| UNITED STATES | |
| SECURITIES AND EXCHANGE COMMISSION | |
| WASHINGTON, D.C. 20549 | |
FORM 10-Q | |
| (Mark One) | |
| [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OF 15(D) OF THE | |
| SECURITIES EXCHANGE ACT OF 1934 | |
| For the quarterly period ended March 31, 2005 | |
| OR | |
| [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF | |
| THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the transition period from ________ to _________ | |
| Commission file number 001-13487 | |
NATIONAL HEALTH REALTY, INC. | |
(Exact name of registrant as specified in its charter) | |
| Maryland | |
(State or other jurisdiction of incorporation or organization) | |
52-2059888 | |
(I.R.S. Employer Identification No.) | |
100 Vine Street | |
| Murfreesboro, TN | |
| 37130 | |
| (Address of principal executive offices) | |
| (Zip Code) | |
(615) 890-2020 | |
| Registrant's telephone number, including area code | |
| Indicate by check mark whether the registrant | |
| (1) Has filed all reports required to be filed by Section 13 or 15(d), of the Securities Exchange | |
| Act of 1934 during the preceding 12 months. | |
Yes X | No |
| (2) Has been subject to such filing requirements for the past 90 days. | |
Yes X | No |
| Indicate by check mark whether the registrant is an accelerated filer. Yes x No | |
| 9.868,403 shares of common stock were outstanding as of May 6, 2005 | |
| Item 1. Financial Statements. | ||
NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES | ||
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS | ||
| (in thousands, except share amounts) | ||
| March 31, | December 31, | |
| 2005 | 2004 | |
| (unaudited) | ||
| ASSETS | ||
| Real estate properties: | ||
| Land | $ 19,464 | $ 19,464 |
| Buildings and improvements | 147,768 | 147,768 |
| 167,232 | 167,232 | |
| Less accumulated depreciation | (47,774) | (46,306) |
| Real estate properties, net | 119,458 | 120,926 |
| Mortgage and other notes receivable | 13,457 | 13,553 |
| Interest and rent receivable | 153 | 367 |
| Cash and cash equivalents | 9,639 | 8,384 |
| Marketable securities | 5,846 | 6,565 |
| Deferred costs and other assets | 331 | 237 |
| Total Assets | $148,884 | $150,032 |
| LIABILITIES | ||
| Debt | $ 15,725 | $ 16,150 |
| Minority interest in consolidated subsidiaries | 13,826 | 13,888 |
| Accounts payable and other accrued expenses | 1,390 | 1,441 |
| Accrued interest | 53 | 53 |
| Dividends payable | 3,281 | 4,001 |
| Distributions payable to partners | 404 | 501 |
| Total Liabilities | 34,679 | 36,034 |
| Commitments, contingencies and guarantees | ||
| STOCKHOLDERS' EQUITY | ||
| Cumulative convertible preferred stock, | ||
| $.01 par value; 5,000,000 shares | ||
| authorized; none issued and outstanding | -- | -- |
| Common stock, $.01 par value; | ||
| 75,000,000 shares authorized; 9,868,403 and | ||
| 9,699,108 shares, respectively, issued and outstanding | 99 | 97 |
| Capital in excess of par value of common stock | 137,883 | 136,460 |
| Cumulative net income | 68,424 | 65,641 |
| Cumulative dividends | (94,563) | (91,282) |
| Unrealized gains on marketable securities | 2,362 | 3,082 |
| Total Stockholders' Equity | 114,205 | 113,998 |
| Total Liabilities and Stockholders' Equity | $148,884 | $150,032 |
The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.
The interim condensed balance sheet at December 31, 2004 is derived from the audited financial statements at that date.
| NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES | ||
| INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME | ||
| (unaudited) | ||
| Three Months Ended | ||
March 31, | ||
| 2005 | 2004 | |
| (in thousands,except share amounts) | ||
| REVENUES: | ||
| Rental income | $ 4,307 | $ 4,340 |
| Mortgage interest income | 593 | 1,070 |
| 4,900 | 5,410 | |
| EXPENSES: | ||
| Interest | 164 | 328 |
| Depreciation of real estate | 1,468 | 1,491 |
| Amortization of loan costs | -- | 8 |
| General and administrative | 266 | 189 |
| 1,898 | 2,016 | |
| INCOME BEFORE MINORITY INTEREST | ||
| IN CONSOLIDATED SUBSIDIARIES | ||
| AND NON-OPERATING INCOME | 3,002 | 3,394 |
| NON-OPERATING INCOME (investment | ||
| and interest income) | 123 | 102 |
| MINORITY INTEREST IN | ||
| CONSOLIDATED SUBSIDIARIES | (342) | (392) |
| NET INCOME | $ 2,783 | $ 3,104 |
| NET INCOME PER COMMON SHARE: | ||
| Basic | $ .29 | $ .32 |
| Diluted | $ .28 | $ .32 |
| WEIGHTED AVERAGE COMMON | ||
| SHARES OUTSTANDING: | ||
| Basic | 9,712,655 | 9,590,588 |
| Diluted | 9,774,491 | 9,814,093 |
| Common dividends per share declared | $ .3325 | $ .3325 |
The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.
| NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES | ||
| INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS | ||
| (unaudited) | ||
| Three Months Ended | ||
| March 31, | ||
| 2005 | 2004 | |
| (in thousands) | ||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||
| Net income | $ 2,783 | $ 3,104 |
| Depreciation of real estate | 1,468 | 1,491 |
| Amortization of loan costs | -- | 8 |
| Minority interest in consolidated subsidiaries | 342 | 392 |
| Decrease in interest and rent receivable | 214 | 254 |
| Increase in other assets | (94) | (54) |
| Increase (decrease) in accounts payable and accrued liabilities | (52) | 200 |
| NET CASH PROVIDED BY OPERATING ACTIVITIES | 4,661 | 5,395 |
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||
| Collection of mortgage notes receivable | 96 | 30,734 |
| Distribution from unconsolidated investment | -- | 67 |
| NET CASH PROVIDED BY INVESTING ACTIVITIES | 96 | 30,801 |
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||
| Payments on long-term debt | (425) | (31,174) |
| Dividends paid to stockholders | (4,001) | (4,723) |
| Distributions paid to partners | (501) | (598) |
| Issuance of common shares | 1,425 | -- |
| NET CASH USED IN FINANCING ACTIVITIES | (3,502) | (36,495) |
| INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 1,255 | (299) |
| CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | 8,384 | 4,982 |
| CASH AND CASH EQUIVALENTS, END OF PERIOD | $ 9,639 | $ 4,683 |
| Supplemental Information: | ||
| Cash payments for interest expense | $ 164 | $ 288 |
The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.
| NATIONAL HEALTH REALTY, INC. AND SUBSIDIARIES | |||||||||
| INTERIM CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY | |||||||||
| FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004 | |||||||||
| (dollars in thousands) | |||||||||
Unrealized | |||||||||
| Cumulative Convertible | Capital in | Gains | Total | ||||||
| Preferred Stock | Common Stock | Excess of | Cumulative | Cumulative | on Marketable | Stockholders' | |||
| Shares | Amount | Shares | Amount | Par Value | Net Income | Dividends | Securities | Equity | |
| BALANCE AT 12/31/03 | -- | $ -- | 9,590,588 | $ 96 | $135,536 | $ 54,206 | $(77,711) | $ 2,115 | $114,242 |
| Net income | -- | -- | -- | -- | -- | 3,104 | -- | -- | 3,104 |
| Unrealized gains on market- | |||||||||
| able securities | -- | -- | -- | -- | -- | -- | -- | 1,332 | 1,332 |
| Total comprehensive income | 4,436 | ||||||||
| Shares sold | -- | -- | -- | -- | -- | -- | -- | -- | -- |
| Dividends to common share- | |||||||||
| holders ($.3325 per share) | -- | -- | -- | -- | -- | -- | (3,189) | -- | (3,189) |
| BALANCE AT 3/31/04 | -- | $ -- | 9,590,588 | $ 96 | $135,536 | $ 57,310 | $(80,900) | $ 3,447 | $115,489 |
| BALANCE AT 12/31/04 | -- | $ -- | 9,699,108 | $ 97 | $136,460 | $ 65,641 | $(91,282) | $ 3,082 | $113,998 |
| Net income | -- | -- | -- | -- | -- | 2,783 | -- | -- | 2,783 |
| Unrealized losses on marketable | |||||||||
| securities | -- | -- | -- | -- | -- | -- | -- | (720) | (720) |
| Total comprehensive income | 2,063 | ||||||||
| Shares sold | -- | -- | 169,295 | 2 | 1,423 | -- | -- | -- | 1,425 |
| Dividends to common share- | |||||||||
| holders ($.3325 per share) | -- | -- | -- | -- | -- | -- | (3,281) | -- | (3,281) |
| BALANCE AT 3/31/05 | -- | $ -- | 9,868,403 | $ 99 | $137,883 | $ 68,424 | $(94,563) | $ 2,362 | $114,205 |
The accompanying notes to interim condensed consolidated financial statements are an integral part of these financial statements.
