we sublease four Florida skilled nursing facilities to a third-party operator.

 

On January 1, 2007, a 15–year lease extension began which included three additional five–year renewal options. In December 2012, NHC extended the lease agreement through the first of the three additional five–year renewal options, which extended the lease date through 2026. The two additional five–year renewal options on the lease still remain. Under the terms of the lease, base rent totals $30,750,000 with rent thereafter escalating by 4% of the increase in facility revenue over a 2007 base year.

 

In September 2013 and under the second lease agreement, NHC began operating seven skilled nursing facilities in New Hampshire and Massachusetts. The 15-year lease term consists of base rent of $3,450,000 annually with rent escalating by 4% of the increase in facility revenue over a 2014 base year. Additionally, NHC has the option to purchase the seven facilities from NHI in the 13th year of the lease for a purchase price of $49,000,000.

 

Base rent expense under both NHI lease agreements totals $34,200,000. Percentage rent under the leases is based on a quarterly calculation of revenue increases and is payable on a quarterly basis. Percentage rent expense under both leases for the periods ending March 31, 2019 and 2018 was $965,000 and $928,000, respectively.

  

We have a right of first refusal with NHI to purchase any of the properties should NHI receive an offer from an unrelated party during the term of the lease or up to 180 days after termination of the related lease.

 

Finance Leases

 

Effective March 1, 2014, NHC began leasing and operating three senior healthcare facilities in the state of Missouri under three separate lease agreements. Two of the healthcare facilities are skilled nursing facilities that also include assisted living facilities and the third healthcare facility is a memory care facility. Each of the leases is a ten-year lease with two five–year renewal options. Under the terms of the leases, base rent totals $5,200,000 annually with rent thereafter escalating by 4% of the increase in facility revenue over the 2014 base year.

 

Lease Classification

 

At March 31, 2019, the Company recorded the following on the condensed consolidated balance sheets (in thousands):

 

 

 

 

 

 

Weighted-average remaining lease terms and discount rates at March 31, 2019 were as follows:

 

 

 

Lease Costs

 

For the three months ended March 31, 2019, the lease costs recorded in the condensed consolidated statement of operations are as follows (in thousands):

 

 

 

Minimum Lease Payments

 

The following table summarizes the maturity of our finance and operating lease liabilities as of March 31, 2019 (in thousands):

 

 

Other

 

Supplemental cash flow data for the three months ended March 31, 2019 was as follows (in thousands):

 

 

 

 

Note 8 – Earnings per Share

 

Basic net income (loss) per share is computed based on the weighted average number of common shares outstanding for each period presented. Diluted net income (loss) per share reflects the potential dilution that would have occurred if securities to issue common stock were exercised, converted, or resulted in the issuance of common stock that would have then shared in our earnings.

 

The following table summarizes the earnings (losses) and the weighted average number of common shares used in the calculation of basic and diluted earnings (loss) per share (in thousands, except for share and per share amounts):

 

 

In the above table, options to purchase 8,475 shares of our common stock have been excluded for the quarter ended March 31, 2019, due to their anti–dilutive impact.  The impact of potentially dilutive securities (1,238,855) for the three months ended March 31, 2018, were not considered because the effect would be anti-dilutive in that period.

 

 

 

Note 9 – Investments in Marketable Securities

 

Our investments in marketable equity securities are carried at fair value with the changes in unrealized gains and losses recognized in our results of operations at each measurement date. Our investments in marketable debt securities are classified as available for sale securities and carried at fair value with the unrealized gains and losses recognized through accumulated other comprehensive income at each measurement date. Realized gains and losses from securities sales are recognized in results of operations upon disposition of the securities using the specific identification method on a trade date basis. Refer to Note 10 for a description of the Company's methodology for determining the fair value of marketable securities.

 

Marketable securities and restricted marketable securities consist of the following (in thousands):

 

 

Included in the marketable equity securities are the following (in thousands, except share amounts):

 

 

The amortized cost and estimated fair value of debt securities classified as available for sale, by contractual maturity, are as follows (in thousands):

 

 

Gross unrealized gains related to marketable equity securities are $116,906,000 and $110,081,000 as of March 31, 2019 and December 31, 2018, respectively. Gross unrealized losses related to marketable equity securities are $21,000 and $34,000 as of March 31, 2019 and December 31, 2018, respectively. For the three months ended March 31, 2019 and 2018, the Company recognized net unrealized gains of $6,838,000 and net unrealized losses of $15,517,000, respectively, for the changes in fair market value of the marketable equity securities in the interim condensed consolidated statement of operations.

