Item 1. Business
General
The Company is a real estate investment trust ("REIT") which invests in income producing health care properties primarily in the long-term care industry. As of December 31, 1998, the Company had interests in net real estate owned by it, mortgage investments and REMIC investments totaling approximately $684.4 million, and other investments in preferred stock and marketable securities of $64.9 million, resulting in total invested assets of $749.3 million. The Company's strategy is to provide current income for distribution to stockholders through investments in health care related facilities, including long-term care facilities, acute care hospitals, medical office buildings, retirement centers and assisted living facilities, all of which are collectively referred to herein as "Health Care Facilities". The Company intends to implement this strategy by acquiring additional properties and making additional mortgage loans nationwide, predominately in the long- term care industry. The Company funds these investments through three sources of capital: current cash flow, including principal prepayments, the sale of equity in the form of common and preferred stock and debt offerings, including bank lines of credit, the issuance of convertible debt instruments, and the issuance of straight debt. NHI is investment grade rated on its senior unsecured debt from the two major rating agencies, Moody's Investment Service (Baa3) and Standard & Poor's (BBB).
As of December 31, 1998, the Company had approximately $684.4 million in real estate and mortgage investments in 203 health care facilities located in 26 states consisting of 151 long-term care facilities, two acute care hospitals, nine medical office buildings, 18 assisted living facilities, six retirement centers and 17 residential projects for the developmentally disabled. These investments consist of approximately $402.0 million aggregate principal amount of loans to 34 borrowers and $245.5 million of purchase leaseback agreements with seven lessees and $36.9 million invested in REMIC pass through certificates. Of these 203 facilities, 43 are leased to NHC and nine additional facilities are managed by NHC.
At December 31, 1998, NHI was committed, subject to due diligence and financial performance goals, to fund approximately $136.9 million in health care real estate projects of which all is expected to be funded within the next 12 months. The commitments include mortgage loans for six long-term health care centers, two medical office buildings, and 24 assisted living centers all at rates ranging from 9.0% to 11.5%. Also included in the $136.9 million of commitments is a commitment to loan an additional $3.3 million on three loans when the mortgagee obtains certain operating ratios.
The Company commenced operations on October 17, 1991 with approximately $121.8 million in net assets obtained when it acquired 40 skilled long-term care facilities and three retirement centers and four first mortgage notes from National HealthCare Corporation, successor to National HealthCare L.P. ("NHC") in exchange for 7,306,570 shares of the Company's Common Stock. Concurrently, the Company assumed mortgage indebtedness and certain other obligations of NHC related to the acquired properties. The 43 properties were then leased to NHC. NHC is a publicly traded corporation which at December 31, 1998 operated 108 long-term care facilities with a total of 13,983 licensed beds. Included within seven of these centers are 129 assisted care beds; within 21 centers are located 650 Alzheimer's beds and finally 487 sub-acute beds are located in 17 centers. NHC also operates five retirement centers with a total of 445 units, nine freestanding assisted living facilities with a total of 645 units and 36 home health care programs. All NHC operations are in the southeastern United States.
Since the Company commenced operations, NHC has provided advisory services pursuant to an Advisory, Administrative Services and Facilities Agreement (the "Advisory Agreement"). In addition, the Company and NHC have certain other relationships. See "Certain Relationships and Related Transactions."
Unless the context indicates otherwise, references herein to the Company include all of the Company's subsidiaries.
Types of Health Care Facilities
Long-term care facilities. As of December 31, 1998, the Company owned and leased 43 licensed long-term care facilities, 40 of which were operated by NHC. The Company also owns four additional licensed long-term care facilities which are managed by Sunrise Healthcare Corporation, a subsidiary of Sun Healthcare Group, Inc. It also had outstanding first mortgage loans on 104 additional licensed long-term care facilities, nine (9) of which were operated by NHC. All of these facilities provide some combination of skilled and intermediate nursing and rehabilitative care, including speech, physical and occupational therapy. The operators of the long-term care facilities receive payment from a combination of private pay sources and government programs such as Medicaid and Medicare. Long-term care facilities are required to obtain state licenses and are highly regulated at the federal, state and local level. Most long-term care facilities must obtain certificates of need from the state before opening or expanding such facilities.
Acute and long term care hospitals. As of December 31, 1998, the Company owned and leased one acute care hospital and had an outstanding first mortgage loan on one additional operating long term care hospital. Acute care hospitals provide a wide range of inpatient and outpatient services and are subject to extensive federal, state and local legislation and regulation. Long-term care hospitals provide specialty care services for chronic care patients, whose average length of stay must exceed twenty-five days. Acute and long term care hospitals undergo periodic inspections regarding standards of medical care, equipment and hygiene as a condition of licensure. Services provided by acute and long term care hospitals are generally paid for by a combination of private pay sources and governmental programs.
Medical office buildings. As of December 31, 1998, the Company owned and leased seven medical office buildings. In addition, the Company had first mortgage loans on two medical office buildings. Medical office buildings are specifically configured office buildings whose tenants are primarily physicians and other medical practitioners. Medical office buildings differ from conventional office buildings due to the special requirements of the tenants and their patients. Each of the Company's owned medical office buildings is leased to one lessee, and is physically attached to an acute care hospital. The lessee then leases individual office space to the physicians or other medical practitioners. The lessee is responsible to the Company for the lease obligations of the entire building, regardless of its ability to lease the individual office space.
Assisted Living Facilities. The Company owns four assisted living facilities all of which are leased to a subsidiary of Marriott International and the remaining eight to Alternative Living Services, Inc. The Company also has first mortgages on six additional assisted living projects. Assisted living unit facilities are free standing facilities or facilities which are attached to long term care facilities or retirement facilities and provide basic room and board functions for the elderly. Some assisted living projects include licensed long term care (nursing home) beds. On-site staff are normally available to assist in minor medical needs on an as needed basis. Additionally, the Company has granted $100,000,000 in a line of credit for construction and permanent financing to one publicly traded assisted living company. Currently $31,628,000 has been funded on this line which is invested in eight assisted living projects now in operation. These lines will expire, if not used, by the end of fiscal year 1999. Each project must be individually approved under each line at the time funding is requested. Certificates of need are normally not necessary to build these projects.
Retirement Centers. The Company owns three retirement centers, all of which are leased to NHC, and has first mortgages on three others. Retirement centers offer specially designed residential units for the active and ambulatory elderly and provide various ancillary services for their residents including restaurants, activity rooms and social areas. Charges for services are paid from private sources without assistance from government 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 normally required for long-term care facilities.
Residences for the developmentally disabled. As of December 31, 1998, the Company had outstanding first mortgage notes on 17 residences for the developmentally disabled. Residences for the developmentally disabled are generally small home-like environments which accommodate six mentally and developmentally disabled persons. These persons obtain custodial care which includes food, lodging, education and transportation services. These community based services are replacing the large state institutions which have historically provided care to the developmentally disabled. Services to the developmentally disabled are primarily paid for by state Medicaid programs.
Nature of Investments
The Company's investments are typically structured as either purchase leaseback transactions or mortgage loans. The Company also provides construction loans for facilities for which it has already committed to provide long-term financing or which agree to enter into a lease with the Company upon completion of the construction. The capitalization rates of the Company's leases and the interest rates on the mortgage loans and construction loans have historically ranged between 9.25% and 12% per annum. For transactions closed in 1998, rates were comparable to those charged in 1997 and generally ranged from 9.25% to 10.75%. The Company charges a commitment fee of 1% based on the purchase price of the property of a purchase leaseback or the total principal loan amount of a mortgage loan. In instances where construction financing has also been supplied, there is generally an additional 1% commitment fee for the construction financing. The Company believes its lease terms, mortgage loan and construction loan terms are competitive in the market place. All of the operating Health Care Facilities are currently performing under their mortgage loans or leases. Typical characteristics of these transactions are as follows:
Mortgage Loans. In general, the term of the Company's mortgage loans is 10 years with the principal amortized over 20 to 25 years and a balloon payment due at the end of the 10 year term. Substantially all mortgage loans have an additional interest component which is based on the escalation of gross revenues at the project level or fixed rate increases. These escalators are between 2.5% and 5% of the increase in gross revenue over a base year for nursing homes (typically, the first year following the close of the financing) and are negotiated on a project by project basis. Assisted living escalators are generally higher, (5 to 7%) while medical office buildings are lower (generally 2% or so). The escalators, while not currently material to net income, are expected to be more significant in future periods. In certain of its mortgage loans, the Company has received an equity participation which allows the Company to share in a portion of any appreciation of the equity value of the underlying property. The Company does not expect the equity participations to constitute a significant or frequent source of income. Most mortgage loans have prepayment penalties starting at 10% during the first year and decreasing by 1% each year thereafter. In most cases, the owner of the property has committed to make minimum annual capital improvements for the purpose of maintenance or upgrading the facility.
In most circumstances, the Company will require some additional form of security and/or collateral beyond that provided by the lien of the mortgage. This additional security or collateral may consist of some or all of the following: (a) a guaranty by the borrowers' parent, if any, affiliates or individual principals; (b) an assignment of the leases and rents relating to the mortgaged property; (c) cross collateralization among loans; (d) security interest in other real property; (e) an assignment of personal property including accounts receivable; (f) letters of credit or certificates of deposit, and (g) other intangibles.
Leases. The Company's leases generally have an initial leasehold term of 10 to 14 years with one or more five year renewal options. The leases are "triple net leases" under which the tenant is responsible to pay all taxes, utilities, insurance premium costs, repairs and other charges relating to the ownership and operation of the Health Care Facilities. The tenant is generally obligated at its expense to keep all improvements and fixtures and other components of the Health Care Facilities covered by "all risk" insurance in an amount equal to at least the full replacement costs thereof and to maintain specified minimal personal injury and property damage insurance, protecting the Company as well as the tenant at such Health Care Facility. The leases also require the tenant to indemnify and hold harmless the Company from all claims resulting from the use and occupancy of each Health Care Facility by the tenant and related activities, as well as to indemnify the Company against all costs related to any release, discovery, clean-up and removal of hazardous substances or materials on, or other environmental responsibility with respect to, each Health Care Facility.
All of the Company's leases contain annual escalators in rent payments. Revenue escalators for both long-term care centers and acute care hospitals are typically between 3% and 5% of the revenue increase per annum. Rent escalators on certain medical office buildings generally range from 2% to 4% of the prior year's rent or in certain instances are based on increases in the Consumer Price Index. All of the acute care and medical office building properties which the Company owns and leases give the lessee an option to purchase the underlying property at the greater of i) the Company's acquisition costs; ii) the then fair market value as established by independent appraisers or iii) the sum of the land costs, construction costs and any additional capital improvements made to the property by the Company. None of the Company's other leases have options to purchase. In addition, the acute care and medical office building leases contain a right of first refusal for the lessee if the Company receives an offer to buy the underlying leased property.
Most of the obligations under the leases are guaranteed by the parent corporation of the lessee, if any, or affiliates or individual principals of the lessee. In some leases, the third party operator will also guarantee some portion of the lease obligations, usually for a fixed period such as six months or one year. Some obligations are further backed by other collateral such as machinery, equipment, furnishings and other personal property.
Construction loans. The Company also provides construction loans that by their terms convert either into purchase leaseback transactions or mortgage loans upon the completion of the construction of the facility. Generally the interest rates on the construction loans range from 9.0% to 11.5%. The term of such construction loans are for a period which commences upon the closing of such loan and terminates upon the earlier of (a) the completion of the construction of the applicable facility or (b) a specific date. During the term of the construction loan, funds are usually advanced pursuant to draw requests made by the borrower in accordance with the terms and conditions of the loan. In addition to the security of the lien against the property, the Company will generally require additional security and collateral in the form of either payment and performance completion bonds or completion guarantees by the borrower's parent, affiliates of the borrower or one or more of the individuals who control the borrower.
