FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Quarterly Report Under Section 13 of 15(d) of the Securities Exchange Act of 1934 For quarter ended September 30, 1998 Commission file number 333-37185 NATIONAL HEALTHCARE CORPORATION (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 Vine Street Murfreesboro, TN 37130 (Address of principal (Zip Code) executive offices) Registrant's telephone number, including area code (615) 890-2020 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. Yes x No (2) Has been subject to such filing requirements for the past 90 days. Yes x No 8,866,822 shares were outstanding as of October 31, 1998.
PART I. FINANCIAL INFORMATION Item 1. Financial Statements. NATIONAL HEALTHCARE CORPORATION <TABLE> INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 1998 1997 1998 1997 (in thousands) (in thousands) <S> <C> <C> <C> <C> REVENUES: Net patient revenues $ 99,931 $ 99,400 $ 307,563 $ 288,640 Other revenues 8,523 12,589 25,974 35,403 Net revenues 108,454 111,989 333,537 324,043 COSTS AND EXPENSES: Salaries, wages and benefits 58,724 59,910 183,855 177,539 Other operating 30,807 28,799 92,745 83,109 Rent 11,174 6,240 32,269 18,270 Depreciation & amort. 2,864 4,349 8,702 12,061 Interest 234 3,314 2,852 9,387 Total costs & expenses 103,803 102,612 320,423 300,366 Income Before Income Taxes 4,651 9,377 13,114 23,677 Income Tax Provision (1,750) -- (4,897) -- NET INCOME $ 2,901 $ 9,377 $ 8,217 $ 23,677 EARNINGS PER SHARE: Basic $ .26 $ 1.06 $ .74 $ 2.68 Diluted $ .26 $ .91 $ .74 $ 2.33 WEIGHTED AVERAGE SHARES OUTSTANDING: Basic 11,308,282 8,860,413 11,050,177 8,836,992 Diluted 11,365,571 10,756,650 11,368,753 10,737,859 </TABLE> The accompanying notes to interim condensed consolidated financial statements are an integral part of these statements. 2
NATIONAL HEALTHCARE CORPORATION <TABLE> INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) <CAPTION> ASSETS September 30 December 31 1998 1997 (unaudited) <S> <C> <C> CURRENT ASSETS: Cash and cash equivalents $ 2,989 $ 17,205 Cash held by trustees 7,211 3,834 Marketable securities 18,784 19,579 Accounts receivable, less allowance for doubtful accounts of $6,761 and $5,116 49,615 71,564 Notes receivable 3,924 6,992 Inventory at lower of cost (first-in, first-out method) or market 4,201 3,948 Deferred income taxes 2,416 1,618 Prepaid expenses and other assets 1,088 553 Total current assets 90,228 125,293 PROPERTY AND EQUIPMENT AND ASSETS UNDER ARRANGEMENT WITH OTHER PARTIES: Property and equipment at cost 126,700 104,597 Less accumulated depreciation and amortization (47,618) (41,171) Assets under arrangement with other parties 4,413 4,853 Net property, equipment and assets under arrangement with other parties 83,495 68,279 OTHER ASSETS: Bond reserve funds, mortgage replacement reserves and other deposits 654 506 Unamortized financing costs 795 1,278 Notes receivable 25,447 11,044 Notes receivable from National 12,059 12,028 Deferred income taxes 3,048 2,922 Minority equity investments and other 8,875 8,831 Total other assets 50,878 36,609 $224,601 $230,181 </TABLE> The accompanying notes to interim condensed consolidated financial statements are an integral part of these consolidated balance sheets. 3
NATIONAL HEALTHCARE CORPORATION <TABLE> INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) <CAPTION> LIABILITIES AND CAPITAL September 30 December 31 1998 1997 (Unaudited) <S> <C> <C> CURRENT LIABILITIES: Current portion of long-term debt $ 3,613 $ 2,682 Trade accounts payable 13,427 12,810 Accrued payroll 22,842 38,123 Distributions payable --- 5,388 Amount due to third-party payors 11,847 6,789 Accrued interest 265 596 Other current liabilities 19,472 14,407 Total current liabilities 71,466 80,795 LONG-TERM DEBT, less current portion 56,660 60,227 DEBT SERVICED BY OTHER PARTIES, LESS CURRENT PORTION 16,464 16,676 MINORITY INTERESTS IN CON- SOLIDATED SUBSIDIARIES 715 763 SUBORDINATED CONVERTIBLE NOTES 714 19,152 DEFERRED INCOME 14,548 14,832 COMMITMENTS, CONTINGENCIES AND GUARANTEES SHAREOWNERS' EQUITY: Preferred stock, $.01 par value; 10,000,000 shares authorized; none issued or outstanding --- --- Common stock, $.01 par value; 30,000,000 shares authorized; 11,316,898 shares issued and outstanding 113 101 Capital in excess of par value, less notes receivable 51,859 33,248 Retained earnings 8,217 --- Unrealized gains on securities 3,845 4,387 Total shareowners' equity 64,034 37,736 $224,601 $ 230,181 </TABLE> The accompanying notes to interim condensed consolidated financial statements are an integral part of these consolidated balance sheets. 4
NATIONAL HEALTHCARE CORPORATION <TABLE> INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <CAPTION> Nine Months Ended September 30 1998 1997 (in thousands) <S> <C> <C> CASH FLOWS PROVIDED BY OPERATING ACTIVITIES: Net income $ 8,217 $ 23,677 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 8,131 11,469 Provision for doubtful accounts receivable 2,335 1,946 Amortization of intangibles and deferred charges 822 642 Amortization of deferred income (427) (1,344) Equity in earnings of unconsolidated investments (776) (110) Distributions from unconsolidated investments 149 161 Deferred income taxes (924) --- Changes in assets and liabilities: (Increase) decrease in accounts receivable 19,614 (14,218) Increase in inventory (253) (686) Increase in prepaid expenses and other assets (535) (98) Increase (decrease) in trade accounts payable 617 (3,133) Decrease in accrued payroll (15,281) (1,823) Increase in amounts due to third party payors 5,058 9,816 Increase (decrease) in accrued interest (331) 39 Increase in other current liabilities 5,065 4,688 Net cash provided by operating activities 31,481 31,026 CASH FLOWS USED IN INVESTING ACTIVITIES: Additions to and acquisitions of property and equipment, net (23,268) (31,263) Investment in long-term notes receivable and loan participation agreements (24,881) (23,494) Collection of long-term notes receivable and loan participation agreements 13,515 21,550 (Increase) decrease in minority equity investments and other 169 (753) Decrease in marketable securities 253 605 Net cash used in investing activities (34,212) (33,355) CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: Proceeds from debt issuance 46 22,948 Increase in cash held by trustee (3,377) (1,727) Decrease in minority interests in subsidiaries (48) (5) Increase in bond reserve funds, mortgage replacement reserves and other deposits (148) (256) Issuance of partnership units 40 505 Collection of receivables 66 5,131 Payments on debt (2,985) (6,954) Cash distributions to partners (5,388) (15,703) Decrease (increase) in financing costs 309 (221) Net cash provided by (used in) financing activities (11,485) 3,718 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (14,216) 1,389 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 17,205 1,881 CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,989 $ 3,270 Supplemental Information: Cash payments for interest expense $ 3,183 $ 9,348 </TABLE> The accompanying notes to interim condensed consolidated financial statements are an integral part of these consolidated statements. 5
