FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report Under Section 13 of 15(d)
of the Securities Exchange Act of 1934
For quarter ended September 30, 1999 Commission file number 333-37173
NATIONAL HEALTH REALTY, INC.
(Exact name of registrant as specified in its Charter)
Maryland 52-2059888
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
100 Vine Street
Murfreesboro, TN 37130
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code (615) 890-2020
Indicate by check mark whether the registrant
(1) Has filed all reports required to be filed by Section 13 or 15(d), of
the Securities Exchange Act of 1934 during the preceding 12 months.
Yes x No
(2) Has been subject to such filing requirements for the past 90 days.
Yes x No
9,588,823 shares of common stock were outstanding as of October 31, 1999.
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
<TABLE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
<CAPTION>
September 30 Dec. 31
1999 1998
<S> <C> <C>
ASSETS (unaudited)
Real estate properties:
Land $ 19,531 $ 19,531
Buildings and improvements 144,866 144,769
Construction in progress 1,092 1,189
165,489 165,489
Less accumulated depreciation (11,870) (6,579)
Real estate properties, net 153,619 158,910
Mortgage and other notes receivable 95,219 93,099
Interest and rent receivable 837 367
Cash and cash equivalents 3,632 2,897
Deferred costs and other assets 456 171
Total Assets $253,763 $255,444
LIABILITIES
Long-term debt $104,764 $103,628
Minority interest in consolidated subsidiaries 16,350 20,351
Accounts payable and other accrued expenses 420 110
Accrued interest 98 325
Dividends payable 3,188 3,141
Distributions payable to partners 404 436
Deferred income 67 ---
Total Liabilities 125,291 127,991
Commitments, contingencies and guarantees
STOCKHOLDERS' EQUITY
Cumulative convertible preferred stock,
$.01 par value; 5,000,000 shares
authorized; none issued and
outstanding --- ---
Common stock, $.01 par value:
75,000,000 shares authorized;
9,588,823 and 9,477,693 shares,
respectively, issued and outstanding 96 94
Capital in excess of par value of common stock 135,270 131,604
Cumulative net income 15,182 8,267
Cumulative dividends (22,076) (12,512)
Total Stockholders' Equity 128,472 127,453
Total Liabilities and Stockholders' Equity $253,763 $255,444
The accompanying notes to interim condensed consolidated financial statements
are an integral part of these financial statements.
The interim condensed balance sheet at December 31, 1998 is derived from the
audited financial statements at that date.
2
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
</TABLE>
<TABLE>
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
(in thousands, except share amounts)
<S> <C> <C> <C> <C>
REVENUES:
Rental income $ 3,871 $ 3,486 $ 11,614 $ 9,695
Mortgage interest income 2,526 2,462 7,240 7,326
Investment interest and other income --- 79 156 203
6,397 6,027 19,010 17,224
EXPENSES:
Interest 1,753 1,772 5,128 4,980
Depreciation of real estate 1,763 1,682 5,291 4,819
Amortization of loan costs 10 10 30 30
General and administrative 314 138 769 418
3,840 3,602 11,218 10,247
INCOME BEFORE MINORITY INTEREST IN
CONSOLIDATED SUBSIDIARIES 2,557 2,425 7,792 6,977
MINORITY INTEREST IN CONSOLIDATED
SUBSIDIARIES 288 295 877 858
NET INCOME $ 2,269 $ 2,130 $ 6,915 $ 6,119
NET INCOME PER COMMON SHARE:
Basic $ .24 $ .23 $ .72 $ .67
Diluted $ .24 $ .22 $ .72 $ .64
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 9,588,823 9,439,115 9,567,827 9,183,239
Diluted 9,604,086 9,514,647 9,588,115 9,518,510
Common dividends per share
declared $ .3325 $ .3325 $ .9975 $ .9975
</TABLE>
The accompanying notes to interim condensed consolidated
financial statements are an integral part of these financial statements.