Competition
The Company competes, primarily on the basis of price, knowledge of the industry, and flexibility of financing structure, with real estate partnerships, other REITs and other investors (including, but not limited to, banks, insurance companies, and investment bankers developing securities in mortgage funds) in the acquisition, leasing and financing of health care related entities.
The operators of the Health Care Facilities compete on a local and regional basis with operators of facilities that provide comparable services. Operators compete for patients and staff based on quality of care, reputation, physical appearance of facilities, services offered, family preference, physicians, staff and price. They compete with independent operators as well as companies managing multiple facilities, some of which are substantially larger and have greater resources than the operators of the Health Care Facilities. Some of these facilities are operated for profit while others are owned by governmental agencies or tax-exempt non-profit organizations.
Operators
The majority (by total real estate assets) of the Health Care Facilities are operated by third party management companies on behalf of the owner or lessee. The balance of the Health Care Facilities are operated by the owner or lessee. As a percent of total investments, 59.7% of the Health Care Facilities are operated by publicly-owned companies, while 23.5% are operated by multistate regional health care operators. Generally, a third party operator of a facility is not liable to the Company under the mortgage or lease; however, the Company considers the operator to be an important factor in determining the creditworthiness of the investment and the Company generally has the right to approve any changes in operators. On some investments, the third party operator of a facility guarantees at least a portion of the lease or mortgage. Operators of the Health Care Facilities include NHC, Marriott Senior Living Services, IATROS Health Network, Inc., Alternative Living Services, Inc., Sun Healthcare, Integrated Health Services, Inc., Columbia/HCA, Living Centers of America, Paracelcus, Beverly Enterprises, Res-Care, Inc., American Retirement Corp., Grand Care, and Healthcare Properties, Inc.
Investment in REMIC Certificates
1993 Transactions
On November 9, 1993, the Company purchased $34.2 million principal amount of SC Commercial Mortgage Pass-Through Certificates, Series 1993-1 (the Certificates), which qualify as a real estate mortgage investment conduit (REMIC). The Certificates consist of nine classes issued in the aggregate principal amount of $172.9 million. The Certificates represent the entire beneficial ownership interest in a trust fund consisting of a pool of forty- one mortgage loans generally secured by a first lien on a single property that provides long-term care and/or assisted living care. All loans bear a fixed rate of interest, the weighted average of which is 9.308%. The Certificates were purchased in a private placement offering and are not readily marketable or freely tradable.
The Company's investment in the Certificates includes Class D and Class E Certificates which bear interest and the Class I Certificates which have no principal amount and are not entitled to distributions of principal, but are entitled to certain priority interest distributions. The Class D and Class E Certificates were issued with original issue discount.
The Class D Certificates were rated "BB" by Standard & Poor's Rating Group (S&P) and Fitch Investors Services (Fitch) and the Class I Certificates were rated "AA" by Fitch. (As a policy S&P does not rate interest only certificates.) The Class E Certificates were not rated. Fitch's rating of the Class I Certificates does not address the possibility that Class I Certificate holders might suffer a lower than anticipated yield or that if there is a rapid rate of principal payments (including both voluntary and involuntary prepayments), investors in such Certificates could fail to recover their initial investments.
Distributions of interest and principal on the Class D and Class E Certificates are subordinated to distributions of interest and principal with respect to the other classes of Certificates (which aggregate $137.9 million in principal amount). Distributions of interest on the Class I certificates are senior to (or, with respect to certain classes of Certificates, pari passu to) distributions of principal and interest of the other classes of Certificates.
1995 Transactions
On December 28, 1995, the Company purchased $7,305,000 face amount (purchase price was $6,158,000) of SC Commercial Mortgage Pass Through Certificates, Series 1995-1 (the Certificates) which qualifies as a REMIC. The Certificates consist of ten classes issued in the aggregate principle amount of $140,258,000. The Certificates represent the entire beneficial ownership interest in a trust fund consisting of a pool of 36 first mortgage loans secured by a first lien on 38 properties that provide long term and/or assisted living care. All loans bear a fixed rate of interest the weighted average of which is 10.47%. The Certificates were purchased in a private placement offering and are not readily marketable or freely tradable.
The Company's investment is in Certificate Class F which are rated "B" by S & P and Fitch. Distributions of interest and principal on the Class F certificates are subordinated to distributions of interest and principle with respect to the other classes of the Certificates totaling $132,953,000 in principal amount.
NHC Master Agreement to Lease
The Master Agreement to Lease (the "Master Agreement") with NHC regarding 40 nursing homes and three retirement centers, sets forth certain terms and conditions applicable to all leases entered into by and between NHC and the Company (the "Leases"). The Leases are for an initial term expiring on December 31, 2001 with two five year renewal options at the election of NHC which allow for the renewal of the leases on an omnibus basis only. During the initial term and the first renewal term (if applicable), NHC is obligated to pay annual base rent for the respective Health Care Facilities aggregating $15.2 million plus additional rent described below. During the second renewal term, NHC is required to pay annual base rent based on the then fair market rental of the property as negotiated at that time between NHC and the Company. The Master Agreement also obligates NHC to pay as additional rent under each Lease all payments of interest and principal and other payments due under each mortgage to which the conveyance of the respective Health Care Facility to the Company was subject or any refinancing of mortgage debt that matures or is required to be paid in its entirety during the term of the Lease. In addition, in each year after 1992 (the first full calendar year of the term of the Master Agreement), NHC is obligated to pay percentage rent to the Company equal to 3% of the amount by which gross revenues of each NHC leased Health Care Facility in such later year exceeds the gross revenues of such Health Care Facility in 1992. NHC paid $2.48 million as percentage rent for 1998.
The Master Agreement is a "triple net lease", under which NHC is responsible to pay all taxes, utilities, insurance premium costs, repairs (including structural portions of the buildings, constituting a part of the Health Care Facilities) and other charges relating to the ownership and operation of the Health Care Facilities. NHC is obligated at its expense to keep all improvements and fixtures and other components of the Health Care Facilities covered by "all risk" insurance in an amount equal to the full replacement costs thereof, insurance against boiler explosion and similar insurance, flood insurance if the land constituting the Health Care Facility is located within a designated flood plain area and to maintain specified minimal personal injury and property damage insurance, protecting the Company as well as NHC at such Health Care Facility. NHC is also obligated to indemnify and hold harmless the Company from all claims resulting from the use and occupancy of each Health Care Facility by NHC or persons claiming under NHC and related activities, as well as to indemnify the Company against, all costs related to any release, discovery, cleanup and removal of hazardous substances or materials on, or other environmental responsibility with respect to, each Health Care Facility leased by NHC.
Repayments
Although NHI structures its first mortgages with a declining prepayment penalty commencing at 10%, the Company experienced material loan prepayments in 1998. $93,891,000 was prepaid during the year, of which $18.3 million was received on December 31, 1998. Funds received have either been reinvested or used to repurchase Company common stock.
1998 All Seasons, Inc. - Center Purchases
On October 31, 1994, the Company loaned approximately $14.5 million to All Seasons, Inc., a Washington state corporation, owned by a single shareholder. The loan was secured by the guarantee of the shareholder as well as first mortgages on four licensed nursing homes and a leasehold mortgage on two additional licensed nursing homes. The sole shareholder passed away unexpectedly in early April 1998. Upon commencement of the administration of the deceased shareholder's estate, irregularities in the handling of All Seasons' cash were disclosed and the Estate informed the Company that it was insolvent. The Board of Directors of All Seasons, Inc., none of whom had any ownership interest therein, informed NHI that they intended to tender their resignation from the Board unless additional capital sources were made available to the corporation. Upon being informed that NHI would not make additional capital lines of credit available, the Board agreed to deed in lieu of foreclosure the four properties owned in fee simple by All Seasons to NHI or a designated subsidiary thereof. This transaction was accomplished on October 16, 1998. Although the Company was also offered the right to assume the two leases, it elected not to do so. Simultaneously with the receipt of the deeds to the properties, the Company entered into a management contract with a public nursing home chain, which management agreement subordinates the payment of management fees to the debt service assumed by NHI's subsidiary. At the present time, the Company's investment in the collateral is approximately $13,700,000 represented by first mortgage notes. Based upon the management company's 1999 budgets, and two months of operation, the Company believes that the properties will generate operating income in excess of the debt service but there can be no assurance that this will be the outcome. The Company and the management company are aggressively seeking new lessees and/or owners for these four properties.
Commitments
The Company has received commitment fees to make loans and to fund construction in progress to third parties for $136.9 million. Commitments include construction financings which have closed but which have not been fully funded as of December 31, 1998 and also investment amounts for which the Company has received a commitment fee but which have not been funded as of December 31, 1998.
The following table sets forth certain information regarding the Company's commitments as of December 31, 1998.
Sources of Revenues
General. The Company's revenues are derived primarily from mortgage interest income and rental income. During 1998, mortgage interest income equaled $52.7 million of which all except $4.8 million was from non-NHC borrowers. Rental income totaled $42.3 million, 76% of which was from properties operated by NHC. The interest and rental payments are primarily derived from the operations of the Health Care Facilities. The source and amount of revenues from such operations are determined by (I) the licensed bed or other capacity of the Health Care Facilities, (ii) the occupancy rate of the Health Care Facilities, (iii) the extent to which the services provided at each Health Care Facility are utilized by the patients, (iv) the mix of private pay, Medicare and Medicaid patients at the Health Care Facilities, and (v) the rates paid by private paying patients and by the Medicare and Medicaid programs.
Governmental and popular concerns regarding health care costs may result in significant reductions in payments to health care facilities, and there can be no assurance that future payment rates for either governmental or private health care plans will be sufficient to cover cost increases in providing services to patients. Any changes in reimbursement policies which reduce reimbursement to levels that are insufficient to cover the cost of providing patient care could adversely affect revenues of the Company's health-related lessees and borrowers and thereby adversely affect those lessees' and borrowers' abilities to make their lease or debt payments to the Company. Failure of the lessees or borrowers to make their lease or debt payments would have a direct and material adverse impact on the Company.
Medicare and Medicaid. A significant portion of the revenue of the Company's lessees and borrowers is derived from governmental-funded reimbursement programs, such as Medicare and Medicaid.
Medicare is a federal health insurance program under the Social Security Act for individuals age 65 and over and certain chronically disabled individuals. In recent years, there have been fundamental changes in the Medicare program which have resulted in reduced levels of payment for a substantial portion of health care services.
Medicaid is a joint federal and state program designed to provide medical assistance to "medically indigent persons". These programs are operated by state agencies which adopt their own medical reimbursement formula and standards, and rates and covered services vary from state to state. However, in many instances, revenues from Medicaid programs are insufficient to cover the actual costs incurred in providing care to those patients.
The Medicare and Medicaid programs are highly regulated and subject to frequent and substantial changes resulting from legislation, adoption of rules and regulations, and administrative and judicial interpretations of existing law. Moreover, health care facilities have experienced increasing pressures from private payors attempting to control health care costs, and reimbursement from private payors has in many cases effectively been reduced to levels approaching those of government payors.
Governmental Funding of Medicare and Medicaid. 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 services to be provided by the Company's lessee's or their operators. 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 the 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 meet 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 give 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 the Company has assets 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. Substantially all of the health care facilities in which the Company has invested will commence reimbursement under this program effective January 1, 1999. The Company anticipates that the deduction in Medicare revenues will negatively impact its additional percentage rent, but not the base rent, of its skilled nursing facilities. 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 those financed by NHI. No assurances can be given that such facilities 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 the operations of its tenants or borrowers; however, any significant reduction in either Medicare or Medicaid payments could adversely affect their cash flows. 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 tenants or borrowers will result in denial of Medicare and Medicaid payments which could result in a significant loss of revenue to those providers. 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 provider 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. 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 tenants or borrowers. 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.
Although it is clear that there will be a reduction in the growth of governmental revenues for Medicare and Medicaid, NHI and similar financial institutions believe that their position as either lessee or first mortgage holder is protected by a sufficient revenue base so that it does not anticipate the creation of problems or defaulting loans due to these cuts.
