========================================================================= SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _______ FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the fiscal year ended Commission File No. December 31, 1997 333-37185 _______ NATIONAL HEALTHCARE CORPORATION, SUCCESSOR BY MERGER TO NATIONAL HEALTHCARE L.P. (Exact name of registrant as specified in its Corporate Charter) Delaware 52-2057472 (State of Formation) (I.R.S. Employer I.D. No.) 100 Vine Street Murfreesboro, Tennessee 37130 (Address of principal executive offices) Telephone Number: 615-890-2020 Securities registered pursuant to Section 12(b) of the Act. Name of Each Exchange on Title of Each Class which Registered _________________________________________________________________________ Units of Limited Partnership Interest, Now Shares of Common Stock American Stock Exchange Senior Subordinated Convertible Debentures Due 2000 (6%) American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: Same Indicate by check mark whether the registrant (a) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x] The aggregate market of voting shares held by nonaffiliates of the registrant was $204,953,100 as of February 28, 1998. Number of Shares outstanding as of February 28, 1998: 10,559,613 Page 1 of 86 Pages Exhibit Index Page 55 =====================================================================
PART 1 ------ ITEM 1 BUSINESS GENERAL National HealthCare Corporation (NHC or the Company) is the successor by merger to National HealthCare L.P. effective 11:59 p.m., December 31, 1997. This 10-K, then, is descriptive of time periods when the investors in the Company were "partners", the Company itself was a "Partnership", the common voting securities were identified as "units" rather than as "shares", and references to the "Board of Directors" were to the board of the then Managing General Partner of the Partnership rather than directly of the Company. For consistency, and because the Company is now a corporation, these partnership references have been changed into corporate terminology. NHC is a corporation organized under the laws of the State of Delaware. It principally operates long-term health care centers and home health care programs in the southeastern United States. The Company's health care centers provide subacute, skilled and intermediate nursing and rehabilitative care. At December 31, 1997, the Company operated 111 long-term health care centers with a total of 14,071 licensed beds. Of the 111 centers operated, 40 are leased from National Health Investors, Inc. (NHI), 18 are leased from National Health Realty, Inc. (NHR) and 53 are managed for other owners. The Company serves as a compensated Investment Advisor to both NHI and NHR. The Company's homecare programs provide rehabilitative care at a patient's residence. During 1997, the Company operated 36 homecare programs and provided 731,349 homecare patient visits. NHC also operates 387 retirement apartments located in one managed and three retirement centers leased from NHI. Additionally, the Company operates 729 assisted living units at twelve leased centers (eight from NHI and four from NHR)and two managed centers. During 1997 NHC opened 1,189 new health care beds, 721 in owned/leased centers and 468 in managed centers. Bed growth in leased centers was due to opening five new centers and purchasing another. All were transferred to and then leased from National Health Realty, Inc. effective January 1, 1998. Managed center bed growth was realized with the expansion of two existing operations, each by 60 beds, plus commencing management on six centers. During the year, construction started on one new center with 60 beds, expansion of four leased centers (157 beds), and a total of 27 managed beds in two locations. A total of 384 beds were under construction at year end. Finally, NHC has obtained certificates of need for the construction of 447 beds at nine owned, leased or managed locations, all of which are expected to start construction in 1998. As of December 31, 1997, the Company operated specialized care units such as Alzheimer's Disease care units (16), sub-acute nursing units (12) and a number of in house pharmacies. Similar specialty units are under development or consideration at a number of the Company's centers, as well as free standing projects. ADDITIONAL SERVICES. The Company plans to continue to expand its continuum of care for the elderly by offering a comprehensive and increasing range of services through related or separately structured health care centers, homecare programs, specialized care units, pharmacy operations, rehabilitative services, assisted living centers and retirement centers. Highlights of these activities during 1997 were as follows:
A. HOMECARE PROGRAMS. The Company's policy has been to affiliate each of its licensed and certified homecare programs with a Company operated health care center. Although the existing programs have decreased their total number of visits from 764,000 in 1996 to 731,349 in 1997, NHC has applied for and received Certificates of Need to expand the program services in both Florida and South Carolina, as well as pursuing a number of acquisition opportunities. Such acquired or new programs are not presently planned to be operated out of a health care center. Additional certificate of need applications will be filed during 1998. The new reimbursement program for homecare services under the Medicare program will pay for a fixed amount for each recipient irrespective of the number of visits, thus the Company is now focusing on its homecare patient census rather than number of visits. B. REHABILITATIVE SERVICES. The Company has long operated an intensive offering of physical, speech, and occupational therapy provided by center specific therapists. NHC increased its staff of professionally licensed therapists from 983 in 1996 to 1,155 in 1997. The Company operates a separate rehabilitation subsidiary known as NHC Rehabilitation. Because of the Company's extensive network of health care centers in the Southeastern United States, the Company is better able to attract, employ, and retain therapists. It is also greatly expanding its customer service base by providing contract services to 629 health care providers owned by third parties. Provision of these services is not covered under the Company's contracts to manage health care centers and must be renegotiated annually with the center owner. The Company's rates for these services are competitive with other market rates. Major Medicare reimbursement changes will occur for therapy services in 1998 and 1999 - reimbursement will be limited to published "salary equivalents" effective April 1, 1998, then licensed skilled nursing centers must bill Medicare directly commencing July 1, 1998. In 1999 skilled nursing centers Medicare per diems will become prospective and will include no separate payment for therapy services. This system will be phased in over a four year period. The Company anticipates a substantial decrease in third party contracts as a result of these changes. C. MEDICAL SPECIALTY UNITS. The Company has required all of its centers to participate in the Medicare program since 1973, and has continually expanded its range of offerings by the creation of center-specific medical specialty units such as the Company's 16 Alzheimer's disease care units and 12 subacute nursing units. The services are provided not only at each NHC operated center, but also at existing specialized care units. D. PHARMACY OPERATIONS. The Company's policy has been to have an in-house pharmacy located in each health care center in those states where licensure permits the operation of an in-house pharmacy. In other states, pharmaceutical services have been provided by third party contracts. NHC continues to review opportunities for regional pharmacy operations and now operates four, one in east Tennessee, one in South Carolina, and two in central Florida. These pharmacy operations operate out of a central office and
supply (on a separate contractual basis) pharmaceutical services and supplies which were formerly purchased by each center from local vendors. The regional pharmacy operations now have 5,574 skilled nursing home beds under contract. E. ASSISTED LIVING PROJECTS. The Company presently owns, leases or manages fourteen assisted living projects, eight of which are located within the physical structure of a long-term health care center or retirement complex. The Company has identified the assisted living market as an expanding area for the delivery of health care and hospitality services and has a planned market review process in its states of operation for the construction of free-standing assisted living centers. Three owned freestanding assisted living projects opened in 1997 with a total of 252 units and one 50 apartment complex was leased in 1997. One additional free standing assisted living project is under construction which will open in 1998. It is anticipated that the Company will start construction on four additional free-standing assisted living apartments during 1998. Assisted living units provide basic room and board functions for the elderly with the on-staff availability to assist in minor medical needs on an as needed basis. F. MANAGED CARE CONTRACTS. The Company operates seven regional contract management offices, staffed by experienced case managers who contract with managed care organizations (MCO's) and insurance carriers for the provision of subacute and other medical specialty services within a regional cluster of centers. Managed care days have increased from 30,226 in 1995 and 50,113 in 1996 to 71,606 in 1997. In fiscal year 1997, 96% of the Company's net revenues were derived from health care services and 4% from other sources. LONG-TERM HEALTH CARE CENTERS The health care centers operated by the Company provide in-patient skilled and intermediate nursing care services and in-patient and out-patient rehabilitation services. Skilled nursing care consists of 24-hour nursing service by registered or licensed practical nurses and related medical services prescribed by the patient's physician. Intermediate nursing care consists of similar services on a less intensive basis principally provided by non-licensed personnel. These distinctions are generally found in the long-term health care industry although for Medicaid reimbursement purposes, some states in which the Company operates have additional classifications, while in other states the Medicaid rate is the same regardless of patient classification. Rehabilitative services consist of physical, speech, and occupational therapies, which are designed to aid the patient's recovery and enable the patient to resume normal activities. Each health care center has a licensed administrator responsible for supervising daily activities, and larger centers have assistant administrators. All have medical directors, a director of nurses and full-time registered nurse coverage. All centers provide physical therapy and most have other rehabilitative programs, such as occupational or speech therapy. Each facility is located near at least one hospital and is qualified
to accept patients discharged from such hospitals. Each center has a full dining room, kitchen, treatment and examining room, emergency lighting system, and sprinkler system where required. Management believes that all centers are in compliance with the existing fire and life safety codes. The Company has developed a quality certification program which it utilizes in each of its health care centers to verify that high standards of care are maintained. An integral part of the program is a computerized patient assessment system which aids in placing the patient in the appropriate section of each center (skilled or intermediate) and monitors the health care needs of the patient, number and frequency of medications and other essential medical information. The data derived from this system is used not only to assure that appropriate care is given to each individual patient, but also to ascertain the appropriate amount of staffing of each section of the center. Additionally, the Company requires a patient care survey to be performed at least quarterly by the regional and home office nursing support team, and a "consumer view" survey by senior management at least twice a year. The Company developed and promotes a "customer satisfaction" rating system, using 1993 as a bench mark, and requires significant improvement in the ratings by each center as a condition of participation in the Company's overall "Excellence Program". The Company provides centralized management and support services to the Company's health care nursing centers. The management and support services include operational support through the use of regional vice presidents and regional nurses, accounting and financial services, cash management, data processing, legal, consulting and services in the area of rehabilitative care. All personnel are employed by the Company's administrative services affiliate, National Health Corporation, which is also responsible for overall services in the area of personnel, loss control, insurance, education and training. The Company reimburses the administrative services contractor by paying all the costs of personnel employed for the benefit of the Company as well as a fee. National Health Corporation (National) is wholly owned by the National Health Corporation Employee Stock Ownership Plan and provides its services only to the Company. National was the Administrative General Partner during the eleven years the Company's organizational form was as a publicly traded partnership. The Company provides identical management services to centers operated under management contracts as it provides to centers owned or leased by the Company. The term of each contract and the amount of the management fee are determined on a case-by-case basis. Typically, the Company charges 6% of net revenues. The initial term of the contracts range from five years to twenty years. The Company maintains a right of first refusal should any owner desire to sell a managed center and, in certain situations, special termination payments have been negotiated should an owner sell to a third party or terminate or non-renew a management contract. All health care centers operated by the Company are licensed by the appropriate state and local agencies. All except two are certified as providers for Medicaid patients, and all are certified as Medicare providers. All of the Company's centers are subject to state and federal licensure and certification surveys. These surveys, from time to time, may produce statements of deficiencies. In response to such a statement, if any, the staff at each center would file a plan of correction after consultation with
the Regional Vice President and any alleged deficiencies would be corrected. Presently, none of the Company's facilities are operating under material statements of deficiencies. The Company has a significant monetary bonus to employees attached to passing these surveys with few or no deficiencies. HEALTH CARE CENTERS UNDER CONSTRUCTION The following table sets forth the long-term health care centers or additions to existing centers currently under construction which the Company owns, leases or manages: Number Owned/Leased/ Projected Location of Beds Managed Opening Date -------- ------- ------------- ------------ Farragut, TN 60 Leased May 1998 Dunlap, TN 60* Leased January 1998 Naples, FL 30* Leased February 1998 Columbia, SC 32* Leased August 1998 Franklin, TN 113 Leased November 1998 Blue Water Bay, FL 60* Managed December 1998 Moulton, AL 29* Leased November 1998 Total 384 *Expansion of existing center CONSTRUCTION STARTS IN 1998 The following table sets forth the new beds authorized by governmental certificates of need which are anticipated to start construction in 1998. Number Number of Number of of Beds New Centers Existing Centers ------- ----------- ---------------- Owned 112 1 0 Leased 137 0 4 Managed 198 0 4 Total 447 1 8 OCCUPANCY RATES The following table shows certain information relating to occupancy rates for the Company's continuing owned and leased long-term health care centers: Year Ended December 31 1997 1996 1995 Overall census 92.2% 93.0% 92.8% Census excluding acquisitions and new openings 94.6% 93.0% 94.5% Occupancy rates are calculated by dividing the total number of days of patient care provided by the number of patient days available (which is determined by multiplying the number of licensed beds by 365 or 366).
HOMECARE PROGRAMS The Company's home health programs (called "Homecare" by the Company) provide nursing and rehabilitative services to individuals in their residences and are licensed by the Tennessee, South Carolina and Florida state governments and certified by the federal government for participation in the Medicare program. Each of the Company's 36 Medicare certified homecare programs and its one private duty program is managed by a registered nurse, with speech, occupational and physical therapists either employed by the program or on a contract basis. Homecare visits decreased from 754,000 visits in 1996 to 731,000 visits in 1997. The new reimbursement program for homecare services under the Medicare program will pay for a fixed amount for each recipient irrespective of the number of visits, thus the Company is now focusing on its homecare patient census rather than number of visits. The Company has homecare programs in Tennessee, Florida, and South Carolina. It opened two new program offices in Tennessee and one in Florida in 1997. The Company's Tennessee homecare programs are associated with its long-term health care centers and, historically, are based within the health care center. The Company's new homecare programs are separately based in an effort to continually expand NHC's market leadership in these services. The Company's experience in this field indicates that homecare is not a substitute for institutional care in a hospital or health care center. Instead, the Company's homecare programs provide an additional level of health care because its centers can provide services to patients after they have been discharged from the center or prior to their admission. ASSISTED LIVING UNITS The Company presently leases and manages fourteen assisted living units, eight of which are located within the physical structure of a long-term health care center or retirement center and six of which are freestanding. Four of those six were opened during 1997. These openings increased NHC's assisted living units from 337 in 1996 to 729 in 1997. The Company plans to add at least four free standing assisted living projects each year with the first priority being to serve markets in which the Company already operates health care centers. Assisted living units provide basic room and board functions for the elderly with the on-staff availability to assist in minor medical needs on an as needed basis. Certificates of Need are not necessary to build these projects and the Company believes that overbuilding has occurred in some of its markets. The Company will open one and expects to start construction on four free standing projects in 1998. RETIREMENT CENTERS NHC's retirement centers offer specially designed residential units for the active and ambulatory elderly and which complexes provide various ancillary services for their residents, including restaurants, activity rooms and social areas. In most cases, retirement centers also include long-term health care facilities, either in contiguous or adjacent licensed health care centers. Charges for services are paid from private sources without assistance from governmental programs. Retirement centers may be licensed and regulated in some states, but do not require the issuance of a Certificate of Need such as is required for health care centers. NHC has, in most cases,
developed retirement centers adjacent to its health care properties with an initial construction of 15 to 40 units and which units are rented by the month; thus these centers offer an expansion of the Company's continuum of care. The projects are designed, however, to be expandable if the demand justifies. The Company believes these retirement units offer a positive marketing aspect of the Company's health care centers. Another type of retirement center which the Company offers is that of "continuing care communities", where the resident pays a substantial endowment fee and a monthly maintenance fee. The resident then receives a full range of services - including nursing home care - without additional charge. One such continuing care community, the 137 unit Richland Place Retirement Center, was opened in January, 1993 and is fully occupied. The Company is currently constructing and marketing an additional continuing care retirement community in Murfreesboro, Tennessee and marketing a proposed independent living center in Farragut, Tennessee. The Company has land under contract for similar communities in Franklin, Tennessee, and Charleston, South Carolina. SOURCES OF REVENUE The Company's revenues are primarily derived from its health care centers. The source and amount of the revenues are determined by (i) the licensed bed capacity of its health care centers, (ii) the occupancy rate of those centers, (iii) the extent to which the rehabilitative and other skilled ancillary services provided at each center are utilized by the patients in the centers, (iv) the mix of private pay, Medicare and Medicaid patients, and (v) the rates paid by private paying patients and by the Medicare and Medicaid programs. The following table sets forth sources of patient revenues from health care centers and homecare services for the periods indicated: Year Ended Dec 31 Source 1997 1996 1995 Private 28% 28% 28% Medicare 38% 38% 38% Medicaid/Skilled 9% 9% 9% Medicaid/Intermediate 24% 24% 24% VA and Other 1% 1% 1% Total 100% 100% 100% GOVERNMENT HEALTH CARE REIMBURSEMENT PROGRAMS The federal health insurance program for the aged is Medicare, which is administered by the Department of Health and Human Services. State programs for medical assistance to the indigent are known as Medicaid in states which the Company operates. All health care centers operated by the Company are certified to participate in Medicare and all but two participate in Medicaid. Eligibility for participation in these programs depends upon a variety of factors, including, among others, accommodations, services, equipment, patient
care, safety, physical environment and the implementation and maintenance of cost controls and accounting procedures. In addition, some of the Company's centers have entered into separate contracts with the United States Veterans Administration which provides reimbursement for care to veterans transferred from Veterans Administration hospitals. Historically, government health care reimbursement programs make payments under a cost based reimbursement system. Although general similarities exist due to federal mandates, each state operates under its own specific system. Medicare, however, is uniform nationwide and pays, as defined by the program, the reasonable direct and indirect cost of services furnished to Medicare patients, including depreciation, interest and overhead. Medicare payments have previously been limited by ceilings which, pursuant to the 1993 Tax Reform Act, were frozen at their 1993 level for 1994, and 1995. During 1997 the Company had 46 owned or leased centers which operated at Medicare costs higher than the ceiling. The Company will file "exception requests" with the fiscal intermediary for substantially all of these centers. Revenues therefrom will not be booked until paid and audited by the appropriate payors. Private paying patients, private insurance carriers and the Veterans Administration generally pay on the basis of the center's charges or specifically negotiated contracts. Average per capita daily room and board revenue from private paying patients is higher than from Medicare and Medicaid patients, while the average per capita daily revenue from Medicare patients is higher than from Medicaid patients. The Company attempts to attract an increased percentage of private and Medicare patients by providing rehabilitative services and increasing its marketing of those services through market areas and "Managed Care Offices", of which seven were open at year end. These services are designed to speed the patient's recovery and allow the patient to return home as soon as is practical. In addition to educating physicians and patients to the advantages of the rehabilitative services, the Company also has implemented incentive programs which provide for the payment of bonuses to its regional and center personnel if they are able to obtain private and Medicare goals at their centers. Items eligible for payment under the Medicare program consist of nursing care, room and board, social services, physical and speech therapy, drugs and other supplies, and other necessary services of the type provided by skilled nursing facilities. Routine service costs for extended care facilities are subject to certain per diem costs limits. Medicare patients are entitled to have payment made on their behalf to a skilled nursing facility for up to 100 days during each calendar year and a prior 3-day hospital stay is required. A patient must be certified for entitlement under the Medicare program before the skilled nursing facility is entitled to receive Medicare payments and patients are required to pay approximately $95.00 per day after the first 20 days of the covered stay. Under the Medicare program, the federal government pays directly to the skilled nursing facility the reasonable direct and indirect costs of the services furnished. The Medicare program only reimburses for skilled nursing services, which generally afford a more intensive level of care. This program is undergoing significant changes. For details see the section "Health Care Reform". Medicaid programs provide funds for payment of medical services obtained by "medically indigent persons". These programs are operated by state agencies which adopt their own medical reimbursement formulas and standards, but which are entitled to receive supplemental funds from the federal government if their programs comply with certain federal government regulations. In all states in which the Company operates, the Medicaid programs authorize reimbursement at a fixed rate per day of service. The
fixed rate is established on the basis of a predetermined average cost of operating nursing centers in the state in which the facility is located or based upon the center's actual cost. The rate is adjusted annually based upon changes in historical costs and/or actual costs and a projected cost of living factor. The 1997 Balanced Budget Act eliminated a federally mandated requirement that Medicaid rates paid by the states must be sufficient to reimburse in full the costs of an "efficiently and reasonably operated" nursing home (the Boron Amendment"). The Company and the nursing home industry in general are concerned about this deletion and are monitoring the activities in state legislature budgetary processes. During the fiscal year, each facility receives payments under the applicable government reimbursement program. Medicaid payments are generally "prospective" in that the payment is based upon the prior years actual costs. Medicare payments are "retrospective" in that current year payments are designed to reasonably approximate the facility's reimbursable costs during that year. Payments under Medicare are adjusted to actual allowable costs each year. The actual costs incurred and reported by the facility under the Medicare program are subject to audit with respect to proper application of the various payment formulas. These audits can result in retroactive adjustments of interim payments received from the program. If, as a result of such audits, it is determined that overpayment of benefits were made, the excess amount must be repaid to the government. If, on the other hand, it is determined that an underpayment was made, the government agency makes an additional payment to the operator. The Company books as receivables the amounts which it expects to receive under the Medicare and Medicaid programs and books into profit or loss any differences in amounts actually received. To date, adjustments have not had a material adverse effect on the Company. The Company believes that its payment formulas have been properly applied and that any future adjustments will not be materially adverse. Effective January 1, 1999, the Medicare program will become prospective in nature. See "Health Care Reform". In November 1996, two NHC managed facilities in Florida were audited by representatives of the regional office of the Office of 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 outside suppliers of services. The OIG completed its audit of one facility, and indicated during an exit conference that it had no further questions. At the second facility, the OIG determined certain records were insufficient and NHC is in the process of supplying additional information. The OIG has agreed to review these additional documents when received. 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 as a part of Operation Restore Trust. NHC will continue to monitor the progress of this audit and cannot predict whether the OIG will take further action or request additional information as a result of either of these audits. A so-called "whistleblower" lawsuit is also outstanding against the Company. For further information, see "Item 3: Legal Proceedings".