3
<PAGE>
<TABLE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<CAPTION>
Nine Months Ended
September 30,
1999 1998
(in thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,915 $ 6,119
Depreciation of real estate 5,291 4,819
Amortization of loan costs 30 30
Deferred income 67 ---
Minority interests in consolidated subsidiaries 877 858
Increase in interest & rent receivable (470) (344)
Increase in other assets (315) (4)
Increase in accounts payable and
accrued liabilities 83 298
NET CASH PROVIDED BY OPERATING ACTIVITIES 12,478 11,776
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to and acquisitions of property &
equipment-net --- (9,246)
(Increase) decrease in mortgage notes receivable - net (2,120) 748
NET CASH USED IN INVESTING ACTIVITIES (2,120) (8,498)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt 2,000 8,253
Payments on debt (864) (867)
Dividends paid to stockholders (9,517) (6,230)
Distribution paid to partners (1,242) (872)
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (9,623) 284
INCREASE IN CASH AND CASH EQUIVALENTS 735 3,562
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,897 3,229
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,632 $ 6,791
Supplemental Information:
Cash payments for interest expense $ 5,355 $ 4,741
During the nine months ended
September 30, 1999 and September 30, 1998,
$710,000 and $18,438,000, respectively,
of Senior Subordinated Convertible
Notes were converted into 46,690 shares and
1,210,270 shares of NHC common stock. NHR is
obligated to issue NHR common stock upon the
conversion of the Notes:
Common stock $ (1) $ 12
Capital in excess of par $(2,379) $ (12)
Minority interest in consolidated subsidiaries $ 2,380 $ ---
During the nine months ended September 30, 1999,
94,440 units of NHR/OP, L.P. units were
exchanged for 94,440 shares of NHR common
stock
Common stock $ (1) $ ---
Capital in excess of par $(1,287) $ ---
Minority interest in consolidated subsidiaries $ 1,288 $ ---
</TABLE>
The accompanying notes to interim condensed consolidated financial statements
are an integral part of these financial statements.
4
<PAGE>
<TABLE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
INTERIM CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(dollars in thousands)
<CAPTION>
Cumulative Convertible Capital in Total
Preferred Stock Common Stock Excess of Cumulative Cumulative Stockholders'
Shares Amount Shares Amount Par Value Net Income Dividends Equity
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT 12/31/98 -- $ -- 9,447,693 $ 94 $131,604 $ 8,267 $ (12,512) $127,453
Net income -- -- -- -- -- 6,915 -- 6,915
Shares issued in con-
version of con-
vertible debentures
to common stock -- -- 46,690 1 2,379 -- -- 2,380
Shares issued in exchange
for NHR/OP, L.P. Units -- -- 94,440 1 1,287 -- -- 1,288
Dividends to common
shareholders ($.9975
per share) -- -- -- -- -- -- (9,564) (9,564)
BALANCE AT 9/30/99 -- $ -- 9,588,823 $ 96 $135,270 $ 15,182 $ (22,076) $128,472
BALANCE AT 12/31/97 -- $ -- 8,237,423 $ 82 $131,616 $ -- $ -- $131,698
Net income -- -- -- -- -- 6,119 -- 6,119
Shares issued in con-
version of con-
vertible debentures
to common stock -- -- 1,210,270 12 (17) -- -- (5)
Dividends to common
shareholders ($.9975
per share) -- -- -- -- -- -- (9,371) (9,371)
BALANCE AT 9/30/98 -- $ -- 9,447,693 $ 94 $131,599 $ 6,119 $ (9,371) $128,441
</TABLE>
The accompanying notes to interim condensed consolidated financial statements
are an integral part of these financial statements.
5
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES:
The unaudited financial statements furnished herein in the opinion of
management include all adjustments which are necessary to fairly present the
financial position, results of operations and cash flows of National Health
Realty, Inc. ("NHR" or the "Company") and its majority owned subsidiaries.
NHR assumes that users of the interim financial statements herein have read or
have access to the audited financial statements and Management's Discussion
and Analysis of Financial Condition and Results of Operations for the
preceding fiscal year ended December 31, 1998, and that the adequacy of
additional disclosure needed for a fair presentation, except in regard to
material contingencies, may be determined in that context. Accordingly,
footnotes and other disclosures which would substantially duplicate the
disclosure contained in the Company's most recent annual report to
stockholders have been omitted. The interim financial information contained
herein is not necessarily indicative of the results that may be expected for a
full year because of various reasons including changes in interest rates,
rents and the timing of debt and equity financings.
