National HealthCare Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; compared with the corresponding 2017 periods. Dollar amounts are in millions unless otherwise indicated. NHC provides senior care services, operating or managing skilled nursing, assisted and independent living, and homecare businesses, primarily in the southeastern United States.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net operating revenue | $242.1 | $238.7 | $485.1 | $477.2 |
| Income from operations | $12.2 | $12.1 | $28.0 | $28.0 |
| Net income attributable to NHC | $22.5 | $10.7 | $19.7 | $23.4 |
| Diluted earnings per share | $1.47 | $0.70 | $1.29 | $1.54 |
| Operating margin | 5.0% | 5.1% | 5.8% | 5.9% |
| Net cash from operating activities | Not separately presented | Not separately presented | $49.4 | $40.3 |
Q2 revenue rose 1.4% year over year, while operating income was nearly flat. Q2 attributable earnings increased substantially, mainly reflecting a $12.4 million unrealized gain on marketable equity securities. For the first half, attributable earnings declined 15.9%, affected by a $3.1 million unrealized investment loss and NHC’s share of Caris hospice’s legal settlement costs. Management’s non-GAAP measure, which excludes specified items including investment fair-value changes, Caris legal charges, start-up facility results and stock compensation, was $14.2 million for Q2 and $30.2 million for the first half; this company-defined measure is not a substitute for GAAP results.
First-half salaries and benefits were $285.6 million, or 58.9% of revenue, versus $280.7 million and 58.8% a year earlier. Other operating costs were $127.8 million, or 26.3% of revenue, versus $125.3 million and 26.2%. Q2 diluted EPS was $1.47; first-half diluted EPS was $1.29.
Cash, debt and liquidity
- At June 30, cash and cash equivalents were $59.3 million; restricted cash was $9.5 million. Marketable equity securities were $136.0 million, while restricted marketable debt securities were $164.9 million in total, including current and noncurrent balances.
- First-half operating cash flow was $49.4 million. Investing activities used $16.8 million, including $15.5 million for property and equipment. Financing activities used $31.1 million, including $15.0 million of debt repayment and $14.6 million of dividends. Cash, cash equivalents and restricted cash increased $1.5 million to $68.9 million.
- Long-term debt was $85.0 million, down from $100.0 million at year-end 2017. The $150 million credit facility had $75 million outstanding and $75 million available; it matures in October 2020 and bears variable-rate interest. A 1 percentage-point rate change would alter annual interest cost by approximately $0.85 million.
- Capital lease obligations were $24.9 million in present-value terms. Operating lease commitments totaled $296.5 million. Management said available cash, marketable securities, operating cash flow and remaining credit capacity were expected to meet near-term obligations and planned growth.
Material changes and operating trends
- Patient revenue increased 1.6% in Q2 and 1.8% in the first half. Inpatient revenue grew, supported by recently opened facilities, per-diem increases and pharmacy services to third parties; homecare revenue declined.
- Skilled nursing census weakened: Q2 average occupancy was 89.3% versus 90.3% a year earlier; first-half occupancy was 89.5% versus 90.4%. Management cited shorter stays and competition from assisted living and home- and community-based services.
- For the first half, Medicare per diem rates declined 0.2% and managed-care rates declined 2.2%; Medicaid and private-pay rates rose 2.0% and 2.4%, respectively. The composite skilled nursing per diem increased 1.1%.
- Adoption of revenue recognition guidance was retrospective and reduced 2017 reported patient revenue and costs by equal amounts, with no effect on net income. A new financial-instrument standard moved equity-security fair-value changes into earnings, increasing reported earnings volatility. The company held $136.0 million of marketable equity securities, approximately 88% of which was NHI stock.
- Assets were $1,070.7 million and total liabilities $364.0 million at June 30, compared with $1,096.5 million and $393.1 million at December 31, 2017. Shareholders’ equity included a large accumulated other comprehensive income reclassification associated with the accounting-standard adoption; this was not a cash inflow.
Outlook, risks and contingencies
- No specific company earnings or revenue guidance was provided. Management expected an approximately 26% 2018 corporate tax rate excluding nondeductible expenses; the first-half effective rate was 29.4%, affected in part by nondeductible Caris settlement costs.
- CMS’s FY2019 skilled-nursing rule provided an approximate 2.4% market-basket update. CMS planned to implement the Patient-Driven Payment Model beginning October 1, 2019. NHC estimated Tennessee FY2019 Medicaid rate increases would add about $2.1 million annually and Missouri increases about $2.2 million annually, subject to implementation and actual results.
- A 60-unit memory-care addition in Farragut, Tennessee, was under construction and expected to open in Q4 2018. The company also reported development work on a 30-bed skilled-nursing addition in Springfield, Missouri.
- Caris, in which NHC holds a 75.1% noncontrolling interest, finalized an $8.5 million settlement plus interest in a hospice False Claims Act matter; the court’s June 2018 order concluded the litigation as to released conduct. Caris recorded $8.4 million of settlement and related legal expense for the first half, affecting NHC through equity-method earnings.
- A separate qui tam complaint names NHC subsidiary Nutritional Support Services and alleges improper National Drug Code reporting. The U.S. government declined to intervene; the subsidiary said it intended to defend the matter.
- Accrued risk reserves were $94.8 million. NHC and/or managed centers were defendants in 63 professional liability claims. Management warned claims, including unasserted claims, could exceed reserves or insurance coverage and materially affect results and cash flows.
- Other risks include labor availability and wage pressure, government reimbursement and regulation, occupancy and competition, variable interest rates, and concentration in NHI securities. A 10% change in equity prices would change the fair value of the equity portfolio by approximately $13.6 million. The company also anticipated a material balance-sheet impact from the upcoming lease-accounting standard.
Important facts for investors to verify
- How much of reported earnings reflects core operations versus volatile equity-security gains or losses and Caris-related charges.
- Whether occupancy, staffing costs and reimbursement rates improve or continue to pressure operating margins.
- The status and financial exposure of the NSS litigation, professional liability claims and accrued risk reserves.
- Credit-facility availability, variable-rate exposure, lease commitments and the concentration and valuation of the NHI investment.
- Actual opening, ramp-up and financial contribution of expansion projects, and the realized effect of Medicare and state Medicaid payment changes.