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
The unaudited financial statements to which these notes are attached include, in our opinion, all adjustments which are necessary to fairly present the financial position, results of operations and cash flows of National Health Realty, Inc. (NHR or the Company) and its majority owned subsidiaries. We assume that users of these interim financial statements have read or have access to the audited December 31, 2004, financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies, may be determined in that context. See our web page at www.nationalhealthrealty.com. Accordingly, footnotes and other disclosures which would substantially duplicate the disclosure contained in our most recent annual report to stockholders have been omitted. This quarter's interim financial information is not necessarily indicative of the results that may be expected for a full year for a variety of reasons including, but not limited to, changes in interest rates, rents, operations and the timing of debt and equity financings.
NOTE 2. EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common shares outstanding during the year.
Diluted earnings per share assumes the exercise of stock options using the treasury stock method.
The following table summarizes the earnings and the average number of common shares and common equivalent shares used in the calculation of basic and diluted earnings per share.
| Three Months Ended | ||
| March 31 | ||
2005 | 2004 | |
| BASIC: | ||
| Weighted average common shares | 9,712,655 | 9,590,588 |
| Net income available to common stockholders | $2,783,000 | $ 3,104,000 |
| Net income per common share | $ .29 | $ .32 |
| DILUTED: | ||
| Weighted average common shares | 9,712,655 | 9,590,588 |
| Stock options | 61,836 | 223,505 |
| Adjusted weighted-average common | ||
| shares outstanding | 9,774,491 | 9,814,093 |
| Net income available to common stockholders | $2,783,000 | $ 3,104,000 |
| Net income per common share | $ .28 | $ .32 |
NOTE 3. COMMITMENTS, CONTINGENCIES AND GUARANTEES
NHR began operating on December 31, 1997 after the exchange of NHR common stock for certain assets of NHC including mortgage notes receivable and real property. In order to protect the REIT status of NHR, certain NHC unitholders received limited partnership units of NHR/OP, L.P. rather than shares of common stock of NHR. As a result of certain unitholders' involuntary acceptance of NHR/OP, L.P. partnership units to benefit all other unitholders, we have indemnified those certain unitholders for any tax consequence resulting from any involuntary conversion of NHR/OP, L.P. partnership units into shares of NHR common stock. The indemnification expires at such time as the NHR/OP, L.P. unitholders are in a position to voluntarily convert their partnership units into NHR common stock on a tax free basis without violating applicable REIT requirements.
We believe that we have operated our business so as to qualify as a REIT under Sections 856 through 860 of the Internal Code of 1986, as amended (the "Code") and we intend to continue to operate in such a manner, but no assurance can be given that we will be able to qualify at all times. If we qualify as a REIT, we will generally not be subject to federal corporate income taxes on our net income that is currently distributed to stockholders. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that typically applies to corporate dividends. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would cause us to owe state and federal income taxes and would have a material adverse impact on our financial position, results of operations and cash flows.