NATIONAL HEALTHCARE CORPORATION <TABLE> INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <CAPTION> Nine Months Ended September 30 1998 1997 (in thousands) <S> <C> <C> During the nine months ended September 30, 1998 and September 30, 1997, $18,438,000 and $169,000, respectively, of convertible subordinated debentures were converted into 1,212,504 shares of common stock and 4,534 units of NHC's partnership units: Convertible subordinated debentures $(18,438) $ (169) Financing costs 10 1 Accrued interest (89) (2) Partner's capital --- 170 Common stock 12 --- Capital in excess of par value 18,505 --- </TABLE> The accompanying notes to interim condensed consolidated financial statements are an integral part of these consolidated statements. 6
NATIONAL HEALTHCARE CORPORATION <TABLE> Interim Condensed Consolidated Statements of Shareowners' Equity and Partners' Capital (in thousands, except share and unit amounts) <CAPTION> Unrealized Total Share- Receivables Gains owners' Equity Common Stock/ Units from Sale Paid in Retained (Losses) on General Limited Partners' Shares/Units Amount of Units Capital Earnings Securities Partners Partners Capital <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Balance at 12/31/97 10,103,172 $ 101 $(16,875) $50,123 $ --- $4,387 $ --- $ --- $ 37,736 Net income --- --- --- --- 8,217 --- --- --- 8,217 Unrealized gains on securities --- --- --- --- --- (542) --- --- (542) Total Comprehensive Income 7,675 Shares sold 4,222 --- --- 115 --- --- --- --- 115 Collection of receivables --- --- 66 --- --- --- --- --- 66 Units purchased (3,000) --- --- (75) --- --- --- --- (75) Shares issued in conversion of convertible debentures to common shares 1,212,504 12 --- 18,505 --- --- --- --- 18,517 Balance at 9/30/98 11,316,898 113 (16,809) 68,668 8,217 3,845 --- --- 64,034 Balance at 12/31/96 8,467,959 --- (22,674) --- --- 2,171 1,408 147,632 128,537 Net income --- --- --- --- --- --- 237 23,440 23,677 Unrealized losses on securities --- --- --- --- --- 1,767 --- --- 1,767 Total Comprehensive Income 13,992 Collection of receivables --- --- 5,131 --- --- --- --- --- 5,131 Units sold 387,753 --- (11,576) --- --- --- --- 12,081 505 Units issued in conversion of convertible debentures to partnership units 11,110 --- --- --- --- --- --- 170 170 Cash distributions declared ($1.80 per unit) --- --- --- --- --- --- (155) (15,548) (15,703) Balance at 9/30/97 8,866,822 $ --- $(29,119) $ --- $ --- $3,938 $ 1,490 $167,775 $144,084 </TABLE> The accompanying notes to interim condensed consolidated financial statements are an integral part of these consolidated statements. 7
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) Note 1 - CONSOLIDATED FINANCIAL STATEMENTS: The financial statements of National HealthCare Corporation ("NHC") for the nine months ended September 30, 1998 and 1997, which have not been examined by independent public accountants, reflect, in the opinion of management, all adjustments necessary to present fairly the data for such periods. The results of the operations for the nine months ended September 30, 1998 are not necessarily indicative of the results that may be expected for the entire fiscal year ended December 31, 1998. The interim condensed balance sheet at December 31, 1997 is taken from the audited financial statements at that date. The interim condensed financial statements should be read in conjunction with the consolidated financial statements, including the notes thereto, for the periods ended December 31, 1997, December 31, 1996, and December 31, 1995. Note 2 - MANDATED LOSS OF PARTNERSHIP TAX STATUS: Under the Revenue Act of 1987, NHC and certain other similar publicly traded partnerships were permitted to be taxed as partnerships and not as corporations through the 1997 tax year. Effective with the 1998 tax year, however, NHC is subject to federal income taxes. In response to the governmentally mandated loss of partnership status, the holders of NHC general and limited partnership units approved a plan of restructure whereby, on December 31, 1997, NHC converted from a limited partnership to a corporation. All partnership units outstanding on December 31, 1997 were effectively converted into shares of common stock. The restructure from a limited partnership to a corporation had no effect on the liquidity or financial condition of NHC. Note 3 - TRANSFER OF ASSETS AND LIABILITIES TO NHR: On December 31, 1997, NHC transferred certain assets including mortgage notes receivable (total book value of $94,439,000), the real property of 17 long-term health care centers, six assisted living facilities and one retirement center (total book value of $144,615,000) and related liabilities (total book value of $86,414,000) to National Health Realty, Inc. ("NHR"), a publicly traded real estate investment trust. NHC received in exchange all of the common stock or other equity interests of NHR, which was transferred to NHC's unitholders. 8
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) Concurrent with NHC's conveyance of the real property to NHR, NHC leased from NHR each of the 24 facilities under leases accounted for as operating leases. Pursuant to the terms of the leases, NHC is obligated to pay NHR annual base rent of $12,417,000 on the 24 facilities. In addition to base rent, in each year after 1999, NHC must pay percentage rent to NHR equal to 3% of the amount by which revenues of each facility in such later year exceeds revenues of such facility in 1999. NHC has also entered into an advisory agreement with NHR whereby services related to investment activities and day-to-day management and operations are provided to NHR by NHC as advisor. For its services under the advisory agreement, NHC is entitled to annual compensation of the greater of 2% of NHR's gross consolidated revenues or the actual expenses incurred by NHC. Note 4 - OTHER REVENUES: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 1998 1997 1998 1997 (in thousands) (in thousands) <S> <C> <C> <C> <C> Revenue from managed centers $ 5,701 $ 8,785 $17,036 $25,780 Guarantee fees 144 157 436 469 Advisory fee from NHI 828 775 2,483 2,326 Advisory fee from NHR 110 --- 331 --- Earnings on securities 379 467 1,118 1,358 Equity in earnings of unconsolidated investments 2 71 165 95 Interest income 765 1,150 2,705 3,099 Other 594 1,184 1,700 2,276 $ 8,523 $12,589 $25,974 $35,403 </TABLE> Revenues from managed centers include management fees and interest income on notes receivable from the managed centers. "Other" revenues include non-health care related earnings. Note 5 - INVESTMENTS IN MARKETABLE SECURITIES: NHC considers its investments in marketable securities as available for sale securities and unrealized gains and losses are recorded in shareowners' equity in accordance with SFAS 115. 9
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) Proceeds from the sale of investments in debt and equity securities during the period ended September 30, 1998 and 1997 were $220,000 and $854,000, respectively. Gross investment losses of $13,000 were realized on these sales during the period ended September 30, 1998. Gross investment gains of $249,000 were realized on these sales during the period ended September 30, 1997. Realized gains and losses from securities sales are determined on the specific identification of the securities. Note 6 - GUARANTEES: In order to obtain management agreements and to facilitate the construction or acquisition of certain health care centers which NHC manages for others, NHC has guaranteed some or all of the debt (principal and interest) on those centers. For this service, NHC charges an annual guarantee fee of 1% to 2% of the outstanding principal balance guaranteed, which fee is in addition to NHC's management fee. The principal amounts outstanding under the guarantees is approximately $69,057,000 (net of available debt service reserves) at variable and fixed interest rates with a weighted average rate of 5.1% at September 30, 1998. NOTE 7 - INCOME TAXES: The provision (benefit) for income taxes for the nine months ended September 30, 1998 is comprised of the following components: <TABLE> <CAPTION> Nine Months Ended (in thousands) September 30, 1998 <S> <C> Current Federal $ 4,776 State 683 Current Income Tax Provision 5,459 Deferred Tax Benefit Federal (492) State (70) Deferred Income Tax Benefit (562) Total Income Tax Provision $ 4,897 Deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The deferred tax assets and liabilities, at the respective income tax rates, as of September 30, 1998 are as follows: 10
