National HealthCare Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; comparative 2017 figures are adjusted where noted. Unless stated otherwise, financial amounts are in millions of dollars. NHC operates senior-care facilities and homecare programs, primarily in the southeastern U.S.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net operating revenue | $246.3 | $241.2 | $731.4 | $718.4 |
| Income from operations | $10.8 | $9.8 | $38.9 | $37.8 |
| Net income attributable to NHC | $21.1 | $11.4 | $40.8 | $34.7 |
| Diluted EPS | $1.39 | $0.75 | $2.68 | $2.28 |
| Operating margin | 4.4% | 4.1% | 5.3% | 5.3% |
- Q3 revenue rose 2.1% year over year; operating income rose 10.7%. NHC-attributable net income increased 86.2%, partly reflecting lower taxes and non-operating gains.
- For the first nine months, revenue increased 1.8% and operating income 2.9%; pretax income declined 6.5%, while NHC-attributable net income increased 17.5%.
- Q3 net patient revenue was $234.8 million, up 2.4%; inpatient revenue increased while homecare revenue declined. Nine-month net patient revenue was $697.2 million, up 2.0%.
- Salary and benefit expense was $149.2 million in Q3 and $434.7 million year to date. It represented 60.6% of revenue in Q3 and 59.4% year to date. Management cited continued wage pressure and recruitment and retention efforts.
- Operating cash flow was $77.1 million for nine months, versus $71.0 million in 2017. Capital spending was $22.7 million, implying operating cash flow less capital spending of approximately $54.4 million.
Balance sheet and liquidity
- At September 30, cash and cash equivalents were $55.6 million; restricted cash was $12.1 million. Marketable equity securities were $139.5 million and restricted marketable debt securities were $168.0 million.
- Total assets were $1.085 billion, total liabilities $363.5 million, and equity $721.2 million. Current assets were $324.5 million versus current liabilities of $151.5 million.
- Long-term debt was $75.0 million, down from $100.0 million at December 31, 2017, following $25.0 million of debt principal payments. The variable-rate credit facility had $75.0 million of borrowing capacity remaining and matures in October 2020. A 1% rate change would affect annual interest expense by about $0.75 million.
- Capital lease obligations totaled $24.0 million on the balance sheet. Future operating lease payments totaled $287.9 million, including $34.2 million due within one year.
- Financing cash outflows included $22.2 million of dividends and $0.9 million of share repurchases. The board authorized a new repurchase program of up to $25 million; no purchases had been made under that new program by quarter-end.
Material changes and unusual items
- NHC acquired a controlling interest in a 14-bed geriatric psychiatric hospital in Missouri in July. The acquisition added $1.1 million of Q3 revenue and generated a $2.1 million remeasurement gain and $3.4 million of goodwill.
- Caris HealthCare, in which NHC holds a 75.1% noncontrolling interest, recorded $8.5 million for settlement of a hospice-related False Claims Act matter, plus related legal costs. NHC’s share negatively affected nine-month non-operating income by $8.364 million. The settlement was finalized and the litigation was concluded as to the released conduct.
- Q3 included a $3.5 million unrealized gain on marketable equity securities; the nine-month gain was $0.4 million. The portfolio is concentrated: NHI stock represented 88.4% of equity-security fair value. Adoption of fair-value accounting for equity securities increases earnings volatility.
- Q3’s 7.5% effective tax rate benefited from $2.2 million of statute-expiration benefits, a $1.4 million tax-return adjustment, and a tax benefit related to the acquisition gain. Management expected an approximately 26% 2018 tax rate excluding nondeductible expenses; the nine-month effective rate was 19.5%.
- Prior-year revenue and other operating expense were retrospectively reduced under the new revenue standard for dual-eligible patient copayments; the change had no effect on reported net income.
Outlook, commentary, and risks
- Management reported skilled-nursing occupancy of 90.1% in Q3 versus 90.4% a year earlier, and 89.7% for the first nine months versus 90.4%. It identified shorter stays and competition from assisted living and home- and community-based services as occupancy challenges.
- Management cited FY2019 Medicaid rate increases expected to add approximately $2.1 million annually in Tennessee and $2.2 million in South Carolina; Missouri increases of about $2.0 million annually were awaiting CMS approval. These are estimates, not company-wide earnings guidance.
- CMS’s FY2019 skilled-nursing rule provided an approximately 2.4% market-basket update. A new Medicare skilled-nursing payment model, PDPM, was scheduled to begin October 1, 2019. NHC also expected a 60-bed Tennessee memory-care facility to open in Q4 2018.
- Accrued risk reserves were $95.8 million. NHC and/or managed centers faced 65 professional-liability claims; management warned claims and unasserted claims could exceed reserves and insurance coverage.
- A separate qui tam suit against wholly owned Nutritional Support Services alleges inaccurate drug-code reporting. The U.S. declined to intervene, and NSS said it would defend the case. Other key risks include government reimbursement and regulatory changes, labor availability and cost, occupancy, competition, and refinancing needs.
- The company expects lease-accounting changes effective in 2019 to materially increase reported assets and liabilities. Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Assess underlying operating performance separately from the acquisition gain, equity-security mark-to-market gains, tax benefits, and Caris settlement effects; the company also provides non-GAAP reconciliations.
- Track skilled-nursing occupancy, payer mix and per-diem rates, homecare trends, wage pressure, and the ramp-up of new facilities.
- Review the $95.8 million risk reserve against the 65 pending claims, insurance limits, and future claim developments; monitor the NSS litigation.
- Evaluate concentration and price exposure in the marketable equity portfolio, especially NHI, along with restricted investment liquidity.
- Confirm implementation and financial impact of Medicaid rate changes, PDPM, and lease accounting, and monitor credit-facility refinancing before its October 2020 maturity.