NOTE 2. EARNINGS PER SHARE:
Basic earnings per share is based on the weighted average number of
common shares outstanding during the year.
Diluted earnings per share assumes the conversion of convertible
subordinated debentures and the exercise of stock options using the treasury
stock method.
The following table summarizes the earnings and the average number of
common shares and common equivalent shares used in the calculation of basic
and diluted earnings per share.
6
<PAGE>
<TABLE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
<S> <C> <C> <C> <C>
BASIC:
Weighted average
common shares 9,588,823 9,439,115 9,567,827 9,183,239
Net income avail-
able to common
shareholders $ 2,269,000 $ 2,130,000 $6,915,000 $6,119,000
Net income per
common share $ .24 $ .23 $ .72 $ .67
DILUTED:
Weighted average
common shares 9,588,823 9,439,115 9,567,827 9,183,239
Stock options 15,000 20,000 15,000 20,000
Shares issuable
upon conversion
of NHC subordi-
nated convertible
notes 263 55,532 5,288 315,271
Average common
shares out-
standing 9,604,086 9,514,647 9,588,115 9,518,510
Net income avail-
able to common
shareholders $ 2,269,000 $ 2,130,000 $6,915,000 $6,119,000
Net income per
common share $ .24 $ .22 $ .72 $ .64
</TABLE>
NOTE 3. COMMITMENTS, CONTINGENCIES AND GUARANTEES:
As of September 30, 1999, NHR is obligated to issue at the election of
the option and note holders 15,000 shares of its common stock related to stock
options originally issued by National HealthCare Corporation ("NHC") and 263
shares of its common stock related to the conversion of certain 6%
subordinated convertible notes (the Notes) issued by NHC. The Notes are the
obligation of NHC and mature July 1, 2000. The stock options are exercisable
and the Notes are convertible at the election of the holders into an equal
number of shares of the common stock of NHC and NHR. Thus, NHR is obligated
to issue NHR common stock upon the exercise of the stock options and
conversion of the Notes. NHR will receive no proceeds from the exercise of
the stock options and the conversion of the Notes. NHR has reserved an
additional 15,263 shares of common stock for the exercise of the stock options
and the conversion of the Notes.
7
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)
NOTE 4. MORTGAGE PREPAYMENT CONTINGENCY:
On October 30, 1998, NHC, NHR's investment advisor and primary lessee,
announced terms of its settlement of litigation with Florida Convalescent
Centers, Inc. of Sarasota, Florida (FCC).
FCC is NHR's primary mortgagee. Under the terms of NHC's settlement
with FCC, NHR may receive prepayment of up to approximately $62 million in
notes receivable. NHR will make every effort to reinvest any amounts prepaid.
However, if NHR were to use the cash received to pay down existing debt, it
would result in a reduction of cash flow which could cause the cash dividend
paid by NHR to remain flat for the near future. Under the terms of the
settlement, prepayment may be made at any time and is currently expected to
occur within the next year.
NOTE 5. FORECLOSURE ON MORTGAGE RECEIVABLE:
As of September 30, 1999, NHR holds mortgage notes receivable of
$10,410,000 from American Healthcare Corporation. Collateral for the loans
includes first and second mortgages on four long-term healthcare centers
located in the state of Indiana and the furniture, fixtures and accounts
receivable of the centers.
NHR has not received its monthly principal and interest payments on
these loans since June, 1999. On September 22, 1999, NHR filed a Motion for
Partial Summary Judgment to allow it to foreclose on the first and second
mortgages. NHR is currently evaluating the value of its collateral. While
the Company has not obtained an independent, third-party appraisal, NHR
believes that the collateral will be sufficient to recover its loan balance
and accrued interest.
NHR's policy is to continue to accrue interest on foreclosed or non-
performing loans up to a maximum total carrying value equal to the fair value
of the respective collateral.