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) </TABLE> <TABLE> <CAPTION> (in thousands) September 30, 1998 <S> <C> Current deferred tax asset: Accounts receivable $ 2,159 Accrued liabilities 1,805 3,964 Current deferred tax liability: Unrealized gains on marketable securities (1,394) Other (154) (1,548) Net current deferred tax asset $ 2,416 Noncurrent deferred tax asset: Deferred gain on sale of assets $ 5,529 Deferred guaranty fees 1,146 Other 429 7,104 Noncurrent deferred tax liability: Tax depreciation in excess of fin- ancial reporting depreciation (4,129) Other 73 (4,056) Net noncurrent deferred tax asset $ 3,048 </TABLE> The provision for income taxes is different than the amount computed using the applicable statutory federal and state income tax rate as follows: <TABLE> <CAPTION> Nine Months Ended September 30, 1998 <S> <C> Tax expense at statutory rates $ 5,774 Tax benefit of timing differences (562) Reversal of current income tax accruals (315) Total Income Tax Provision $ 4,897 </TABLE> 11
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) Note 8 - NEW ACCOUNTING PRONOUNCEMENTS: In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") effective for fiscal years beginning after December 15, 1997. SFAS 130 requires that changes in the amounts of certain items, including gains and losses on certain securities, be shown in the financial statements. NHC has adopted the provisions of SFAS 130 effective January 1, 1998. NHC has elected to disclose comprehensive income, which includes net income and unrealized gains and losses on securities, in the Consolidated Statements of Shareowners' Equity and Partners' Capital. Prior periods have been restated to conform to the SFAS 130 requirements. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131") effective for fiscal years beginning after December 15, 1997. This statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. NHC will be required to adopt SFAS 131 in the fourth quarter of 1998 and is currently determining the impact that SFAS 131 will have on its financial statements. If appropriate, NHC will begin disclosing the required information accordingly. In April 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 98-5 ("SOP 98-5") effective for fiscal years beginning after December 15, 1998. SOP 98-5 requires that all nongovernmental entities expense the costs of start-up activities as those costs are incurred. The statement also requires nongovernmental entities to write off any unamortized start-up costs that remain on the balance sheet at the date of adoption. NHC will adopt the provisions of SOP 98-5 effective January 1, 1999. Management does not expect the adoption to have a material impact on NHC's financial position or cash flows. 12
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) Note 9- LEGAL PROCEEDINGS: In March 1996, Florida Convalescent Centers, Inc. (FCC), an independent Florida corporation for whom NHC manages sixteen licensed nursing centers in Florida, gave NHC notice of its intent not to renew a management contract at one of the centers. Pursuant to written agreements between the parties (the "Valuation Process"), NHC first valued the center, then gave FCC the option to either i) sell the center to NHC at that value (minus certain deferred contingency fees owed NHC based on that value) or ii) elect to pay NHC a certain deferred contingency fee based upon that value and retain ownership. FCC responded on March 26, 1996, by filing a Declaratory Judgment suit in the Circuit Court of the Twelfth Judicial Circuit in and for Sarasota County, Florida, requesting that the court interpret the parties' rights under their contractual arrangements, and naming NHC and its then general partners as defendants. In January 1997, FCC notified NHC that it intends to terminate its management contracts with NHC as they become eligible for termination. Four such contracts matured in 1997 and the expiration date of a fifth center is in dispute; however, the parties have stipulated that NHC will remain as manager of all centers and the Valuation Process will be deferred until a final decision is reached by the Sarasota Court. The balance of the FCC contracts may be terminated in the years 2001-2003, although some of those dates are in dispute. Since the suit was filed, FCC has amended its complaint four times, the most recent amendment occurring in January 1998. These amendments assert numerous claims against NHC including claims for breach of all management agreements between the parties; for a declaration that FCC does not owe any deferred compensation to NHC or, if so, a declaration that such deferred compensation constitute usurious interest; that the recorded mortgages securing FCC's debt to NHC do not secure payment of the deferred compensation; for breach of a 1994 loan agreement between FCC and defendants related to the construction of a facility in Orlando; for business libel; for breach of fiduciary duty arising from defendants' alleged obstruction of FCC's right to audit; from defendants' alleged failure to properly manage FCC's facilities; from defendants' alleged self dealing by causing FCC and defendants or their affiliates to enter 13
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) into contracts that are not customary or usual in the industry; and in January, 1998 a breach resulting from NHC's conversion from a publicly traded partnership into a publicly traded corporation effective December 31, 1997. In addition to declaratory relief, FCC asserts that it is entitled to unspecified damages and has the right to terminate all of the management agreements between the parties for cause. The defendants have answered, denying all of FCC's claims and asserting counterclaims against FCC. On November 5, 1997, the trial court ruled against FCC's Partial Motion for Summary Judgment in which FCC asked the Court to order that the mortgages securing NHC's loans and guarantees to FCC did not secure the deferred compensation due upon termination of the contract. The Court stated as follows: "Defendants (NHC) are not required to release the encumbered properties from the mortgage liens until all secured amounts, including deferred contingency fees, are paid". In January, 1998, FCC filed with the Sarasota Court a Motion for Summary Judgment alleging all FCC management contracts were breached upon NHC's conversion into a corporation. NHC responded to this motion with numerous affidavits; the Court heard arguments on this issue on May 7 and has denied FCC's motion. The Court also set a trial date for the Fifth Amended Complaint commencing October 26, 1998. As discussed further in Note 10, after the jury was impaneled, but before opening arguments, the parties settled the litigation as follows: Under the terms of the settlement, NHC will purchase, subject to regulatory approval, two of the 16 long-term health care centers it currently manages for FCC and certain accounts receivable in exchange for all of NHC's rights in deferred contingency fees receivable from FCC and for the assumption of approximately $15 million of debt. Additionally, NHC will pay a one-time cash settlement of $15 million. FCC has the right to cancel the management contracts for the remaining 14 centers which cancellation may occur no earlier than June 30, 1999. Additionally, NHC has agreed to accept any adjustment to previously filed Medicare and routine cost limit exceptions related to these 16 centers. As previously disclosed, the loss of the management contract and related revenues from these 14 facilities will have a material negative impact on NHC's earnings, even after taking into consideration the purchase of two of the 16 long-term health care centers. 14