REGULATION Health care centers are subject to extensive federal, state and in some cases, local regulatory, licensing, and inspection requirements. These requirements relate, among other things, to the adequacy of physical buildings and equipment, qualifications of administrative personnel and nursing staff, quality of nursing provided and continued compliance with laws and regulations relating to the operation of the centers. In all states in which the Company operates, before the facility can make a capital expenditure exceeding certain specified amounts or construct any new long-term health care beds, approval of the state health care regulatory agency or agencies must be obtained and a Certificate of Need issued. The appropriate state health planning agency must determine that a need for the new beds or expenditure exists before a Certificate of Need can be issued. A Certificate of Need is generally issued for a specific maximum amount of expenditure and the project must be completed within a specific time period. There is no advance assurance that the Company will be able to obtain a certificate of need in any particular instance. In some states, approval is also necessary in order to purchase existing health care beds, although the purchaser is normally permitted to avoid a full scale certificate of need application procedure by giving advance written notice of the acquisition and giving written assurance to the state regulatory agency that the change of ownership will not result in a change in the number of beds or the services offered at the facility. While there are currently no significant legislative proposals to eliminate certificates of need pending in the states in which the Company does business, deregulation in the certificate of need area would likely result in increased competition among nursing home companies and could adversely affect occupancy rates and the supply of licensed and certified personnel. HEALTH CARE REFORM Government at both the federal and state levels has continued in its efforts to reduce, or at least limit the growth of, spending for health care services, including the type of services provided by NHC. On August 5, 1997, President Clinton signed into law the Balanced Budget Act of 1997 ("BBA"), which contains numerous Medicare and Medicaid cost-saving measures, as well as new anti-fraud provisions. The BBA has been projected to save $115 billion in Medicare spending over the next five years, and $13 billion in the Medicaid program. Section 4711 of BBA, entitled "Flexibility in Payment Methods for Hospital, Nursing Facility, ICF/MR, and Home Health Services", repealed the Boren Amendment, which has required that state Medicaid programs pay to nursing home providers amounts adequate to enable them to met government quality and safety standards; the Boren Amendment was previously the foundation of litigation by nursing homes seeking rate increases. In place of the Boren Amendment, the BBA requires only that, for services and items furnished on or after October 1, 1997, a state Medicaid program must provide for a public process for determination of Medicaid rates of payment for nursing facility services, under which proposed rates, the methodologies underlying the establishment of such rates, and justifications for the proposed rates are published, and which given providers, beneficiaries and other concerned state residents a reasonable opportunity for review and comment on the proposed rates, methodologies and justifications. Several of the states in which NHC operates are actively seeking ways to reduce Medicaid spending for nursing home care by such methods as capitated payments and substantial reductions in reimbursement rates.
The BBA also 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. In addition, the BBA creates a managed care Medicare Program called "Medicare + Choice", which allows Medicare beneficiaries to participate in either the original Medicare fee-for-service program or to enroll in a coordinated care plan such as health maintenance organizations ("HMOs"). Such coordinated care plans would allow HMOs to enter into risk-based contracts with the Medicare program, and the HMO's would then contract with providers such as the Company. No assurances can be given that the facilities to be operated by the Company will be successful in negotiating favorable contracts with Medicare + Choice managed care organizations. The BBA also contains several new antifraud provisions. Given the recent enactment of the BBA, the Company is unable to predict the impact of the BBA and potential changes in state Medicaid reimbursement methodologies on its operations; however, any significant reduction in either Medicare or Medicaid payments could adversely affect the Company. Changes in certification and participation requirements of the Medicare and Medicaid programs have restricted, and are likely to continue to restrict further, eligibility for reimbursement under those programs. Failure to obtain and maintain Medicare and Medicaid certification at the Company's facilities will result in denial of Medicare and Medicaid payments which could result in a significant loss of revenue to the Company. In addition, private payors, including managed care payors, increasingly are demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments whereby the Company is responsible for providing, for a fixed fee, all services needed by certain patients. Capitated payments can result in significant losses if patients require expensive treatment not adequately covered by the capitated rate. Efforts to impose reduced payments, greater discounts and more stringent cost controls by government and other payors are expected to continue. For the fiscal year ended December 31, 1997, NHC derived 38% and 33% of its net patient revenues from the Medicare and Medicaid programs, respectively. Any reforms that significantly limit rates of reimbursement under the Medicare and Medicaid programs, therefore, could have a material adverse effect on the Company's profitability. The Company is unable to predict what reform proposals or reimbursement limitations will be adopted in the future or the effect such changes will have on its operations. No assurance can be given that such reforms will not have a material adverse effect on the Company. Nursing homes and home health agencies have recently been the target of health care reform, from both fraud and reimbursement perspectives. Operation Restore Trust, a demonstration project which has been conducted by the Department of Health and Human Services in five states, is expanding to a dozen more states. "ORT Plus" will continue its focus on fraud in the areas of home health, nursing home and DME suppliers, as well as adding new anti- fraud and abuse targets. The Company will operate nursing homes and home health agencies in five ORT Plus states and could be subject to increased scrutiny. Although NHC's management believes that its home care and nursing home operations are in compliance with applicable laws and regulations, there can be no assurance that the Company, its home care and nursing home operations will not be the subject of an investigation nor that they will be found to be in compliance if investigated. See "Item 3-Legal Proceedings".
OTHER BUSINESS AND PROPERTIES A. NUTRITIONAL SUPPORT SERVICES. The Company owns a medical support services business, which primarily provides nutritional enteral, parenteral feeding materials, urological and medical supplies to patients in the Company's facilities as well as in other long-term care or home settings. This company is headquartered in Knoxville, Tennessee and is known as Nutritional Support Services (NSS). Revenues from this subsidiary accounted for from 4.0% to 5.5% of the Company's net revenues in 1997, 1996 and 1995. B. MEDICAL SPECIALTY UNITS. The Company has required all of its centers to participate in the Medicare program since 1973, and has continually expanded its range of offerings by the creation of center-specific medical specialty units such as the Company's 16 Alzheimer's disease care units and 12 subacute nursing units. The services are actually provided not only at each NHC operated center, but also at existing specialized care units. C. PHARMACY OPERATIONS. The Company's policy has been to have an in- house pharmacy located in each health care center in those states where licensure permits the operation of an in-house pharmacy. In other states, pharmaceutical services have been provided by third party contracts. NHC is now creating wholly owned regional pharmacy operations and currently operates one in east Tennessee, one in South Carolina and two in central Florida. These regional pharmacies operate out of a central office and supply (on a separate contractual basis) pharmaceutical services and supplies which were formerly purchased by each center from local vendors. The regional pharmacy operations had 5,574 nursing home beds under contract by December 31, 1997. D. ADVISORY SERVICES TO NATIONAL HEALTH INVESTORS, INC. In 1991 the Company formed National Health Investors, Inc., as a wholly-owned subsidiary. It then transferred to NHI certain healthcare facilities then owned by NHC and then distributed the shares of NHI to NHC's unitholders. The distribution had the effect of separating NHC and NHI into two independent public companies. As a result of the distribution, all of the outstanding shares of NHI were distributed to the then NHC investors. NHI entered into an Advisory, Administrative Services and Facilities Agreement (the "Advisory Agreement") with NHC pursuant to which NHC provides NHI, for a fee, with investment advice, office space, personnel and other services. For its services under the Advisory Agreement, the Advisor is entitled to a base annual compensation of $1,625,000. Compensation paid to executive officers of NHI is credited against this Advisory Fee. NHC executive officers W. Andrew Adams, Robert G. Adams and Richard F. LaRoche, Jr. serve as executive officers of NHI. For 1993 and later years in which per share Funds From Operations of NHI exceed per share Funds From Operations during 1992, the $1,625,000 annual compensation increased by the same percentage that per share Funds From Operations in such later year exceed those in 1992. NHC earned approximately $3,100,000 in 1997.
The Advisory Agreement provides that the Advisor shall pay all expenses incurred in performing its obligations thereunder, without regard to the amount of compensation received under the Agreement. Expenses specifically listed as expenses to be borne by the Advisor without reimbursement include: the cost of accounting, statistical or bookkeeping equipment necessary for the maintenance of NHI's books and records; employment expenses of the officers and directors and personnel of the Advisor and all expenses. E. ADVISORY SERVICES TO NATIONAL HEALTH REALTY, INC. 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 Maryland corporation qualified as a real estate investment trust under federal laws, and its operating subsidiary NHR/OP, L.P. (the "Operating Partnership"). NHR/OP, L.P. is a Delaware limited partnership which is the operating entity of NHR. In exchange for the assets transferred, NHC received shares of common stock of NHR. NHC distributed the common stock of NHR to NHC's unitholders at the rate of one share for each unit outstanding on the record date of December 31, 1997. In order to protect the REIT status of NHR, certain NHC unitholders received 1,310,194 units of the Operating Partnership rather than NHR shares. NHR was incorporated on September 26, 1997 as a wholly-owned subsidiary of NHC for the purpose of consummating the transactions described above. The distribution of NHR's common stock to NHC unitholders effectively separated NHC and NHR into two independent public companies, although the Board of Directors are identical save for one additional member for NHC. NHC has 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. The Advisor is subject to the supervision of and policies established by NHR's Board of Directors. Either party may terminate the Advisory Agreement on 90 days notice at any time after January 1, 2000. NHR may terminate the Advisory Agreement for cause at any time. 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. The Advisory Agreement provides that prior to the earlier to occur of (i) termination, for any reason, of the Advisory Agreement or (ii) NHC ceasing to be actively engaged as the investment advisor for NHI, NHR will not (without the prior approval of NHI) transact business with any party, person, company or firm other than NHC. It is the intent of the foregoing restriction that NHR will not be
actively or passively engaged in the pursuit of additional investment opportunities, but rather will focus upon its capacities as landlord and note holder of those certain assets conveyed to it. F. MANAGED CARE CONTRACTS. The Company has identified a number of potential regional offices, which will be staffed by experienced case managers contracting with health maintenance organizations (HMO's) and insurance carriers for the provision of subacute and other medical specialty services within its regional cluster of centers. Seven case managers were in place by year end 1997. Managed care days have increased from 30,226 in 1995 and 50,113 in 1996 to 71,606 in 1997. G. PRINCIPAL OFFICE. The Company maintains its home office staff in Murfreesboro, Tennessee in a building owned by a limited partnership, which is 69.7% owned by NHC. COMPETITION In most of the communities in which the health care centers are operated by the Company, there are other health care centers with which the Company competes. The Company operates 111 long-term health care facilities, all of which are located in the states of Alabama, Florida, Georgia, Indiana, Kentucky, Missouri, South Carolina, Tennessee and Virginia. Each of these states are certificate of need states which generally requires the state to approve the opening of any new long-term health care facilities. There are hundreds of operators of long-term health care facilities in each of these states and no single operator, including the Corporation, dominates any of these state's long-term health care markets, except for some small rural markets which might have only one long-term health care facility. In competing for patients and staff with these centers, the Company depends upon referrals from acute care hospitals, physicians, residential care facilities, church groups and other community service organizations. The reputation in the community and the physical appearance of the Company's health care centers are important in obtaining patients, since members of the patient's family generally participate to a greater extent in selecting health care centers than in selecting an acute care hospital. The Company believes that by providing and emphasizing rehabilitative as well as skilled care services at its centers, it will be able to broaden is patient base and to differentiate its centers from competing health care centers. As the Company expands into the assisted living market, it constantly monitors proposed or existing competing assisted living centers. The Company's development goal is to link its health care centers with its assisted living centers, thereby obtaining a competitive advantage for both. In certain markets where the Company operates health care centers, the Company believes the assisted living centers in the area to be sufficient or over sufficient for current population, and does not plan current entry in those markets. The Company experiences competition in employing and retaining nurses, technicians, aides and other high quality professional and non-professional employees. In order to enhance its competitive position, the Company has an educational tuition loan program, an American Dietary Association approved
internship program, a specially designed nurse's aide training class, and makes financial scholarship aid available to physical therapy vocational programs and The Foundation for Geriatric Education. The Company also maintains an "Administrator in Training" course, 24 months in duration, for the professional training of administrators. Presently, the Company has 12 full-time individuals in this program. Four of its eight regional vice presidents and 54 of its 112 health care center administrators have graduated therefrom. NHC's employee benefit package offers a tuition reimbursement program. The goal of the program is to insure a well trained qualified work force to meet future demands. While the program is offered to all disciplines, special emphasis has been placed on supporting students in nursing and physical therapy programs. Students are reimbursed at the end of each semester after presenting tuition receipts and grades to management. The program has been successful in providing a means for many bright students to pursue a formal education. EMPLOYEES As of December 31, 1997, the Company's Administrative Services Contractor plus the Company's managed centers had approximately 16,000 full and part time employees, who are called "Partners" by the Company. This nomenclature will continue even though the Company is now in corporate rather than partnership form. No employees are presently represented by a bargaining unit. The Company believes its current relations with its employees are good.