Licensure and Certification. The health care industry is highly regulated by federal, state and local law, and is directly affected by state and local licensing requirements, facility inspections, state and federal reimbursement policies, regulations concerning capital and other expenditures, certification requirements, and other such laws, regulations and rules. Sanctions for failure to comply with these regulations and laws include (but are not limited to) loss of licensure, fines, and loss of certification to participate in the Medicare and Medicaid programs, as well as potential criminal penalties. The failure of any lessee or borrower to comply with such laws, requirements and regulations could affect its ability to operate the facility or facilities and could adversely affect such lessee's or borrower's ability to make lease or debt payments to the Company.
In the past several years, due to rising health care costs, there has been an increased emphasis on detecting and eliminating fraud and abuse in the Medicare and Medicaid programs. Payment of any consideration in exchange for referral of Medicare and Medicaid patients is generally prohibited by federal statute, which subjects violators to severe penalties, including exclusion from the Medicare and Medicaid programs, fines, and even prison sentences. In recent years, both federal and state governments have significantly increased investigation and enforcement activity to detect and punish wrongdoers. In addition, legislation has been adopted at both state and federal levels which severely restricts the ability of physicians to refer patients to entities in which they have a financial interest.
It is anticipated that the trend toward increased investigation and enforcement activity in the area of fraud and abuse, as well as self-referral, will continue in future years. Certain of the Company's investments are with lessees or borrowers which are partially or wholly owned by physicians. In the event that any lessee or borrower were to be found in violation of laws regarding fraud and abuse or self-referral, that lessee's or borrower's ability to operate the facility as a health care facility could be jeopardized, which could adversely affect the lessee's or borrower's ability to make lease or debt payments to the Company and thereby adversely affect the Company.
Certificates of Need. Certain Health Care Facilities in which the Company invests are also generally subject to state statutes which may require regulatory approval, in the form of a certificate of need ("CON") prior to the addition or construction of new beds, the addition of services or certain capital expenditures. CON requirements are not uniform throughout the United States and are subject to change. The Company cannot predict the impact of regulatory changes with respect to CON's on the operations of the Company's lessees and mortgagees.
Investment Policies
The Company's investment objectives are (I) to provide current income for distribution to its stockholders through investments primarily in health care related facilities, (ii) to provide the opportunity to realize capital growth resulting from appreciation, if any, in the residual value of its portfolio properties, and (iii) to preserve and protect stockholders' capital. There can be no assurance that these objectives will be realized. It is not the present intention of the Company to sell its properties and reinvest in other investments for the purpose of realizing gains resulting from the appreciation of value of those properties; the Company, however, in the future would consider selling properties in the event circumstances should arise which would make a sale advisable or attractive.
The Company intends to seek further health care related investment opportunities and to provide lease or mortgage financing for such investments with additional capital, possibly including debt, from public or private sources. The Company plans to continue its goal of maintaining a one to one ratio of debt to shareholder's equity. The Company will be competing with health care providers and investors, including other real estate investment trusts, for additional health care related investments. In evaluating potential investments, the Company expects to consider such factors, as (I) the geographic area and type of property, (ii) the location, construction quality, condition and design of the property, (iii) the current and anticipated cash flow and its adequacy to meet operational needs and lease or mortgage obligations and to provide a competitive market return on equity to the Company's investors, (iv) the growth, tax and regulatory environments of the communities in which the properties are located, (v) occupancy and demand for similar health care facilities in the same or nearby communities, (vi) the quality, experience and creditworthiness of the management operating the facilities located on the property; and (vii) the mix of private and government sponsored patients. There can be no assurances that these intentions will be realized.
The Company will not, without the prior approval of a majority of the Board of Directors, enter into any joint venture relationships with or acquire from or sell to any director, officer, or employee of NHC or the Company, or any affiliate thereof, as the case may be, any of the assets or other property of the Company. The Company's Credit Agreements limit the amount of investment in any one borrower to 25% of the Company's assets, except for investments in NHC which is limited to 35% of the Company's assets. As of December 31, 1998, investments in NHC totaled approximately 22.8%. The Company is unable to predict the extent to which it will engage in activities with NHC or any other operator within these limits.
The Board of Directors, without the approval of the stockholders, may alter the Company's investment policies if they determine that such a change is in the best interests of the Company and its stockholders. The methods of implementing the Company's investment policies may vary as new investment and financing techniques are developed or for other reasons.
The Company may incur additional indebtedness in the future to make investments in health care related facilities when it is advisable in the opinion of the Board of Directors. The Company may negotiate other lines of credit, or arrange for other short or long term borrowings from banks, NHC or otherwise. The Company has and may arrange for long term borrowings from institutional investors or through public offerings. The Company has invested and may in the future invest in properties subject to existing loans or secured by mortgages, deeds of trust or similar liens with favorable terms or REMIC investments.
Advisory Agreement
The Company entered into the Advisory Agreement on October 17, 1991 with NHC as "Advisor" under which NHC provides management and advisory services to the Company during the term of the Advisory Agreement. The Company believes the Advisory Agreement benefits the Company by providing it access to NHC's extensive experience in the ownership and management of long-term care facilities and retirement centers. Under the Advisory Agreement, the Company engaged NHC to use its best efforts (a) to present to the Company a continuing and suitable investment program consistent with the investment policies of the Company adopted by the Board of Directors from time to time; (b) to manage the day-to-day affairs and operations of the Company; and (c) to provide administrative services and facilities appropriate for such management. In performing its obligations under the Advisory Agreement, NHC is subject to the supervision of and policies established by the Company's Board of Directors.
The Advisory Agreement was initially for a stated term which expired December 31, 1997. The Agreement is now on a year to year term. Either party may terminate the Advisory Agreement at any time on 90 days notice, and the Company may terminate the Advisory Agreement for cause at any time. For its services under the Advisory Agreement, the Advisor is entitled to annual compensation in a base amount of $1.6 million, payable in monthly installments of $135,417. Under the Advisory Agreement, the Company reimburses NHC for certain out of pocket expenses including those incurred in connection with borrowed money, taxes, fees to independent contractors, legal and accounting services and stockholder distributions and communications. For 1993 and later years the annual compensation is calculated on a formula which is related to the increase in Funds from Operations per common share (as defined in the Advisory Agreement). In 1998, the annual compensation under the Advisory Agreement was $3.3 million.
Pursuant to the Advisory Agreement, NHC manages all of the day-to-day affairs of the Company and provides all such services through its personnel. The Advisory Agreement provides that without regard to the amount of compensation received by NHC under the Advisory Agreement, NHC shall pay all expenses in performing its obligations including the employment expenses of the officers and directors and personnel of NHC providing services to the Company. The Advisory Agreement further provides that the Company shall pay the expenses incurred with respect to and allocable to the prudent operation and business of the Company including any fees, salaries, and other employment costs, taxes and expenses paid to directors, officers and employees of the Company who are not also employees of NHC. Currently, other than the directors who are not employees of NHC, the Company does not have any officers or employees who are not also employees of NHC. The Company's three executive officers, Mr. W. Andrew Adams, Mr. Robert G. Adams and Mr. LaRoche are employees of NHC and all of their fees, salaries and employment costs are paid by NHC, but a portion of their bonus, if any, is allocated to the Company.
In addition, although not specifically provided for in the Advisory Agreement, during 1993 the Company granted stock options to purchase a total of 100,000 shares of Common Stock for the benefit of various NHC employees and outside directors of NHC who provided services to the Company. An additional 100,000 shares were granted as options to various NHC employees and outside directors in 1995 and 194,000 shares in 1997. Additionally, the Company has implemented an option exercise loan guaranty program, the purpose of which is to facilitate Directors and key personnel exercising options to purchase NHI common stock. Pursuant to Board of Directors' resolution unanimously passed, each Director and Key Employee to whom options to purchase NHI common shares have been granted is eligible to benefit from a Company guaranty on up to $100,000 per year of loans made from commercial banking institutions, the proceeds of which are used to exercise NHI options. The guarantee is structured as follows: Option holders must pledge to NHI 125% of the loan amount in publicly traded stock as additional collateral for the guarantee; the option holder must personally guarantee the loan to the bank; the interest rate charged by the bank and all expenses pertaining to the loan are to be borne by the Director or Employee and the maximum outstanding amount of loan guarantees is $5.0 million. Furthermore, this facility is to have a one year term and be renewable at the Board's discretion. The table in Item 13 indicates the current amount of loans outstanding by Directors of NHI individually and by all designated NHC employees collectively as of December 31, 1998. The total outstanding as of December 31, 1998 is $1.3 million, and none is owed by directors or executive officers.
Federal Income Tax
The Company believes that it has operated its business so as to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code") and the Company intends to continue to operate in such a manner, but no assurance can be given that the Company will be able to qualify at all times. If the Company qualifies as a REIT, it will generally not be subject to federal corporate income taxes on its net income that is currently distributed to its stockholders. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that typically applies to corporate dividends.
Item 2.
Item 2. Properties
REAL ESTATE MORTGAGE INVESTMENT CONDUITS
20.0% participating interest 15 Properties 2,039 5.2% participating interest 25 Properties 3,124
Item 3.
Item 3. Legal Proceedings
The Company is not subject to any pending litigation. The Health Care Facilities are subject to claims and suits in the ordinary course of business. The Company's lessees and mortgagees have indemnified and will continue to indemnify the Company against all liabilities arising from the operation of the Health Care Facilities, and will indemnify the Company against environmental or title problems affecting the real estate underlying such facilities. While there are lawsuits pending against certain of the owners and/or lessees of the Health Care Facilities, management believes that the ultimate resolution of all pending proceedings will have no material adverse effect on the Company or its operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of the Shareholders was held on March 31, 1998.
(b) Matters voted upon at the meeting are as follows:
PROPOSAL NO. 1: Election of Ted H. Welch and Richard F. LaRoche, Jr. to serve as directors for terms of three years or until their successors have been fully elected and qualified. Other directors whose terms of office continue are Mr. Robert T. Webb; Mr. Jack Tyrrell and Mr. W. Andrew Adams.
PROPOSAL NO. 2: Ratify the appointment of Arthur Andersen LLP as the Company's independent accountant.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
On October 16, 1996, the NHI Board of Directors, pursuant to powers granted by NHI's charter, changed the limit on the percentage of ownership which any person may have in the outstanding common stock of NHI from a limit of 7.0% (as passed on October 17, 1995) to a limit of 9.9%. The limit on ownership of any other class of stock (including issues convertible into common stock) remains at 9.9% of the outstanding stock.
In order to qualify for the beneficial tax treatment accorded to a REIT, the Company must make quarterly distributions to holders of its Common Stock equal on an annual basis to at least 95% of the Company's REIT taxable income (excluding net capital gains), as defined in the Code. Cash available for distribution to stockholders of the Company is primarily derived from interest payments received on its mortgages and from rental payments received under the Company's leases. All distributions will be made by the Company at the discretion of the Board of Directors and will depend on the cash flow and earnings of the Company, its financial condition, bank covenants contained in its financing documents and such other factors as the Board of Directors deems relevant. The Company's REIT taxable income is calculated without reference to its cash flow. Therefore, under certain circumstances, the Company may not have received cash sufficient to pay its required distributions.
Common Stock Market Prices and Dividends
The Company's common stock is traded on the New York Stock Exchange under the symbol NHI. The closing price for NHI stock on February 26, 1999 was $25.50. As of December 31, 1998, there were approximately 3,274 holders of record of shares and the Company estimates that as of such date there were in addition in excess of 23,500 beneficial owners of the shares.
High and low stock prices and dividends for the last two years were:
Item 6.
Item 6. Selected Financial Data
The following table represents financial information with respect to the Company for the five years ended December 31, 1998. 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.