NOTE 4. MORTGAGE NOTE RECEIVABLE
The following is a summary of the terms and amounts of mortgage and other notes receivable:
| Final | Interest Rate | Principal Amount | |
| 2016 | Monthly payments of $43,318, which | ||
| includes interest at the prime rate plus 2% | $ 4,645 | ||
| 2014 | Monthly payments of $38,250, which | ||
| includes interest at 8.5% | 4,307 | ||
| 2016 | Monthly payments of $7,845, which includes | ||
| interest at the prime rate plus 2% | 552 | ||
| 2014 | Monthly payments of $5,396, which includes | ||
| interest at 9.0% | 78 | ||
| 2005 | Monthly payments of $72,800, which | ||
| includes interest at 10.5%, plus balance | |||
| due December 31, 2005 | 10.25% | 2,088 | |
| 2005 | Monthly payments of $10,400, which | ||
| includes interest at 10.5%, plus balance | |||
| due December 31, 2005 | 10.25% | 434 | |
| 2005 | Monthly payments of $46,800, which | ||
| includes interest at 10.5%, plus balance | |||
| due December 31, 2005 | 10.25% | 1,353 | |
| Weighted Average Interest and Total | $13,457 | ||
FCC Notes Receivable Prepayments
On February 27, 2004, we received prepayments of the balance (approximately $30,384,000) of our 10.25% notes receivable from Florida Convalescent Centers, Inc. or affiliates (FCC) of Sarasota, Florida. The notes were scheduled to mature on October 31, 2004.
The proceeds of the prepayments plus cash on hand were used to pay 100% (approximately $31,175,000) of the credit facility debt, which had a current interest rate of 3.10%.
NOTE 5. INVESTMENT IN MARKETABLE SECURITIES
On September 17, 2002, we purchased 225,000 shares of National Health Investors, Inc. ("NHI") common stock for approximately $3,483,000. At March 31, 2005, the fair value of the shares is $5,846,000. This investment in marketable securities is classified as an investment in securities available for sale. Unrealized gains and losses on available for sale securities are recorded in stockholders' equity in accordance with SFAS No. 115.
NOTE 6. STOCK OPTION PLAN
Our stockholders have approved the 1997 Stock Option and Appreciation Rights Plan under which options to purchase shares of our common stock are available for grant to our consultants, advisors, directors and employees at a price no less than the market value of the stock on the date the option is granted. The vesting period and term of the options is from five to six years. The following table summarizes option activity:
Weighted | ||
| Number | Average | |
| of Shares | Exercise Price | |
| Outstanding December 31, 2001 | 412,000 | 8.51 |
| Options granted | 10,000 | 16.95 |
| Outstanding December 31, 2002 | 422,000 | 8.71 |
| Options granted | 15,000 | 14.80 |
| Options exercised | (25,000) | 11.67 |
| Outstanding December 31, 2003 | 412,000 | 8.75 |
| Options granted | 20,000 | 16.50 |
| Options exercised | (108,520) | 8.52 |
| Options forfeited | (20,000) | 11.42 |
| Outstanding December 31, 2004 | 303,480 | 9.17 |
| Options exercised | (173,420) | 8.61 |
| Outstanding March 31, 2005 | 130,060 | 9.91 |
| Options exercisable March 31, 2005 | 35,000 | $14.07 |
At March 31, 2005, options to purchase 35,000 shares of common stock are outstanding and exercisable. Exercise prices on the options range from $6.50 to $16.95 per share. The weighted average contractual life of options outstanding at March 31, 2005 is 1.13 years. We have reserved 500,000 shares of common stock for issuance under the stock option plan. At March 31, 2005, options to purchase 36,802 additional shares of common stock may be issued under the stock option plan.
Based on the number of options granted 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 our net income or earnings per share.
NOTE 7. TERM NOTE PAYABLE
In May 2004, we entered into a $17,000,000 bank term loan agreement ($15,725,000 outstanding at March 31, 2005). The proceeds of the loan were used to repay a note payable to NHC in the approximate amount of $14,922,000 (interest rate of LIBOR +2.25% with a floor of 4%) and a senior secured note payable to NHC in the approximate amount of $1,723,000 (interest rate of 8.4%). The term note payable requires monthly interest payments at the interest rate of 30 day LIBOR plus 1.50%. Quarterly principal payments in the amount of $425,000 are required until maturity (May 14, 2007) at which time the entire outstanding principal balance shall be due.