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) The centers NHC purchased are Palm Garden of Pensacola, Florida with 180 beds and Palm Garden of Lake City, Florida with 120 beds. NHC is also a defendant in a lawsuit styled Braeuning, et al vs. National HealthCare L.P., et al filed "under seal" in the U.S. District Court of the Northern District of Florida on April 9, 1996. The court removed the seal from the complaint - but not the file itself - on March 20, 1997, and service of process occurred on July 8, 1997, with the government participating as an intervening plaintiff. By agreement, and with court approval, the suit has been moved from the Pensacola District Court to the Tampa, Florida, District Court. NHC has filed its answer denying the allegations. The suit alleges that NHC submitted cost reports and routine cost limit exception requests containing "fraudulent allocation of routine nursing services to ancillary service cost centers" and also alleges that NHC improperly allocated skilled nursing service hours in four managed centers, all in the state of Florida. The suit was filed under the Qui Tam provisions of the Federal False Claims Act, commonly referred to as the "Whistleblower Act". NHC has denied all allegations and believes the facts will vindicate its position. The individual plaintiff Braeuning has amended the suit to allege that he was "retaliatory discharged" from his position due to the filing of the suit. In an order (March 13, 1998) denying Braeuning's Motion for Summary Judgment on this issue, the court stated, "That the defendants have submitted a legitimate non-retaliatory reason for firing Mr. Braeuning casts significant doubt on Mr. Braeuning's likelihood of success on the merits." The Court has now ordered that Mr. Braeuning can proceed to prepare for an evidentiary hearing limited to this issue, and discovery has commenced. In regard to the initial allegations contained in the lawsuit, NHC believes that the cost report information of its centers has been either appropriately filed or, upon amendment, will reflect adjustments only for the correction of unintentional misallocations. Prior to the filing of the suit, NHC had commenced an in-depth review of the nursing time allocation process at its owned, leased and managed centers. A number of amended cost reports have been filed and NHC will continue to schedule 15
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) and prepare revised cost reports and exception requests. NHC's self audit process has been approved by the plaintiffs and NHC has retained a nationally recognized accounting firm to review the self audit process. It is anticipated that all cost report years in question will be reviewed prior to there being further action in this matter at the judicial level. The cost report periods under review include periods from 1991 through 1996, plus the 1997 reports as they are initially filed. Adjustments to the reimbursable cost claimed will be the responsibility of the center where costs were incurred, whether owned, leased or managed by the Company. Under the terms of NHC's settlement discussed previously, NHC has agreed to accept any adjustments to previously filed Medicare and routine cost limit exceptions related to the 16 FCC centers. Negative adjustments to managed centers would reduce NHC's management fee (6% of net revenue), while adjustments to owned or leased centers would impact the Company's financial statements. NHC intends to continue it's revenue policy of not reflecting routine cost limit exception requests as income until the process, including cost report audits, is completed. NHC will continue to fully cooperate with the government in an attempt to determine dollar amounts involved, and will and is aggressively pursuing an amicable settlement. NHC cannot predict at this time the ultimate outcome of the suit. An adverse determination in the lawsuit could subject NHC to settlements which could have a material negative impact on the financial position or results of operations of NHC. In October 1996, two managed centers in Florida were audited by representatives of the regional office of the Office of the Inspector General ("OIG"). As part of these audits, the OIG reviewed various records of the facilities relating to allocation of nursing hours and contracts with suppliers of outside services. At one center, the OIG indicated during an exit conference that it had no further questions but has not yet issued a final report. At the second facility, which is one of four named in the Braeuning lawsuit, the OIG determined that certain records were insufficient and NHC supplied the additional requested information. These audits have been incorporated into the lawsuit. Florida is one of the states in which governmental officials are conducting "Operation Restore Trust", a federal/state program aimed at detecting and eliminating fraud and abuse by providers in the Medicare and Medicaid programs. The OIG has increased its investigative actions in Florida (and has now opened a Tennessee office) as part of Operation Restore Trust. 16
NATIONAL HEALTHCARE CORPORATION NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) There is certain additional litigation incidental to NHC's business, none of which, in management's opinion, would be material to the financial position or results of operations of NHC. Note 10 - EVENT SUBSEQUENT TO THE BALANCE SHEET DATE On October 30, 1998, NHC announced the terms of its settlement of litigation with Florida Convalescent Centers, Inc., as more fully described in Note 9. In connection with the settlement, NHC will report a one-time nonrecurring charge of $15.0 million during its fourth quarter to record its cash settlement with FCC. The reduction of earnings after taxes will be approximately $9.0 million or 79 cents per diluted share. As previously disclosed, the loss of management contracts from 14 FCC facilities, which will occur no earlier than June 30, 1999, will have a material negative impact on NHC's earnings, even after taking into consideration NHC's purchase of two of FCC's 16 long-term care facilities. Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations Overview National HealthCare Corporation (NHC, or the Company) operates or manages 112 long-term health care centers with 14,291 beds in nine states. NHC provides nursing care as well as ancillary therapy services to patients in a variety of settings including long-term care nursing centers, managed care specialty units, subacute care units, Alzheimer's care units, homecare programs, and facilities for assisted living. NHC also operates retirement centers. Two significant events occurred on December 31, 1997 which will have a permanent impact on NHC's results of operations and financial condition - the transfers to National Health Realty, Inc. and the governmentally mandated loss of partnership tax status. 17