BALANCE OF THIS PAGE LEFT INTENTIONALLY BLANK
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
National Health Investors, Inc. ("NHI" or the "Company") is a real estate investment trust which invests primarily in income producing health care properties with emphasis on the long-term care sector. As of December 31, 1998, NHI had interests in net real estate owned, and investments in mortgages, REMICs, preferred stock and marketable securities resulting in total invested assets of $741.5 million. NHI's strategy is to invest in health care real estate which generates current income which will be distributed to stockholders. NHI intends to implement this strategy by making mortgage loans and acquiring properties to lease nationwide primarily in the long-term health care industry.
As of December 31, 1998, the Company was diversified with investments in 203 health care facilities located in 26 states consisting of 151 long-term care facilities, two acute care hospitals, nine medical office buildings, 18 assisted living facilities, six retirement centers and 17 residential projects for the developmentally disabled. These investments consisted of approximately $394.2 million aggregate principal amount of loans to 34 borrowers, $245.5 million of purchase leaseback transactions with seven lessees and $36.9 million invested in REMIC pass through certificates backed by first mortgage loans to four operators. Of these 203 facilities, 43 are leased to National HealthCare Corporation ("NHC") and nine additional facilities are managed by NHC. NHC is the Company's investment advisor. Consistent with its strategy of diversification, the Company has reduced the portion of its portfolio operated or managed by NHC from 100.0% of total invested assets on October 17, 1991 to 20.8% of total invested assets on December 31, 1998.
At December 31, 1998, 59.7% of the total invested assets of the health care facilities were operated by public operators, 23.5% by regional operators, and 16.8% by small operators.
Liquidity and Capital Resources
Sources and Uses of Funds
NHI has generated net cash from operating activities during 1998 totaling $84.9 million. Net cash from operating activities generally includes net income plus non-cash expenses, such as depreciation and amortization and provision for loan losses, and working capital changes. In 1998, collections on mortgage notes receivable were $3.9 million and prepayments on mortgage notes receivable were $93.9 million. Proceeds from NHI's line of credit draw were $58.5 million.
While maintaining its high investment standards, during 1998, NHI made investments in real estate properties of $40.7 million, mortgage loans of $67.6 million, preferred stock of another real estate investment trust of $38.1 million, and marketable securities of other real estate investment trusts totaling $30.1 million.
Stockholders' equity was reduced by $31.3 million as a result of the repurchase of 1,122,000 shares of the Company's common stock.
Debt of $4.3 million was repaid in 1998. Dividends paid to the stockholders were $75.8 million. NHI expects to be able to maintain the current quarterly dividend of 74 cents per common share in 1999, assuming continued success in the Company's investment program.
The amount available to be drawn on NHI's $100 million revolving line of credit was $41.5 million at December 31, 1998. The Company's balance sheet was further strengthened by the conversion of $19.0 million of convertible debentures to common equity during 1998. NHI's nonconvertible debt as a percentage of total capitalization is 27.3% at December 31, 1998. The Company continues to be well positioned to take advantage of new investment opportunities.
Commitments
At December 31, 1998, the Company was committed, subject to due diligence and financial performance goals, to fund approximately $136.9 million in health care real estate projects, all of which is expected to be funded within the next 12 months. The commitments include mortgage loans or purchase leaseback agreements for six long-term health care centers, two medical office buildings, and 24 assisted living facilities all at rates ranging from 9% to 11.5 %. Also included in the $136.9 million of commitments is a commitment to loan an additional $3.3 million on three existing loans when the mortgagee obtains certain operating ratios.
Financing for current commitments and future commitments to others may be provided by cash balances, by borrowings under the Company's bank credit facilities, new lines of credit, private placements or public offerings of debt or equity, the assumption of secured or unsecured indebtedness, or by the sale of all or a portion of certain currently held investments.
The Company believes it has sufficient liquidity and financing capability to finance future investments as well as to repay borrowings at or prior to their maturity.
Results of Operations
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Net income for the year ended December 31, 1998 is $69.6 million versus $75.4 million for the same period in 1997, a decrease of 7.7%. Diluted earnings per common share decreased 23 cents or 7.9%, to $2.69 in 1998 from $2.92 in 1997.
Total revenues for the year ended December 31, 1998 decreased $7.9 million or 7.2% to $102.3 million from $110.2 million for the year ended December 31, 1998. Revenues from mortgage interest income decreased $13.5 million, or 20.4%, when compared to the same period in 1997. Revenues from rental income increased $2.3 million, or 5.8% in 1998 as compared to 1997. Revenues from investment interest and other income increased $3.3 million or 84% compared to 1997.
The decrease in mortgage interest income is due to the receipt by NHI of prepayments of $93.9 million of first mortgages receivable during 1998, compared to new mortgage investments of $67.6 million during the same period. Mortgage interest income included $7.3 million of prepayment penalties and unamortized commitment fees applicable to early loan repayments in 1998. Loan loss provisions were $4.3 million for 1998 based on the application of the Company's policy for determining loan loss provisions.
The increase in rental income resulted primarily from the increase in investments in real estate properties of $40.7 million during the last 12 months and also from increased "revenue participations" and "additional rent" earned under NHI's existing leases and mortgage agreements. The increase in investment interest and other income is due to the investment of higher cash amounts, as well as the investment of $38.1 million in the preferred stock of LTC Properties, Inc. and $30.1 million in marketable securities.
Total expenses for the 1998 twelve month period decreased $2.2 million or 6.3% to $32.6 million from $34.8 million for the 1997 twelve month period. Interest expense decreased $3.1 million or 14.0% in the 1998 twelve month period as compared to the 1997 period. Depreciation of real estate increased $.9 million or 11.4% while amortization of loan and organization costs decreased $.1 million or 17.7% in 1998 when compared to 1997. General and administrative costs increased 5.2%.
Interest expense decreased due to lower average levels of long-term and subordinated debt compared to a year ago. Depreciation increased as a result of the Company placing newly constructed assets in service and property acquisitions.
The 1998 repurchase of 1,122,000 shares of common stock for $31.3 million resulted in a reduction of weighted average basic and diluted common shares outstanding in 1998 of 343,000. Notwithstanding alternative uses of the cash used to repurchase the common stock, the repurchase resulted in an increase in 1998 net income per share of 3 cents basic and diluted.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996.
Net income for the year ended December 31, 1997 is $75.4 million versus $67.2 million for 1996, an increase of 12.2%. Diluted earnings per common share increased 11 cents or 3.9% to $2.92 in 1997 from $2.81 in 1996.
Total revenues for the year ended December 31, 1997 increased $10.8 million or 10.8% to $110.2 million from $99.4 million in the year ended December 31, 1996. Revenues from mortgage interest income increased $3.8 million or 6.0% when compared to the same period in 1996. Mortgage interest income included $5.1 million of prepayment penalties and unamortized commitment fees applicable to early loan repayments in 1997. Loan loss provisions were $1.2 million for 1997.
Revenues from rental income increased $5.4 million or 15.5% in 1997 as compared to 1996. These increases resulted primarily from investments in additional facilities during 1997 and 1996 and from the recognition of commitment fees.
Total expenses for 1997 increased $2.5 million or 7.8% to $34.8 million from $32.3 million for 1996. Interest expense increased $1.6 million or 7.7% in 1997 as compared to 1996. Depreciation on real estate increased $1.2 million or 17.6% while amortization of loan and organization costs decreased $0.3 million or 25.0% when compared to 1996. General and administrative costs increased 0.4%.
The increase in interest expense is due primarily to higher average amounts borrowed in 1997 when compared to 1996. Depreciation increased as a result of the Company placing newly constructed assets in service in 1997 and 1996.
Future Growth
The Company expects increases in both mortgage interest income and rental income from the additional investments it has made in mortgage loans and owned facilities during 1998 and from revenue participations and escalators the Company has negotiated in its mortgages and leases. Additionally, the Company expects to make new investments in health care facilities that would increase interest and rental revenues as well as interest and depreciation expense. Increases in revenues are expected to more than offset increases in associated expenses.
Impact of Inflation
Inflation may affect the Company in the future by changing the underlying value of the Company's real estate or by impacting the Company's cost of financing its operations.
Revenues of the Company are primarily from long-term investments. Certain of the Company's leases require increases in rental income based upon increases in the revenues of the tenants. The Company has negotiated similar provisions in many of its mortgage notes receivable.
New Accounting Pronouncements
In 1997, NHI 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 NHI's financial condition or results of operations.
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 requires that changes in the amounts of certain items, including gains and losses on marketable securities, be shown in the consolidated financial statements. NHI adopted the provisions of SFAS 130 effective January 1, 1998. NHI has elected to disclose comprehensive income, which includes net income and unrealized gains and losses on marketable securities, in the consolidated statements of stockholders' equity.
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either as asset or liability measured at its fair value. SFAS 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Statement 133 is effective for fiscal quarters beginning after June 15, 1999. The impact of the adoption of SFAS 133 is not expected to have a material impact on NHI's results of operations or financial position.
Year 2000 Compliance
NHI has evaluated its information technology systems and embedded technology with respect to potential Year 2000 problems. Although management believes that the majority of NHI's information technology systems and embedded technology is already Year 2000 compliant, NHI will complete the testing of its information technology systems and embedded technology in the third quarter of 1999. In addition, NHI has developed corrective plans for any technology assessed to be non-compliant.
As a result of its advisory agreement with NHC, NHI is reliant upon NHC for much of its information technology systems and embedded technology. NHC has performed an evaluation of its information technology as it relates to NHI. Although NHI believes that the majority of NHC's information technology systems and embedded technology is already Year 2000 compliant, NHC will complete the testing of its information technology systems and embedded technology in the third quarter of 1999. NHI believes that NHC has developed corrective plans for any technology assessed to be non-compliant.
Costs incurred to date for NHI's internal Year 2000 remediation efforts have not been material, and NHI does not expect that the cost of future internal actions will be material to its financial condition or results of operations. Based upon current information, NHI anticipates successful completion and testing of its own Year 2000 remediation efforts during 1999. However, there can be no guarantee that the Year 2000 will not have a material adverse effect on NHI's operations, financial position or liquidity if NHI's remediation efforts are not successful or completed in a timely manner. NHI is currently developing a contingency plan in the event that it is not able to achieve Year 2000 compliance. This contingency plan is expected to include identifying back-up processes that do not rely on computers, whenever possible.
However, NHI also depends upon the proper functioning of information technology systems and embedded technology operated by certain other third parties. These third parties include lessors and debtors that participate in the Medicare and Medicaid programs, commercial banks and other lenders, and vendors such as telecommunications and utilities providers. NHI is currently evaluating and obtaining information concerning the Year 2000 compliance status of these third parties. If third parties have Year 2000 problems that are not remedied, the following problems could result: (i) in the case of lessors and debtors that rely on third party payors, in delayed collection of rent, mortgage notes and interest payments; (ii) in the case of banks and other lenders, in the disruption of capital flows potentially resulting in liquidity stress; or (iii) in the case of vendors, in disruption of important services upon which NHI depends, such as telecommunications and electrical power.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure 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. The Company's investment in preferred stock represents an investment in the preferred stock of another real estate investment trust and bears interest at a fixed rate of 8.5%. The underlying mortgages included in the Company's investments in real estate mortgage investment conduits (REMIC's) also 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 investment in notes receivable, preferred stock and REMIC's are fixed, a hypothetical 10% change in interest rates has no impact on the Company's future earnings and cash flows related to these instruments. A hypothetical 10% change in interest rates has an immaterial impact on the fair values of these instruments.
As of December 31, 1998, $114,506,000 of the Company's long-term debt bears interest at fixed interest rates. As of December 31, 1998, all of the Company's $100,096,000 of convertible subordinated debentures bear interest at fixed rates. Because the interest rates of these instruments are fixed, a hypothetical 10% change in interest rates has no impact on the Company's future earnings and cash flows related to these instruments. A hypothetical 10% change in interest rates has an immaterial impact on the fair values of these instruments. The remaining $37,053,000 of the Company's long-term debt and $58,500,000 line of credit facility bear interest at variable rates. However, in order to mitigate the impact of fluctuations in interest rates on its variable rate debt, the Company has entered into interest rate swap agreements whereby the Company has exchanged certain variable interest rates on a $50,000,000 notional principal amount for a fixed rate of interest. Therefore, after including the mitigating impact of the interest rate swaps, a hypothetical 10% change in interest rates has an immaterial impact on the Company's future earnings and cash flows related to these instruments. A hypothetical 10% change in interest rates has an immaterial impact on the fair values of these instruments.