Item 2. Management's Discussion and Analysis of Financial Conditions and
Results of Operations
Overview
National Health Realty, Inc. (NHR) is a real estate investment trust
that began operations on January 1, 1998. NHR, through its subsidiary
NHR/OP, L.P. (the Operating Partnership) acquired ownership of 23 health care
facilities including 16 licensed skilled nursing facilities, six assisted
living facilities and one independent living center (the Healthcare
Facilities), plus 51 first and second mortgage secured promissory notes with
an initial principal balance of $94.4 million (the Notes) from its then sole
owner National HealthCare L.P. NHR then leased (the Leases) the Healthcare
Facilities to National HealthCare Corporation (NHC), a successor by merger to
National HealthCare L.P. NHR also assumed certain debt, initially in the
amount of $86.4 million. The Leases covering the Healthcare Facilities are
"triple net" leases.
8
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
Competitive Restrictions
NHR entered into an advisory services agreement with NHC pursuant to
which NHC will provide NHR with investment advice, office space and personnel.
This agreement also provides that prior to the earlier to occur of (i) the
termination of the advisory agreement for any reason and (ii) NHC ceasing to
be actively engaged as the investment advisor for National Health Investors,
Inc. (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 by National HealthCare L.P.
Capital Resources and Liquidity
The assets of NHR as of September 30, 1999 include mortgage and other
notes receivable (book value of $95,219,000) and the real estate of 23
properties, including 16 long-term care centers, six assisted living
facilities and one independent living center (total book value of
$153,619,000). Long-term debt of $104,764,000 includes a term loan with a
principal amount of $92,500,000 which matures in 2002.
Approximately $61,672,000 of the mortgage and other notes receivable is
due from Florida Convalescent Centers, Inc. (FCC) of Sarasota, Florida. FCC
owns 14 licensed nursing centers that were managed by NHC until July 31, 1999.
NHR is the primary lender to FCC. On October 30, 1998, NHC announced terms of
its settlement of litigation with FCC. Under the terms of NHC's settlement
with FCC, NHR may receive prepayments without penalty of up to $61,672,000
from FCC. NHR will attempt to reinvest any amounts prepaid, but as noted
above, there are restrictions on NHR's ability to do so. Although NHR's
existing line of credit requires a portion of the prepayments to be used to
reduce bank debt, NHR may seek to obtain a waiver of this requirement. In the
event that NHR uses the money to pay down existing debt, it will result in a
reduction of cash flow. This could result in dividends per share remaining
constant. However, no dividend reductions are expected in the near future.
Under the terms of the settlement, prepayments may be made at any time and are
expected to occur within the next year.
FCC terminated its management contract with NHC effective July 31, 1999.
The FCC properties are currently leased by FCC to Integrated Health Systems,
Inc.
As of September 30, 1999, NHR holds mortgage notes receivable of
$10,410,000 from American Healthcare Corporation. Collateral for the loans
includes first and second mortgages on four long-term healthcare centers
located in the state of Indiana and the furniture, fixtures and accounts
receivable of the centers.
9
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
NHR has not received its monthly principal and interest payments on
these loans since June, 1999. On September 22, 1999, NHR filed a Motion for
Partial Summary Judgment to allow it to foreclose on the first and second
mortgages. NHR is currently evaluating the value of its collateral. While
the Company has not obtained an independent, third-party appraisal, NHR
believes that the collateral will be sufficient to recover its loan balance
and accrued interest.
NHR is leasing each of the 23 owned facilities to NHC. 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. NHR accounts for
its leases as operating leases.
During the initial term and each renewal term, NHC is obligated to pay
NHR annual base rent (commencing for each center when construction is
complete) of $15,449,000 on the 23 facilities. In addition to base rent, in
each year after 1999, NHC must pay percentage rent to NHR equal to 3% of the
amount by which gross revenues of each facility in such later year exceed the
gross revenues of such facility in 1999. Each lease 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 operation of the
facilities.
NHR has entered into an advisory services agreement with NHC whereby the
services related to investment activities and day-to-day management and
operations are provided to NHR by NHC. Because of the competitive
restrictions contained in the advisory services agreement, NHR does not intend
to seek further health care-related investment opportunities or to provide
lease or mortgage financing for such investments with operations other than
NHC but expects to continue to engage in the existing transactions with NHC
and potentially new investments.