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) Transfers to National Health Realty- As more fully described in Note 3 to the financial statements and in NHC's prior year annual report, at December 31, 1997, NHC transferred certain assets, liabilities and equity to National Health Realty, Inc. ("NHR"), a real estate investment trust. NHC received in exchange all of the common stock or other equity interests of NHR, which was transferred to NHC's unitholders. NHC management believed that, compared to other alternatives then available, the transfer will enhance unitholders' value. Concurrent with the transfers to NHR, NHC leased from NHR the real property which had been transferred. Effect of the Transfers on Results of Operations- The effect of the transfer of assets and liabilities to NHR on results of operations is as follows. "Other revenues" are reduced for the interest income on notes receivable transferred and operating expenses are increased by the rent expense on the property transferred. These reductions in net income are offset in part by the reduction of interest expense on debt transferred, by the reduction of depreciation expense on assets transferred, and by the receipt of an advisory fee from NHR under an advisory agreement. The net effect of these transactions is to reduce pretax net income when compared to periods prior to the transfer. Effect of the Transfer on Liquidity and Financial Condition- Assets transferred to NHR include mortgage notes receivable (total book value of $94,439,000), as well as the real property of 17 long-term health care centers, six assisted living facilities and one retirement center (total book value of $144,615,000) and related liabilities (total book value of $86,414,000). Equity transferred to NHR totaled $152,640,000. Although these physical assets were transferred, the operational revenues and expenses remain, as before, with NHC. Mandated Loss of Partnership Tax Status- Under the Revenue Act of 1987, NHC and certain other similar publicly traded partnerships were permitted to be taxed as partnerships and not as corporations through the 1997 tax year. Effective with the 1998 tax year, however, NHC is subject to federal income taxes. In response to the governmentally mandated loss of partnership tax status, 18
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) the holders of NHC general and limited partnership units approved a plan of restructure whereby, on December 31, 1997, NHC converted by merger from a limited partnership to a corporation. All partnership units (or rights to obtain same) outstanding on December 31, 1997 were effectively converted into shares of common stock. The restructure from a limited partnership to a corporation had no effect on the liquidity or financial condition of NHC. Results of Operations Three Months Ended September 30, 1998 Compared to Three Months Ended September 30, 1997. Results for the three month period ended September 30, 1998 include a 3.2% decrease compared to the same period in 1997 in net revenues and a 69.1% decrease in net income. The decreased revenues for the quarter reflect the decreased levels of service and changes in payment systems for rehabilitative services and homecare services. The decreased revenues for the quarter were partially offset by the continued growth of operations. Compared to the quarter a year ago, NHC has increased the number of owned or leased long-term care beds by 487 beds from 7,028 beds to 7,515 beds. In addition, the number of owned or leased assisted living units has increased by 145 units from 629 units to 774 units. Also contributing to increased revenues are improvements in both private pay and third party payor rates. Revenues from managed centers, which are included in the Statements of Income in Other Revenues, decreased 35.1% in 1998 from $8.8 million in 1997 to $5.7 million in 1998 due primarily to decreased interest income on notes receivable of $94,439,000 which were transferred to NHR on December 31, 1997. Total costs and expenses for the 1998 third quarter increased $1.2 million or 1.1% to $103.8 million from $102.6 million. Salaries, wages and benefits, the largest operating costs of this service company, decreased $1.2 million or 2.0% to $58.7 million from $59.9 million. Other operating expenses increased $2.0 million or 7.0% to $30.8 million for the 1998 second quarter compared to $28.8 million in the 1997 period. Rent increased $4.9 million or 79.1% to $11.2 million from $6.2 million. Depreciation and amortization decreased 34.1% to $2.9 million. Interest costs decreased $3.1 million or 92.9% to $0.2 million from $3.3 million for last year. 19
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) Decreases in salaries, wages and benefits are attributable to decreased staffing levels in therapy and home care services and reductions in bonus and benefit programs for the quarter offset in part by the increase in staffing levels due to long-term care bed additions and assisted living expansions. Also contributing to higher costs of labor are inflationary increases for salaries and the associated benefits. Operating costs have increased in part due to the increased number of beds in operation and the expansion of assisted living services. These increased beds and expansions are expected to provide increased revenues in future periods. Rent increased due to rent expense on the assets transferred to NHR and leased back to NHC. Depreciation and amortization decreased as a result of the transfer of real property to NHR, offset in part by the placing of newly purchased personalty in service. Interest expense decreased compared to the quarter a year ago due to the transfer of debt to NHR and due to the capitalization of interest for assets under construction. The income tax provision for the quarter was $1.8 million compared to no provision for the previous quarter. The change is due to the restructure from a limited partnership to a corporation. The total census at owned and leased centers for the quarter averaged 91.3% compared to an average of 92.1% for the same quarter a year ago. When newly opened centers are excluded, the total census of owned and leased centers for the quarter averaged 93.0%. Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30, 1997. Results for the nine month period ended September 30, 1998 include a 2.9% increase over the same period in 1997 in net revenues and a 65.3% decrease in net income. The increased revenues for the nine months reflect the continued growth of operations. Compared to the nine month period a year ago, NHC has increased the number of owned, leased and managed long-term care beds by 365 beds from 13,926 beds to 14,291 beds. In addition, the number of owned or leased assisted living units has increased by 145 units from 629 units in 1997 to 774 units in 1998. Also contributing to increased revenues are improvements in both private pay and third party payor rates. 20