The Company's use of derivative instruments is limited to the interest rate swap discussed above. The Company does not use derivative instruments for trading purposes and the use of such instruments is subject to strict approvals by the Company's senior officers. The Company's exposure related to such derivative instruments is not material to the Company's financial position, results of operations or cash flows.
Equity Price Risk
The Company considers its investments in marketable securities as available for sale securities and unrealized gains and losses are recorded in stockholders' equity in accordance with Statement of Financial Accounting Standards No. 115. The investments in marketable securities are recorded at their fair market value based on quoted market prices. Thus, there is exposure to equity price risk, which is the potential change in fair value due to a change in quoted market prices. Hypothetically, a 10% change in quoted market prices would result in a related 10% change in the fair value of the Company's investments in marketable securities. In addition, a hypothetical 10% change in the quoted market prices of the Company's subordinated convertible debentures would result in a related 10% change in the fair value of the debenture instruments.
Item 8.
Item 8. Financial Statements and Supplementary Data
The following Consolidated Financial Statements are included as Exhibit 13 and are incorporated in this Item 8 by reference:
a. Report of Independent Public Accountants b. Consolidated Balance Sheets c. Consolidated Statements of Income d. Consolidated Statements of Cash Flows e. Consolidated Statements of Stockholders' Equity f. Notes to Consolidated Financial Statements
The following table sets forth selected quarterly financial data for the two most recent fiscal years.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Not Applicable
PART III
Item 10.
Item 10. Directors and Executive Officers of Registrant
Management
The following table sets forth the directors and executive officers of the Company. Each executive officer of the Company is elected by the directors, serves at the pleasure of the Board of Directors and holds office until a successor is elected or until the earliest of resignation or removal. Directors hold office until the annual meeting for the year in which their term expires and until their successor is elected and qualified. A director may be removed from office for cause only.
W. Andrew Adams has been President and a director of the Company since its inception in 1991. Mr. Adams has also been President and a director of National HealthCare Corporation ("NHC"), the Company's Investment Advisor, since 1974. He has served on the Multi-Facility Committee of the American Health Care Association, the trade association for long-term health care center companies. He has an M.B.A. from Middle Tennessee State University. Mr. Adams serves on the Board of Directors of David Lipscomb University in Nashville, Tennessee, the Board of Directors of SunTrust Bank in Nashville, Tennessee, and the Board of Directors of National Health Realty, Inc.
Richard F. LaRoche, Jr. has served as Vice President, Secretary and a director of the Company since its inception in 1991. Mr. LaRoche has also been General Counsel of NHC since 1971, Secretary of NHC since 1974 and Senior Vice President of NHC since 1986. He serves in the same capacities for National Health Realty, Inc. He received a J.D. from Vanderbilt University and an A.B. from Dartmouth College. Mr. LaRoche is responsible for legal affairs, acquisitions and finance for all three companies.
Jack Tyrrell has served as a director of the Company since its inception in 1991. Mr. Tyrrell is managing partner of Richland Ventures, L.P. and Richland Ventures II, L.P., venture capital firms based in Nashville, Tennessee which were founded in May 1994 and September 1996. He also currently serves as general partner of Lawrence, Tyrrell, Ortale & Smith and Lawrence, Tyrrell, Ortale & Smith, II, L.P., venture capital partnerships based in Nashville, Tennessee and New York, New York.
Robert T. Webb has served as a director of the Company since its inception in 1991. Mr. Webb is the owner of commercial buildings and rental properties in the Middle Tennessee area, a subdivision developer, and a partner in commercial properties located in Rosslyn, Virginia and Phoenix, Arizona. Mr. Webb is the President and the sole owner of Webb's Refreshments, Inc. which has been in operation serving the Middle Tennessee area since 1976. Mr. Webb attended David Lipscomb College and received a B.A. in business marketing from Middle Tennessee State University in 1969.
Ted H. Welch has served as a director of the Company since its inception in 1991. Mr. Welch has owned and operated income producing real estate (primarily office buildings) in the southeastern United States since 1976. From 1953 until 1971, Mr. Welch worked for the Southwestern Company where he became Executive Vice President. From 1971 to 1974, he served as the Commissioner of Finance and Administration for the State of Tennessee, in which capacity he was responsible for all construction and maintenance of State of Tennessee real property, along with being chief operating officer. Mr. Welch received a B.S. from the University of Tennessee at Martin and attended the Graduate School of Management at Indiana University. Mr. Welch is Chairman and Chief Executive Officer of Eagle Communications. Mr. Welch serves on the Board of Directors of American Constructors, Inc.; First American Corporation, Nashville, Tennessee; Logan's Roadhouse, Inc.; and Southeast Service Corporation.
Robert G. Adams has served as Vice President since 1997. He is the brother of W. Andrew Adams. He is the Chief Operating Officer of NHC, serves on NHC's Board of Directors and on the Board of National Health Realty, Inc. He is responsible for oversight of all company due diligence reports and financial pro formas. He received a B.S. degree from Middle Tennessee State University.
The following employees of NHC have material involvement with the Company:
Donald K. Daniel (Vice President and Controller) joined NHC 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.
Kenneth D. DenBesten (Vice President/Finance) has served as Vice President/ Finance since 1992. From 1987 to 1992, he was employed by Physicians Health Care, most recently as Chief Operating Officer. From 1984 to 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.
Charlotte A. Swafford (Treasurer) has been Treasurer of NHC since 1985. She joined NHC in 1973 and has served as Staff Accountant, Accounting Supervisor and Assistant Treasurer. She has a B.S. degree from Tennessee Technological University.
Dinsie B. C. Hale (Senior Accountant) has been with NHC since 1985. She oversees portfolio compliance and reports on those issues monthly to the NHC Advisory Committee and quarterly to the Board of Directors. She has a B.S. degree from Middle Tennessee State University.
Jack W. Anderson (Chief Development Officer) joined NHI in 1998 with 19 years experience in real estate and investment banking. He is responsible for investment identification, review and presentation, as well as overseeing the due diligence process through closing. Mr. Anderson received a B.A. degree in Business Administration from Austin College.
Item 11.
Item 11. Executive Compensation
The Company's day to day operations are conducted by personnel provided by NHC. The Company does have three executive officers, all of whom are also officers of NHC. The three executive officers may receive a bonus for their work for NHI, which is paid by NHC and credited against the advisory fee; however, no bonus has yet been declared or paid to them for 1998.
The following Table 1 sets forth certain information concerning the compensation of the Company's chief executive officer and the other executive officers of the Company:
The compensations of Messrs. Adams and Mr. LaRoche are set by the board of directors of NHC (NHC Board) and are the obligations of NHC pursuant to the Advisory Agreement. Any compensation paid by the Company is credited against the Advisory fee paid to NHC. See "Business - Advisory Agreement". NHC's Board is composed of J. K. Twilla, Olin O. Williams, W. Andrew Adams, Ernest G. Burgess, III, Robert G. Adams, and Lawrence C. Tucker.
Messrs. Adams and Mr. LaRoche also serve as Executive Officers of National Health Realty, Inc., and National HealthCare Corporation.
Directors' Compensation
Directors not affiliated with NHC (Messrs. Welch, Tyrrell, and Webb) receive $2,500 for each meeting attended, plus reimbursement for any actual travel expenses. In addition, non-NHC affiliated directors are granted options to purchase 15,000 shares of Common Stock at the first Annual Meeting each year pursuant to the 1997 Stock Option Plan. See "Stock Option Plan" below.
Stock Option Plan
The 1991 Option Plan (as amended in 1994) provided for an automatic grant to each non-NHC affiliated director of an option to purchase 5,000 shares of Common Stock on the date of the Annual Stockholder's Meeting at the then fair market value. The 1997 Stock Option Plan increased that number to 15,000 shares per Annual Meeting.
Both Plans permit options to be exercised for cash or by surrender of shares of Common Stock of the Company valued at the then fair market value. Unless otherwise specifically provided in the option agreement, no option or SAR shall be transferable other than by will, family gift, or the laws of descent and distribution. All shares which may be issued under either Plan and the exercise prices for outstanding options are subject to adjustment in the event that the number of outstanding shares of Common Stock will be changed by reason of stock splits, stock dividends, reclassifications or recapitalizations. In addition, upon a merger or consolidation involving the Company, participants are entitled to shares in the surviving corporation.
Pursuant to the automatic grant provisions of the Plans, the three non-NHC affiliated directors have each received options to purchase shares at $28.75 per share in 1994, $25.375 in 1995, $33.50 in 1996, $36.00 in 1997 and $39.875 in 1998. The outside directors have exercised all options granted in 1994, all but 5,060 of the 1995 grants, all but 10,000 of the 1996 grants and none of the 1997 and 1998 grants.
In 1993 the Board awarded options on 100,000 shares at the then fair market value of $25.00 to its Investment Advisor, with the direction that they be allocated among those employees who were directly involved in the provision of investment advisory services to the Company. On June 1, 1995, the Company awarded options on another 100,000 shares at the then fair market value of $26.00 per share to key NHC employees. On January 15, 1997, the balance of the shares available under the 1991 Plan were granted to Key Employees at $36.00 per share. 90,000 shares of the 1997 Plan have been granted to non NHC affiliated directors, and -0- to NHC Key Employees.
Options Granted in 1998
The table below provides certain information on grants of stock options to the executive officers and directors pursuant to the Company's 1991 Option Plan during the fiscal year ended December 31, 1998. Although stock appreciation rights are available under the plan, none have been issued to date.
1998 Year-End Option Values
The following table summarizes certain information regarding stock options exercised during the fiscal year ended December 31, 1998 and stock options held as of December 31, 1998 by the Executive Officers and Directors. No SARs were held or exercised during fiscal 1998.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as to the number of shares of Common Stock of the Company beneficially owned as of December 31, 1998 (a) by each person (including any "group" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") who is known to the Company to own beneficially 5% or more of the outstanding shares, (b) by each director, and (c) by all executive officers and directors of the Company:
The Charter contains certain limitations on the number of shares of the Company's stock that any one stockholder may own, which limitations are designed to ensure that the Company maintains its status as a REIT. This limitation (as amended) states that no person (as defined in the Code) may own directly or indirectly 9.9 percent or more of the Common Stock of the Company. Any shares of Common Stock in excess of such limits are deemed to be "Excess Common Stock". Excess Common Stock shall be deemed automatically to have been converted into a class separate and distinct from the class from which converted and from any other class of Excess Common Stock, each such class being designated "Excess Common Stock of [stockholder's name]". No Excess Common Stock may be voted, nor considered outstanding for the purpose of determining a quorum at any meeting of stockholders. Any dividends or other distributions payable upon the Excess Common Stock may, in the discretion of the Company, be paid into a non-interest bearing account and released to the stockholder only at such time as he or she ceases to be the holder of Excess Common Stock. The Company, upon authorization of the Board of Directors, may redeem any or all Excess Common Stock, and from the date of the giving of notice of redemption such shares shall cease to be outstanding and the stockholder shall cease to be entitled to dividends, voting rights and other benefits with respect to such shares. The redemption price will be based on the trading prices of the class of stock from which the Excess Common Stock being redeemed were converted, and is payable, without interest, only upon the liquidation of the Company. However, the Charter contains provisions under which the holder of Excess Common Stock may cause the Company to rescind such redemption by selling (and notifying the Company of such sale), within 30 days after notice of the redemption, a number of the shares of Common Stock held by such holder equal to the number of shares of Excess Common Stock. In addition, Excess Common Stock held by any holder may be converted back into shares of Common Stock if the holder sells such shares prior to their being called for redemption.