<TABLE> ITEM 2 PROPERTIES LONG-TERM HEALTH CARE CENTERS <CAPTION> Total Beds under Development Joined State City Center Affiliation Beds and Special Care Units NHC <S> <C> <C> <C> <C> <C> <C> Alabama Anniston NHC HealthCare, Anniston Leased 151(1) 55 bed Alzheimer's unit 1973 Moulton NHC HealthCare, Moulton Leased 136(1) 29 beds under development 1973 Florida Brooksville Brooksville Nursing Manor Managed 180 30 bed Alzheimer's unit 1993 Clearwater Palm Garden of Clearwater Managed(3) 120 1987 Coconut Creek NHC HealthCare, Coconut Creek Leased(2) 120 1997 Crystal River Cypress Cove Care Center Managed 120 1993 Dade City Royal Oak Nursing Center Managed 120 1993 Daytona Beach NHC HealthCare, Daytona Beach Leased(2) 60 1996 Ft. Lauderdale NHC of Ft. Lauderdale Managed 169 1984 Gainesville Palm Garden of Gainesville Managed(3) 120 30 bed subacute care unit 1987 Hudson Bear Creek Nursing Center Managed 120 1993 Hudson NHC HealthCare, Hudson Leased(1) 180 50 bed subacute care unit 1986 Jacksonville Palm Garden of Jacksonville Managed(3) 120 1990 Lake City Palm Garden of Lake City Managed(3) 120 28 bed Alzheimer's unit 1992 Largo Palm Garden of Largo Managed(3) 140 1987 Largo Palm Garden of Pinellas Managed(3) 120 36 bed subacute care unit 1991 Madison Lake Park of Madison Managed 79 40 beds under development 1995 Merritt Island NHC HealthCare, Merritt Island Leased(1) 180 22 bed Alzheimer's unit 1990 Miami The Nursing Center at Mercy Managed 120 1995 Naples NHC HealthCare, Imperial Leased(2) 60 30 beds under development 1994 Naples NHC HealthCare, Naples Leased(2) 60 1996 New Port Richey Heather Hill Nursing Home Managed 120 1993 Niceville The Manor at Blue Water Bay Managed 60 60 beds under development 1993 N. Miami Beach Palm Garden of N. Miami Beach Managed(3) 120 1988 Ocala Palm Garden of Ocala Managed(3) 180 60 bed subacute care unit 1987 Ocoee Ocoee Health Care Center Managed 120 1990 Orlando Palm Garden of Orlando Managed(3) 120 1987 Orlando NHC HealthCare, Orlando Leased(2) 120 30 bed Alzheimer's unit 1997 20 bed subacute care unit Palatka Palatka Health Care Center Managed 180 20 bed Alzheimer's unit 1989 Panama City NHC of Panama City Managed 120 1986 Pensacola Palm Garden of Pensacola Managed(3) 180 22 bed Alzheimer's unit 1987 Plant City NHC HealthCare, Plant City Leased(1) 171 1 bed under development 1985 Port Charlotte NHC HealthCare, Port Charlotte Leased(2) 180 60 bed subacute care unit 30 bed Alzheimer's unit 1994
Port St. Lucie Palm Garden of Port St. Lucie Managed(3) 120 1988 St. Cloud Osceola Health Care Center Managed 120 1991 St. Petersburg NHC HealthCare, St. Petersburg Managed 159 1984 Sarasota Sarasota Health Care Center Managed 120 1990 Stuart NHC HealthCare, Stuart Leased(1) 118 24 bed Alzheimer's unit 1989 35 beds under development Sun City Palm Garden of Sun City Managed(3) 120 1991 Tampa Palm Garden of Tampa Managed(3) 120 1987 Trenton Medic-Ayers Nursing Center Managed 120 30 bed Alzheimer's unit 1993 Vero Beach Palm Garden of Vero Beach Managed(3) 173 7 beds under development 1987 W. Palm Beach Palm Garden of West Palm Beach Managed(3) 162 1988 Winter Haven Palm Garden of Winter Haven Managed(3) 120 1987 Georgia Ft Oglethorpe NHC HealthCare, Fort Oglethorpe Owned(4) 135 1989 Rossville NHC HealthCare, Rossville Leased(1) 112 1971 Indiana Brownsburg Brownsburg Health Care Center Managed 178 20 bed Alzheimer's unit 1990 Castleton Castleton Health Care Center Managed 120 18 bed Alzheimer's unit 1990 Evansville Center for Geriatric Nursing Managed 156 1997 Ladoga Ladoga Health Care Center Managed 95 1990 Logansport Camelot Care Center Managed 75 1997 Markle Markle Health Care Managed 66 1997 Plainfield Plainfield Health Care Center Managed 199 22 bed Alzheimer's unit 1990 Westfield Westfield Village Health Care Managed 80 1997 Kentucky Dawson Springs NHC HealthCare, Dawson Springs Leased(1) 80 1973 Glasgow NHC HealthCare, Glasgow Leased(1) 206 1971 Madisonville NHC HealthCare, Madisonville Leased(1) 94 1973 Missouri Desloge NHC HealthCare, Desloge Leased(1) 120 1982 Joplin NHC HealthCare, Joplin Leased(1) 126 1982 Kennett NHC HealthCare, Kennett Leased(1) 160 10 beds under development 1982 Macon Macon Health Care Center Managed 120 1982 Osage Beach Osage Beach Health Care Center Managed 120 1982 St. Charles NHC HealthCare, St. Charles Leased(1) 120 1982 St. Louis NHC HealthCare, Maryland Heights Leased(1) 220 1987 Springfield Springfield Health Care Center Managed 120 1982 West Plains West Plains Health Care Center Leased(2) 120 1982
South Carolina Aiken Mattie C. Hall Health Care Center Managed 176 44 bed Alzheimer's unit 1982 Anderson NHC HealthCare, Anderson Leased(1) 290 1973 Clinton NHC HealthCare, Clinton Leased(2) 131 1993 Columbia NHC HealthCare, Parklane Leased(2) 120 30 bed Alzheimer's unit 1997 Greenwood NHC HealthCare, Greenwood Leased(1) 152 1973 Greenville NHC HealthCare, Greenville Leased(2) 176 1992 Laurens NHC HealthCare, Laurens Leased(1) 176 1973 Lexington NHC HealthCare, Lexington Leased(2) 88 12 bed subacute care unit 1994 32 beds under development Mauldin NHC HealthCare, Mauldin Leased(2) 120 1997 Murrells Inlet NHC HealthCare, Garden City Leased(2) 88 1992 North Augusta NHC HealthCare, North Augusta Leased(2) 132 1991 Sumter NHC HealthCare, Sumter Managed 123 1985 Tennessee Athens NHC HealthCare, Athens Leased(1) 98 1971 Carthage Smith County Health Care Center Managed 128 1997 Chattanooga NHC HealthCare, Chattanooga Leased(1) 212 20 bed sub-acute care 1971 Columbia NHC HealthCare, Columbia Leased(1) 120 12 bed subacute care unit 1973 Columbia NHC HealthCare, Hillview Leased(1) 98 1971 Columbia Maury Regional Hospital Managed 20 1997 Cookeville NHC HealthCare, Cookeville Managed 96 1975 Dickson NHC HealthCare, Dickson Leased(1) 197 1971 Dunlap NHC HealthCare, Sequatchie Leased(1) 60 60 beds under development 1976 Franklin Franklin Manor Leased(2) 47 1997 Franklin NHC HealthCare, Franklin Leased(1) 84 1979 Hendersonville NHC HealthCare, Hendersonville Leased(1) 117 1987 Johnson City NHC HealthCare, Johnson City Leased(1) 179 18 bed Alzheimer's unit 1971 Knoxville NHC HealthCare, Fort Sanders Owned(4) 180 12 bed subacute unit 1977 Knoxville NHC HealthCare, Knoxville Leased(1) 152 1971 Lawrenceburg NHC HealthCare, Lawrenceburg Managed 97 1985 Lawrenceburg NHC HealthCare, Scott Leased(1) 62 1971 Lewisburg NHC HealthCare, Lewisburg Leased(1) 95 1971 Lewisburg NHC HealthCare, Oakwood Leased(1) 62 1973 McMinnville NHC HealthCare, McMinnville Leased(1) 150 1971 Milan NHC HealthCare, Milan Leased(1) 129 1971 Murfreesboro AdamsPlace Leased(2) 40 20 beds under development 1997 Murfreesboro NHC HealthCare, Murfreesboro Managed 190 69 bed subacute care unit 1974 Nashville The Health Center of Richland Place Managed 98 1992 Nashville NHC HealthCare, Nashville Leased(1) 133 1975 Nashville West Meade Place Managed 120 1993 Oak Ridge NHC HealthCare, Oak Ridge Managed 130 1977 Pulaski NHC HealthCare, Pulaski Leased(1) 104 1971
Smithville NHC HealthCare, Smithville Leased(1) 107 1971 Somerville NHC HealthCare, Somerville Leased(1) 72 1976 Sparta NHC HealthCare, Sparta Leased(1) 150 1975 Springfield NHC HealthCare, Springfield Leased(1) 112 1973 Virginia Bristol NHC HealthCare, Bristol Leased(1) 120 1973 </TABLE> <TABLE> ASSISTED LIVING UNITS <CAPTION> State City Center Affiliation Assisted Living Units <S> <C> <C> <C> <C> Alabama Anniston NHC Place/Anniston (free-standing) Leased(2) 68 bed assisted living unit Florida Merritt Island NHC Place/Merritt Island (free-standing) Leased(2) 84 bed assisted living unit Naples NHC HealthCare, Imperial Leased(2) 60 bed assisted living unit Naples NHC HealthCare, Naples Leased(1) 36 bed assisted living unit Stuart NHC Place/Stuart (free-standing) Leased(2) 84 bed assisted living unit Vero Beach NHC Place/Vero Beach (free-standing) Leased(2) 84 bed assisted living unit W. Palm Beach Palm Garden of West Palm Beach Managed(3) 25 bed assisted living unit Missouri St. Charles Lake St. Charles Retirement Center Leased(1) 25 bed assisted living unit St. Peters NHC Place (free-standing) 100 bed assisted living unit Tennessee Dickson NHC HealthCare, Dickson Leased(1) 20 bed assisted living unit Johnson City NHC HealthCare, Johnson City Leased(1) 15 bed assisted living unit Murfreesboro AdamsPlace (free-standing) Leased(2) 84 bed assisted living unit Nashville Richland Place Managed 32 bed assisted living unit Somerville NHC HealthCare, Somerville Leased(1) 12 bed assisted living unit RETIREMENT APARTMENTS State City Retirement Apartments Affiliation Units Established Missouri St. Charles Lake St. Charles Retirement Apartments Leased(1) 155 1984 Tennessee Chattanooga Parkwood Retirement Apartments Leased(1) 32 1986 Johnson City Colonial Hill Retirement Apartments Leased(1) 63 1987 Murfreesboro AdamsPlace Leased(2) 53 1997 Nashville Richland Place Retirement Apartments Managed 137 1993 </TABLE>
<TABLE> HOMECARE PROGRAMS <CAPTION> State City Homecare Programs Affiliation Established <S> <C> <C> <C> <C> Florida Blountstown NHC HomeCare of Blountstown Owned 1994 Carrabelle NHC HomeCare of Carrabelle Owned 1994 Chipley NHC HomeCare of Chipley Owned 1994 Crawfordville NHC HomeCare of Crawfordville Owned 1994 Madison NHC HomeCare of Madison Owned 1994 Marianna NHC HomeCare of Marianna Owned 1994 Ocala NHC HomeCare of Ocala Owned 1996 Panama City NHC HomeCare of Panama City Owned 1994 Panama City NHC Private Nursing Owned 1994 Perry NHC HomeCare of Perry Owned 1994 Port St. Joe NHC HomeCare of Port St. Joe Owned 1994 Quincy NHC HomeCare of Quincy Owned 1994 Stuart NHC HomeCare of Stuart Owned 1996 Tallahassee NHC HomeCare of Tallahassee Owned 1994 Vero Beach NHC HomeCare of Vero Beach Owned 1997 South Carolina Aiken NHC HomeCare of Aiken Owned 1996 Greenwood NHC HomeCare of Greenwood Owned 1996 Laurens NHC HomeCare of Laurens Owned 1996 Tennessee Athens NHC HomeCare of Athens Owned 1984 Chattanooga NHC HomeCare of Chattanooga Owned 1985 Columbia NHC HomeCare of Columbia Owned 1977 Cookeville NHC HomeCare of Cookeville Owned 1976 Dickson NHC HomeCare of Dickson Owned 1977 Johnson City NHC HomeCare of Johnson City Owned 1978 Kingsport NHC HomeCare of Kingsport Owned 1997 Knoxville NHC HomeCare of Knoxville Owned 1977 Lawrenceburg NHC HomeCare of Lawrenceburg Owned 1977 Lebanon NHC HomeCare of Lebanon Owned 1997 Lewisburg NHC HomeCare of Lewisburg Owned 1977 McMinnville NHC HomeCare of McMinnville Owned 1976 Milan NHC HomeCare of Milan Owned 1977 Murfreesboro NHC HomeCare of Murfreesboro Owned 1976 Pulaski NHC HomeCare of Pulaski Owned 1985 Somerville NHC HomeCare of Somerville Owned 1983 Sparta NHC HomeCare of Sparta Owned 1984 Springfield NHC HomeCare of Springfield Owned 1984 </TABLE>
(1) Leased from NHR (2) Leased from NHR (3) Managed by NHC for FCC. NHC and FCC are currently involved in litigation regarding certain of these management agreements. See "Legal Proceedings." (4) NHC HealthCare/Fort Oglethorpe and NHC HealthCare/Fort Sanders are owned by separate limited partnerships. The Company owns approximately 80% of the partnership interest in Fort Oglethorpe and 25% of the partnership interest in Fort Sanders. (5) Currently under construction.
ITEM 3 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, NHC valued the center, offering to either purchase the center at the price so valued or FCC could elect to pay NHC certain deferred compensation based upon that value. 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 the court to 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, FCC has agreed that NHC will remain as manager of all centers 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 original suit was filed, FCC has amended its complaint five times, the most recent amendment being 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 contingent fees to NHC or, if so, a declaration that such deferred fees constitute usurious interest; that the recorded mortgages securing FCC's debt to NHC do not secure payment of the deferred contingent 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 (most recently) 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 a counterclaim against FCC. On November 5, 1997, the trial court ruled against FCC's Partial Motion for Summary Judgment in which they 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 has responded to this motion with numerous affidavits and the Court has scheduled a hearing on May 7, 1998. The Court has also set a trial date for the Fifth Amended Complaint commencing October 26, 1998.
The loss of management contract revenue on an individual FCC center would not have a material impact on NHC, but the loss of the revenues from all sixteen centers would have a material impact. This impact could be offset, however, by the receipt by NHC of the deferred contingency fee and/or the fact that NHC might purchase some or all of the facilities, thus allowing the revenues to be operating income for NHC; provided such fees or rights are not disallowed by the lawsuit. 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 of 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." In regard to the substantive allegations contained in the lawsuit, NHC believes that the cost report information of its centers has been either appropriately filed or, upon appropriate 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. 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 statements. NHC intends to continue it's revenue policy which is not to reflect routine cost limit exception requests as income until the process, including cost report audits, until this matter 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. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ------- ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED UNITHOLDER MATTERS The partnership units of National HealthCare L.P. and the shares of common stock of National HealthCare Corporation were and are traded on the American Stock Exchange under the symbol NHC. The closing price for the NHC units on Wednesday, December 31, 1997 was $56.00 and the price opened at $39.375 on January 5, 1998 reflecting the spinoff of the National Health Realty, Inc. shares. NHR opened trading for $17.00 per share that same day. On December 31, 1997, NHC had approximately 4,713 unitholders, comprised of 2,171 unitholders of record and an additional 2,542 unitholders indicated by security position listings. The following table sets out the quarterly high and low sales prices of NHC's units of partnership interest. The cash distributions per unit during each quarter are also shown.
Unit Prices Cash Distributions High Low Declared Per Unit - ----------------------------------------------------------------------- 1996 1st Quarter $41.125 $37.125 $ .52 2nd Quarter 41.375 34.875 .52 3rd Quarter 39.875 37.000 .52 4th Quarter 45.000 37.500 .60 - ------------------------------------------------------------------------ 1997 1st Quarter $47.250 $44.250 $ .60 2nd Quarter 46.188 40.750 .60 3rd Quarter 59.250 44.375 .60 4th Quarter 61.875 53.625 .60 - ----------------------------------------------------------------------- NHC paid cash distributions on its outstanding partnership units related to reporting years as follows: 1994, $1.35 per unit; 1995, $1.98 per unit; 1996, $2.16 per unit; and 1997, $2.40 per unit. The Company's policy while in partnership form was to distribute 60% of its taxable income to its partners. The Company has announced that it does not currently plan to declare dividends as a corporation. ITEM 6 SELECTED FINANCIAL DATA The following table represents selected financial information with respect to the Company for the five years ended December 31, 1997. This financial information has been derived from financial statements included elsewhere in this Form 10-K and should be read in conjunction with those financial statements and accompanying footnotes. <TABLE> <CAPTION> Year Ended December 31, 1997 1996 1995 1994 1993 (in thousands, except unit and per unit data) <S> <C> <C> <C> <C> <C> Operating Data: Revenue $463,477 $386,266 $349,398 $298,192 $269,858 Expenses 426,260 356,980 328,283 282,339 232,296 Income before income taxes 37,217 29,286 21,115 15,853 37,562 Income taxes 209 --- --- --- --- Net income 37,008 29,286 21,115 15,853 37,562 Earnings per unit: Basic 4.17 $ 3.48 $ 2.67 $ 2.03 $ 4.85 Diluted 3.58 2.97 2.32 1.80 4.05 Balance Sheet Data: Total assets $230,181 $404,740 $355,491 $396,133 $344,680 Long-term debt 60,227 124,678 100,871 104,243 54,625 Debt serviced by other parties 16,676 32,857 40,771 89,764 112,116 Partners' capital --- 128,537 108,899 101,006 92,526 Shareowners' equity 37,736 --- --- --- ---
Cash distributions declared per unit/share: Quarterly and year end $ 2.40 $ 2.16 $ 1.98 $ 1.35 $ .88 Special --- --- --- --- 1.10 </TABLE> ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview-- National HealthCare Corporation ("NHC" and formerly National HealthCare L.P.) is a leading provider of long-term health care services. NHC operates or manages 111 long-term health care centers with 14,071 beds in nine states. NHC provides nursing care as well as ancillary therapy services to patients in a variety of settings including long-term 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. Results of Operations-- The following table and discussion sets forth items from the consolidated statements of income as a percentage of net revenues for the audited years ended December 31, 1997, 1996 and 1995. <TABLE> PERCENTAGE OF NET REVENUES <CAPTION> Year Ended December 31 1997 1996 1995 <S> <C> <C> <C> Revenues: Net patient revenues 88.7% 88.5% 88.1% Other revenues 11.3 11.5 11.9 Net revenues 100.0 100.0 100.0 Costs and expenses: Salaries, wages and benefits 55.8 54.3 54.1 Other operating 29.8 31.8 30.9 Depreciation and amortization 3.6 3.5 4.2 Interest 2.8 2.8 4.8 Total costs and expenses 92.0 92.4 94.0 Income before income taxes 8.0% 7.6% 6.0% </TABLE> The following table sets forth the increase in certain items from the consolidated statements of income as compared to the prior period.
<TABLE> Period to Period Increase (Decrease) <CAPTION> 1997 vs. 1996 1996 vs. 1995 ----------------- ----------------- (dollars in thousands) Amount Percent Amount Percent ------ ------- ------ ------- <S> <C> <C> <C> <C> Revenues: Net patient revenues $69,145 20.2% $33,849 11.0% Other revenues 8,066 18.1 3,019 7.3 Net revenues 77,211 20.0 36,868 10.6 Costs and expenses: Salaries, wages and benefits 48,680 23.2 20,660 10.9 Other operating 15,155 12.3 15,090 14.0 Depreciation & amortization 3,185 23.3 (915) (6.3) Interest 2,260 21.0 (6,138) (36.3) Total costs and expenses 69,280 19.4 28,697 8.7 Income before income taxes $ 7,931 27.1% $ 8,171 38.7% </TABLE> NHC's owned or leased long-term health care centers and contract therapy services provided 78% of net revenues in 1997 and 1996 and 76% in 1995. Homecare programs provided 12% of net revenues in 1997, 13% in 1996 and 15% in 1995. The overall census in owned or leased centers for 1997 was 92.2% compared to 93.6% in 1996 and 93.0% in 1995. The census excluding acquisitions and new openings was 94.4%, 93.8% and 93.0%, respectively, for the same periods. NHC opened a net of 1,189 new owned, leased or managed long-term care beds in 1997. Approximately 56% (1997) and 60% (1996 and 1995) of NHC's net revenues are derived from Medicare, Medicaid, and other government programs. Amounts earned under these programs are subject to review by the third party payors. In the opinion of management, adequate provision has been made for any adjustments that may result from such reviews. NHC generally expects final determinations to occur two to three years subsequent to the year in which amounts are earned. Any differences between estimated settlements and final determinations are reflected in operations in the year finalized. NHC has submitted various requests for exceptions to Medicare routine cost limitations for reimbursement. NHC has received approval on certain requests and others are pending approval. NHC will record revenues associated with the approved requests when such approvals, including cost report audits, are assured. The preparation of financial statements in conformity with generally accepted accounting principles requires management 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. <page 1997 Compared to 1996-- In 1997, NHC achieved strong annual growth in earnings, earnings per unit, and revenues. Net income totaled $37,008,000, a 26% increase over the comparable prior year amount. Basic earnings per unit totaled $4.17, a 20% increase. Net revenues totaled $463,477,000, a 20% increase. NHC's pretax net margin ratio, which is defined as pretax net income divided by net revenues, increased to 8.0% from 7.6% in 1996 and 6.0% in 1995, illustrating that NHC has been able to grow its revenues at a faster rate than its expenses. The growth in net patient revenues in 1997 occurred primarily in long- term care services, rehabilitative care services, and homecare services. Improved revenues in long-term care were due primarily to increased types and levels of services being offered and to increases in private pay and third party billing rates. Additionally, the total number of owned or leased beds increased by 468 beds from 6,221 beds at the end of 1996 to 6,689 beds at the end of 1997. During 1997 and 1996, NHC had 46 and 48, respectively, owned or leased centers which operated at Medicare costs higher than the routine cost limits. Revenues also improved during 1997 due to continued emphasis on rehabilitative care services. To boost the ability to offer physical, speech and occupational therapy to greater numbers of patients, NHC increased its staff of professionally licensed therapists by 15% to 1,155 therapists in 1997 and by 26% to 1,005 therapists in 1996. Six hundred twenty-nine (629) companies, including homecare companies, school systems, hospitals, a sports medicine company and outpatient clinics contracted for NHC's rehabilitative services in 1997, which number is up from 586 companies in 1996. Revenues from therapy services in 1997 were also enhanced by the favorable resolution of certain prior years cost report issues with fiscal intermediaries. Homecare revenues improved due to increased payor rates, offset in part by decreased numbers of visits at NHC's 36 Florida, Tennessee and South Carolina homecare locations. There were 731,000 homecare visits in 1997 compared to 754,000 visits in 1996. The decreased number of visits is due primarily to NHC's early adaptation to changes in Medicare reimbursement for home health care services brought about by the Balanced Budget Act of 1997. Other revenues, which increased 18.1% in 1997, are more fully detailed in Note 6 to the financial statements. The majority of the increase in other revenues is attributable to the increase in revenues from management services, which grew 18.5% in 1997. The revenues from management services increased due to the increased number of beds being managed for others, increased amounts and types of management and other support services being offered, and increased interest income from higher principal amounts on loans to managed centers. In 1997, four long-term care centers and 517 long-term care beds came under new management contracts. Management fees are generally based
upon a percentage of net revenues of the managed center and therefore tend to increase as a facility matures and as prices rise in general. NHC's management contracts are generally long-term (up to ten years) and include equity participation agreements and the right of first refusal upon the sale of the property. (See "Transfers to National Health Realty" and "Litigation" below for factors which may reduce future revenues from management services.) Increases in salaries, wages and benefits in 1997 are attributable to the increase in staffing levels due to long-term care bed additions, and the expansion of assisted living services, rehabilitation services and homecare services. Further contributing to higher costs of labor are inflationary increases for salaries and the associated benefits. Salaries, wages and benefits increased also due to forgiveness by NHC of the debt of certain key employees related to stock options which had been exercised in previous years. The debt forgiveness was to reward employees for prior years service and is also contingent upon the employees remaining employed with NHC through certain future dates. Labor costs are the most significant costs of NHC. Operating costs have increased due to the increased numbers of long-term care beds in operation, the expansion of assisted living services, the expansion of rehabilitative services, the expansion of homecare services, and the growth in management services. Depreciation and amortization increased as a result of NHC's placing of newly constructed or purchased assets in service and due to capital improvements at existing properties. Interest expense increased due to additional borrowing for newly constructed long-term care beds and assisted living apartments. 1996 Compared to 1995-- In 1996, NHC achieved record earnings while growing in the variety and quality of services offered. Results for 1996 included a 39% increase in net income, a 30% increase in basic earnings per unit, and a 11% increase in net revenues. The growth in revenues in 1996 occurred in long-term care services, in rehabilitative and managed care services and in management services. Improved revenues in long-term care were due in part to increased numbers of owned beds having been placed in service. In 1996, 130 beds were opened or acquired in owned and leased centers. Furthermore, 111 long-term care beds which had been added in 1995 had improved occupancy rates in 1996. Also contributing to improved revenues in long-term care were increases in types and levels of services being offered and in private pay and third party payor rates. Increases in third party payor rates were held down in part by the negative impact of routine cost limits for Medicare certified nursing homes. During 1996 and 1995, NHC had 48 and 44, respectively, owned or leased centers which operated at Medicare costs higher than the ceiling.