 

 

Gross unrealized gains related to available for sale debt securities are $1,089,000 and $335,000 as of March 31, 2019 and December 31, 2018, respectively. Gross unrealized losses related to available for sale debt securities are $1,338,000 and $3,809,000 as of March 31, 2019 and December 31, 2018, respectively.

 

For the marketable securities in gross unrealized loss positions, (a) it is more likely than not that the Company will not be required to sell the investment securities before recovery of the unrealized losses, and (b) the Company expects that the contractual principal and interest will be received on the investment securities. As a result, the Company recognized no other-than-temporary impairment during the three months ended March 31, 2019 or for the year ended December 31, 2018.

 

Proceeds from the sale of available for sale debt securities during the three months ended March 31, 2019 and 2018 were $6,576,000 and $3,535,000, respectively. Investment gains of $0 and $11,000 were realized on these sales during the three months ended March 31, 2019 and 2018, respectively. No sales were reported for marketable equity securities for the three months ended March 31, 2019 and 2018, respectively.

 

 

 

Note 10 – Fair Value Measurements

 

The accounting standard for fair value measurements provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. Fair value is defined as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. This accounting standard establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs, where available. The following summarizes the three levels of inputs that may be used to measure fair value:

 

	Level 1 – The valuation is based on quoted prices in active markets for identical instruments.
	Level 2 – The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model–based valuation techniques for which all significant assumptions are observable in the market.
	Level 3 – The valuation is based on unobservable inputs that are supported by minimal or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques that incorporate management’s own estimates of assumptions that market participants would use in pricing the instrument, or valuations that require significant management judgment or estimation.

 

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

The following table summarizes fair value measurements by level at March 31, 2019 and December 31, 2018 for assets and liabilities measured at fair value on a recurring basis (in thousands):

 

 

 

 

 

 

Note 11 – Long–Term Debt

 

Long–term debt consists of the following:

 

 

The available borrowing capacity of the credit facility is $110,000,000. The credit facility has a maturity date of October 2020. Loans bear interest at either (i) LIBOR plus 1.40% or (ii) the base rate plus 0.40%.

 

 

 

Note 12 - Stock Repurchase Program

 

In August 2018, the Board of Directors authorized a common stock purchase program. The program will allow for repurchases of up to $25 million of its common stock. During the quarter ended March 31, 2019, the Company repurchased 10,396 shares of its common stock for a total cost of $872,000. The shares were funded from cash on hand and were cancelled and returned to the status of authorized but unissued.

 

 

 

Note 13 – Stock–Based Compensation

 

NHC recognizes stock–based compensation expense for all stock options granted over the requisite service period using the fair value at the date of grant using the Black–Scholes pricing model. Stock–based compensation totaled $424,000 and $428,000 for the three months ended March 31, 2019 and 2018, respectively. Stock–based compensation is included in “Salaries, wages and benefits” in the interim condensed consolidated statements of operations.

 

At March 31, 2019, the Company had $5,343,000 of unrecognized compensation cost related to unvested stock–based compensation awards. This unrecognized compensation cost will be amortized over an approximate three-year period.

 

 

Stock Options

 

The following table summarizes the significant assumptions used to value the options granted for the three months ended March 31, 2019 and for the year ended December 31, 2018.

 

 

The following table summarizes our outstanding stock options for the three months ended March 31, 2019 and for the year ended December 31, 2018.

 

 

 

 

 

Note 14 – Income Taxes

 

The income tax provision for the three months ended March 31, 2019 is $7,392,000 (an effective income tax rate of 25.8%). The income tax provision and effective tax rate for the three months ended March 31, 2019 were unfavorably impacted by adjustments to unrecognized tax benefits of $200,000 but was favorably impacted by a tax benefit of $228,000 relating to the exercise of stock options. The income tax provision for the three months ended March 31, 2019 was favorably impacted by the higher pre-tax book income resulting from the unrealized gain of $6,838,000 for the market value increase in our marketable equity securities portfolio.  The income tax provision for the three months ended March 31, 2018 was $200,000 (an effective income tax rate of -7.4%). The income tax provision and effective tax rate for the three months ended March 31, 2018 were unfavorably impacted by nondeductible expenses of $855,000 (primarily the non-deductible portion of the estimated potential settlement of the Caris HealthCare, L.P. Qui Tam legal matter) or -31.7% of income before taxes. The income tax provision for the three months ended March 31, 2018 was also unfavorably impacted by the lower pre-tax book income resulting from the unrealized loss of $15,517,000 for the market value decrease in our marketable equity securities portfolio. Prior to 2018, such market value changes ran through the balance sheet and did not impact our income statement.