Upon demand of the Company, each stockholder must disclose to the Company such information with respect to direct and indirect ownership of stock owned (or deemed to be owned after applying the rules applicable to REITs under the Code) as the Board of Directors deems reasonably necessary in order that the Company may fully comply with the REIT provisions of the Code. Proposed transferees of stock must also satisfy the Board, upon demand, that such transferees will not cause the Company to fall out of compliance with such provisions.
Item 13.
Item 13. Certain Relationships and Related Transactions
Advisory, Administrative Services and Facilities Agreement
The Company entered into an Advisory, Administrative Services and Facilities Agreement with NHC as "Advisor" under which NHC provides management and advisory services to the Company during the term of the Advisory Agreement. See "Business - Advisory, Administrative Services and Facilities Agreement".
Leases
Pursuant to NHC's conveyance of certain of the Health Care Facilities to the Company, the Company leases to NHC 43 of the Health Care Facilities. Pursuant to these Leases, the Company and NHC have entered into a Master Agreement to Lease. See "Business - NHC Master Agreement to Lease". Since the date of the original lease to NHC (October 17, 1991), NHC has expanded the number of licensed beds at 15 of the 43 centers. By authority and unanimous vote of the non-NHC affiliated Directors, at such time as the bed additions were completed, NHI reimbursed NHC its actual out of pocket costs and expenses in connection with the plant expansions and received a corresponding increase in the base rent paid by NHC. The 15 expansions were funded at a cost of $10,534,135 in 1996 and $23,375,000 in 1997 and the lease increases at all expanded centers are now in effect. At the expiration of the leases, all of the expansions remain the full and complete property of NHI.
The Mortgage Debt
In connection with NHC's conveyance of 43 of the Health Care Facilities (the "NHC Health Care Facilities") to the Company in 1991, the Company assumed mortgage debt of $120.4 million (the "NHC Mortgage Debt"). As of December 31, 1998, after the early retirement by the Company of $20,662,000 for which NHC is still obligated under the original terms, the aggregate principal balance of the mortgage debt was $48,676,000. If the Company were required to redeem all or a material portion of such debt, there can be no assurance that the Company would be able to replace such debt on the same or similar terms or in a similar amount. NHC has agreed to indemnify and hold the Company harmless from certain costs and damages incurred in refinancing or so redeeming this debt, including closing or commitment fees, legal fees, and increased interest rates. The balance of the mortgage indebtedness encumbering the Health Care Facilities received from NHC is long-term self-amortizing debt with final maturities from 1999 through 2017.
Although the Company assumed the NHC Mortgage Debt, NHC remains liable on such debt and the Company has agreed to indemnify NHC in respect of such continuing liability. In connection with the transfer of the NHC Health Care Facilities and the Notes to the Company, and the assumption by the Company of the NHC Mortgage Debt, NHC and the Company obtained the written consent of each material lender of such Mortgage Debt and of the Guaranteed Debt (defined below). In addition, the Company and NHC have covenanted with such lenders to maintain certain debt coverage and similar financial ratios. Although there can be no assurance, management believes that the Company and NHC will be able to comply with each such covenant, during all relevant periods. In the event, however, that the Company or NHC fails to comply with any such covenant, and such failure is deemed to constitute a default under the related NHC Mortgage Debt or Guaranteed Debt, the Company may be required to retire such NHC Mortgage Debt or Guaranteed Debt prior to its stated maturity. A default under such debt, if not waived or cured, could result in a loss of certain of the Company's assets through foreclosure or other means. NHC has agreed to indemnify and hold the Company harmless from suffering any loss, liability or harm as a result of this cross-collateralization, regardless of the form of such loss, liability or harm.
The majority of the NHC Mortgage Debt is cross-defaulted with other NHC liabilities and is cross-collateralized as mentioned above. Thus, in the event NHC defaulted on its remaining obligations under its debt package, the Company could lose its interest in the Notes or the NHC Health Care Facilities, even if its own payments on the NHC Mortgage Debt were current.
The Guaranteed Debt
In order to obtain the consent of appropriate lenders to NHC's transfer of assets to NHI, NHI guaranteed the debt ($17,679,000 at December 31, 1998) of unrelated parties which NHC has also guaranteed. The debt is at fixed interest rates with a weighted average interest rate of 8.3% at December 31, 1998. NHI receives from NHC compensation of approximately $88,000 per annum for the guarantees which is credited against NHC's base rent requirements. Additionally, NHI has outstanding letters of credit for $10,316,000 of debt. NHI also has guaranteed bank loans in the amount of $1,449,570 to key employees and directors of the Company and NHC employees and directors utilized for the exercise of stock options. No fee is charged for these option exercise guarantees.
In management's opinion, these guarantee fees approximate the guarantee fees that NHI would currently charge to enter into similar guarantees.
All of the guaranteed indebtedness is secured by first mortgages, pledges of personalty, accounts receivable and, in certain instances, by the guarantees of the owners of the facilities. The borrower has granted second mortgages over the relevant properties in favor of NHC, and NHC has assigned its rights in such mortgages to NHI. Such rights may be enforced if either party is required to pay under their respective guarantees. 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.
Management Conflict of Interest
Two of the five directors and all of the officers of the Company occupy positions with NHC, and therefore, there may be conflicts of interest in their duties to the NHC Unitholders and Company stockholders. Although the Directors of the Company believe the terms of the NHC leases and the Advisory Agreement are fair and reasonable, not all of the terms of the leases or the Advisory Agreement are fair and reasonable, not all of the terms of the leases or the Advisory Agreement were negotiated on an arm's-length basis. The Company may purchase additional equity interests in real estate from, or make additional mortgage loans to, NHC. Since NHC will be the Company's investment advisor, it will have a conflict of interest in determining the price to be paid by the Company for additional assets which may be purchased from NHC and the terms of any leases to be entered into between the Company and NHC.
Security Counsel to NHC also represents the Company on certain security matters. In the course of such representation, circumstances may arise in which NHC and the Company have conflicting interests, in which event separate counsel will be retained to represent one or both of the parties.
Investment Advisor's Conflict of Interest
The Company's Investment Advisor, NHC, is also serving as the Investment Advisor for National Health Realty, Inc. ("NHR") a separate health care real estate investment trust founded in December, 1997, by NHC. Although NHR is publicly traded on the American Stock Exchange, its investment activities are restricted by the terms of NHC's Advisory Agreement.
NHR's Advisory Agreement provides that prior to the earlier to occur of (i) the 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 upon its formation by NHC.
Option Exercise Loan Guaranty Program
The Company has implemented an option exercise loan guaranty program, the purpose of which is to facilitate Directors and key personnel exercising options to purchase NHI common stock. Pursuant to Board of Directors' resolution unanimously passed, each Director and Key Employee to whom options to purchase NHI common shares have been granted is eligible to obtain an NHI guaranty of up to $100,000 per year on loans made from commercial banking institutes, the proceeds of which are used to exercise NHI options. The guarantee is structured as follows: Option holders must pledge to NHI 125% of the loan amount in publicly traded stock as additional collateral for the guarantee; the option holder must personally guarantee the loan to the bank; the interest rate charged by the bank and all expenses pertaining to the loan are to be borne by the Director or Employee and the maximum outstanding amount of loan guarantees is $5,000,000. Furthermore, this facility is to have a one year term and be renewable at the Board's discretion. The table below indicates the current amount of loans outstanding by Directors of NHI individually and by all designated NHC employees collectively as of December 31, 1998.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
FINANCIAL STATEMENTS AND SCHEDULES
(a) The following documents are filed as part of this Report:
1. Financial Statements
The Consolidated Financial Statements are included as Exhibit 13 and are filed as part of this report.
2. Financial Statement Schedules
The Financial Statement Schedules and Report of Independent Public Accountants on Financial Statement Schedules listed in the Index to Financial Statements are filed as part of this Form 10-K.
3. Exhibits
Exhibits required as part of this report are listed in the Exhibit Index.
(b) Reports on Form 8-K. - Filed July 31, 1998
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, in the City of Murfreesboro, State of Tennessee, on the 11th day of March, 1999.
NATIONAL HEALTH INVESTORS, INC.
BY: /s/ Richard F. LaRoche, Jr. Richard F. LaRoche, Jr. Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed on the dates indicated by the following persons in the capacities indicated.
Signature Title Date
/s/ W. Andrew Adams President & Director March 11, 1999 W. Andrew Adams (Principal Executive Officer)
/s/ Richard F. LaRoche, Jr. Secretary and Director March 11, 1999 Richard F. LaRoche, Jr. (Principal Financial Officer)
/s/ Jack Tyrrell Director March 11, 1999 Jack Tyrrell
/s/ Robert T. Webb Director March 11, 1999 Robert T. Webb
/s/ Ted H. Welch Director March 11, 1999 Ted H. Welch
NATIONAL HEALTH INVESTORS, INC. FORM 10-K FOR THE FISCAL YEAR ENDING DECEMBER 31, 1998
NATIONAL HEALTH INVESTORS, INC. FORM 10-K FOR THE FISCAL YEAR ENDING DECEMBER 31, 1998
EXHIBIT 13
NATIONAL HEALTH INVESTORS, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Financial Statements
Report of Independent Public Accountants
Consolidated Balance Sheets-December 31, 1998 & 1997
Consolidated Statements of Income-For the Years Ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows-For the Years Ended December 31, 1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity-For the Years Ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
Financial Statements Schedules
Report of Independent Public Accountants on Financial Statement Schedules
Schedule II Valuation and Qualifying Accounts
Schedule III Real Estate and Accumulated Depreciation
Schedule IV Mortgage Loans on Real Estate
All other schedules are not submitted because they are not applicable or not required or because the required information is included in the financial statements or notes thereto.
The 1998 consolidated financial statements, together with the Report of Independent Public Accountants, listed in the above index are filed herewith.
NATIONAL HEALTH INVESTORS, INC.
Report of Independent Public Accountants
To National Health Investors, Inc.:
We have audited the accompanying consolidated balance sheets of National Health Investors, Inc. (a Maryland corporation) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for the years ended December 31, 1998, 1997 and 1996. These consolidated financial statements are the responsibility of the Company'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 Health Investors, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the years ended December 31, 1998, 1997 and 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Nashville, Tennessee January 13, 1999
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
Notes to Consolidated Financial Statements Years Ended December 31, 1998, 1997, and 1996
Note 1. Organization
National Health Investors, Inc. ("NHI" or the "Company") is a Maryland real estate investment trust which was incorporated on July 24, 1991. The majority of NHI's revenue is derived from interest income on mortgage loans and from rent generated on leased properties. NHI invests in health care properties including long-term care centers, acute care hospitals, medical office buildings, assisted living facilities and retirement centers. These properties are located throughout the United States and are operated by qualified health care providers.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation - The consolidated financial statements include the accounts of NHI and its wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated.
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.
Real Estate Properties - NHI records properties at cost, including capitalized interest during construction periods. NHI uses the straight-line method of depreciation for buildings and improvements over their estimated remaining useful lives of up to 40 years.
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"), NHI evaluates the recoverability of the carrying values of its properties on a property by property basis.
Allowance for Loan Losses - The allowance for loan losses is considered adequate to cover potential losses in NHI's mortgage and other notes receivable. The allowance is determined on a specific loan basis and is based on an evaluation of the estimated collectibility of loan payments and general economic conditions.
Cash Equivalents - Cash equivalents consist of all highly liquid investments with a maturity of three months or less.
Federal Income Taxes - NHI intends at all times to qualify as a real estate investment trust under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. Therefore, NHI will not be subject to federal income tax provided it distributes at least 95% of its annual real estate investment trust taxable income to its stockholders and meets other requirements to continue to qualify as a real estate investment trust. Accordingly, no provision for federal income taxes has been made in the financial statements.