Homecare revenues improved due to increased payor rates and number of visits at NHC's 16 additional Tennessee locations. At all locations, there were 754,000 visits in 1996 compared to 717,000 visits in 1995. Revenues also improved during 1996 as a result of NHC's increased emphasis on rehabilitative and managed care services. To boost the ability to offer physical, speech and occupational therapy to greater numbers of patients, NHC increased its staff of professionally licensed therapists from nearly 800 last year to over 1,000 in 1996. Over 585 companies, including school systems, hospitals, homecare companies and outpatient clinics contracted for NHC's rehabilitative services in 1996, which number is up from 420 companies in 1995. Revenues from management services, which are included in the Statements of Income in Other Revenues, increased 13% in 1996 due to increased management fees and increased interest income from higher principal amounts on loans to managed centers. In 1996, 60 additional long-term care beds came under management contract. Management fees are generally based upon a percentage of net revenues of the managed center and therefore tend to increase as a facility matures and as prices rise in general. (See "Transfers to National Health Realty" and "Litigation" below for factors which may reduce future revenues from management services.) Increases in salaries, wages and benefits in 1996 were attributable to the increase in staffing levels due to long-term care bed additions and the increased emphasis on rehabilitative services. Also contributing to higher costs of labor were inflationary increases for salaries and the associated benefits. Operating costs increased due to the increased numbers of beds in operation, the expansion of rehabilitative and managed care services, the growth in management services provided to others, and due to the increase in rent expense as explained below. Depreciation expense and interest expense both decreased compared to last year due primarily to capital transactions which occurred in 1995. During December 1995, National Health Investors, Inc. ("NHI") prepaid debt on which NHC had also been obligated in the amount of $20,544,000. In addition, NHC was released from its obligation on approximately $25,324,000 of debt which had been transferred to NHI in 1991. Since NHC is no longer obligated on transferred debt in the amount of $45,868,000, debt serviced by other parties and assets under arrangement with other parties was reduced by $45,868,000. The leases with NHI provide that NHC shall continue to make non-obligated debt service rent payments equal to the debt service including principal and interest on the obligated debt which was prepaid and from which NHC has been released as a direct obligor. As a result, other operating expenses are increased by the amount of the rent payments, depreciation is decreased by the amount of depreciation formerly charged on assets under arrangement with other parties and interest expense is decreased by the amount of interest expense formerly associated with the debt serviced by other parties.
Growth and Development-- NHC plans to continue to expand its continuum of care to the elderly by offering a comprehensive range of services through related or separately structured health care centers, homecare programs, specialized care units, pharmacy operations, rehabilitative services, assisted living centers and retirement centers. During 1997, NHC grew its long-term health care business by acquiring or constructing additions totaling 721 licensed beds at six owned or leased health care centers and totaling 468 licensed beds at five managed health care centers. All in all, 1,189 owned, leased or managed long-term care beds were added in 1997. These additions increased the total number of owned, leased or managed centers from 100 centers to 111 centers and the total number of licensed beds from 12,882 beds to 14,071 beds. At December 31, 1997, NHC had under construction 447 long-term care beds at four new or existing owned or leased centers, all of which are expected to open during 1998. NHC also has been granted governmental certificates of need to permit construction of 356 beds at seven owned or leased locations and 137 beds at five managed locations which are expected to start construction during 1998. NHC has identified the assisted living market as an expanding area for the delivery of health care and hospitality services. Assisted living centers provide basic room and board functions for the elderly with on-staff availability to assist in minor medical and living needs on an as needed basis. NHC currently operates 14 assisted living projects, nine of which are located within the physical structure of a long-term care center or retirement center and five of which are freestanding. It is expected that NHC will complete construction of one assisted living project with 84 units and start construction of four additional assisted living projects with 264 units in 1998. Certificates of need are not required to build assisted living projects. Liquidity, Capital Resources and Financial Condition-- During 1997, NHC spent approximately $34,827,000 on construction, acquisitions and routine capital expenditures, $21,021,000 on cash distributions to partners, $30,286,000 as principal payments and financing costs on debt, and $38,436,000 to invest in notes receivable. These and other cash needs were financed through cash on hand; cash flow from operations of $35,224,000; the collection of long-term notes receivable, loan participation agreements, investments and receivables related to stock options of $41,787,000; the issuance of $65,319,000 of debt and convertible notes and the issuance of partnership units for $2,344,000. NHC is committed to spend approximately $17,105,000 for ongoing construction contracts. NHC has also guaranteed approximately $68,499,000 of debt of certain health care centers which NHC manages for others. At December 31, 1997, NHC expects to have no additional liability as a result of its debt guarantees.
For all financial instruments except the subordinated convertible notes, NHC believes that the financial statement carrying amounts approximate fair value at December 31, 1997. The fair value of the subordinated convertible notes were estimated based on quoted market prices. Transfers to National Health Realty-- 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. Concurrent with the transfer to NHR, NHC leased from NHR the real property which had been transferred. Effect of the Transfer on Results of Operations-- Because the transfer of assets and liabilities to NHR occurred at the end of the year, the transfer had no material effect on 1997 results of operations. Had the transfer occurred at the beginning of the year, interest income would have been reduced for the interest income on notes receivable transferred ($9,263,000) and operating expenses would have been increased by the rent expense on the property transferred ($12,417,000). These reductions in net income would have been offset in part by the reduction of interest expense on debt transferred ($4,943,000), by the reduction of depreciation expense on assets transferred ($4,695,000) and by the receipt of an advisory fee from NHR under an advisory agreement ($433,000). The net effect of these transactions would have been to reduce pretax net income by approximately $11,609,000 from $37,217,000 as reported to approximately $25,608,000 and to reduce diluted earnings by $1.07 per share from $3.58 per share as reported to $2.51 per share. Effect of the Transfer on Liquidity and Financial Condition-- Assets transferred to NHR included 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. The transfer changed the ratio of long-term debt to equity from 1.0:1 prior to the transfer to 2.5:1 after the transfer. Subordinated convertible debentures in the amount of $19,152,000 may be converted at a price of $15.2063 per share into 1,259,478 shares of both NHC and NHR. Conversion of the subordinated convertible debentures would change the ratio of long-term debt to equity to 1.4:1. The current ratio is 1.6:1 at December 31, 1997 and working capital is $44,498,000.
NHC's current cash on hand, marketable securities, short-term notes receivable, operating cash flows and, as needed, its borrowing capacity are expected to be adequate to finance NHC's operating requirements and growth and development plans for 1998 and into 1999. Restructure from Limited Partnership to Corporation-- 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 will be subject to federal income taxes. In response to the governmentally mandated loss of partnership tax 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. Cash Dividends-- NHC may pay dividends at the discretion of the Board of Directors. NHC, as restructured, does not anticipate initially paying dividends. New Accounting Pronouncements-- In 1997 NHC adopted Statement of Financial Accounting Standards No. 128 "Earnings Per Share" and Statement of Financial Accounting Standards No. 129 "Disclosure of Information About Capital Structure". The adoption of the provisions of these accounting pronouncements did not have a material impact on NHC's financial condition or results of operations. 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. 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 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 15 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 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 is aggressively pursuing an amicable settlement. 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 15 to the financial statement, NHC is a defendant in 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 suit, FCC seeks to terminate all of its management agreements with NHC. NHC has filed an answer denying all of FCC's claims and asserting a counterclaim against FCC. The loss of management contract revenue on an individual FCC center would not have a material impact on NHC, but the loss of the revenues from all sixteen centers would have a material impact. This impact could be offset, however, by the receipt by NHC of the deferred contingency fee and/or the fact that NHC might purchase some or all of the facilities, thus allowing the revenues to be maintained by NHC; provided such fees or rights are not disallowed by the law suit. Year 2000 Compliance-- NHC is currently in the process of evaluating its information technology infrastructure for Year 2000 compliance. NHC does not expect that the cost to modify its information technology infrastructure to be Year 2000 compliant 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 does not currently have any information concerning Year 2000 compliance status of its suppliers, customers and third party payors. In the event that any of NHC's significant suppliers, customers or third party payors do not successfully and timely achieve Year 2000 compliance, NHC's business or operations could be adversely affected. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following table sets forth selected quarterly financial data for the two most recent fiscal years. <TABLE> SELECTED QUARTERLY FINANCIAL DATA <CAPTION> (unaudited, in thousands, except per unit amounts) 1st 2nd 3rd 4th Quarter Quarter Quarter Quarter(A) 1997 ------- ------- ------- ---------- <S> <C> <C> <C> <C> Net Revenues $105,863 $106,191 $111,989 $139,434 Net Income 6,958 7,342 9,377 13,331 Basic Earnings Per Unit .790 .830 1.060 1.480 Diluted Earnings Per Unit .690 .720 .910 1.230 1996 Net Revenues $ 92,155 $ 91,629 $ 95,818 $106,664 Net Income 5,465 6,007 8,070 9,744 Basic Earnings Per Unit .650 .710 .960 1.150 Diluted Earnings Per Unit .560 .620 .810 .990 </TABLE> Note A: In the fourth quarters of 1996 and 1997 net revenues and income were increased by approximately $2,400,000 ($.28 per unit, basic and $.23 per unit, diluted) and by $4,000,000 ($.45 per unit, basic and $.36 per unit, diluted), respectively, due to enhanced retroactive Medicare and Medicaid reimbursement which, if known, would have been reported periodically throughout the year. The financial statements are included as Exhibit 13 and are incorporated in this Item 8 by reference.
ITEM 9 DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no disagreements on accounting and financial disclosure. PART III -------- ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT DIRECTORS AND EXECUTIVE OFFICERS: The Company is managed by its Board of Directors, all but one of which were on the Board of Directors of the Company's Managing General Partner when the Company was organized as a public partnership. The Board of Directors is divided into three classes. The Directors hold office until the annual meeting for the year in which their term expires and until their successor is elected and qualified. As each of their terms expire, the successor shall be elected to a three-year term. A director may be removed from office for cause only. Officers serve at the pleasure of the Board of Directors for a term of one year. The following table sets forth the directors and the executive officers and vice presidents of the Company: <TABLE> <CAPTION> Director of Position Managing Officer of with the General Managing Company Partner or Current General or Managing Company's Term as Partner or General Predecessor Director Predecessor Name Age Partner Since Expires Since - ---- --- ------- ----------- ------- ----------- <S> <C> <C> <C> <C> <C> W. Andrew Adams 52 Chairman of the Board/ 1994(CEO) 1999 1973 President 1974(Pres.) J.K. Twilla 71 Director 1972 2001 --- Olin O. Williams 67 Director 1971 2000 --- Ernest G. Burgess, III 58 Director 1992 1999 1975 Robert G. Adams 51 S. Vice President/ Director 1993 2000 1985 Lawrence C. Tucker 55 Director 1998 2001 --- Richard F. LaRoche, Jr. 52 Sr. Vice President/ Secretary and General Counsel -- -- 1974 Charlotte Swafford 49 Treasurer -- -- 1985 Donald K. Daniel 51 Vice President/ Controller -- -- 1977 Julia W. Powell 48 Vice President/ Patient Services -- -- 1985 Joanne G. Batey 53 Vice President/ HomeCare -- -- 1989 D. Gerald Coggin 46 Vice President/ Government and Rehabilitative -- -- 1994
David L. Lassiter 43 Vice President/ Corporate Affairs -- -- 1995 Steven A. Strawn 40 Vice President/ Operations -- -- 1995 Kenneth D. DenBesten 45 Vice President/ Finance -- -- 1992 </TABLE> Drs. Twilla and Williams were physicians in private practice in Tennessee for more than 30 years each. Dr. Williams serves as Chairman of the Board of the Bank of Murfreesboro, Murfreesboro, Tennessee and both are Directors of National Health Realty, Inc. Mr. W. Andrew Adams has been President since 1974 and Chairman of the Board since 1994. He was president from 1981 until 1983 of the National Council of Health Centers, the trade association for multi-facility long-term health care center companies, and served as Chairman of the Multi-facility Committee of the American Health Care Association from 1992 through 1994. He has an M.B.A. degree from Middle Tennessee State University. Mr. Adams serves on the Board of Trust of David Lipscomb University, Nashville, Tennessee, is President and Chairman of the Board of Directors of National Health Investors, Inc., and National Health Realty, Inc. and serves on the Board of SunTrust Bank in Nashville, Tennessee. Mr. Robert Adams (Senior Vice President, Chief Operating Officer and Director) has served both as Administrator and as Regional Administrator, holding the last position from 1977 to 1985. He has a B.S. degree from Middle Tennessee State University. He serves as Chief Operations Officer for the Company. He is on the Board of Directors of National Health Realty, Inc. Mr. Robert Adams and Mr. W. Andrew Adams are brothers. Mr. Burgess (Director) served as the Company's Senior Vice President for Operations from 1975 through 1994. He has an M.S. degree from the University of Tennessee. He is on the Board of Directors of National Health Realty, Inc. Mr. Tucker (Director) has been with Brown Brothers Harriman & Co. ("BBH&Co."), a private banking company, for 31 years and became a general partner in January 1979. Mr. Tucker currently serves as a member of the Steering Committee of BBH&Co. He is responsible for the corporate finance activities of BBH&Co., including management of the 1818 Fund's private equity investing partnerships with committed capital exceeding $1 billion. Mr. Tucker is a director of WorldCom, Inc., Riverwood International Corporation and WellCare Management Company, Inc. Mr. Tucker has a B.S. degree from Georgia Institute of Technology and an MBA from the Wharton School of the University of Pennsylvania. Mr. LaRoche (Senior Vice President) has been Senior Vice President since 1985, Secretary since 1974 and General Counsel since 1971. He has a law degree from Vanderbilt University and an A.B. degree from Dartmouth College. His responsibilities include acquisitions and finance. Mr. LaRoche also serves on the Board of National Health Investors, Inc. Mr. Strawn (Vice President/Operations) has been with the Company since 1979. He trained in NHC's A.I.T. program and then served both as administrator and Regional Vice President before being appointed to the present position in 1995. He has a B.S. degree from Middle Tennessee State University.
Mr. Daniel (Vice President and Controller) joined the Company in 1977 as Controller. He received a B.A. degree from Harding University and an M.B.A. from the University of Texas. He is a certified public accountant. Mr. Lassiter (Vice President/Corporate Affairs) joined the Company in 1995. From 1988 to 1995, he was Executive Vice President, Human Resources and Administration for Vendell Healthcare. From 1980-1988, he was in human resources positions with Hospital Corporation of America and HealthTrust Corporation. Mr. Lassiter has a B.S. and an M.B.A. from the University of Tennessee. Ms. Swafford (Treasurer) has been Treasurer of the Company since 1985. She joined the Company in 1973 and has served as Staff Accountant, Accounting Supervisor and Assistant Treasurer. She has a B.S. degree from Tennessee Technological University. Ms. Powell (Vice President/Patient Services) has been with the company since 1974. She has served as a nurse consultant and director of patient assessment computerized services for NHC. Ms. Powell has a bachelor of science in nursing from the University of Alabama, Birmingham, and a master's of art in sociology with an emphasis in gerontology from Middle Tennessee State University. She co-authored Patient Assessment Computerized in 1980 with Dr. Carl Adams, the Company's founder. Ms. Batey (Vice President/Homecare) has been with the company since 1976. She served as homecare coordinator for five years before being named Vice President in 1989. Prior to that she was director of communication disorders services. Ms. Batey received her bachelor's and master's degrees in speech pathology from Purdue University. Mr. Coggin (Vice President/Governmental and Rehabilitative Services) has been employed by NHC since 1973. He has served as both Administrator and Regional Vice President before being appointed to the present position. He received a B.A. degree from David Lipscomb University and a M.P.H. degree from the University of Tennessee. He is responsible for the Company's rehabilitation, managed care and legislative activities. Mr. DenBesten (Vice President/Finance) has served as Vice President of Finance since 1992. From 1987 to 1992, he was employed by Physicians Health Care, most recently as Chief Operating Officer. From 1984-1986, he was employed by Health America Corporation as Treasurer, Vice President of Finance and Chief Financial Officer. Mr. DenBesten received a B.S. in business administration and an M.S. in Finance from the University of Arizona. The above officers serve in identical capacities for the Company and its administrative services contractor, National Health Corporation. Outside directors receive $2,500 per meeting attended. In addition, outside directors will receive a stock option to purchase 10,000 shares of REIT common stock at a purchase price equal to the closing price of the Corporation Shares on the initial date of trading and will be automatically granted an option to purchase 10,000 shares of Corporation common stock at the closing price on the date of the Corporation's annual meeting. There were five Board meetings during 1997 and no Board member missed a meeting.