Sources and Uses of Funds
NHR's leasing and mortgage services generated net cash from operating
activities during the nine months ended September 30, 1999 in the amount of
$12,478,000 compared to $11,776,000 in the prior period. Net cash from
operating activities generally includes net income plus non-cash expenses,
such as depreciation and amortization and provision for loan losses, if any,
and working capital changes. The year to year increase is due primarily to
increased net income and depreciation offset by increases in interest and rent
receivable and other assets.
Cash flows used in investing activities during the first nine months of
1999 included the net investment of $2,120,000 in new mortgage notes
receivable compared to collections on mortgage notes receivable of $748,000 in
the prior period. Also in the prior period, $9,246,000 was invested in
additions to and acquisitions of property and equipment.
Cash flows from financing activities for the first nine months of 1999
included $2,000,000 of borrowings against the credit facility compared to
borrowings of $8,253,000 in the prior period. Also, cash flows used in
financing activities included $864,000 to fund payments on debt ($867,000 last
year), $9,517,000 to pay dividends to stockholders ($6,230,000 last year), and
$1,242,000 to pay cash distributions to partners ($872,000 last year).
10
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
Commitments
NHR intends to pay quarterly distributions to its stockholders in an
amount at least sufficient to satisfy the distribution requirements of a real
estate investment trust. Such requirements necessitate that at least 95% of
NHR's taxable income be distributed annually. The primary source for
distributions will be rental and interest income NHR earns on the real
property and mortgage notes receivable transferred to it by NHC. It is
estimated that cash distributions in the amount of $1.33 per share will be
declared for payment for 1999.
Results of Operations
Three Months Ended September 30, 1999 Compared to Three Months Ended September
30, 1998
Net income for the three months ended September 30, 1999 is $2,269,000
versus $2,130,000 for the same period in 1998, an increase of 6.5%. Diluted
earnings per common share increased 2 cents or 9.1% to 24 cents in the 1999
period from 22 cents in the 1998 period.
Total revenues for the three months ended September 30, 1999 increased
$370,000 or 6.1% to $6,397,000 from $6,027,000 for the three months ended
September 30, 1998. Revenues from rental income increased $385,000 or 11.0%
when compared to the same period in 1998. Revenues from mortgage interest
increased $64,000 or 2.6% in 1999 as compared to the same period in 1998.
The increase in rental income is due to additions to and acquisitions of
property and equipment of $11,628,000 during the last twelve months.
The increase in mortgage interest income resulted from the funding of
additional mortgage notes receivable.
Total expenses for the 1999 three month period increased $238,000 or
$6.6% to $3,840,000 from $3,602,000 for the 1998 three month period. Interest
expense decreased $19,000 or 1.1% in the 1999 three month period as compared
to the 1998 period. Depreciation of real estate increased $81,000 or 4.8%.
General and administrative costs increased $176,000 or 127.5%.
Interest expense decreased due to a reduction in the interest rate of
variable debt compared to a year ago. The interest expense decrease was
offset in part by additional interest expense from additional amounts
borrowed. Depreciation increased as a result of the Company placing newly
constructed assets in service and property acquisitions. General and
administrative expense increased due to additional franchise tax expenses.
11
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Net income for the nine months ended September 30, 1999 is $6,915,000
versus $6,119,000 for the same period in 1998, an increase of 13.0%. Diluted
earnings per common share increased 8 cents or 12.5% to 72 cents in the 1999
period from 64 cents in the 1998 period.
Total revenues for the nine months ended September 30, 1999 increased
$1,786,000 or 10.4% to $19,010,000 from $17,224,000 for the nine months ended
September 30, 1998. Revenues from rental income increased $1,919,000 or 19.8%
when compared to the same period in 1998. Revenues from mortgage interest
decreased $86,000 or 1.2% in 1999 as compared to the same period in 1998.
The increase in rental income is due to additions to and acquisitions of
property and equipment of $11,628,000 during the last twelve months.
The decrease in mortgage interest income resulted primarily from
decreased mortgage notes receivable due to the receipt of monthly payments.
Total expenses for the 1999 nine month period increased $971,000 or 9.5%
to $11,218,000 from $10,247,000 for the 1998 nine month period. Interest
expense increased $148,000 or 3.0% in the 1999 nine month period as compared
to the 1998 period. Depreciation of real estate increased $472,000 or 9.8%.