NOTE 8. NEW ACCOUNTING PRONOUNCEMENTS
In December of 2004, the FASB issued FASB Statement No. 153,Exchanges of Nonmonetary Assets-An Amendment of APB Opinion No. 29("Statement 153"). Statement 153 amends APB Opinion No. 29,Accounting for Non-monetary Transactions, that was issued in 1973. The amendments made by Statement 153 are based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for non-monetary exchanges of similar productive assets and replace it with a broader exception for exchanges of non-monetary assets that do not have "commercial substance". Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The provisions in Statement 153 are effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Early application is permitted and companies must apply the standard prospectively. The Company plans to adopt Statement 153 beginning July 1, 2005. The future effect of Statement 153 on the Company's financial statements will depend on whether the Company enters into certain non-monetary transactions. The Company, however, does not expect the adoption of Statement 153 to have a significant impact on its financial statements.
In December 2004, the FASB issued SFAS No. 123(R),Share-Based Payment.SFAS No. 123(R) replaces SFAS No. 123,Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees. SFAS No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. SFAS No. 123(R) is effective for the Company beginning January 1, 2006. The Company does not expect the adoption of this pronouncement to have a significant impact on the Company's financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
OVERVIEW
National Health Realty, Inc. (NHR or the Company) is a real estate investment trust (REIT) that began operations on January 1, 1998. Currently our assets, through our subsidiary NHR/OP, L.P. (the Operating Partnership), include the real estate of 23 health care facilities, including 16 licensed skilled nursing facilities, six assisted living facilities and one independent living center (the Health Care Facilities). We also own seven first and second mortgage promissory notes with principal balances totaling $13,457,000 (the Notes) at March 31, 2005 and secured by the real property of health care facilities. Our revenues are derived primarily from rent and interest income from these real estate properties and mortgages receivable. Our primary lessee is National HealthCare Corporation (NHC) which leases 14 of our 23 properties and guarantees the lease payments on the remaining nine properties.
Investment Restriction Removed
The NHR Advisory Agreement provides that we will not, without the prior approval of NHI, be actively or passively engaged in the pursuit of additional investment opportunities until the earlier of the termination of the Advisory Agreement or such time as NHC is no longer actively engaged as investment advisor to NHI. NHC announced on November 1, 2004 that it is no longer the advisor to NHI. Therefore, the restriction on NHR's investment activities has been removed.
Areas of Focus
Management is currently focusing upon our capacities as landlord and note holder. Our objectives are to (1) provide current income for distribution to stockholders, (2) to provide the opportunity for additional returns to investors by participating in any increase in the operating revenues of our leased properties; (3) to provide the opportunity to realize capital growth resulting from appreciation, if any, in the value of our portfolio properties; and (4) to preserve and protect stockholder's capital. We can offer no assurance that these objectives will be realized.
NHR's quarterly common stock dividend of 33.25 cents per share is expected to remain unchanged for the near future.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us 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 and cause our reported net income to vary significantly from period to period.
Our significant accounting policies and the associated estimates and the issues which impact these estimates are as follows:
Revenue Recognition - Mortgage Interest and Rental Income
We collect interest and rent from our customers. Generally our policy is to recognize revenues on an accrual basis as earned. However, we may in the future determine that, based on insufficient historical collections and the lack of expected future collections, revenue for interest or rent is not realizable. For any such nonperforming investments, our policy is to recognize interest or rental income only in the period when payments are received. If conclusions as to the realizibility of revenue change, our revenues could vary significantly from period to period.
Valuations of and Impairments to Our Investments
Since the passage of the Balanced Budget Act of 1997 which affected Skilled Nursing Facilities (SNFs) beginning in January 1999, the long-term care industry has experienced material reductions in government and private insurance reimbursement. Some legislative relief was granted in 2000 and 2001 as a result of the Balanced Budget Refinement Act of 1999, however, some of the add-on provisions expired October 1, 2002 materially reducing reimbursement. Effective October 1, 2004, the Centers for Medicare and Medicaid Services (CMS) issued the annual market basket (inflationary) increase of 2.8% for skilled nursing facilities' reimbursement of Medicare Part A. In the President's fiscal year 2006 budget request, the Administration has proposed a refinement of the Medicare resource utilization groups (RUGs) that would result in $25 billion in cuts to skilled nursing care over ten years. Further, the Administration has proposed more than $39 billion in Medicaid cuts also over ten years. The effect of these cuts on the future revenues of our tenants and borrowers, if implemented, cannot at this time be determined. The Centers for Medicare and Medicaid Services is currently preparing a report on skilled nursing facility payments that will recommend payment methodology changes to Congress.