ITEM 11 EXECUTIVE COMPENSATION INTRODUCTION: The Board of Directors have elected to continue unchanged the Company's prior compensation and bonus plans. Their goals in executive compensation and compensation at all levels within the Company are derived from the following priorities: First, to encourage the achievement of the highest levels of quality in its fields of endeavor; and second, to provide the strongest incentive possible in order to average, over a five year period, a 20% return on shareholder's equity. With these goals in mind, the Company's executive compensation program is based on employee performance rewarded as follows: (1) the achievement of a return on investment for shareholders; (2) returns generated from stock performance based incentive plans; and (3) from base salary. The following text and tables describe the various components of this plan as were attained and applied during 1997. TOTAL COMPENSATION: Table I sets forth certain information concerning the total compensation paid by the administrative general partner and reimbursed to it by the Company for the year ended December 31, 1997 to the three executive officers of the Company. OPTION PLANS: At the 1994 Annual Meeting, the 1994 Option Plan was adopted and approved. A total of 1,200,000 units were reserved for issuance upon exercise of options to be granted by the Board of Directors. No options were granted to key employees during 1997, however, pursuant to the Plan, non employee directors each receive an option to purchase 5,000 shares on the date of the Annual Meeting and for the closing share price that day. 15,000 units were granted to the three non-employee Directors at $46.25 per share on March 20, 1997. At December 31, 1997, options to purchase 2,500 shares at $11.25 per share are outstanding, an option to purchase 5,000 units at $24.88 per share is outstanding to one director, options to purchase 6,500 units at $25.12 per share are outstanding to six employees, options to purchase 15,000 shares are outstanding at $38.625 per share to three directors. during 1997, 31 key employees exercised options to purchase 361,000 shares at $31.00 per share. The Company's Board of Directors and the then sole shareholder of the Company have adopted the 1997 Stock Option and Stock Appreciation Rights Plan (the "1997 Stock Option Plan"), under which options to purchase shares of the Company's common stock are available for grant to consultants, advisors, directors and employees of the Company, providing an equity interest in the Company and additional compensation based on appreciation of the value of such stock.
The 1997 Stock Option Plan allows for options to purchase in the aggregate up to 1,000,000 shares of NHC common stock to be granted by the Board of Directors. The Board of Directors may, in its discretion grant incentive stock options ("ISO's"), non-qualified stock options or stock appreciation rights ("SAR's") In addition, the 1997 Stock Option Plan provides that the non-employee directors will receive a non-qualified stock option to purchase 10,000 shares of common stock at a purchase price equal to the closing price of the Shares on the initial date of trading and will be automatically granted an option to purchase 10,000 shares of common stock annually on the date of the Company's annual meeting with an exercise price equal to the closing price on the date of such annual meeting. The 1997 Stock Option Plan provides that the exercise price of an ISO option must not be less than the fair market value of the common stock on the trading day next preceding the date of the grant. Payment for shares of common stock to be issued upon exercise of an option may be made either in cash, Company common stock or any combination thereof, at the discretion of the option holder. Options are nontransferable, other than by will, the laws of descent and distribution; assignable to family partnerships, trusts or immediate family members; or pursuant to certain domestic relations orders. Common stock subject to options granted under the 1997 Stock Option Plan that expire, terminate or are canceled without having been exercised in full become available again for option grants. The 1997 Stock Option Plan is administered by the Board of Directors, or, at the discretion of the Board of Directors, a committee of directors. Subject to certain limitations, the Board and its committee have the authority to determine the recipients, as well as the exercise prices, exercise periods, length and other terms of stock options granted pursuant to the 1997 Stock Option Plan and Company repurchase options upon termination of a recipients employment. In making such determinations, the Board may take into account the nature of the services rendered or to be rendered by option recipients, and their past, present or potential contributions to the Company. The number of shares of common stock that may be granted under the 1997 Stock Option Plan or under any outstanding options granted thereunder will be proportionately adjusted, to the nearest whole share, in the event of any stock dividend, stock split, share combination or similar recapitalization involving the common stock or any spin-off, spin-out or other significant distribution of the Company's assets to its stockholders for which the Company receives no consideration. Generally, in the event an option holder is terminated as an employee by reason of disability or death, the holder or his or her representative may exercise the option for a period of 12 months following such termination unless the Board of Directors elects, in its sole discretion, to extend the exercise period. If the employment of an option holder is terminated for "cause," as defined in the 1997 Stock Option Plan, the unexercised options expire. In the event the option holder is terminated as an employee for any reason other than disability, death or cause, the holder may not exercise his or her option unless authorized by agreement of the Company.
In the event of a dissolution or liquidation of the Company or a merger or consolidation or acquisition in which the Company is not the surviving corporation, each outstanding option will become fully exercisable and each holder will have the right, within 60 days prior to such dissolution, liquidation, merger, consolidation or acquisition, to exercise his or her options, in whole or in part. Either non-qualified or incentive stock options may be granted under the 1997 Stock Option Plan. No federal income tax consequences occur to either the Company or the optionee upon the Company's grant or issuance of a non- qualified stock option. Upon an optionee's exercise of a non-qualified stock option, the optionee will recognize ordinary income in an amount equal to the difference between the fair market value of the common stock purchased pursuant to the exercise of the option and the exercise price of the option. However, if the common stock purchased upon exercise of the option is not transferable or is subject to a substantial risk of forfeiture, then the optionee will not recognize income until the stock becomes transferable or is no longer subject to such a risk of forfeiture (unless the optionee makes an election under Internal Revenue Code Section 83(b) to recognize the income in the year of exercise, which election must be made within 30 days of the option exercise). The Company will be entitled to a deduction in an amount equal to the ordinary income recognized by the optionee in the year in which such income is recognized by the optionee. Upon a subsequent disposition of the shares of common stock, the optionee will recognize a capital gain to the extent the sales proceeds exceed the optionee's cost of the shares plus the previously recognized ordinary income. Incentive stock options granted under the 1997 Stock Option Plan are intended to qualify for a favorable tax treatment under Internal Revenue Code Section 422. No individual may be granted incentive stock options under the Corporation Stock Option Plan exercisable for the first time during any calendar year and having an aggregate fair market value in excess of $100,000. If the recipient of an incentive stock option disposes of the underlying shares before the end of certain holding periods (essentially the later of one year after the exercise date or two years after the grant date), he or she will generally recognize ordinary income in the year of disposition in an amount equal to the difference between his or her purchase price and the fair market value of the Corporation common stock on the exercise date. If a disposition does not occur until after the expiration of the holding periods, the recipient will generally recognize a capital gain equal to the excess of the disposition price over the price paid by the recipient on the exercise date. The Company generally will not be entitled to a tax deduction for compensation expense on account of the original sales to employees, but may be entitled to deduction if a participant disposes of stock received upon exercise of an incentive stock option under the 1997 Stock Option Plan prior to the expiration of the holding periods. The Company has also established several non-qualified deferred compensation plans for its key employees similar to the plans offered by NHC, one of which provides a matching contribution (15%) for all deferred compensation used to purchase shares of common stock held by an independent trustee. The matching contribution is forfeited to the Company unless the employee achieves eight years of vesting service before withdrawing funds from the Trustee account. The Company grants credit to employees for years of service with the prior partnership.
Table II shows as to the three executive officers: (i) the number of shares as to which options have been granted from January 1, 1996 through December 31, 1997 under the 1994 Option Plan; (ii) the percentage of all shares granted represented by these individuals (iii) the option exercise price per share and the expiration date; and (iv) the potential realizable value of these options assuming both a five percent and ten percent share price appreciation over the next four years. Table III identifies for the same three person group all options exercised during 1997, the value realized upon exercise, and the unrealized value of the balance of options outstanding. The Company maintains several non-qualified deferred compensation plans for its key employees, one of which provides a matching contribution (15%) for all deferred compensation used to purchase shares interest held by an independent trustee. The matching contribution is forfeited to the company unless the employee achieves eight years of vesting service before withdrawing funds from the Trustee account. Mr. LaRoche participated in this plan during 1997. Other than as described herein or as identified in Tables I, II and III, the Company has no other long-term incentive plans for its executive officers.
<TABLE> TABLE I NATIONAL HEALTHCARE CORPORATION SUMMARY COMPENSATION TABLE 1997-1995 <CAPTION> Long Term Compensation --------------------------------- Annual Compensation<F1> Awards Payouts - ----------------------------------------------------------- ------------------------ ------- (a) (b) (c) (d) (e) (f) (g) (h) (i) Other annual Restricted LTIP All Other Name and Principal Compensation Stock Options/SARs Payouts Compensa. Position Year Salary Bonus($)<F4> ($)<F2> Awards($) (#)<F3> ($) ($) - ------------------ ---- ------ ----------- ------- ---- ------------ ------ ------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> W. Andrew Adams 1997 126,806 1,786,842 26,115 -0- -0- -0- -0- President & CEO 1996 129,757 1,850,026 8,147 -0- -0- -0- -0- 1995 129,964 579,200 121,350 -0- 40,000 -0- -0- - --------------------------------------------------------------------------------------------------------------- Robert G. Adams 1997 140,553 882,626 3,817 -0- -0- -0- -0- Senior V. P. 1996 140,279 1,238,857 8,269 -0- -0- -0- -0- & COO 1995 145,647 646,227 6,452 -0- 30,000 -0- -0- - --------------------------------------------------------------------------------------------------------------- Richard F. LaRoche, Jr. 1997 135,159 1,086,355 14,904 -0- -0- -0- -0- Sr. VP & Secretary 1996 135,784 1,012,096 18,823 -0- -0- -0- -0- 1995 142,639 380,365 8,453 -0- 30,000 -0- -0- - --------------------------------------------------------------------------------------------------------------- </TABLE> <F1>Compensation deferred at the election of an executive has been included in salary column (d). <F2>Includes (a) life insurance benefit, (b) 401-K matching contribution, (c) nonqualified deferred compensation matching contribution, (d) ESOP contribution. <F3>The 1995 awards are NHC Unit Options issued at $31.00 per unit. These officers also received stock options from National Health Investors, Inc. in 1993, 1995, and 1997 which are disclosed in that Company's Form 10-K. <F4>These officers also received bonuses from National Health Investors, Inc. and National Health Realty, Inc. which are disclosed in those Company's Form 10-K or proxy statements.
<TABLE> TABLE II NATIONAL HEALTHCARE CORPORATION OPTION/SAR GRANTS IN LAST FISCAL YEAR December 31, 1997 <CAPTION> Potential Realizable Value at Assumed Annual Rates of Unit Price Appreciation for Option Term<F2> Individual Grants - -------------------------------------------------------------------------------- ---------------------------------- (a) (b) (c) (d) (e) (f) (g) % of Total Options/SARs Granted to Exercise Options/SARs Employees in or Base Expiration Executive Officers Granted(#)<F1> Fiscal Year Price ($/Sh) Date 5%($) 10%($) - -------------------- ------------- ------------ ------------ ---------- ----- ------ <S> <C> <C> <C> <C> <C> <C> W. Andrew Adams, President & CEO -0- -0- -0- -0- -0- -0- Robert G. Adams, Sr. VP -0- -0- -0- -0- -0- -0- Richard F. LaRoche, Jr., Sr. VP -0- -0- -0- -0- -0- -0- - ------------------------------------------------------------------------------------------------------------- </TABLE> <F1>No options were awarded during 1997 to Executive Officers <F2>Based on remaining option term (if any) and annual compounding. <TABLE> TABLE III NATIONAL HEALTHCARE CORPORATION AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES December 31, 1997 <CAPTION> Number of Unexercised Value of Unexercised In-the- Options/SARs at FY-End (#) Money Options/SARs at FY- End ($) - ------------------------------------------------------------------------------------------------------------------------- Shares Acquired on Value Exercisable/ Exercisable/ Executive Officers Exercise(#) Realized($)<F1> Unexercisable Unexercisable - ---------------------- ------------------ -------------- ------------- ------------- <S> <C> <C> <C> <C> W. Andrew Adams, 40,000 560,000 -0- -0- President & CEO Robert G. Adams, 30,000 420,000 -0- -0- Sr. VP Richard F. LaRoche, Jr., 30,000 420,000 -0- -0- Sr. VP - -------------------------------------------------------------------------------------------------------------------------- </TABLE> <F1>Market value of underlying securities at exercise date, minus the exercise or base price.
EMPLOYEE STOCK OWNERSHIP PLAN: In 1986 National Health Corporation ("National"), the former partnership's Administrative General Partner adopted as its Employee Stock Ownership Plan and Trust ("ESOP") the ESOP previously sponsored by the Company's corporate predecessor. The ESOP is a qualified pension plan under Section 401(a) of the Internal Revenue Code. National makes contributions to the ESOP for all employees and is reimbursed for same by the Company. Employees make no contributions. All contributions are used by the ESOP to purchase "qualifying employer securities" which is the Common Stock of National. These securities are allocated among National's employees who participate in the ESOP in the ratio of the employee's wages to the total wages of all participating employees during that fiscal year. Participating employees are all employees, including officers, who have earned one year of service by working more than 1,000 hours during the fiscal year. On January 20, 1988, National formed a Leveraged Employee Stock Purchase Plan (Leveraged ESOP). During 1988, the Leveraged ESOP borrowed, in two separate transactions, $88.5 million from four commercial banks, the proceeds of which were used to purchase additional stock from National. National, in turn, purchased eight (8) health care centers from the Company and contracted with the Company to manage these centers for a 20-year period. National also loaned $8.5 million to City Center, Ltd. to construct a 15-story office building in Murfreesboro, Tennessee, approximately 67% of which is occupied by the Company. In late 1988, National entered into a Loan Agreement with the Company and advanced $50,000,000 to the Company to be used by the Company to pay off its existing $30,000,000 revolving line of credit, with the balance to be used for acquisition, development and general working capital needs. In September of 1988, the original ESOP was merged into the Leveraged ESOP so that as of December 31, 1997, the employees still participated in only one qualified plan. On December 28, 1990, the Leveraged ESOP borrowed $50,000,000 from three commercial lenders, the proceeds of which were used as an equity contribution to National, which in turn loaned said proceeds to the company at 8.48% fixed rate of interest. The proceeds were used for acquisition and new construction. The Leveraged ESOP is administered by an Administrative Committee, currently consisting of Ernest G. Burgess, III (Director), Donald K. Daniel and Charlotte Swafford (officers of the Company), which is appointed by National's Board of Directors. The Trustees of the Leveraged ESOP are Dr. Olin O. Williams, a director, and Richard F. LaRoche, Jr., the Company's Senior Vice President and General Counsel. The amounts contributed to the ESOP in 1997 and allocated to the Company's executive officers are included in Table I, and total $10,107. EMPLOYEE STOCK PURCHASE PLAN: The Company has established its Employee Stock Purchase Plan for employees. Pursuant to the Plan, eligible employees may purchase Company common stock through payroll deductions at the lesser of the closing asked price of the common stock as reported on the American Stock Exchange on the
first trading or the last trading day of each year. At the end of each year, funds accumulated in the employee's account will be used to purchase the maximum number of shares at the above price. The Company makes no contribution to the purchase price. 23,198 shares were issued pursuant to the Plan in January, 1998, with all payroll deductions being made in 1997. All employees (including officers and directors) may elect to participate in the Plan if they meet minimum employment requirements. The maximum payroll deduction is the employee's normal monthly pay. Participating employee's rights under the plan are nontransferable. Prior to the end of a year, a participant may elect to withdraw from the Plan and the amount accumulated as a result of his payroll deductions shall be returned to him without interest. Any terminated employee immediately ceases to be a participant and also receives his or her prior contributions. In no event may a participant in the Plan purchase thereunder during a calendar year, common stock having a fair market value more than $25,000. The stock purchased pursuant to the Plan are freely tradeable, except for any shares held by an "affiliate" of the Company, which would be subject to the limitations of Rule 144. Only Mr. LaRoche and Mr. Robert Adams of the Company's executive officers participated in this Plan during 1997 and the positive spread between the purchase price and the then fair market price for these individuals is included in Table I. 1975 PERFORMANCE BONUS PLAN: In 1975 the Company implemented a Performance Bonus Plan which was reaffirmed and readopted by the shareholders in 1994. This plan provides for the Chairman of the Board to allocate, with the approval of the non-employee directors, the bonus at the end of each fiscal year. The total amount available for bonuses under the plan is 20% of the Company's net income (without regard to NHI lease payments or Advisory fee income) after a 20% return on partners' equity as determined at the beginning of that fiscal year. Bonuses of $4,166,509 were paid under this plan to a total of 142 employees for fiscal year 1997. 401(K) PLAN: The Company and its affiliates offer a 401(K) Plan for all employees who are over 18 years of age. The Board of Directors has authorized a matching contribution to be made for 50% of contributions with contributions being matched up to 2.5% of quarterly gross wages. No employee may contribute more than 15% of wages to the Plan, and employees who earn more than $66,000 were limited to a contribution of no more than $3,500. These matching funds will be used to purchase Company stock on the open market, which shares will vest in the employees account only after the employee has achieved five years of vesting service. A total of $1,388,878 was contributed to the Plan as matching contributions for 1997.
EMPLOYEE LOAN AND BONUS PROGRAMS: The Company has for many years participated in an Employee Stock Financing Plan (the "Financing Plan"). The Plan was designed to enable key employees of the Company to finance the exercise of stock options granted to them by the Board of Directors and only if authorized by the Board. Under the Plan, the Company may (but is not required)finance the exercise of any stock options by the acceptance of the employees' full recourse promissory note bearing interest at a fixed rate equal to 2.5% below New York prime on the date of the note, with interest payable quarterly and principal due and payable on ninety days notice, but no longer than 60 months. The notes are secured by company common stock having a fair market value equal to twice the note amount. The following tables shows, as to each executive officer whose indebtedness exceeded $60,000, the largest aggregate amount of such indebtedness since December 31, 1996 and the present outstanding balance. <TABLE> <CAPTION> Financing Plan ------------------------------ Largest Balance out- Aggregate standing as of Indebtedness 12/31/97 ------------ -------------- <S> <C> <C> <C> W. Andrew Adams Pres. & CEO $ 4,101,131 $1,641,920 Robert G. Adams Sr. VP & Dir. 2,426,309 1,206,950 Richard F. LaRoche, Jr. Sr. VP & Sec. 2,418,076 1,181,200 Ernest G. Burgess Director 1,309,368 802,031 J. K. Twilla Director 84,375 --- Olin O. Williams Director 679,463 369,000 All Executive Officers & Directors as a Group (6) $11,018,722 $5,201,101 </TABLE> Obligations to repay the Financing Plan loans are an asset of the Company, but are not reflected as increasing shareholder equity until paid. 1997 RETENTION BONUS: From time to time the Board has declared a special key employee bonus, directing that the proceeds of same be used to retire some or all of these financing plan notes. These bonuses are included in Table I. Bonuses paid in 1997 to retire principal on these notes carry with them a covenant of continued employment. The Company retains the option to require a payment equal to the note repayment bonus from any employee who terminates employment with the Company prior to April 2002. Bonuses totaling $16,346,797 were paid to 149 key employees in 1997. SHAREHOLDER RETURN: Table IV is a line graph comparing the yearly percentage change in the cumulative shareholder return on the Company's shares against the cumulative total return of the S & P composite S & P 500 and the Health Care-Miscellaneous Index for the five-year period ended on December 31, 1997.