The primary difference between NHI's tax basis and the reported amounts of NHI's assets and liabilities is a higher tax basis than book basis (by approximately $17,298,000) in its real estate properties.
Earnings and profits, which determine the taxability of dividends to stockholders, differ from net income reported for financial reporting purposes due primarily to differences in the basis of assets, differences in recognition of commitment fees, differences in the estimated useful lives used to compute depreciation expense and differences in the treatment of accrued interest expense which existed at the time the debentures were converted to common stock.
Concentration of Credit Risks - NHI's credit risks primarily relate to cash and cash equivalents, to the investments in real estate mortgage investment conduits and to mortgage and other notes receivable. Cash and cash equivalents are primarily held in bank accounts and overnight investments. The investments in real estate mortgage investment conduits relate to a participating interest in two real estate mortgage investment conduits as discussed in Note 8. Mortgage and other notes receivable relate primarily to secured loans with health care facilities as discussed in Note 4.
NHI's financial instruments, principally its investments in the real estate mortgage investment conduits and 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. NHI obtains various collateral and other protective rights, and continually monitors these rights, in order to reduce such possibilities of loss. NHI 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 4 and 8 for additional information on the notes receivable and real estate mortgage investment conduits.
NHI considers its investments in marketable securities as available for sale securities and unrealized gains and losses are recorded in stockholders' equity in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115").
Deferred Costs - Costs incurred to acquire financings are amortized by the interest method over the term of the related debt.
Loan Commitment Fees - Non-refundable loan commitment fees received by NHI are amortized into income by the interest method over the expected period of the related loans. In the event that a potential borrower chooses not to borrow funds from NHI, the related commitment fees are recognized into income when the commitment expires.
In management's opinion, these loan commitment fees approximate the loan commitment fees that NHI would currently charge to enter into similar agreements based on the terms of the agreements and the creditworthiness of the parties, and the committed interest rates are approximately the same as current levels of interest rates.
Rental Income - Rental income is recognized by NHI based on the terms of NHI's leases.
Mortgage Interest Income - Mortgage interest income is recognized by NHI based on the interest rates and principal amounts outstanding of the mortgage notes receivable. Mortgage interest income includes prepayment penalties, which are recognized into income upon prepayment of notes receivable.
Note 3. Real Estate Properties
The following table summarizes NHI's real estate properties by type of facility and by state as of December 31, 1998:
In 1994, NHI funded a mortgage loan for All Seasons Living Centers in the original principal amount of $15,000,000. Collateral for the loan included first mortgages on four long-term health care facilities and a leasehold mortgage on two additional properties, all located in the State of Washington. On October 16, 1998, NHI purchased from All Seasons Living Centers for approximately $13,700,000 (the then current loan balance) all of the real estate, property and equipment of the four long term health care facilities described above (502 beds), but excluding the two leasehold properties. The purchase was undertaken in lieu of foreclosure after certain technical defaults on NHI's loan agreements and after the death of the principal owner. Sunrise Healthcare Corporation, a subsidiary of Sun Healthcare Group, Inc., has been engaged by NHI to manage the facilities. NHI will elect to treat the property as foreclosure property for federal income tax purposes. With this election, unqualified income generated by the property is expected to be treated as qualified income for up to two years from the purchase date for purposes of the income-source tests which must be satisfied by real estate investment trusts to maintain their tax status. Net operating income of the facilities for the period subsequent to acquisition was not material in 1998 and has been included in investment interest and other income in the consolidated statements of income.
Note 4. Mortgage and Other Notes Receivable
The following is a summary of mortgage and other notes receivable by type:
The following is a summary of the terms and amounts of mortgage and other notes receivable at December 31, 1998:
The mortgage notes receivable are generally first mortgage notes secured by the real estate of long-term health care centers, medical office buildings, assisted living facilities and retirement centers in the states of Alabama, Arizona, Colorado, Florida, Georgia, Kansas, Louisiana, Maryland, Massachusetts, Missouri, New Hampshire, Oklahoma, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin. Construction loans are for the construction of two nursing homes located in New Jersey, one nursing home addition in Florida, one assisted living facility in North Carolina and one assisted living facility located in Maryland. NHI has agreed to provide permanent financing for the projects upon completion of the construction.
The mortgage notes receivable are secured by first mortgages on the real property and UCC liens on the personal property of the facilities. Certain of the notes receivable are also secured by guarantees of significant parties and by cross-collateralization on properties with the same respective owner.
Mortgage and other notes receivable are reduced by an allowance for loan losses of $7,826,000 at December 31, 1998 and $3,566,000 at December 31, 1997. The provision for loan losses in 1998, 1997, and 1996 was $4,260,000, $1,231,000, and $(325,000) respectively, and has been recorded as a reduction of mortgage interest income in the consolidated statements of income.
Note 5. 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 practicable to estimate that value:
Mortgage and other notes receivable - The fair value of NHI's mortgage and other notes receivable is estimated based on the current rates offered by NHI and other real estate investment trusts and financial institutions for the same or similar types of mortgage and other notes receivable of the same or similar maturities.
Investments in real estate mortgage investment conduits - The fair value of NHI's investments in real estate mortgage investment conduits is estimated based on the present value of the estimated cash flows discounted at a rate comparable to current rates offered by NHI and other real estate investment trusts for similar investments.
Investment in preferred stock - The fair value is estimated based on the current rates offered by NHI and other real estate investment trusts for similar investments and is the same as the carrying amount.
Investment in marketable securities - The fair market value is estimated based on quoted market prices and is the same as the carrying amount.
Interest and rent receivable - The carrying amount approximates fair value because of the short term nature of these receivables.
Cash and cash equivalents - The carrying amount approximates fair value because of the short maturity of these instruments.
Long-term debt and credit facilities - The fair value of NHI's long-term debt and credit facilities is estimated based on the current rates offered to NHI and other real estate investment trusts for debt of the same remaining maturities. The fair value of the debt transferred from National HealthCare Corporation ("NHC") to NHI is estimated to approximate the carrying value of the debt as NHC is obligated to pay NHI debt service rent.
Convertible subordinated debentures - The fair value of NHI's 1997 debentures, 1995 debentures and senior debentures is estimated based on the quoted market prices of the debentures.
The estimated fair values of NHI's financial instruments are as follows:
Note 6. Investment in Preferred Stock
In September 1998, NHI purchased two million shares of the cumulative preferred stock of another real estate investment trust. The nonvoting preferred stock is convertible into common stock at a 1:1 ratio. The preferred stock has an annual cumulative coupon rate of 8.5% payable quarterly and a liquidation preference of $19.25 per share. The preferred stock is not redeemable by NHI or the issuer. The preferred stock, which is not listed on a stock exchange, is considered a nonmarketable security and is recorded at cost in the consolidated balance sheets. Amounts received from the 8.5% coupon rate are recorded as income when earned.
Note 7. Investment in Marketable Securities
NHI considers its investments in marketable securities as available for sale securities and unrealized gains and losses are recorded in stockholders' equity in accordance with SFAS 115. No sales of marketable securities occurred during 1998. Upon sale, realized gains and losses from securities sales are determined on the specific identification of the securities.
Note 8. Investments in Real Estate Mortgage Investment Conduits
On December 29, 1995, NHI purchased for $6,158,000 a participating interest in a real estate mortgage investment conduit ("REMIC") in the form of one class of certificates issued in the aggregate principal amount of $146,104,000 ("the 1995 REMIC"). On November 9, 1993, NHI purchased for $34,196,000 a participating interest in a REMIC in the form of nine classes of certificates issued in the aggregate principal amount of $172,928,000 ("the 1993 REMIC"). Both of the REMICs represent the entire beneficial ownership interest in a trust fund. Each trust fund consists of pools of mortgage loans, each secured by a first lien on a property which is used in providing long-term nursing care and certain other assets.
A portion of the 1993 REMIC certificates are interest-only certificates and entitle NHI to receive cash flow designated as interest. Principal and interest distributions on other certificates purchased by NHI are subordinated to distributions of principal and interest with respect to certain other classes of certificates.
Pursuant to SFAS 115, NHI has classified its investments in the certificates as held-to-maturity debt securities. Accordingly, the investments in the certificates have been recorded at the amortized cost in NHI's consolidated financial statements. The effective yields, as calculated, have been used to accrue income based on actual and projected future cash flows that reflect actual and assumed mortgage prepayments and interest rates. The average remaining lives of the mortgages in the 1995 REMIC and the 1993 REMIC are calculated to be 6.9 years and 4.8 years, respectively. NHI continually monitors the carrying values of the 1995 and 1993 REMIC investments based on actual cash payments received and revised cash flow projections that reflect updated assumptions about interest rates and prepayment rates. In the opinion of management, no impairments of the carrying values have occurred as of December 31, 1998.
Note 9. Long-term Debt and Credit Facilities
Short-Term Borrowings - As of December 31, 1998 and 1997, there were no short-term borrowings outstanding.
Long-Term Debt - Long-term debt and credit facilities, including refinancing commitments, consist of the following:
NHI has established a senior unsecured revolving line of credit which allows it to borrow a maximum of $100,000,000. The agreement allows NHI to borrow up to two-thirds of its borrowing base, which consists primarily of NHI's mortgage notes receivable and REMIC investments. The loan bears interest at the prime rate or at a premium over the London Interbank Offered Rate ("LIBOR") at the option of NHI. The loan matures in October 2000. At December 31, 1998, NHI had borrowed $58,500,000 under this credit facility.
On June 25, 1997, NHI received proceeds from the sale of $100,000,000 of 7.3% notes payable ("the Notes"), which mature on July 16, 2007 and have no sinking fund provisions. The Notes are general unsecured obligations of NHI and rank equally with NHI's other unsecured and subordinated debt. NHI agrees in the note indenture that it will limit liens on assets to certain percentages of tangible assets and that it will limit the issuance of new debt to certain multiples of capital or net worth.
On October 11, 1995 and April 28, 1995, NHI entered into two five-year interest rate swap agreements. Pursuant to these agreements, NHI has exchanged certain variable interest rates on a $50,000,000 notional principal amount for a weighted average fixed rate of 7.6% per annum.
Interest rate swap agreements are used to reduce the potential impact of increases in interest rates on variable rate long-term debt and credit facilities. The fair value of the swap agreements are not recognized in the consolidated financial statements as they are accounted for as hedges. Amounts payable under such agreements are accrued as an increase in interest expense. NHI is exposed to credit losses in the event of nonperformance by the counterparties to these agreements. NHI anticipates, however, that counterparties will be able to fully satisfy their obligations under the contracts. NHI does not obtain collateral or other security to support these agreements subject to credit risk but does monitor the credit standing of counterparties.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Statement 133 is effective for fiscal quarters beginning after June 15, 1999. The impact of the adoption of SFAS 133 is not expected to have a material impact on NHI's results of operations or financial position.
Substantially all real estate property and certain mortgage notes receivable are either pledged as collateral on the long-term debt and credit facilities or are subject to a negative pledge.
The debt identified as senior secured notes is cross-defaulted with other liabilities of NHC and its affiliates and is cross-collateralized to the extent of approximately $17,679,000 of debt. Thus, in the event NHC defaulted on its obligations under its debt packages, NHI could lose its interest in the related mortgage notes receivable or real estate properties.
The aggregate principal maturities of all long-term debt and credit facilities, including refinancing commitments, for the five years subsequent to December 31, 1998 are as follows:
1999 $ 4,505,000 2000 62,930,000 2001 4,617,000 2002 4,769,000 2003 4,948,000
Certain loan agreements require maintenance of specified operating ratios as well as specified levels of working capital and stockholders' equity by NHI and NHC. All such covenants have been met by NHI, and NHI believes all such covenants have been met by NHC.
Note 10. Convertible Subordinated Debentures
1997 Debentures - On January 29, 1997, NHI issued $60,000,000 of 7% convertible subordinated debentures (the "1997 debentures") due on February 1, 2004. At December 31, 1998, 1997 debentures in the amount of $56,286,000 were outstanding.