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) The increased revenues for the nine months were partially offset by decreased levels of service and changes in payment systems for rehabilitative services and homecare services. Revenues from managed centers, which are included in the Statements of Income in Other Revenues, decreased 33.9% in 1998 from $25.8 million in 1997 to $17.0 million in 1998 due primarily to decreased interest income on $94,439,000 notes receivable which were transferred to NHR on December 31, 1997. Total costs and expenses for the 1998 nine months increased $20.1 million or 6.7% to $320.4 million from $300.4 million. Salaries, wages and benefits, the largest operating costs of this service company, increased $6.3 million or 3.6% to $183.6 million from $177.5 million. Other operating expenses increased $9.6 million or 11.6% to $92.7 million for the 1998 nine months compared to $83.1 million in the 1997 period. Rent increased $14.0 million or 76.6% to $32.3 million from $18.3 million. Depreciation and amortization decreased 27.9% to $3.4 million. Interest costs decreased $6.5 million or 69.6% to $2.9 million from $9.4 million for last year. Increases in salaries, wages and benefits are attributable to the increase in staffing levels due to long-term care bed additions and assisted living expansions. Also contributing to higher costs of labor are inflationary increases for salaries and the associated benefits. Increased salaries, wages and benefits were offset in part by deceased staffing levels in the therapy and homecare services. Operating costs have increased in part due to the increased number of beds in operation and the expansion of assisted living services. These increased beds and expansions are expected to provide increased revenues in future periods. Rent increased due to rent expense on the assets transferred to NHR and leased back to NHC beginning January 1, 1998. Depreciation and amortization decreased as a result of the transfer of real property to NHR, offset in part by the placing of newly purchased personalty in service. Interest expense decreased compared to the nine months a year ago due primarily to the transfer of debt to NHR and due to the capitalization of interest for assets under construction. The income tax provision for the nine months was $4.9 million compared to no provision for the previous nine months. The change is due to the restructure from a limited partnership to a corporation. 21
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) The total census at owned and leased centers for the nine months averaged 90.1% compared to an average of 92.8% for the same nine months a year ago. When newly opened centers are excluded, the total census of owned and leased centers for the quarter averaged 92.7%. Liquidity and Capital Resources During the first nine months of 1998, the Company generated net cash of $31.5 million from operating activities, $13.5 million from the collection of long-term notes receivable, $0.3 million from the increase in financing costs, and $0.2 million from the decrease in marketable securities. Of these funds, $23.3 million was used for additions to and acquisitions of property and equipment, $24.9 million for investment in long-term notes receivable and loan participation agreements, $3.4 million to increase cash held by trustees, $0.1 million to increase bond reserve funds and mortgage replacement reserves, $3.0 million for payments on debt, and $5.4 million for cash distributions to partners for the last quarter of 1997. NHC does not currently plan to declare or pay dividends in 1998 or beyond. Cash and cash equivalents decreased $14.2 million during the period. At September 30, 1998, the Company's ratio of long-term obligations to convertible debt and capital is 1.1 to 1. Cash Dividends NHC may pay dividends at the discretion of the Board of Directors. NHC, as a corporation, does not anticipate initially paying dividends. Impact of Inflation Reimbursement rates under the Medicare and Medicaid programs generally reflect the underlying increases in costs and expenses resulting from inflation. For this reason, the impact of inflation on profitability has not been significant. Development During the first nine months of 1998, the Company added a net total of 220 licensed long-term care beds, 133 beds of which are owned or leased and 87 beds of which are managed for other owners. During the same period, NHC added 45 assisted living apartments. 22
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) Currently, NHC has 509 long-term care beds under development at 11 owned, leased or managed health care centers in various locations. These beds are either under construction or a Certificate of Need has been received from the appropriate state agency authorizing the construction of additional centers or beds. In addition, NHC has 211 retirement apartments at two independent living centers under development, all of which are owned. Health Care Legislation-- During 1997, the Federal government enacted the Balanced Budget Act of 1997 ("BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The BBA requires that nursing homes transition to a prospective payment system under the Medicare program during a three year "transition period" commencing with the first cost reporting period beginning on or after July 1, 1998. Home health agencies must also transition from a cost-based reimbursement system to a prospective payment system beginning in 1999. The BBA also contains certain measures that could lead to future reductions in Medicare therapy cost reimbursement and Medicaid payment rates. Given the recent enactment of the BBA, NHC is unable to predict the ultimate impact of the BBA on its future operations. However, any reductions in government spending for long-term health care would likely have an adverse effect on the operating results and cash flows of NHC. NHC will attempt to increase nongovernmental revenues and continue the expansion of its service component income in order to help offset any loss of governmental revenues as a result of the enactment of the BBA. The President's 1998-99 budget proposal also calls for the imposition of new provider paid service fees. Litigation-- As discussed in more detail in Note 9 to the financial statements, NHC is a defendant in a lawsuit filed under the Qui Tam provisions of the Federal False Claims Act, commonly referred to as the "Whistleblower Act", with the government participating as an intervening plaintiff. The suit alleges that NHC has submitted cost reports and routine cost limit exception requests containing "fraudulent allocation of routine nursing 23