The long-term health care industry has also experienced a dramatic increase in professional liability claims and in the cost of insurance to cover such claims. These factors have combined to cause a number of bankruptcy filings, bankruptcy court rulings and court judgments about refinancing which have affected some of our lessees and mortgagees.
Decisions about valuations and impairments of our investments require significant judgements and estimates on the part of management. We monitor the liquidity and credit worthiness of our tenants and borrowers on an ongoing basis. For real estate properties, the need to recognize an impairment is evaluated on a property by property basis in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144). Recognition of an impairment is based upon estimated future cash flows from a property compared to the carrying value of the property. For notes receivable, impairment recognition is based upon an evaluation of the estimated collectibility of loan payments on a specific loan basis in accordance with Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan - An Amendment of FASB Statements No. 5 and 15". While we believe that the carrying amounts of our properties and notes receivable are realizable, it is possible that future events could require us to make significant adjustments or revisions to these estimates.
REIT Status and Taxes
We believe that we have operated our 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 we intend to continue to operate in such a manner, but no assurance can be given that we will be able to qualify at all times. If we qualify as a REIT, we will generally not be subject to federal corporate income taxes on our net income that is currently distributed to our stockholders. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that typically applies to corporate dividends. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would cause us to owe state and federal income taxes and would have a material adverse impact on our financial position, results of operations and cash flows.
CAPITAL RESOURCES AND LIQUIDITY
FCC Notes and Bank Credit Facility Prepayments
On February 27, 2004, we received prepayment of the balance (approximately $30,384,000) of our 10.25% notes receivable from Florida Convalescent Centers, Inc. or affiliates (FCC) of Sarasota, Florida. The notes were scheduled to mature on October 31, 2004.
The proceeds of the prepayments plus cash on hand were used to pay 100% (approximately $31,175,000) of the credit facility debt, which had a current interest rate of 3.10%.
Term Note Payable
In May 2004, we borrowed $17,000,000 ($15,725,000 outstanding at March 31, 2005) under a bank term loan with an interest rate of 30 day LIBOR plus 1.5% and a three year term. The proceeds of the loan were used to repay a note payable to NHC in the approximate amount of $14,922,000 (interest rate of LIBOR + 2.25% with a floor of 4%) and a senior secured note payable to NHC in the approximate amount of $1,723,000 (interest rate of 8.4%). The new term note payable requires monthly interest payments plus quarterly principal payments in the amount of $425,000 until maturity on May 14, 2007 at which time the entire outstanding principal balance is due.
Leases
We lease our 23 health care facilities to various lessees: 14 properties are leased to NHC, and nine properties that were previously leased to NHC are leased to nine separate lessees not related to NHC. With respect to these nine properties, NHC remains obligated under its master lease agreement and continues to remain obligated to make the lease payments to us. Lease payments made to us from the new lessees are credited against NHC's overall rent obligation. At March 31, 2005, all payments are current. Our leases with NHC and the nine separate lessees have initial five or ten year terms with provisions for two five year renewal terms.
Contractual Cash Obligations
Our contractual cash obligations for periods subsequent to March 31, 2005 are as follows:
| Less than | |||||
| (in thousands) | Total | 1 Year | 2-3 Years | 4-5 Years | After 5 Years |
| Long-term debt | $15,725 | $1,700 | $14,025 | $ --- | $ --- |
| Total Contractual Cash Obligations | $15,725 | $1,700 | $14,025 | $ --- | $ --- |
Interest expense has not been included in the above table due to the difficulty in projecting variable rate interest. During the three months ended March 31, 2005, our cash payments for interest were $164,000.
We expect that current cash on hand, marketable securities, short-term notes receivable, operating cash flows, and as needed, our borrowing capacity will be adequate to finance our operating and financing requirements for 2005 and 2006.
Sources and Uses of Funds
Our leasing and mortgage services generated net cash from operating activities during the three months ended March 31, 2005 in the amount of $4,661,000 compared to $5,395,000 in the prior period. Net cash from operating activities generally includes net income plus non-cash expenses, such as depreciation and amortization and provision for loan losses, if any, and working capital changes. The period to period decrease is due primarily to reduced mortgage interest income offset in part by reduced interest expense.