The 1997 debentures are convertible at the option of the holder into common stock of NHI at a conversion price of $37.50, subject to adjustment. During 1998 and 1997, $3,349,000 and $365,000, respectively, of the 1997 debentures were converted into 89,302 and 9,733 shares of common stock. NHI has reserved an additional 1,500,960 shares of common stock for 1997 debenture conversions.
The 1997 debentures will not be redeemable prior to February 8, 2002 except in the event of certain tax-related events or to the extent necessary to preserve and protect NHI's status as a real estate investment trust. The debentures are subordinated in right of payment to the prior payment in full of all senior indebtedness of the Company. Interest is payable semiannually on February 1 and August 1 of each year.
1995 Debentures - On December 12, 1995, NHI sold $45,000,000 of a total of $100,000,000 of 7.75% convertible subordinated debentures (the "1995 debentures") due on January 1, 2001. The remaining $55,000,000 were sold on January 15, 1996. At December 31, 1998, 1995 debentures in the amount of $38,070,000 were outstanding.
The 1995 debentures are convertible at the option of the holder into common stock of NHI at a conversion price of $31.625, subject to adjustment. During 1998 and 1997, $9,352,000 and $27,472,000, respectively, of the 1995 debentures were converted into 295,711 and 868,664 shares of common stock. NHI has reserved an additional 1,203,794 shares of common stock for 1995 debenture conversions.
The 1995 debentures will not be redeemable prior to maturity except in the event of certain tax-related events or to the extent necessary to preserve and protect NHI's status as a real estate investment trust. The debentures are subordinated in right of payment to the prior payment in full of all senior indebtedness of the Company. Interest is payable semiannually on January 1 and July 1 of each year.
1995 Debt Service Debentures - In November 1995, NHI began offering 7% subordinated convertible debentures due on January 1, 2006. NHI may offer up to $25,000,000 of these debentures to current and future mortgagees and lessees of NHI to satisfy existing debt service reserve escrow requirements under applicable mortgages or leases. At December 31, 1998, debentures in the amount of $5,535,000 were outstanding.
The debentures are convertible at the option of the holder into common stock of NHI at a conversion price of 110% of the market price on the date of issuance of the debentures, subject to adjustment. During 1998, $871,000 of the debentures were converted into 26,393 shares of common stock. NHI has reserved 157,419 shares of common stock for conversion of 1995 debt service debentures. Interest is payable semiannually on April 1 and October 1 of each year.
1993 Debentures - On March 25, 1993, NHI issued $112,210,000 of 7.375% convertible subordinated debentures (the "1993 debentures"). During 1998 and 1997, $5,305,000 and $3,790,000, respectively, of the debentures were converted into 194,671 and 139,074 shares of common stock. In accordance with the terms of the 1993 debentures, in April 1998, NHI redeemed all of the remaining 1993 debentures.
Senior Debentures - On October 17, 1991, NHI issued $110,000,000 of 10% senior convertible subordinated debentures (the "senior debentures") due 2006. At December 31, 1998, senior debentures in the amount of $205,000 were outstanding.
The senior debentures are convertible at the option of the holder into NHI's common stock at a price of $20 per share, subject to adjustment. In 1998 and 1997, $25,000 and $70,000, respectively, of the senior debentures were converted into 1,250 and 3,500 shares of common stock. NHI has reserved an additional 10,250 shares of common stock for senior debenture conversions.
The senior debentures rank equally with other unsecured debt of NHI (other than the trade debt) but are subordinated to all existing and secured indebtedness. NHI may not incur or guarantee unsecured indebtedness which is senior in right of payment to the senior debentures. Interest at 10% is payable semiannually on January 1 and July 1 of each year.
Note 11. Commitments and Guarantees
At December 31, 1998, NHI was committed, subject to due diligence and financial performance goals, to fund approximately $136,900,000 in health care real estate projects, all of which is expected to be funded within the next 12 months. The commitments include mortgage loans or purchase leaseback agreements for six long-term health care centers, two medical office buildings, and 24 assisted living facilities, all at rates ranging from 9% to 11.5%. Also included in the $136,900,000 of commitments is a commitment to loan an additional $3,300,000 on three existing loans when the mortgagee obtains certain operating ratios.
In order to obtain the consent of appropriate lenders to NHC's transfer of assets to NHI, NHI guaranteed certain debt ($17,679,000 at December 31, 1998) of NHC and its affiliates. The debt is at fixed interest rates with a weighted average interest rate of 8.3% at December 31, 1998. NHI receives from NHC compensation of approximately $88,000 per annum for the guarantees which is credited against NHC's base rent requirements.
In management's opinion, these guarantee fees approximate the guarantee fees that NHI would currently charge to enter into similar guarantees.
All of the guaranteed indebtedness discussed above is secured by first mortgages and rights which may be enforced if either party is required to pay under their respective guarantees. 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.
Additionally, NHI has outstanding letters of credit totaling $10,316,000. NHI also has guaranteed bank loans in the amount of $1,449,570 to key employees and directors utilized for the exercise of stock options. All shares of NHI stock purchased with the proceeds of the guaranteed loans are held as collateral by NHI and the loans are limited to $100,000 per individual per year. NHI's potential accounting loss related to these guaranteed bank loans, if all collateral failed, is the face amount of the guaranteed loans outstanding.
Note 12. Cumulative Convertible Preferred Stock
In February and March 1994, NHI issued $109,558,000 of 8.5% cumulative convertible preferred stock ("Preferred Stock") with a liquidation preference of $25 per share. Dividends at an annual rate of $2.125 are cumulative from the date of issuance and are paid quarterly.
The Preferred Stock is convertible into NHI common stock at the option of the holder at any time at a conversion price of $27.625 per share of common stock, which is equivalent to a conversion rate of 0.905 per share of common stock for each share of Preferred Stock, subject to adjustment in certain circumstances.
The Preferred Stock is not redeemable by NHI prior to February 15, 1999 and is not redeemable for cash. On or after February 15, 1999, the Preferred Stock will be redeemable by NHI for common stock. NHI may redeem the Preferred Stock only if the trading price of the common stock on the New York Stock Exchange ("NYSE") exceeds $27.625 per share for 20 trading days within a period of 30 trading days prior to the exercise.
At December 31, 1998, 768,894 shares of the Preferred Stock, which are convertible into 695,849 shares of common stock, are outstanding. During 1998 and 1997, respectively, 64,770 and 216,458 shares of preferred stock were converted into 58,596 and 195,894 shares of common stock. NHI has reserved 695,849 shares of common stock for Preferred Stock conversions.
Note 13. Limits on Common Stock Ownership
On October 16, 1996, the NHI Board of Directors, pursuant to powers granted by the Company's charter, changed the limit on the percentage of ownership which any person may have in the outstanding common stock of the Company from a limit of 7.0% to a limit of 9.9%. The limit on ownership of any other class of stock (including issues convertible into common stock) remains at 9.9% of the outstanding stock. This limit is a provision of the Company's charter and is necessary in order to reduce the possibility of the Company's failing to meet the stock ownership requirements for qualification as a real estate investment trust under the Internal Revenue Code.
Note 14. Stock Option Plan
NHI has stock option plans which provide for the granting of options to key employees and directors of NHI to purchase shares of common stock at a price no less than the market value of the stock on the date the option is granted. The options may be exercised immediately, but the Company may purchase the shares 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:
At December 31, 1998, all options outstanding are exercisable. Exercise prices on the exercisable options range from $25.38 to $39.88. The weighted average remaining contractual life of options outstanding at December 31, 1998 is 3.2 years. NHI has reserved 767,347 shares of common stock for issuance under the stock option plans.
NHI has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). As a result, no compensation cost has been recognized for NHI's stock option plans. Based on the number of options outstanding and the historical and expected future trends of factors affecting valuation of those options, management believes that the additional compensation cost, as calculated in accordance with SFAS 123, has no effect on NHI's pro forma earnings and earnings per share.
Note 15. Supplemental Cash Flow Information
Supplemental disclosure of cash flow information is as follows:
Note 16. Earnings Per Share
In 1997, the FASB issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). NHI adopted the provisions of SFAS 128 during the fourth quarter of 1997 and has restated earnings per share for 1996.
Basic earnings per share is based on the weighted average number of common shares outstanding during the year. Net income is reduced by dividends to holders of cumulative convertible preferred stock.
Diluted earnings per share assumes the conversion of convertible subordinated debentures, the conversion of cumulative convertible preferred stock and the exercise of stock options using the treasury stock method. Net income is increased for interest expense on the convertible subordinated debentures.
The following table summarizes the average number of common shares and the net income used in the calculation of basic and diluted earnings per share:
Note 17. Comprehensive Income
In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 requires that changes in the amounts of certain items, including gains and losses on marketable securities, be shown in the consolidated financial statements. NHI adopted the provisions of SFAS 130 effective January 1, 1998. SFAS 130 requires retroactive application; however, the Company had no comprehensive income items other than net income in 1997 and 1996. NHI has elected to disclose comprehensive income for 1998, which includes net income and unrealized gains and losses on marketable securities, in the consolidated statements of stockholders' equity.
Note 18. Dividends
Dividend payments by NHI to its common stockholders are characterized in the following manner for tax purposes in 1998:
Note 19. Relationship with National HealthCare Corporation
Leases - On October 17, 1991, concurrent with NHC's conveyance of real property to NHI, NHI leased to NHC 40 long-term care facilities 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. NHI accounts for its leases as operating leases.
During the initial term of the first renewal term, NHC is obligated to pay annual base rent on all 43 facilities of $15,238,000. If NHC exercises its option to extend the leases for a second renewal term, the base rent will be the then fair rental value as negotiated by NHI and NHC.
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. Payments for debt still being serviced are required for the shorter of the remaining life of the mortgage or lease term.
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 revenue of each facility in such later year exceeds the gross revenue of such facility in 1992.
Each lease with NHC 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 initial 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.
Rental income was $42,268,000 ($31,732,000 from NHC) in 1998; $39,948,000 ($29,829,000 from NHC) in 1997; and $34,579,000 ($26,910,000 from NHC) in 1996.
During 1997, NHI purchased $23,375,000 of additional property from NHC. This property represents capital improvements at 15 long-term care centers owned by NHI and leased to NHC. Additional base rent equal to 9.5% of the amount transferred is paid annually by NHC.
At December 31, 1998, the future minimum lease payments to be received by NHI under its operating leases, including debt service payments which are based on interest rates in effect at December 31, 1998, are as follows:
Advisory Agreement - NHI has entered into an Advisory Agreement with NHC whereby services related to investment activities and day-to-day management and operations are provided to NHI by NHC. As Advisor, NHC 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, the Advisor is entitled to annual compensation of $3,310,000 in 1998 ($3,101,000 in 1997 and $3,101,000 in 1996). The annual compensation is reduced by any compensation paid by NHI to its executive officers, if any. However, the payment of such annual compensation is conditional upon NHI having funds from operations sufficient to enable NHI to pay annual dividends of $2.00 per common share and upon NHI paying such dividends. Funds from operations is defined for these purposes as net income, plus depreciation and amortization, less the effect of any capital gains or losses included in such net income. Increases in compensation to NHC under the Advisory Agreement are proportional to increases in NHI's funds from operations per common share as defined above.
Note 20. Prior Year Reclassifications
Certain reclassifications have been made to the 1996 and 1997 financial statements to conform to the 1998 presentation.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES
To National Health Investors, Inc.:
We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of National Health Investors, Inc. included in Exhibit 13 to this Form 10-K, and have issued our report thereon dated January 13, 1999. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The financial statement schedules listed in the accompanying index to Exhibit 13 are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not otherwise a required part of the basic consolidated financial statements. The financial statement schedules have been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Nashville, Tennessee January 13, 1999
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K into the Company's previously filed Registration Statement File No. 33-72370 and No. 33-85398.
ARTHUR ANDERSEN LLP
Nashville, Tennessee March 11, 1999