General and administrative costs increased $351,000 or 84.0%.
Interest expense increased due to increased debt of $7,523,000 compared
to a year ago. Interest expense increases were offset in part by a reduction
in the interest rate of variable debt as compared to a year ago. Depreciation
increased as a result of the Company placing newly constructed assets in
service and property acquisitions. General and administrative expenses
increased due to increased franchise taxes.
The rental income revenues are believed by management to be secure.
However, all of the rental income is from NHC, NHR's sole lessee.
Approximately 60% of NHC's revenues are from participation in the Medicare and
Medicaid programs. During 1997, the federal government enacted the Balanced
Budget Act of 1997 (BBA) which contains numerous Medicare and Medicaid cost-
saving measures. As part of these cost saving measures, the BBA requires that
nursing homes transition to a prospective payment system over a three year
transition period. The BBA also contains certain measures which have or will
lead to reductions in Medicare payments for home health agency services and
therapy services. Furthermore, NHC has stated in its financial statements
that it is a defendant in a lawsuit filed under the Qui Tam provisions of the
Federal False Claims Act. NHR and NHC are unable to predict the ultimate
effect the enactment of the BBA or the pending lawsuit will have on NHC's
ability to make its lease payments to NHR.
12
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
Excluding the possibility of mortgage prepayments as previously
discussed, mortgage interest income revenues are also believed by management
to be secure. However, the mortgages are with five different owners (one of
which is subject to foreclosure proceedings) and are secured with the property
of 23 long-term health care centers located in two states, all of which are
currently managed by NHC or, in the case of the FCC centers, leased by
Integrated Health Services, Inc. The revenues of the 23 health care centers
are subject to the cost-saving measures of the BBA. Furthermore, the
healthcare centers may be subject to additional liabilities related to NHC's
lawsuit filed under the Federal False Claims Act. NHR and NHC are unable to
predict the ultimate effect the enactment of the BBA or the pending lawsuit
will have on the ability of the 23 health care centers to make their debt
service payments to NHR.
Impact of Inflation--
Inflation may affect NHR in the future by changing the underlying value
of NHR's real estate or by impacting NHR's cost of financing its operations.
Revenues of NHR are primarily from long-term investments. NHR's leases
with NHC require increases in rent income based on increases, if any, in the
revenues of the leased facilities.
Year 2000 Compliance
The Year 2000 issue generally relates to computer programs that were
written using two digits rather than four to define the applicable year. In
those programs, the year 2000 may be incorrectly identified as the year 1900,
which can result in a system failure or miscalculations causing a disruption
of operations, including a temporary inability to process transactions,
prepare financial statements or engage in other normal business activities.
The following discussion identifies the actions taken by NHR to assess and
address its Year 2000 issues.
State of Readiness--
NHR has developed a plan to address its Year 2000 issues, and is
utilizing its internal resources to assess, remediate and test its systems.
As a result of its advisory agreement with NHC, NHR is completely reliant upon
NHC for its information technology systems and embedded technology. NHC is
also NHR's sole lessee. NHC is currently performing an evaluation of its
information technology and embedded technology that are utilized in the
operations of NHR. The Year 2000 readiness plan developed by NHC and NHR
includes an inventory and review of
all core application systems, networks, desktop systems, infrastructure and
critical supply chains. NHR's Year 2000 readiness plan is focused on
addressing Year 2000 readiness in the following four categories: (1) mainframe
computer operations, critical applications and related networks, (2) personal
computer hardware and software, (3) third party mortgagees and lessees, and
(4) other third party vendors that provide such services as telecommunications
and electrical power.
13
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
For each of the above categories, NHR, through its advisor (NHC), will
perform or has performed the phases of assessment, remediation and testing of
the applicable hardware, software or equipment, as applicable. The assessment
phase has been completed for category 1. The remediation phase is underway
and modifications of non-compliant application programs have begun. NHR has
historically developed the majority of its application programs internally.