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) services to ancillary cost centers" and improper allocation of skilled nursing service hours in four managed centers. NHC is cooperating fully with the government and will aggressively pursue an amicable settlement, if such appears necessary at the conclusion of the in-house audit currently underway. Adjustments to the reimbursable cost claimed will be the responsibility of the center where costs were incurred, whether owned, leased or managed by the Company. Negative adjustments to managed centers would reduce NHC's management fee (6% of net revenue), while adjustments to owned or leased centers would impact the Company's financial statement. An adverse determination in the lawsuit could subject NHC to repayments which could have a material negative impact on the financial position or results of operations of NHC. Also as discussed in more detail in Note 9 to the financial statements, NHC settled a lawsuit filed by Florida Convalescent Centers, Inc. ("FCC"), an independent Florida corporation for whom NHC manages 16 licensed nursing centers in Florida. Under the terms of the settlement, NHC will purchase, subject to regulatory approval, two of the 16 long-term health care centers it currently manages for FCC and certain accounts receivable in exchange for all of NHC's rights in deferred contingency fees receivable from FCC and for the assumption of approximately $15 million of debt. Additionally, NHC will pay a one-time cash settlement of $15 million. FCC has the right to cancel the management contracts for the remaining 14 centers which cancellation may occur no earlier than June 30, 1999. Additionally, NHC has agreed to accept any adjustment to previously filed Medicare and routine cost limit exceptions related to these 16 centers. As previously disclosed, the loss of the management contract and related revenues from these 14 facilities will have a material negative impact on NHC's earnings, even after taking into consideration the purchase of two of the 16 long-term health care centers. Year 2000 Compliance NHC has evaluated its information technology systems and embedded technology with respect to potential Year 2000 problems. Although management believes that the majority of NHC's information technology systems and embedded technology is already Year 2000 compliant, NHC will 24
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) complete the testing of its information technology systems and embedded technology in the third quarter of 1999. In addition, NHC has developed corrective plans for any technology assessed to be non-compliant. Costs incurred to date for NHC's internal Year 2000 remediation efforts have not been material, and NHC does not expect that the cost of future internal actions will be material to its financial condition or results of operations. NHC does not anticipate any material disruption in its operations as a result of any failure by NHC to be in compliance. NHC also depends upon the proper functioning of information technology systems and embedded technology operated by certain other third parties. These third parties include third party payors such as the Medicare and Medicaid programs, commercial banks and other lenders, and vendors such as providers of food supplies and services, telecommunications and utilities. NHC currently is gathering information concerning the Year 2000 compliance status of these third parties. If third parties with whom NHC interacts have Year 2000 problems that are not remedied, the following problems could result (I) in the case of third party payors, in delayed collection of accounts receivable potentially resulting in liquidity stress; (ii) in the case of banks and other lenders, in the disruption of capital flows potentially resulting in liquidity stress; or (iii) in the case of vendors, in disruption of important services upon which NHC depends, such as food services and supplies, tele- communications and electrical power. Based upon current information, NHC anticipates successful completion and testing of its Year 2000 remediation efforts during 1999. However, there can be no guarantee that the Year 2000 will not have a material adverse effect on NHC's operations, financial position or liquidity if NHC's remediation efforts are not successful or completed in a timely manner. NHC is currently developing a contingency plan in the event that it is not able to achieve Year 2000 compliance. This contingency plan is expected to include establishing sources of liquidity that could be drawn upon in the event of systems disruption and identifying alternative vendors and back-up processes that do not rely on computers, whenever possible. The contingency plan is expected to be completed in the third quarter of 1999. 25
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) Item 3. Quantitative and Qualitative Information About Market Risk Not Applicable. PART II. OTHER INFORMATION Item 1. Legal Proceedings. In March 1996, Florida Convalescent Centers, Inc. ("FCC"), an independent Florida corporation for whom NHC manages sixteen licensed nursing centers in Florida, gave NHC notice of its intent not to renew a management contract at one of the centers. Pursuant to written agreements between the parties the "Valuation Process"), NHC first valued the center, then gave FCC the option to either I) sell the center to NHC at that value (minus certain deferred contingency fees owed NHC based on that value) or ii) elect to pay NHC a certain deferred contingency fee based upon that value and retain ownership. FCC responded on March 26, 1996, by filing a Declaratory Judgment suit in the Circuit Court of the Twelfth Judicial Circuit in and for Sarasota County, Florida, requesting that the court interpret the parties' rights under their contractual arrangements, and naming NHC and its then general partners as defendants. In January 1997, FCC notified NHC that it intends to terminate its management contracts with NHC as they become eligible for termination. Four such contracts matured in 1997 and the expiration date of a fifth center is in dispute; however, the parties have stipulated that NHC will remain as manager of all centers and the Valuation Process will be deferred until a final decision is reached by the Sarasota Court. The balance of the FCC contracts may be terminated in the years 2001-2003, although some of those dates are in dispute. 26
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) Since the suit was filed, FCC has amended its complaint four times, the most recent amendment occurring in January 1998. These amendments assert numerous claims against NHC including claims for breach of all management agreements between the parties; for a declaration that FCC does not owe any deferred compensation to NHC or, if so, a declaration that such deferred compensation constitutes usurious interest; that the recorded mortgages securing FCC's debt to NHC do not secure payment of the deferred compensation fees; for breach of a 1994 loan agreement between FCC and defendants related to the construction of a facility in Orlando; for business libel; for breach of fiduciary duty arising from defendants' alleged obstruction of FCC's right to audit; from defendants' alleged failure to properly manage FCC's facilities; from defendants' alleged self dealing by causing FCC and defendants or their affiliates to enter into contracts that are not customary or usual in the industry; and in January, 1998 a breach resulting from NHC's conversion from a publicly traded partnership into a publicly traded corporation effective December 31, 1997. In addition to declaratory relief, FCC asserts that it is entitled to unspecified damages and has the right to terminate all of the management agreements between the parties for cause. The defendants have answered, denying all of FCC's claims and asserting counterclaims against FCC. On November 5, 1997, the trial court ruled against FCC's Partial Motion for Summary Judgment in which FCC asked the Court to order that the mortgages securing NHC's loans and guarantees to FCC did not secure the deferred compensation due upon termination of the contract. The Court stated as follows: "Defendants (NHC) are not required to release the encumbered properties from the mortgage liens until all secured amounts, including deferred contingency fees, are paid". In January, 1998, FCC filed with the Sarasota Court a Motion for Summary Judgment alleging all FCC management contracts were breached upon NHC's conversion into a corporation. NHC responded to this motion with numerous affidavits; the Court heard arguments on this issue on May 7 and has denied FCC's motion. The Court also set a trial date for the Fifth Amended Complaint commencing October 26, 1998. As discussed further in Note 10, after the jury was impaneled, but before opening arguments, the parties settled the litigation as follows: 27