<TABLE> TABLE IV NATIONAL HEALTHCARE CORPORATION AND ITS PREDECESSOR Comparison of Cumulative Total Return <CAPTION> [GRAPH] 1993 1994 1995 1996 1997 <S> <C> <C> <C> <C> <C> National HealthCare Corporation 165.1 165.8 251.2 283.4 366.6 S & P 500 110.0 111.4 153.1 188.3 251.1 S & P Health Care Diverse 73.1 62.6 98.9 95.7 110.0 </TABLE> Assumes $100 Invested December 31, 1992 in NHC, S&P 500 and S&P Health Care Diversified
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information as to the number of shares of the Company beneficially owned as of December 31, 1997 (a) by each person (including any "group" as that term is used in Section 13(d)(3) of the Exchange Act) who is known to the Company to own beneficially 5% or more of the outstanding units (9,547,617 as of December 31, 1997), (b) by each director, and (c) by all executive officers and directors of the Company as a group. Members of management of the Company listed below are all members of management and/or the Board of Directors, but they disclaim that they are acting as a "group" and the table below is not reflective of them acting as a group: Names and Addresses Number of Units(1) Percentage of of Beneficial Owner Beneficially Owned Total Units ------------------- ------------------ ------------- W. Andrew Adams, President & Chief Executive Officer 1,067,064 11.17% 801 Mooreland Lane Murfreesboro, TN 37128 Dr. J.K. Twilla, Director 83,392 .87% 525 Golf Club Lane Smithville, TN 37166 Dr. Olin O. Williams, Director 109,392 1.15% 2007 Riverview Drive Murfreesboro, TN 37129 Robert G. Adams, Director, Sr. V.P. 431,299 4.52% and Chief Operating Officer 2217 Tomahawk Trace Murfreesboro, TN 37129 Ernest G. Burgess, Director 189,299 1.98% 2239 Shannon Drive Murfreesboro, TN 37129 Richard F. LaRoche, Jr., Sr. V.P. 377,201 3.95% 2103 Shannon Drive Murfreesboro, TN 37130 National Health Corporation 1,400,840 14.67% P.O. Box 1398 Murfreesboro, TN 37133 Lawrence C. Tucker, Director 690,155(2) 7.23% 1818 Fund, II 59 Wall Street New York NY 10005
Albert O. Nicholas 443,600 4.65% 6002 North Highway 83 Hartland, WI 53029 All Executive Officers, Directors 4,348,916 45.55% as a Group (1) Assumes exercise of stock options and convertible subordinated debentures outstanding. See "Option Plans". (2) Mr. Tucker, as a general partner of the 1818 Fund II, is attributed the ownership of the 1818 Fund II shares, but does not claim beneficial ownership thereof. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CERTAIN TRANSACTIONS W. ANDREW ADAMS NHC has developed the preeminent continuing care retirement community in Nashville, Tennessee (Richland Place) and is pursuing similar projects in Tennessee. Having identified Murfreesboro, Rutherford County, Tennessee as a viable market, the Company invited a number of potential residents to serve as a focus group to assist in the location and design of the project. After reviewing a number of potential locations, management and the focus group chose a twenty-two acre tract with extensive frontage on US Highway 231 as the optimum location. This site was owned and occupied by Mr. and Mrs. W. Andrew Adams, NHC's chief executive officer. After negotiations and appraisal, the Company acquired in 1993 and 1994 (by exchange of like kind property and cash) the site from Mr. and Mrs. Adams for a total valuation of $1,500,000, which the Company believes to be equal to or even less than comparable property in the market. NATIONAL HEALTH CORPORATION ("NATIONAL") In January, 1988, NHC sold the assets of eight health care centers (1,121 licensed beds) to National for a total consideration of $40,000,000. The consideration consisted of $30,000,000 in cash and a $10,000,000 note receivable due December 31, 2007. The note receivable earns interest at 8.5% per annum. NHC has agreed to manage the centers under a 20-year management contract for management fees comparable to those in the industry. NHC has a receivable from National for management fees of approximately $4.5 million at December 31, 1997. As of December 31, 1997, National had borrowed $2,028,000 form NHC to finance the construction of additions at two health care centers. These notes are unsecured, mature in 2008 and require monthly principal and interest payments, with interest at the prime rate. In January, 1988, NHC obtained long-term financing of $8.5 million from National for its new headquarters building. The note requires quarterly principal and interest payments with interest at 9%. At December 31, 1997, the outstanding balance was approximately $5.1 million. The building is owned by a separate partnership of which NHC is the general partner and the other
building tenants are limited partners. NHC has guaranteed the debt service of the building partnership. In addition, NHC's bank credit facility and the senior secured notes were financed through National and National's ESOP. NHC's interest costs, financing expenses and principal payments are equal to those incurred by National. In October 1991, NHC borrowed $10.0 million from National. This term note requires quarterly interest payments at 8.5% with the entire principal due at maturity in 2008. Contemporaneous with the merger of National HealthCare L.P. into NHC, the Company and National have entered into an Employee Services Agreement (the "Services Agreement") whereby NHC leases all of its employees from National. Pursuant to the Service Agreement, NHC will reimburse National for the gross payroll of employees provided to the Company plus a monthly fee equal to two percent of such month's gross payroll, but in no event shall such fee be less than the actual cost of administering the payroll and personnel department. The Services Agreement may be terminated by either at anytime with or without notice. National will be responsible for: the employment of all persons necessary to conduct the business of the Corporation and set all wages and salaries; the provision of all fringe benefits; the utilization of any qualified leveraged employee stock ownership plan; the payment of pensions, and establishment or continue and carry out pension, profit sharing, bonus, purchase, option, savings, thrift and other incentive and employee benefit plans; the purchase and payment of insurance; the indemnification and purchase of insurance on behalf of any fiduciary of any employee benefit plans and health insurance on behalf of any fiduciary of such plans. In the Services Agreement, the Company agrees to indemnify, defend and hold harmless National from any damages caused by a misrepresentation by the Company, litigation arising from the acts or failure to act of the Company or its agents in accordance with law or the Services Agreement, any employment matters relating to the employees as a result of gross negligence or intentional misconduct by the Company or the failure of the Company to obtain and/or follow specific advice and direction from National in matters of employee separation and/or discipline. In addition, National agrees to indemnify and defend and hold harmless the Company from any damages caused by reason of or resulting from or relating to employee separation and/or discipline of National employees. PART IV ------- ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K a) (i) Financial Statements: The Financial Statements are included as Exhibit 13 and are filed as part of this report.
(ii) Exhibits: Reference is made to the Exhibit Index, which is found on page 46 of this Form 10-K Annual Report. b) Reports on Form 8-K: None. For the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statement on Form S-8 File No. 33-9881 (filed December 28, 1987): Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To National HealthCare Corporation: We have audited, in accordance with generally accepted auditing standards, the financial statements included in this Form 10-K of National HealthCare Corporation (formerly National HealthCare L.P.), and have issued our report thereon dated February 12, 1998. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule listed in the accompanying index is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and regulations under the Securities and Exchange Act of 1934 and is not otherwise a required part of the basic financial statements. The financial statement schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements, and in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Nashville, Tennessee February 12, 1998
<TABLE> NATIONAL HEALTHCARE CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 (in thousands) <CAPTION> Column A Column B Column C Column D Column E - -------- -------- -------- -------- -------- Additions -------------------- Balance- Charged to Charged Balance Beginning Costs and to other -End of Description of Period Expenses Accounts Deductions<F1> Period - ----------- --------- ---------- -------- ------------- ------- <S> <C> <C> <C> <C> <C> For the year ended December 31, 1995 - Allowance for doubtful accounts $3,367 $2,182 $ --- $1,108 $4,441 For the year ended December 31, 1996 - Allowance for doubtful accounts $4,441 $1,654 $ --- $1,356 $4,739 For the year ended December 31, 1997 - Allowance for doubtful accounts $4,739 $1,688 $ --- $ 949 $5,478 </TABLE> __________ <F1> Amounts written off, net of recoveries.
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NATIONAL HEALTHCARE CORPORATION BY:/s/ Richard F. LaRoche, Jr. Richard F. LaRoche, Jr. Secretary Date: March 25, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 25, 1998, by the following persons on behalf of the registrant in the capacities indicated. Each director of the registrant whose signature appears below hereby appoints W. Andrew Adams and Richard F. LaRoche, Jr., and each of them severally, as his Attorney in Fact to sign in his name on his behalf as a director of the registrant and to file with the Commission any and all amendments of this report on Form 10-K. /s/ W. Andrew Adams /s/ Olin O. Williams W. Andrew Adams, President Olin O. Williams, M.D., Director Executive and Financial Officer /s/ Robert G. Adams /s/ J. K. Twilla Robert G. Adams, Senior Vice J.K. Twilla, M.D., Director President, Director /s/ Ernest G. Burgess /s/ Donald K. Daniel Ernest G. Burgess, Director Donald K. Daniel, Vice President and Principal Accounting Officer
NATIONAL HEALTHCARE CORPORATION AND SUBSIDIARIES FORM 10-K FOR THE FISCAL YEAR ENDING DECEMBER 31, 1997 EXHIBIT INDEX Exhibit No. Description Page No. or Location - ----------- ------------ --------------------- 3.1 Charter Specifically incorporated by reference to Exhibit A attached to Form S-4, (Proxy Statement-Prospectus), amended, Registration No. 333-37185, (December 5, 1997) 3.2 By-laws Specifically incorporated by reference to Exhibit A attached to Form S-4, (Proxy Statement-Prospectus), amended, Registration No. 333-37185, (December 5, 1997) 4.1 Form of Common Stock Specifically incorporated by reference to Exhibit A attached to Form S-4, (Proxy Statement-Prospectus), amended, Registration No. 333-37185, (December 5, 1997) 10 Material Contracts Incorporated by reference from Exhibits 10.1 thru 10.9 attached to Form S-4, (Proxy Statement- Prospectus), as amended, Registration No. 333-37185 (December 5, 1997) 10.11 Employee Stock Specifically incorporated Purchase Plan by reference to Exhibit A attached to Form S-4, )Proxy Statement-Prospectus), amended, Registration No. 333-37185, (December 5, 1997) 10.12 1997 Stock Option Incorporated by reference Plan from 1997 Proxy Statement/ Prospectus filed on December 5, 1997 12 Statements Re: Computation of Ratios Page 57 13 Report of Independent Public Accountants Exhibit 13 beginning Consolidated State- on Page 58 ments of Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Partners' Capital Notes to Consolidated Financial Statements
22 Subsidiaries of Registrant Specifically incorporated by reference to Exhibit A attached to Form S-4, (Proxy Statement-Prospectus), amended, Registration No. 333-37185, (December 5, 1997) 23 Consent of Independent Page 86 Public Accountants 27 Financial Data Schedule (for SEC purposes only)
<TABLE> EXHIBIT 12 STATEMENT RE: COMPUTATION OF RATIOS AS REQUIRED BY ITEM 601(b)(12) OF REGULATION S-K NATIONAL HEALTHCARE CORPORATION <CAPTION> December 31 ----------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> Current Assets $125,293 $ 80,094 $ 89,440 $ 97,506 $109,291 Current Liabilities $ 80,795 $ 72,803 $ 59,047 $ 55,038 $ 39,798 Current Ratio 1.55 1.10 1.51 1.78 2.75 Long-Term Debt and Debt Serviced by Other Parties $ 76,903 $157,535 $141,642 $194,007 $166,741 Equity $ 37,736 $128,537 $108,899 $101,006 $ 92,526 Long-Term Debt and Debt Serviced by Other Parties to Equity 2.04 1.23 1.30 1.92 1.80 Net Income $ 37,008 $ 29,286 $ 21,115 $ 15,853 $ 37,562 Average Equity $159,457 $118,718 $104,953 $ 96,766 $ 80,224 Return on Average Equity 23.2% 24.7% 20.1% 16.4% 46.8% Total Liabilities $177,613 $260,037 $231,501 $279,847 $237,306 Partners' Capital and Deferred Income $ 52,568 $144,703 $123,990 $116,286 $107,374 Total Liabilities to Partners' Capital/Share- owners' Equity and and Deferred Income 3.38 1.8 1.9 2.4 2.2 </TABLE>
EXHIBIT 13 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Public Accountants 59 Consolidated Statements of Income 60 Consolidated Balance Sheets 61-62 Consolidated Statements of Cash Flows 63-64 Consolidated Statements of Shareowners' Equity and Partners' Capital 65 Notes to Consolidated Financial Statements 66-85
To National HealthCare Corporation We have audited the accompanying consolidated balance sheets of National HealthCare Corporation (a Delaware partnership and formerly National HealthCare L.P.) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareowners' equity and partners' capital, and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of National HealthCare Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National HealthCare Corporation and subsidiaries as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Nashville, Tennessee February 12, 1998
<TABLE> NATIONAL HEALTHCARE CORPORATION Consolidated Statements of Income (in thousands, except unit amounts) <CAPTION> Year Ended December 31 1997 1996 1995 <S> <C> <C> <C> Revenues: Net patient revenues $ 410,963 $ 341,818 $ 307,969 Other revenues 52,514 44,448 41,429 Net revenues 463,477 386,266 349,398 Costs and Expenses: Salaries, wages and benefits 258,325 209,645 188,985 Other operating 138,103 122,948 107,858 Depreciation and amortization 16,819 13,634 14,549 Interest 13,013 10,753 16,891 Total costs and expenses 426,260 356,980 328,283 Income Before Income Taxes 37,217 29,286 21,115 Income Tax Provision 209 --- --- Net Income $ 37,008 $ 29,286 $ 21,115 Earnings Per Unit: Basic $ 4.17 $ 3.48 $ 2.67 Diluted 3.58 2.97 2.32 Weighted Average Units Outstanding: Basic 8,874,627 8,421,523 7,920,795 Diluted 10,838,567 10,496,407 9,933,157 Net Income Allocable to Partners: General Partners $ 370 $ 293 $ 211 Limited Partners 36,638 28,993 20,904 $ 37,008 $ 29,286 $ 21,115 </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
<TABLE> NATIONAL HEALTHCARE CORPORATION Consolidated Balance Sheets (in thousands, except share amounts) <CAPTION> December 31 1997 1996 <S> <C> <C> Assets Current Assets: Cash and cash equivalents $ 17,205 $ 1,881 Cash held by trustees 3,834 2,274 Marketable securities 19,579 17,968 Accounts receivable, less allowance for doubtful accounts of $5,478 and $4,739, respectively 71,564 50,902 Notes receivable 6,992 2,515 Inventory, at lower of cost (first-in, first-out method) or market 3,948 3,572 Deferred income taxes 1,618 --- Prepaid expenses and other assets 553 982 Total current assets 125,293 80,094 Property, Equipment and Assets Under Arrangement With Other Parties: Property and equipment, at cost 104,597 234,934 Accumulated depreciation and amortization (41,171) (48,171) Assets under arrangement with other parties, net 4,853 22,538 Net property, equipment and assets under arrangement with other parties 68,279 209,301 Other Assets: Bond reserve funds, mortgage replacement reserves and other deposits 506 141 Unamortized financing costs 1,278 1,601 Notes receivable 11,044 95,206 Notes receivable from National 12,028 12,153 Deferred income taxes 2,922 --- Minority equity investments and other 8,831 6,244 Total other assets 36,609 115,345 $230,181 $404,740 </TABLE>
<TABLE> NATIONAL HEALTHCARE CORPORATION Consolidated Balance Sheets (in thousands, except share amounts) <CAPTION> December 31 1997 1996 Liabilities, Shareowners' Equity and Partners' Capital <S> <C> <C> Current Liabilities: Current portion of long-term debt $ 2,682 $ 8,574 Trade accounts payable 12,810 11,835 Accrued payroll 38,123 28,963 Distributions payable 5,388 -- Amount due to third party payors 6,789 13,135 Accrued interest 596 501 Other current liabilities 14,407 9,795 Total current liabilities 80,795 72,803 Long-Term Debt, Less Current Portion 60,227 124,678 Debt Serviced by Other Parties, Less Current Portion 16,676 32,857 Minority Interests in Consolidated Subsidiaries 763 791 Subordinated Convertible Notes 19,152 28,908 Deferred Income 14,832 16,166 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; 10,103,172 shares, issued and outstanding 101 -- Capital in excess of par value, less notes receivable 33,248 -- Retained earnings -- -- Unrealized gains on securities 4,387 -- Total shareowners' equity 37,736 -- Partners' Capital: General partners -- 1,408 Limited partners, less notes receivable -- 124,958 Unrealized gains on securities -- 2,171 Total partners' capital -- 128,537 $230,181 $404,740 </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
<TABLE> NATIONAL HEALTHCARE CORPORATION Consolidated Statements of Cash Flows (in thousands) <CAPTION> Year Ended December 31 1997 1996 1995 <S> <C> <C> <C> Cash Flows From Operating Activities: Net income $ 37,008 $ 29,286 $ 21,115 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 15,665 12,453 14,081 Provision for doubtful accounts receivable 1,688 1,654 2,182 Amortization of intangibles and deferred charges 598 1,083 1,845 Amortization of deferred income (1,334) (295) (497) Equity in earnings of unconsolidated investments (201) (313) (347) Distributions from unconsolidated investments and other 160 210 236 Deferred income taxes (4,540) --- --- Changes in assets and liabilities: Increase in accounts receivable (22,350) (5,271) (1,095) Increase in inventory (376) (497) (123) (Increase) decrease in prepaid expenses and other assets 389 (89) 680 Increase (decrease) in trade accounts payable 975 5,693 (10,910) Increase in accrued payroll 9,160 5,087 5,232 Increase (decrease) in amounts due to third party payors (6,346) 3,335 5,404 Increase (decrease) in accrued interest 116 (1,321) (401) Increase in other current liabilities 4,612 946 2,456 Net cash provided by operating activities 35,224 51,961 39,858 Cash Flows From Investing Activities: Additions to and acquisitions of property and equipment, net (34,827) (69,970) (29,435) Investments in long-term notes receivable and loan participation agreements (38,436) (20,170) (30,694) Collections of long-term notes receivable and loan participation agreements 23,807 38,862 39,157 (Increase) decrease in minority equity investments and other (2,827) (441) 210 (Increase) decrease in marketable securities, net 605 (14,628) 2,361 Sales of investments --- 1,900 --- Net cash used in investing activities (51,678) (64,447) (18,401) Cash Flows From Financing Activities: Proceeds from debt issuance 45,319 29,183 2,368 Proceeds from issuance of subordinated convertible notes 20,000 --- --- Increase in cash held by trustees (1,560) (553) (117) Increase (decrease) in minority interests in subsidiaries (28) (21) 10 Issuance of partnership units 2,344 1,378 820 Collections of receivables from exercise of options 17,375 3,522 795 (Increase) decrease in bond reserve funds, mortgage replacement reserves and other deposits (365) 1,648 (69) Payments on debt (30,007) (8,138) (6,767) Cash distributions to partners (21,021) (17,466) (14,702) Increase in financing costs (279) (21) (402) Net cash provided by (used in) financing activities 31,778 9,532 (18,064) Net Increase (Decrease) In Cash and Cash Equivalents 15,324 (2,954) 3,393 Cash and Cash Equivalents, Beginning of Period 1,881 4,835 1,442 Cash and Cash Equivalents, End of Period $ 17,205 $ 1,881 $ 4,835 </TABLE>
<TABLE> <CAPTION> Year Ended December 31 1997 1996 1995 (in thousands, except share and unit amounts) <S> <C> <C> <C> Supplemental Information: Cash payments for interest expense $ 12,918 $ 12,074 $ 17,292 During 1997 and 1996 $29,756 and $1,092 respectively, of convertible subordinated notes were converted into 1,197,119 and 71,810 of NHC's partnership units and common stock Subordinated convertible notes $(29,756) $ (1,092)$ -- Financing costs 131 -- -- Accrued interest 320 -- -- Partners' capital and shareowners' equity 29,305 1,092 -- During 1997, 1996 and 1995, NHC was released from its liability on debt serviced by others by the respective lenders Debt serviced by other parties $(15,569) $ (5,136)$(45,868) Assets under arrangement with other parties $ 15,569 $ 5,136 $ 45,868 The Company transferred certain assets, related liabilities and equity to National Health Realty, Inc., a real estate investment trust Net book value of assets transferred $239,054 $ -- $ -- Mortgage notes payable transferred 86,414 -- -- Equity transferred $152,640 $ -- $ -- </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
<TABLE> NATIONAL HEALTHCARE CORPORATION Consolidated Statements of Shareowners' Equity and Partners' Capital (in thousands, except share and unit amounts) <CAPTION> Unrealized Total Share Receivables Gains owners' Eq. 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 12/31/94 7,826,165 $ --- $(14,697) $ --- $ --- $ 480 $ 1,095 $114,128 $101,006 Net income --- --- --- --- --- --- 211 20,904 21,115 Collection of receivables --- --- 795 --- --- --- --- --- 795 Units sold 526,949 --- (12,294) --- --- --- 131 12,983 820 Unrealized losses on securities --- --- --- --- --- (135) --- --- (135) Cash distributions declared ($1.88 per unit) --- --- --- --- --- --- (147) (14,555) (14,702) Balance at 12/31/95 8,353,114 --- (26,196) --- --- 345 1,290 133,460 108,899 Net income --- --- --- --- --- --- 293 28,993 29,286 Collection of receiv- ables --- --- 3,522 --- --- --- --- --- 3,522 Units sold 43,035 --- --- --- --- --- --- 1,378 1,378 Units issued in conversion of convertible debentures to partnership units 71,810 --- --- --- --- --- --- 1,092 1,092 Unrealized gains on securities --- --- --- --- --- 1,826 --- --- 1,826 Cash distributions declared ($2.08 per unit) --- --- --- --- --- --- (175) (17,291) (17,466) Balance at 12/31/96 8,467,959 --- (22,674) --- --- 2,171 1,408 147,632 128,537 Net income --- --- --- --- --- --- 370 36,638 37,008 Collection of receivables --- --- 17,375 --- --- --- --- --- 17,375 Units sold 438,094 --- (11,576) --- --- --- --- 13,920 2,344 Units issued in conversion of convertible debentures to partnership units 1,197,119 --- --- --- --- --- --- 29,305 29,305 Unrealized gains on securities --- --- --- --- --- 2,216 --- --- 2,216 Equity transferred to National Health Realty, Inc. --- --- --- --- --- --- (1,514) (151,126) (152,640) Cash distributions declared ($3.00 per unit) --- --- --- --- --- --- (264) (26,145) (26,409) 10,103,172 --- (16,875) --- --- 4,387 --- 50,224 37,736 Effect of reorganization from limited partnership to corporation --- 101 --- 50,123 --- --- --- (50,224) --- Balance at 12/31/97 10,103,172 $ 101 $(16,875) $50,123 $ --- $4,387 $ --- $ --- $ 37,736 </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Presentation-- The consolidated financial statements include the accounts of National HealthCare Corporation and its subsidiaries ("NHC" and formerly National HealthCare L.P.). Investments are accounted for on either the cost or equity method. All material intercompany balances, profits, and transactions have been eliminated in consolidation, and minority interests are reflected in consolidation. Investments in entities in which NHC lacks control but has the ability to exercise significant influence over operating and financial policies are accounted for on the equity method. Investments in entities in which NHC lacks the ability to exercise significant influence are included in the consolidated financial statements at the cost of NHC's investment. Certain reclassifications have been made to the 1995 and 1996 financial statements to conform to the 1997 presentation. Use of Estimates-- The preparation of financial statements in conformity with generally accepted accounting principles requires management 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. Health Care Revenues-- NHC's principal business is operating and managing long-term health care centers, including the provision of routine and ancillary services. Approximately 56% of NHC's net revenues in 1997 and 60% in 1996 and 1995 are from participation in Medicare and Medicaid programs. Amounts paid under these programs are generally based on a facility's allowable costs or a fixed rate subject to program cost ceilings. Revenues are recorded at standard billing rates less allowances and discounts principally for patients covered by Medicare, Medicaid and other contractual programs. These allowances and discounts were $99,273,000, $110,795,000 and $103,186,000 for 1997, 1996 and 1995, respectively. Amounts earned under the Medicare, Medicaid and other governmental programs are subject to review by the third party payors. In the opinion of management, adequate provision has been made for any adjustments that may result from such reviews. NHC generally expects final determinations to occur two to three years subsequent to the year in which amounts are earned. Any differences between estimated settlements and final determinations are reflected in operations in the year finalized. NHC has submitted various requests for exceptions to Medicare routine cost limitations for reimbursement. NHC has received approval on certain requests, and others are pending approval. NHC will record revenues associated with the approved requests when such approvals, including cost report audits, are assured. Provision for Doubtful Accounts-- Provisions for estimated uncollectible accounts and notes receivable are included in other operating expenses.