All internally developed systems have been assessed and inventoried and plans
have been made to modify or replace them, if necessary, in order to make them
Year 2000 compliant. Purchased applications are either being modified,
replaced or upgraded. Most critical applications, whether internally
developed or purchased externally, have been tested and are already Year 2000
compliant. All server hardware, dumb terminals and printers have also been
assessed, repaired as necessary and tested and are now Year 2000 compliant.
It is expected that the remediation and testing phases related to category 1
will be completed by December 31, 1999.
NHR is currently in the assessment phase for categories 2, 3 and 4. For
personal computer software vendors, NHR is aware of the packages that will not
be Year 2000 compliant and is currently in the process of assessing the types
of packages utilized by each personal computer. This assessment was completed
by October 1, 1999 with remediation and testing to be completed by December
31, 1999. NHR has also requested all mortgagees, lessees and other third
party vendors (financial institutions, electrical providers, etc.) to disclose
their current Year 2000 readiness and their plan for achieving Year 2000
readiness. Responses have been received from most vendors and third parties.
For those vendors and third parties that have not yet responded, NHR is in the
process of sending out additional requests. Although most third party vendors
have indicated that they are currently Year 2000 compliant or expect to be
compliant prior to January 1, 2000, there can be no assurance that such third
parties will achieve Year 2000 compliance by January 1, 2000.
NHR's sole lessee, NHC, is currently in the process of evaluating its
Year 2000 issues. NHC has formed an internal task force and is utilizing its
internal resources to assess, remediate and test its Year 2000 compliance.
NHC's Year 2000 readiness plan is focused on addressing Year 2000 readiness in
the following five categories: (1) mainframe computer operations, critical
applications and related networks, (2) personal computer hardware and
software, (3) other internal equipment such as infusion pumps, phone systems,
monitoring devices and smoke/fire alarms which rely on embedded technology
(microchips) or telecommunications, (4) third party payors, and (5) other
third party vendors utilized by NHC's healthcare centers such as financial
institutions, electrical providers, and food services suppliers. NHC has
completed the assessment phase related to its mainframe computer operations
and related networks. Although the majority of NHC's information technology
applications are already Year 2000 compliant, NHC is currently modifying or
replacing applications and hardware as necessary. NHC is expected to
complete the remediation and testing of any non-compliant applications and
hardware by December 31, 1999. NHC is currently in the assessment phase of
its plan for personal computer applications and hardware, internal equipment
utilizing embedded technology, third party payors and other third party
vendors. NHC has completed the assessment phase for its personal computer
applications and hardware and for its internal equipment and will complete
remediation and testing by December 31, 1999. It is expected that the
assessments of third party payors and third party vendors will be an ongoing
process that will continue through December 31, 1999.
14
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
NHR's mortgagees and NHC participate in the Medicare and Medicaid
programs. NHC and the mortgagees are reimbursed under these programs through
fiscal intermediaries. The Health Care Financing Administration ("HCFA"), the
government agency that administers the Medicare program, had previously
publicly stated that it would be Year 2000 compliant by December 31, 1998.
HCFA announced that it required all fiscal intermediaries to be Year 2000
compliant by December 31, 1998 and that it expected state Medicaid agencies to
be Year 2000 compliant by March 31, 1999. While HCFA has made no public
announcement as to whether the fiscal intermediaries and state Medicaid
agencies have met this schedule, recent reports by the General Accounting
Office report that the various states may not currently be in compliance.
With respect to itself, HCFA issued a Provider Correspondence Letter dated
January 12, 1999 indicating that they have not met their schedule. This
letter states that HCFA's systems will function on January 1, 2000 and will be
able to process "acceptable" claims.
NHC and the mortgagees have little or no control over the Year 2000
compliance of governmental payors and fiscal intermediaries and it is expected
that this assessment phase will be an ongoing process throughout 1999. NHR
will continue to request and seek information through all sources available
related to the Year 2000 readiness of NHC, the mortgagees, governmental payors
and fiscal intermediaries.
Year 2000 Costs--
As a result of its advisory agreement with NHC, costs related to NHR's
Year 2000 readiness plan have not been material and are not expected to be
material in future periods. No additional advisory fees have been charged to
NHR related to the assessment, remediation or testing of NHR's Year 2000
compliance.