 

Interest and penalties expense related to U.S. federal and state income tax returns are included within income tax expense.

 

The Company is no longer subject to U.S. federal and state examinations by tax authorities for years before 2015 (with certain state exceptions).

 

 

 

Note 15 – Contingencies and Commitments

 

Accrued Risk Reserves

 

We are self–insured for risks related to health insurance and have wholly–owned limited purpose insurance companies that insure risks related to workers’ compensation and general and professional liability insurance claims both for our owned and leased entities and certain of the entities to which we provide management or accounting services. The liability we have recognized for reported claims and estimates for incurred but unreported claims totals $98,542,000 and $96,024,000 at March 31, 2019 and December 31, 2018, respectively. The liability is included in accrued risk reserves in the interim condensed consolidated balance sheets and is subject to adjustment for actual claims incurred. It is possible that these claims plus unasserted claims could exceed our insurance coverages and our reserves, which could have a material adverse effect on our consolidated financial position, results of operations and cash flows.

 

As a result of the terms of our insurance policies and our use of wholly–owned limited purpose insurance companies, we have retained significant insurance risk with respect to workers’ compensation and general and professional liability. We consider the professional services of independent actuaries to assist us in estimating our exposures for claims obligations (for both asserted and unasserted claims) related to deductibles and exposures in excess of coverage limits, and we maintain reserves for these obligations. Such estimates are based on many variables including historical and statistical information and other factors.

 

Workers’ Compensation

 

For workers’ compensation, we utilize a wholly–owned Tennessee domiciled property/casualty insurance company to write coverage for NHC affiliates and for third–party customers. Policies are written for a duration of twelve months and cover only risks related to workers’ compensation losses. All customers are companies which operate in the senior care industry. Business is written on a direct basis. Direct business coverage is written for statutory limits and the insurance company’s losses in excess of $1,000,000 per claim are covered by reinsurance.

 

General and Professional Liability Lawsuits and Insurance

 

The senior care industry has experienced increases in both the number of personal injury/wrongful death claims and in the severity of awards based upon alleged negligence by nursing facilities and their employees in providing care to residents. As of March 31, 2019, we and/or our managed centers are currently defendants in 63 such claims.

 

Insurance coverage for both periods includes both primary policies and excess policies. The primary coverage is in the amount of $1.0 million per incident, $3.0 million per location with an annual primary policy aggregate limit that is adjusted on an annual basis. For 2018 and 2019, the excess coverage is $9.0 million per occurrence. Additional insurance is purchased through third party providers that serve to supplement the coverage provided through our wholly–owned captive insurance company.

 

Financing Commitments

 

In conjunction with our management contract with National, we have entered into a line of credit arrangement whereby we may have amounts due from National from time to time. The maximum loan commitment under the line of credit is $2,000,000. At March 31, 2019, National did not have an outstanding balance on the line of credit.

 

 

Nutritional Support Services, L.P., Qui Tam Litigation

 

On June 19, 2018, a First Amended Complaint was filed naming Nutritional Support Services, L.P. (“NSS”), a wholly-owned subsidiary of the Company, as a defendant in the action captained U.S. ex rel. McClain v. Nutritional Support Services, L.P., No. 6:17-cv-2608-AMQ (D.S.C.), which was filed in the United States District Court for the District of South Carolina. The action alleges that NSS violated the False Claims Act by reporting a National Drug Code (“NDC”) number that did not correspond to the NDC for dispensed prescriptions. On April 16, 2018, the United States filed a Notice of Election to Decline Intervention with respect to the allegations asserted in this action. NSS intends to vigorously defend itself with respect to this action.

 

Governmental Regulations

 

Laws and regulations governing the Medicare, Medicaid and other federal healthcare programs are complex and subject to interpretation. Management believes that it is following all applicable laws and regulations in all material respects. However, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties, and exclusions from the Medicare, Medicaid and other federal healthcare programs.

 

 

 

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