Cash flows provided by investing activities totaled $96,000 during the three months ended March 31, 2005 compared to $30,801,000 in the prior period. Collection of mortgage notes receivable provided $96,000 of cash flow in the current period compared to $30,734,000 in the same period last year. Prior year collections include the prepayment of $30,384,000 of notes receivable from FCC. There are no distributions from an unconsolidated investment in the current period compared to $67,000 in the prior period.
Cash flows used in financing activities totaled $3,502,000 ($36,495,000 last year) and included payments on long-term debt of $425,000 ($31,174,000 last year), payments for dividends to stockholders of $4,001,000 ($4,723,000 last year), and payments for cash distributions to partners of $501,000 ($598,000 last year) offset in part by $1,425,000 in proceeds from issuance of common shares (- 0 - last year). The prior year payments on long-term debt include the prepayment of 100% of our credit facility debt of $31,175,000.
Dividends
We intend to pay quarterly distributions to our stockholders in an amount at least sufficient to satisfy the distribution requirements of a real estate investment trust. Such requirements necessitate that at least 90% of our taxable income be distributed annually. The primary source for distributions will be rental and interest income we earn on the real property and mortgage notes receivable.
Debt to Equity Ratio
At March 31, 2005, our debt as a percentage of total liabilities and capital was 11.6%.
Our current cash on hand, marketable securities, collections on leases and notes receivable, operating cash flows and, as needed, our borrowing capacity is expected to be adequate to pay or finance any scheduled debt reduction, plus our operating requirements for 2005 and into 2006.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004
Net income for the three months ended March 31, 2005 is $2,783,000 versus $3,104,000 for the same period in 2004, a decrease of 10.3%. Diluted earnings per common share is 28 cents in the 2005 period, compared to 32 cents in the 2004 period.
Total revenues for the three months ended March 31, 2005 decreased $510,000 to $4,900,000 from $5,410,000 for the three months ended March 31, 2004. Revenues from rental income decreased $33,000 or ..8% when compared to the same period in 2004. Revenues from mortgage interest decreased $477,000 or 44.6% in 2005 as compared to the same period in 2004.
Rental income declined because percentage rent reported in the first quarter of 2005 included a negative adjustment from the fourth quarter of 2004 which could not be previously determined. Percentage rent is calculated at 3% of the amount by which gross revenues of each leased health care center in each quarter of each year after 1999 exceed the gross revenues of such health care facility in the applicable quarter of 1999.
The decrease in mortgage income is the result of lower balances of notes receivable. We received prepayments on mortgages receivable totaling $30,384,000 in February 2004. Mortgage interest decreased also because of the reductions in the principal of mortgage notes receivable due to regular monthly amortization.
Total expenses for the 2005 three month period decreased $118,000 or 5.8% to $1,898,000 from $2,016,000 for the 2004 three month period. Interest expense decreased $164,000 or 50.0% in the 2005 three month period as compared to the 2004 period. Depreciation of real estate decreased $23,000 or 1.5%. General and administrative costs increased $77,000 or 40.7%.
Interest expense declined due to the paydown of our $31,175,000 credit facility in the first quarter of 2004. Interest expense also decreased because of regular quarterly payments on our bank term loan.
General and administrative expenses increased due to increased audit fees, increased costs of indemnification insurance, and expenses related to cash-less exercise of directors' stock options.
Revenues from investment and interest income for the three months ended March 31, 2005 increased $21,000 or 20.6% compared to the same period in 2004. Investment and interest income for the three months ended March 31, 2005 includes $101,000 of dividend income and $22,000 of bank interest income.
Funds From Operations
Our funds from operations ("FFO") for the three months ended March 31, 2005, on a diluted basis was $4,090,000, a decrease of $335,000 as compared to $4,425,000 for the same period in 2004. FFO represents net earnings available to common stockholders, excluding the effects of asset dispositions, plus depreciation associated with real estate investments. Diluted FFO assumes, if dilutive, the conversion of cumulative convertible preferred stock and the exercise of stock options using the treasury stock method.