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) Under the terms of the settlement, NHC will purchase, subject to regulatory approval, two of the 16 long-term health care centers it currently manages for FCC and certain accounts receivable in exchange for all of NHC's rights in deferred contingency fees receivable from FCC and for the assumption of approximately $15 million of debt. Additionally, NHC will pay a one-time cash settlement of $15 million. FCC has the right to cancel the management contracts for the remaining 14 centers which cancellation may occur no earlier than June 30, 1999. Additionally, NHC has agreed to accept any adjustment to previously filed Medicare and routine cost limit exceptions related to these 16 centers. As previously disclosed, the loss of the management contract and related revenues from these 14 facilities will have a material negative impact on NHC's earnings, even after taking into consideration the purchase of two of the 16 long-term health care centers. The centers NHC purchased are Palm Garden of Pensacola, Florida with 180 beds and Palm Garden of Lake City, Florida with 120 beds. NHC is also a defendant in a lawsuit styled Braeuning, et al vs. National HealthCare L.P., et al filed "under seal" in the U.S. District Court of the Northern District of Florida on April 9, 1996. The court removed the seal from the complaint - but not the file itself - on March 20, 1997, and service of process occurred on July 8, 1997, with the government participating as an intervening plaintiff. By agreement, and with court approval, the suit has been moved from the Pensacola District Court to the Tampa, Florida, District Court. NHC has filed its answer denying the allegations. The suit alleges that NHC submitted cost reports 28
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) and routine cost limit exception requests containing "fraudulent allocation of routine nursing services to ancillary service cost centers" and also alleges that NHC improperly allocated skilled nursing service hours in four managed centers, all in the state of Florida. The suit was filed under the Qui Tam provisions of the Federal False Claims Act, commonly referred to as the "Whistleblower Act". NHC has denied all allegations and believes the facts will vindicate its position. The individual plaintiff Braeuning has amended the suit to allege that he was "retaliatory discharged" from his position due to the filing of the suit. In an order (March 13, 1998) denying Braeuning's Motion for Summary Judgment on this issue, the court stated, "That the defendants have submitted a legitimate non-retaliatory reason for firing Mr. Braeuning casts significant doubt on Mr. Braeuning's likelihood of success on the merits." The Court has now ordered that Mr. Braeuning can proceed to prepare for an evidentiary hearing limited to this issue. In regard to the initial allegations contained in the lawsuit, NHC believes that the cost report information of its centers has been either appropriately filed or, upon amendment, will reflect adjustments only for the correction of unintentional misallocations. Prior to the filing of the suit, NHC had commenced an in-depth review of the nursing time allocation process at its owned, leased and managed centers. A number of amended cost reports have been filed and NHC will continue to schedule and prepare revised cost reports and exception requests. NHC's self audit process has been approved by the plaintiffs and NHC has retained a nationally recognized accounting firm to review the self audit process. It is anticipated that all cost report years in question will be reviewed prior to there being further action in this matter at the judicial level. The cost report periods under review include periods from 1991 through 1996, plus the 1997 reports as they are initially filed. 29
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) Adjustments to the reimbursable cost claimed will be the responsibility of the center where costs were incurred, whether owned, leased or managed by the Company. Under the terms of NHC's settlement discussed previously, NHC has agreed to accept any adjustments to previously filed Medicare and routine cost limit exceptions related to the 16 FCC centers. Negative adjustments to managed centers would reduce NHC's management fee (6% of net revenue), while adjustments to owned or leased centers would impact the Company's financial statements. NHC intends to continue it's revenue policy of not reflecting routine cost limit exception requests as income until the process, including cost report audits, is completed. NHC will continue to fully cooperate with the government in an attempt to determine dollar amounts involved, and will and is aggressively pursuing an amicable settlement. NHC cannot predict at this time the ultimate outcome of the suit. An adverse determination in the lawsuit could subject NHC to settlements which could have a material negative impact on the financial position or results of operations of NHC. In October 1996, two managed centers in Florida were audited by representatives of the regional office of the Office of the Inspector General ("OIG"). As part of these audits, the OIG reviewed various records of the facilities relating to allocation of nursing hours and contracts with suppliers of outside services. At one center, the OIG indicated during an exit conference that it had no further questions but has not yet issued a final report. At the second facility, which is one of four named in the Braeuning lawsuit, the OIG determined that certain records were insufficient and NHC supplied the additional requested information. These audits have been incorporated into the lawsuit. Florida is one of the states in which governmental officials are conducting "Operation Restore Trust", a federal/state program aimed at detecting and eliminating fraud and abuse by providers in the Medicare and Medicaid programs. The OIG has increased its investigative actions in Florida (and has now opened a Tennessee office) as part of Operation Restore Trust. There is certain additional litigation incidental to NHC's business, none of which, in management's opinion, would be material to the financial position or results of operations of NHC. 30
NATIONAL HEALTHCARE CORPORATION September 30, 1998 (Unaudited) Item 2. Changes in Securities. Not applicable Item 3. Defaults Upon Senior Securities. None Item 4. Submission of Matters to Vote of Security Holders. None Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K. (a) List of exhibits - Exhibit 27 - Financial Data Schedule (for SEC purposes only) (b) Reports on Form 8-K - Filed October 30, 1998 SIGNATURES Pursuant to the requirements of the Security Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NATIONAL HEALTHCARE CORPORATION (Registrant) Date November 16, 1998 /s/ Richard F. LaRoche, Jr. Richard F. LaRoche, Jr. Secretary Date November 16, 1998 /s/ Donald K. Daniel Donald K. Daniel Vice President and Controller Principal Accounting Officer 31