Property, Equipment and Assets Under Arrangement with Other Parties-- NHC uses the straight-line method of depreciation over the expected useful lives of property and equipment estimated as follows: buildings and improvements, 20-40 years; equipment and furniture, 3-15 years; and properties under arrangement with other parties, 10-20 years. The provision for depreciation includes the amortization of properties under capital leases and properties under arrangement with National Health Investors, Inc. ("NHI") (See Note 4). Expenditures for repairs and maintenance are charged against income as incurred. Betterments are capitalized. NHC removes the costs and related allowances from the accounts for properties sold or retired, and any resulting gains or losses are included in income. NHC includes interest costs incurred during construction periods in the cost of buildings ($1,277,000 in 1997 and $1,428,000 in 1996). In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of" ("SFAS 121"), NHC evaluates the recoverability of the carrying values of its properties on a property by property basis. 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 Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). Intangible Assets-- Any excess of cost over net assets of companies purchased is amortized generally over 40 years using the straight-line method. Deferred financing costs are amortized principally by the interest method over the terms of the related loans. Income Taxes-- During 1997 and since 1987, NHC was a publicly traded limited partnership. Accordingly, NHC was not a taxable entity and the earnings of NHC were taxable to the individual partners. Effective December 31, 1997, NHC became a taxable corporate entity. In accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"), effective December 31, 1997, NHC recognized deferred income taxes for the consequences of temporary differences by applying enacted statutory tax rates for differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Concentration of Credit Risks-- NHC's credit risks primarily relate to cash and cash equivalents, cash held by trustees, accounts receivable, marketable securities and notes receivable. Cash and cash equivalents are primarily held in bank accounts and overnight investments. Cash held by trustees is primarily invested in commercial paper and certificates of deposit with financial institutions.
Accounts receivable consist primarily of amounts due from patients (funded approximately 78% through Medicare, Medicaid, and other contractual programs and approximately 22% through private payors) in the states of Alabama, Florida, Georgia, Kentucky, Missouri, South Carolina, Tennessee, and Virginia and from other health care companies for management services. NHC performs continual credit evaluations of its clients and maintains allowances for doubtful accounts on these accounts receivable. Marketable securities are held primarily in two accounts with brokerage institutions. Notes receivable relate primarily to secured loans with health care facilities and to secured notes receivable from officers, directors and supervisory employees as discussed in Notes 16 and 17. NHC also has notes receivable from National Health Corporation as discussed in Note 5. NHC's financial instruments, principally its notes receivable, are subject to the possibility of loss of the carrying values as a result of either the failure of other parties to perform according to their contractual obligations or changes in market prices which may make the instruments less valuable. NHC obtains various collateral and other protective rights, and continually monitors these rights, in order to reduce such possibilities of loss. NHC evaluates the need to provide for reserves for potential losses on its financial instruments based on management's periodic review of its portfolio on an instrument by instrument basis. See Notes 16 and 17 for additional information on the notes receivable. Cash and Cash Equivalents-- Cash equivalents include highly liquid investments with an original maturity of less than three months. New Accounting Pronouncements-- During 1997 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128") and Statement of Financial Accounting Standards No. 129, "Disclosure of Information about Capital Structure" ("SFAS 129"). NHC adopted the provisions of SFAS 128 and SFAS 129 during the fourth quarter of 1997. The adoption of SFAS 128 and SFAS 129 did not have a material effect on NHC's financial statements. See Note 7 for calculation of NHC's earnings per unit and Notes 12, 13, and 17 for discussion of NHC's capital structure. During 1997 the Financial Accounting Standards Board also issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") and Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). NHC will adopt the provisions of SFAS 130 and SFAS 131 in 1998 and does not expect that the adoption of these new accounting pronouncements will have a material effect on NHC's financial statements. NOTE 2 - RESTRUCTURE FROM LIMITED PARTNERSHIP TO CORPORATION: 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 will be subject to federal income taxes. In response to the
governmentally mandated loss of partnership tax 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 - RELATIONSHIP WITH NATIONAL HEALTH REALTY, INC.: Transfer of Assets-- 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 Maryland corporation qualified as a real estate investment trust ("REIT") under federal laws, and NHR/OP, L.P. (the "Operating Partnership"). NHR/OP, L.P. is a Delaware limited partnership which is the operating entity of NHR. In exchange for the assets transferred, NHC received 8,237,423 shares of common stock of NHR, which is all of the outstanding common stock of NHR. NHC distributed the common stock of NHR to NHC's unitholders at the rate of one share for each unit outstanding on the record date December 31, 1997. In order to protect the REIT status of NHR, certain NHC unitholders received 1,310,194 units of the Operating Partnership rather than NHR shares. NHR was incorporated on September 26, 1997 as a wholly-owned subsidiary of NHC for the purpose of consummating the transactions described herein. The distribution of NHR's common stock to NHC unitholders effectively separated NHC and NHR into two independent public companies, although the Boards of Directors are identical save for one additional member on NHC's Board. Leases-- Concurrent with NHC's conveyance of the real property to NHR, NHC leased from NHR each of the 24 facilities. Each lease is for an initial term expiring December 31, 2007, with two additional five year renewal terms at the option of NHC, assuming no defaults. NHC accounts for the leases as operating leases. During the initial term and each renewal term, NHC is obligated to pay NHR annual base rent on all 24 facilities of $12,417,000. 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 gross revenues of each facility in such later year exceeds the gross revenues of such facility in 1999. Each lease with NHR is a "triple net lease" under which NHC is responsible for paying all taxes, utilities, insurance premium costs, repairs and other charges relating to the ownership of the facilities. NHC is obligated at its expense to maintain adequate insurance on the facilities' assets. NHC has a right of first refusal with NHR to purchase any of the properties transferred from NHC should NHR receive an offer from an unrelated party during the term of the lease or up to 180 days after termination of the related lease.
At December 31, 1997, the approximate future minimum base rent commitments to be paid by NHC on non-cancelable operating leases with NHR are as follows: 1998 $12,417,000 1999 12,417,000 2000 12,417,000 2001 12,417,000 2002 12,417,000 Thereafter 62,085,000 Advisory Agreement-- NHC has 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. The Advisor is subject to the supervision of and policies established by NHR's Board of Directors. Either party may terminate the Advisory Agreement on 90 days notice at any time after January 1, 2000. NHR may terminate the Advisory Agreement for cause at any time. 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. Pursuant to the Advisory Agreement, NHR has agreed that as long as both the NHR Advisory Agreement and the NHI Advisory Agreement are obligations of NHC, NHR will only do business with NHC and will not compete with NHI. As a result, NHR is severely limited in its ability to grow and expand its business. Furthermore, NHC will not seek additional investments to expand NHR's investment portfolio. Tax Treatment of the Transfer-- The transfer of assets was treated as a nontaxable exchange under Section 351 of the Internal Revenue code of 1986, as amended. For federal income tax purposes, no gain or loss was recognized by NHC or by its unitholders upon the transfer of assets to NHR or upon the distribution of the shares of NHR. The tax basis of shares of NHR received by NHC unitholders in the distribution was $16.54 per share before a number of special tax adjustments related to the price paid for NHC units and the length of time such units were held. The tax basis in each share of NHR cannot exceed the overall basis in NHC units. Pro Forma Results-- The unaudited pro forma results of NHC for the year ended December 31, 1997 are presented as if the transaction with NHR had occurred on January 1, 1997 and include the following adjustments: 1) Advisory fee income from NHR, 2) Changes in interest income and interest expense related to the transfer of mortgage notes receivable and debt to NHR, 3) Base rent expense related to real property transferred to NHR, and 4) Decrease in depreciation expense related to real property transferred to NHR.
The unaudited pro forma results are as follows: (in thousands, except per unit amounts) (unaudited) Net Revenues $454,647 Total cost and expenses 429,248 Net income $ 25,399 Earnings per unit Basic $ 2.86 Diluted $ 2.51 NOTE 4 - RELATIONSHIP WITH NATIONAL HEALTH INVESTORS, INC.: Leases-- On October 17, 1991, concurrent with NHC's conveyance of real property to NHI, NHC leased from NHI the real property of 40 long-term care centers and three retirement centers. Each lease is for an initial term expiring December 31, 2001, with two additional five-year renewal terms at the option of NHC, assuming no defaults. NHC accounts for the leases as operating leases. During the initial term and first renewal term of the leases, NHC is obligated to pay NHI annual base rent on all 43 facilities of $15,238,000. If NHC exercises its option to extend the leases for the second renewal term, the base rent will be the then fair rental value as negotiated by NHC and NHI. The leases also obligate NHC to pay as debt service rent all payments of interest and principal due under each mortgage to which the conveyance of the facilities was subject. The payments are required over the remaining life of the mortgages as of the conveyance date, but only during the term of the lease. Payments for debt service rent are being treated by NHC as payments of principal and interest if NHC remains obligated on the debt ("obligated debt service rent") and as operating expense payments if NHC has been relieved of the debt obligation by the lender ("non-obligated debt service rent"). See "Accounting Treatment of the Transfer" for further discussion. In addition to base rent and debt service rent, in each year after 1992, NHC must pay percentage rent to NHI equal to 3% of the amount by which gross revenues of each facility in such later year exceed the gross revenues of such facility in 1992. Percentage rent for 1997 and 1996 was approximately $2,294,000 and $1,817,000, respectively. Each lease with NHI is a "triple net lease" under which NHC is responsible for paying all taxes, utilities, insurance premium costs, repairs and other charges relating to the ownership of the facilities. NHC is obligated at its expense to maintain adequate insurance on the facilities' assets. NHC has a right of first refusal with NHI to purchase any of the properties transferred from NHC 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.
Base rent expense to NHI was $15,238,000 in 1997, 1996 and 1995. Non-obligated debt service rent to NHI was $5,430,000 in 1997 and $5,048,000 in 1996. At December 31, 1997, the approximate future minimum base rent and non-obligated debt service rent commitments to be paid by NHC on non-cancelable operating leases with NHI during the initial term are as follows: 1998 $20,354,000 1999 20,372,000 2000 20,409,000 2001 20,486,000 Thereafter --- Advisory Agreement-- NHC has entered into an Advisory Agreement with NHI whereby services related to investment activities and day-to-day management and operations are provided to NHI by NHC as Advisor. The Advisor is subject to the supervision of and policies established by NHI's Board of Directors. Either party may terminate the Advisory Agreement on 90 days notice at any time. NHI may terminate the Advisory Agreement for cause at any time. For its services under the Advisory Agreement, NHC's annual compensation is calculated to be $3,101,000, $3,100,000, and $2,827,000 in 1997, 1996 and 1995, respectively. However, the payment of such annual compensation is conditional upon NHI having sufficient funds from operations to pay annual dividends of $2.00 per share and upon NHI paying such dividends. NHI met this condition in 1997, 1996 and 1995. Accounting Treatment of the Transfer-- NHC has accounted for the conveyance in 1991 of assets (and related debt) to NHI and the subsequent leasing of the real estate assets as a "financing/leasing" arrangement. Since NHC remains obligated on certain of the transferred debt, the obligated debt and applicable asset balances have been reflected on the Consolidated Balance Sheets as "assets under arrangement with other parties" and "debt serviced by other parties". The net book value equity of the assets transferred has been transferred from NHC to NHI. As NHC utilizes the applicable real estate over the lease term, its Consolidated Statements of Income will reflect the continued depreciation of the applicable assets over the lease term, the continued interest expenses on the obligated debt balances and the additional base and non-obligated debt service rents (as an operating expense) payable to NHI each year. NHC has recovery provisions from NHI if NHC is required to service the debt through a default by NHI. Release from Debt Serviced by Other Parties-- In 1997, 1996 and 1995, NHI prepaid or NHC was released from its obligation on transferred debt in the amounts of $15,569,000, $5,136,000 and $45,868,000, respectively. Since NHC is no longer obligated on this transferred debt, debt serviced by other parties and assets under arrangement with other parties have been reduced by $15,569,000, $5,136,000 and $45,868,000 in 1997, 1996 and 1995, respectively. The leases with NHI provide that NHC shall continue to make non-obligated debt service rent payments equal to the debt service including principal and interest on the obligated debt which was prepaid and from which NHC has been released.
NOTE 5 - RELATIONSHIP WITH NATIONAL HEALTH CORPORATION: Sale of Health Care Centers-- On January 20, 1988, NHC sold the assets (inventory, property and equipment) of eight health care centers (1,121 licensed beds) to National Health Corporation ("National"), the administrative general partner of NHC at the time of the sale, for a total consideration of $40,000,000. The consideration consisted of $30,000,000 in cash and a $10,000,000 note receivable due December 31, 2007. The note receivable earns interest at 8.5%. NHC has agreed to manage the centers under a 20-year management contract for management fees comparable to those in the industry. With the prior consent of NHC, National sold one center to an unrelated third party in 1997; thus, NHC now manages seven centers for National. NHC has a receivable from National for management fees of approximately $4,512,000 and $3,184,000 at December 31, 1997 and 1996, respectively. NHC's basis in the assets sold was approximately $24,255,000. The resulting profit of $15,745,000 was deferred and will be amortized into income beginning with the collection of the note receivable (up to $12,000,000) with the balance ($3,745,000) of the profit being amortized into income on a straight-line basis over the management contract period. As of December 31, 1997, National had borrowed $2,028,000 from NHC to finance the construction of additions at two health care centers. The notes require monthly principal and interest payments. The interest rate is equal to the prime rate, and the notes mature in 2008. Financing Activities-- On January 20, 1988, NHC obtained long-term financing of $8,500,000 for its new headquarters building from National through the National Health Corporation Leveraged Employee Stock Ownership Plan and Trust (the "ESOP"). The note requires quarterly principal and interest payments with interest at 9%. At December 31, 1997 and 1996, the outstanding balance on the note was approximately $5,078,000 and $5,520,000, respectively. The building is owned by a separate partnership of which NHC is the general partner and building tenants are limited partners. NHC has guaranteed the debt service of the building partnership. In addition, NHC's $14,085,000 bank credit facility and the $9,383,000 senior secured notes described in Note 11 were financed through National and the ESOP. NHC's interest costs, financing expenses and principal payments are equal to those incurred by National. In October 1991, NHC borrowed $10,000,000 from National. The term note payable requires quarterly interest payments at 8.5%. The entire principal is due at maturity in 2008. Payroll and Related Services-- The personnel conducting the business of NHC are employees of National, which provides payroll services, provides employee fringe benefits, and maintains certain liability insurance. NHC pays to National all the costs of personnel employed for the benefit of NHC, as well as an administrative fee ($2,305,000 in 1997) equal to 1% of payroll costs. National maintains and makes contributions to its ESOP for the benefit of eligible employees.