Year 2000 Risks--
The failure of NHR or third parties to be fully Year 2000 compliant for
essential systems and equipment by January 1, 2000 could result in
interruptions of normal business operations. Based on all available
information as of September 30, 1999, management's estimate of NHR's most
reasonably likely worst
case scenario includes: (i) delayed collection of rent mortgage principal
payments and interest payments, (ii) the disruption of capital flows from
banks or other lenders resulting in liquidity stress, and (iii) the disruption
of important services upon which NHR depends, such as telecommunications and
electrical power. Each of these events could have a material adverse impact
on NHR's business, results of operations and financial condition.
Contingency Plans--
Contingency plans for NHR's Year 2000 issues continue to be developed
and include, but are not limited to, the identification of alternate
suppliers, alternate technologies and alternate manual systems and processes.
15
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
NHR's Year 2000 efforts are ongoing and its overall plan and cost
estimations will continue to evolve as new information becomes available. The
costs of NHR's Year 2000 compliance plan and the date on which NHR expects to
complete it are based on current estimates, which reflect numerous assumptions
about future events, including the continued availability of certain
resources, the timing and effectiveness of third party remediation plans and
other factors. NHR can give no assurance that these estimates will be
achieved, and actual results could differ materially from NHR's plans.
Specific factors that might cause such material differences include, but are
not limited to, the availability and cost of personnel trained in this area,
the ability to locate and correct relevant computer source codes and embedded
technology, the results of internal assessment, remediation and testing and
the timeliness and effectiveness of remediation efforts of third parties. In
addition, NHR's analysis of its Year 2000 issues is based in part on
information from third parties. There can be no assurance that such
information is accurate or complete.
Item 3. Quantitative and Qualitative Information About Market Risk
INTEREST RATE RISK
The Company's cash and cash equivalents consist of highly liquid
investments with a maturity of less than three months. All of the Company's
mortgage and other notes receivable bear interest at fixed interest rates. As
a result of the short-term nature of the Company's cash instruments and
because the interest rates on the Company's investments in notes receivable
are fixed, a hypothetical 10% change in interest rates would have no impact on
the Company's future earnings and cash flows related to these instruments. A
hypothetical 10% change in interest rates would also have an immaterial impact
on the fair values of these instruments.
As of September 30, 1999, $95,700,000 of the Company's long-term debt
bears interest at floating interest rates. Because the interest rates of
these instruments are variable, a hypothetical 10% increase in interest rates
would result in additional annual interest expense of approximately $613,000
and likewise, a reduction in interest rates would result in annual interest
expense declining by approximately $613,000. A hypothetical 10% change in
interest rates would not have a material impact on the fair values of these
instruments.
The remaining $9,064,000 of the Company's long-term debt bears interest
at fixed rates. Because the interest rates of these instruments are fixed, a
hypothetical 10% change in interest rates would have no impact on the
Company's future earnings and cash flows related to these instruments. A
hypothetical 10% change in interest rates would not have a material impact on
the fair values of these instruments.
The Company currently does not use any derivative instruments to hedge
its interest rate expense or for trading purposes. The use of such instruments
would be subject to strict approvals by the Company's senior officers.
Therefore, the Company's exposure related to such derivative instruments is
not material to the Company's financial position, results of operations or
cash flows.
16
<PAGE>
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES
September 30, 1999
(Unaudited)
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. None
Item 2. Changes in Securities. Not applicable
Item 3. Defaults Upon Senior Securities. None
Item 4. Submission of Matters to a Vote of Security Holders. None
Item 5. Other Information. None
Item 6. Exhibits and Reports on Form 8-K.
(a) List of exhibits - Exhibit 27 - Financial Data Schedule
(for SEC purposes only)
(b) Reports on Form 8-K - none required
SIGNATURES
Pursuant to the requirements 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 HEALTH REALTY, INC.
(Registrant)
Date November 12, 1999 /s/ Richard F. LaRoche, Jr.
Richard F. LaRoche, Jr.
Secretary
Date November 12, 1999 /s/ Donald K. Daniel
Donald K. Daniel
Principal Accounting Officer
17
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<PERIOD-END> SEP-30-1999
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