NOTE 6 - OTHER REVENUES: Revenues from management services include management fees, interest income on notes receivable, and revenues from other services provided to managed long-term care centers. "Other" revenues include non-health care related earnings. (in thousands) Year Ended December 31 1997 1996 1995 Revenues from managed services $38,339 $32,363 $28,719 Guarantee fees 628 693 814 Advisory fees from NHI 3,101 3,100 3,265 Dividends and other realized gains on securities 1,728 932 450 Equity in earnings of unconsolidated investments 201 313 347 Interest income 4,333 4,386 6,457 Other 4,184 2,661 1,377 $52,514 $44,448 $41,429 NOTE 7 - EARNINGS PER UNIT: In 1997 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). NHC adopted the provisions of SFAS 128 during the fourth quarter of 1997 and has restated earnings per unit for 1996 and 1995. Basic earnings per unit is based on the weighted average number of common units outstanding during the year. Diluted earnings per unit assumes the conversion of the subordinated convertible notes and the exercise of all unit options using the treasury stock method. Net income is increased for interest expense on the subordinated convertible notes. The following table summarizes the earnings and the average number of common units used in the calculation of basic and diluted earnings per unit: <TABLE> <CAPTION> (dollars in thousands, except per unit amounts) Year Ended December 31 1997 1996 1995 <S> <C> <C> <C> Basic: Weighted average common units 8,874,627 8,421,523 7,920,795 Net income $ 37,008 $ 29,286 $ 21,115 Earnings per common unit, basic $ 4.17 $ 3.48 $ 2.67 Diluted: Weighted average common units 8,874,627 8,421,523 7,920,795 Stock options 5,565 148,685 39,496 Convertible subordinated notes 1,958,375 1,926,199 1,972,866 Assumed average common units outstanding 10,838,567 10,496,407 9,933,157
Net income $ 37,008 $ 29,286 $ 21,115 Interest expense on subordinated convertible notes 1,809 1,850 1,892 Net income assuming conversion of subordinated convertible notes $ 38,817 $ 31,136 $ 23,007 Earnings per common unit, diluted $ 3.58 $ 2.97 $ 2.32 </TABLE> NOTE 8 - PROPERTY, EQUIPMENT AND ASSETS UNDER ARRANGEMENT WITH OTHER PARTIES: Property and equipment, at cost, consist of the following: (in thousands) December 31 1997 1996 Land $ 3,404 $ 20,607 Buildings and improvements 38,173 99,564 Furniture and equipment 58,355 70,947 Construction in progress 4,665 43,816 $104,597 $234,934 Assets under arrangement with other parties, net of accumulated depreciation, consist of the following: (in thousands) December 31 1997 1996 Land $ 556 $ 2,313 Buildings and improvements 1,336 15,885 Fixed equipment 285 1,664 Mortgage notes receivable 2,676 2,676 $ 4,853 $ 22,538 NOTE 9 - SUPPLEMENTAL INFORMATION FOR STATEMENTS OF CASH FLOWS: Supplemental information for statements of cash flows includes the following: During 1997 and 1996 $29,756 and $1,092 respectively, of convertible subordinated notes were converted into 1,197,119 and 71,810 of NHC's partnership units and common stock Subordinated convertible notes $ (29,756) $ (1,092) $ --- Financing costs 131 --- --- Accrued interest 320 1,092 --- Partners' capital and share- owners' equity 29,305 1,092 --- During 1997, 1996 and 1995, NHC was released from its liability on debt serviced by others by the respective lenders Debt serviced by other parties $ (15,569) $ (5,136) $(45,868) Assets under arrangement with other parties 15,569 5,136 $ 45,868
At December 31, 1997, NHC transferred certain assets, related liabilities and equity to National Health Realty, Inc., a real estate investment trust Net book value of assets transferred $ 239,054 $ --- $ --- Mortgage notes payable transferred (86,414) --- --- Equity transferred $(152,640)$ --- $ --- NOTE 10 - ACQUISITIONS AND DISPOSITIONS: In July 1996, NHC purchased, for total consideration of approximately $4,680,000, a 120 bed long-term health care center located in West Plains, Missouri. NHC had managed the health care center since its opening in 1982. Also in July 1996, NHC purchased, for total consideration of approximately $6,500,000, a long-term health care center with assisted living apartments located in Naples, Florida. There are 60 long-term health care beds and 36 assisted living apartments. The purchase prices for the acquisitions above were allocated to the underlying assets based on their relative fair market values. The Consolidated Statements of Income for 1997 and 1996 include the results of operations from the respective dates of acquisition. NOTE 11 - 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. Proceeds from the sale of investments in debt and equity securities during the years ended December 31, 1997 and 1996 were $854,000 and $1,669,000 respectively. Gross investment gains of $249,000 and $92,000 were realized on these sales during the years ended December 31, 1997 and 1996. Gross investment losses of $41,000 were realized on these sales during the year ended December 31, 1996. Realized gains and losses from securities sales are determined on the specific identification of the securities. NOTE 12 - DEBT AND LEASE COMMITMENTS: Long-Term Debt-- Long-term debt and debt serviced by other parties consist of the following:
<TABLE> <CAPTION> Weighted Average Final Debt Serviced by Long-Term Interest Rate Maturities Other Parties Debt ---------------- ---------- ---------------- --------- (in thousands) December 31 1997 1996 1997 1996 -------- --------- --------- -------- <S> <C> <C> <C> <C> <C> <C> Bank credit facility, interest payable periodically, principal variable, due at maturity 6.7% 1999 $ --- $ --- $ 20,000 $ --- Bank revolving credit facility, repaid in 1997 --- ---- --- --- --- 28,000 Bank credit facility, principal and interest payable variable, quarterly 6.0 2009 --- --- 14,085 14,831 Senior secured notes, principal and interest payable semiannually 8.4 2005 --- 17,567 9,383 24,397 First mortgage notes, repaid in 1997 --- ---- --- --- --- 22,106 Notes and other obligations, principal and interest payable periodically 7.1 1997-2019 4,333 4,443 8,461 30,679 First mortgage revenue bonds, principal payable periodically, variable, interest payable monthly 5.0 2000-2010 13,323 14,086 --- --- Unsecured term note payable to National, interest payable quarterly, principal payable at maturity 8.5 2008 --- --- 10,000 10,000 17,656 36,096 61,929 130,013 Less current portion (980) (3,239) (1,702) (5,335) $16,676 $ 32,857 $ 60,227 $124,678 </TABLE> The $14,085,000 bank credit facility and the $9,383,000 senior secured notes were borrowed through National. NHC granted certain credits and interest rate concessions related to its management fees from National in obtaining these loans. The debt identified above as senior secured notes is cross-defaulted with other NHC, NHR and NHI liabilities and is cross-collateralized to the extent of approximately $9,383,000 of other debt. To obtain the consent of various lenders to the transfer of assets, NHI guaranteed certain NHC debt which was not transferred to NHI. A default by NHI under its obligations would default the debt or guarantees of NHC. The aggregate maturities of long-term debt and debt serviced by others for the five years subsequent to December 31, 1997 are as follows: Long-Term Debt Serviced Debt By Others Total 1998 $ 1,702,000 $ 980,000 $ 2,682,000 1999 22,157,000 716,000 22,873,000 2000 2,147,000 999,000 3,146,000 2001 2,231,000 894,000 3,125,000 2002 2,322,000 923,000 3,245,000
Certain property and equipment of NHC and NHI are pledged as collateral on long-term debt or capital lease obligations. Other property and assets are available for use as collateral as needed. Certain loan agreements require maintenance of specified operating ratios as well as specified levels of cash held in escrow, working capital and shareowners' equity by NHC and NHI. All such covenants have been met by NHC, and management believes that NHI is in compliance with the loan covenants. Lease Commitments-- Operating expenses for the years ended December 31, 1997, 1996, and 1995 include expenses for leased premises and equipment under operating leases of $26,396,000, $25,036,000, and $18,820,000, respectively. See Notes 3 and 4 for the approximate future minimum rent commitments on non-cancelable operating leases with NHR and NHI. Construction and Financing Commitments-- NHC is committed to spend approximately $17,105,000 in 1998 for ongoing construction contracts. NHC's cash on hand, marketable securities, short-term notes receivable, operating cash flow and, as needed, its borrowing capacity are expected to be adequate to fund these commitments. NOTE 13 - SUBORDINATED CONVERTIBLE NOTES: 1997 Debentures-- On October 15, 1997 NHC issued $20,000,000 of 5.75% senior convertible subordinated debentures (the "1997 debentures") due June 30, 2004. At December 31, 1997, all of the 1997 debentures were converted into common shares of NHC at a conversion price of $36.00 per share. NHC issued 555,555 shares of common stock for the 1997 debenture conversions. Notes-- At December 31, 1997, $19,152,000 of 6% subordinated convertible notes ("the notes") remain outstanding. The notes mature July 1, 2000. Interest is payable quarterly. The notes are convertible at the option of the holder at any time into shares of NHC at a price of $15.2063 per share, subject to adjustment for certain changes in the number of shares outstanding. After December 31, 1997, the notes are convertible into NHC shares and also into an equal number of NHR shares. The notes may be redeemed at the option of NHC after December 31, 1997. During 1997, $9,756,000 of the notes were converted into 641,564 units. NHC has reserved an additional 1,259,478 shares of stock for conversion of the notes. NOTE 14 - INCOME TAXES: Effective December 31, 1997, NHC recorded a deferred tax benefit related to the establishment of net deferred tax assets and liabilities in connection with its reorganization from a partnership to a corporation. NHC also recorded a current tax provision related to taxable income of corporate subsidiaries and other contingencies. The provision (benefit) for income taxes for the year ended December 31, 1997 is comprised of the following components:
For the Year Ended December 31, 1997 Taxes Payable (in thousands) Federal $ 4,736 State 13 4,749 Deferred Tax Benefit Federal (3,859) State (681) (4,540) Income Tax Provision $ 209 The deferred tax assets and liabilities, at the respective income tax rates, as of December 31, 1997 are as follows: December 31, 1997 Current deferred tax asset: Allowance for doubtful accounts receivable $ 1,766 Accrued liabilities 1,689 3,455 Current deferred tax liability: Unrealized gains on marketable securities (1,755) Other (82) (1,837) Net current deferred tax asset $ 1,618 Noncurrent deferred tax asset: Deferred gain on sale of assets 5,588 Deferred guaranty fees 1,146 Unearned insurance premium income 369 Other 244 7,347 Noncurrent deferred tax liability: Tax depreciation in excess of financial reporting depreciation (4,386) Other (39) (4,425) Net noncurrent deferred tax asset $ 2,922 As NHC was not a taxable entity as of or for the years ended December 31, 1996 and 1995, no provisions or benefits for income taxes or deferred tax assets and liabilities were recorded in those years.
NOTE 15 - CONTINGENCIES AND GUARANTEES: Litigation-- 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, NHC valued the center, offering to either purchase the center at the price so valued or FCC could elect to pay NHC certain deferred compensation based upon that value. 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 the court to 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; however, FCC has agreed that NHC will remain as manager 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 dates are in dispute. Since the original suit was filed, FCC has amended its complaint five times, the most recent amendment being 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 contingent fees to NHC or, if so, a declaration that such deferred fees constitute usurious interest; that the recorded mortgages securing FCC's debt to NHC do not secure payment of the deferred contingent 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 (most recently) 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 a counterclaim against FCC. On November 5, 1997, the trial court ruled against FCC's Partial Motion for Summary Judgment in which they 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 has responded to this motion with numerous affidavits and the Court has scheduled a hearing on March 23, 1998. The Court has also set a trial date for the Fifth Amended Complaint commencing October 26, 1998.
The loss of management contract revenue on an individual FCC center would not have a material impact on NHC, but the loss of the revenues from all sixteen centers would have a material impact. This impact could be offset, however, by the receipt by NHC of the deferred contingency fee and/or the fact that NHC might purchase some or all of the facilities, thus allowing the revenues to be operating income for NHC; provided such fees or rights are not disallowed by the lawsuit. 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. A case management conference is scheduled for March 13, 1998. The suit alleges that NHC has submitted cost reports and routine cost limit exception requests containing "fraudulent allocation of routine nursing services to ancillary service cost centers" and improper allocation of 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". The individual plaintiff Braeuning has amended the suit to allege he was "retalitorily discharged" from his position due to the filing of the suit. NHC has denied this and believes the facts will vindicate its position. 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. In regard to the substantive allegations contained in the lawsuit, NHC believes that the cost report information of its centers has been either appropriately filed or, upon appropriate 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.
NHC would be responsible for any settlement related to its owned or leased facilities and to the extent that managed centers have settlements, NHC's 6% management fee would be adversely impacted. NHC will continue its's revenue policy which is not to reflect 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. 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. 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 offset any loss of governmental revenues as a result of the enactment of the BBA. Professional Liability and Other Insurance-- NHC carries a professional liability insurance policy for coverage from liability claims and losses incurred in its health care business. The policy is a fixed premium and occurrence form policy and has no provisions for a retrospective refund or assessment due to actual loss experience. In the opinion of management, NHC's insurance coverage is adequate to cover settlement of outstanding claims against NHC. NHC has assumed certain risks related to health insurance and workers compensation insurance claims of the employees of National and the managed facilities. The liability for reported claims and estimates for incurred but unreported claims of the managed facilities is $7,585,000 and $5,078,000 at December 31, 1997 and December 31, 1996, respectively. The liability is included in other current liabilities in the Consolidated Balance Sheets. NHC remits for the claims with regards to National's employees utilized by NHC on a monthly basis. The amounts are subject to adjustment for actual claims incurred.
Guarantees and Related Events-- In order to obtain management agreements and to facilitate construction or acquisition of certain health care centers which NHC manages for others, NHC has guaranteed some or all of the centers' first mortgage bond debt (principal and interest). 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 amount outstanding under the guarantees is approximately $68,499,000 (net of available debt service reserves) at variable and fixed interest rates with a weighted average rate of 5.0% at December 31, 1997. In management's opinion, these guarantee fees approximate fees that NHC would currently charge to enter into similar guarantees. All of the guaranteed indebtedness is secured by first mortgages, pledges of personal property, accounts receivable and, in certain instances, by the personal guarantees of the owners of the facilities. The borrower has granted second mortgages over the relevant properties in favor of NHC. Such rights may be enforced if NHC is required to pay under its guarantees. NHI has guaranteed certain of the debts of NHC. NHC has agreed to indemnify and hold harmless NHI against any and all loss, liability or harm incurred by NHI as a result of having to perform under its guarantee of any or all of the guaranteed debt. NOTE 16 - NOTES RECEIVABLE: Notes receivable generally consist of loans and accrued interest to managed health care centers and retirement centers for construction costs, development costs incurred during construction and working capital during initial operating periods. The notes generally require monthly payments with maturities beginning in 1998 through 2003. Interest on the notes is generally at prime plus 2%. The collateral for the notes consists of first and second mortgages, certificates of need and personal guarantees and stock pledges. NOTE 17 - SHAREOWNERS' EQUITY: NHC has Incentive Option Plans which provide for the granting of options to key employees and directors to purchase shares of common stock at no less than market value on the date of grant. The options may be exercised immediately, but NHC may purchase the shares of stock at the grant price if employment is terminated prior to six years from the date of grant. The maximum term of the options is five years. The following table summarizes option activity:
Number of Weighted Average Shares Exercise Price Options outstanding December 31, 1994 490,500 $25.00 Options granted 376,000 30.76 Options exercised 489,000 25.14 Options outstanding December 31, 1995 377,500 30.56 Options granted 15,000 38.63 Options exercised 2,500 11.25 Options outstanding December 31, 1996 390,000 30.99 Options granted 20,000 46.25 Options exercised 376,000 31.13 Options expired 9,000 21.67 Options outstanding December 31, 1997 25,000 $40.05 At December 31, 1997, all options outstanding are exercisable. Exercise prices on the exercisable options range from $24.88 to $46.25. The weighted average remaining contractual life of options outstanding at December 31, 1997 is 3.3 years. Additionally, NHC has an employee stock purchase plan which allows employees to purchase shares of stock of NHC through payroll deductions. The plan allows employees to terminate participation at any time. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation" ("SFAS 123"). SFAS 123 established new financial accounting and reporting standards for stock-based compensation plans. NHC has adopted the disclosure-only provisions of SFAS 123. As a result, no compensation cost has been recognized in the Consolidated Statements of Income for NHC's stock-based compensation plans. Management believes that any compensation cost attributable to stock-based compensation plans is immaterial. In connection with the exercise of certain stock options, NHC has received interest-bearing (ranging from 5.0% to 6.25%), full recourse notes in the amount of $16,875,000 at December 31, 1997. The notes are secured by shares of NHC or shares of NHI having a fair market value of not less than 150% of the amount of the note. The principal balances of the notes are reflected as a reduction of shareowners' equity in the consolidated financial statements. NOTE 18 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS: The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to estimate that value: Cash and cash equivalents; Cash held by trustees; Accounts receivable; Bond reserve funds, mortgage replacement reserves and other deposits; Accounts payable and Accrued liabilities--
The fair value approximates the carrying amount because of the short maturity or the nature of these instruments. Marketable securities-- The fair value is estimated based on quoted market prices and is the same as the carrying amount. Notes receivable-- The fair value of NHC's notes receivable is estimated based on the current rates offered by NHC or comparable parties for the same or similar types of notes receivable of the same or similar maturities and is approximately the same as the carrying amount. Long-term debt and debt serviced by other parties-- The fair value is estimated based on the current rates offered to NHC for similar debt of the same maturities and is approximately the same as the carrying amounts. Subordinated convertible notes-- The fair values are estimated based on quoted market prices and approximate $70,531,000 and $82,995,000 at December 31, 1997 and December 31, 1996, respectively, as compared to carrying values of $19,152,000 and $28,908,000 at December 31, 1997 and December 31, 1996, respectively.
EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our reports on National HealthCare Corporation (formerly National HealthCare L.P.) dated February 12, 1998, included in this Form 10-K for the year ended December 31, 1997, into the Company's previously filed post-effective Amendment No. 1 to Form S-4 on Form S-8 Registration Statement No. 33-9881. It should be noted that we have not audited any financial statements of the Company subsequent to December 31, 1997 or performed any audit procedures subsequent to the date of our report. ARTHUR ANDERSEN LLP Nashville, Tennessee March 25, 1998