We believe that funds from operations is an important supplemental measure of operating performance for a real estate investment trust. Because the historical cost accounting convention used for real estate assets requires straight-line depreciation (except on land), such accounting presentation implies that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen and fallen with market conditions, presentations of operating results for a real estate investment trust that use historical cost accounting for depreciation could be less informative, and should be supplemented with a measure such as FFO. The term FFO was designed by the real estate investment trust industry to address this issue. Our measure may not be comparable to similarly titled measures used by other REITs. Consequently, our funds from operations may not provide a meaningful measure of our performance as compared to that of other REITs. Since other REITs may not use our definition of FFO, caution should be exercised when comparing our Company's FFO to that of other REITs. Funds from operations in and of itself does not represent cash generated from operating activities in accordance with GAAP (funds from operations does not include changes in operating assets and liabilities) and therefore should not be considered an alternative to net earnings as an indication of operating performance, or to net cash flow from operating activities as determined by GAAP in the United States, as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs.
The following table reconciles net income to funds from operations:
| Net income applicable to common stockholders | $2,783 | $3,104 |
| Adjustments: | ||
| Real estate depreciation | 1,468 | 1,491 |
| Minority interest in NHR/OP, L.P. share | ||
| of add back for real estate depreciation | (161) | (170) |
| Funds from operations | $4,090 | $4,425 |
| Weighted average shares: | ||
| Basic | 9,712,655 | 9,590,588 |
| Diluted | 9,774,491 | 9,814,093 |
FUTURE RENTAL AND MORTGAGE INTEREST INCOME UNCERTAINTIES
Our rental and mortgage interest income revenues are believed by management to be secure. However, the majority of the income of our lessees and borrowers is derived from the lessees' participation in the Medicare and Medicaid programs. Adverse changes in these programs or the inability of our lessees and borrowers to participate in these programs would have a material adverse impact on the financial position, results of operations and cash flows of our lessees and borrowers and their resultant ability to service their obligations to us. Additionally, prepayment by our borrowers of their mortgage notes to us would reduce our future income.
INCOME TAXES
We intend at all times to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. Therefore, we will not be subject to federal income tax provided we distribute at least 90% of our annual REIT taxable income to our stockholders and meet other requirements to continue to qualify as a REIT. Accordingly, no provision for federal income taxes has been made in the consolidated financial statements. Our failure to continue to qualify under the applicable REIT qualification rules and regulations would have a material adverse impact on our financial position, results of operations and cash flows.
IMPACT OF INFLATION
Inflation may affect us in the future by changing the underlying value of our real estate or by impacting our cost of financing operations.
Our revenues are primarily from long-term investments. Our leases with NHC require increases in rent income based on increases in the revenues of the leased facilities.
FORWARD-LOOKING STATEMENTS
References throughout this document to the Company, "we" or "us" include National Health Realty, Inc. and its subsidiaries. In accordance with the Securities and Exchange Commission's "Plain English" guidelines, this Quarterly Report on Form 10-Q has been written in the first person. In this document, the words "we", "our", "ours" and "us" refer only to National Health Realty, Inc. and its subsidiaries and not any other person.
This Quarterly Report on Form 10-Q and other information we provide from time to time, contains certain "forward-looking" statements as that term is defined by the Private Securities Litigation Reform Act of 1995. All statements regarding our expected future financial position, results of operations, cash flows, funds from operations, continued performance improvements, ability to service and refinance our debt obligations, ability to finance growth opportunities, and similar statements including, without limitations, those containing words such as "believes", "anticipates", "expects", "intends", "estimates", "plans", and other similar expressions are forward-looking statements.
Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from those projected or contemplated in the forward-looking statements as a result of, but not limited to, the following factors:
* national and local economic conditions, including their effect on the availability and cost of labor, utilities and materials;
* the effect of government regulations and changes in regulations governing the healthcare industry, including compliance with such regulations by us and our borrowers and/or lessees;
* changes in Medicare and Medicaid payment levels and methodologies and the application of such methodologies by the government and its fiscal intermediaries;
* the ability to pay when due or refinance certain debt obligations when they mature;
* the competitive environment in which we operate;
See the notes to the quarterly financial statement, and "Item 1. Business" as is found in our 2004 Annual Report on Form 10-K for a discussion of various governmental regulations and other operating factors relating to the healthcare industry and the risk factors inherent in them. The Annual Report and Form 10-Q's are available on our web site atwww.nationalhealthrealty.com. You should carefully consider those risks before making any investment decisions in the Company. These risks and uncertainties are not the only ones facing the Company. There may be additional risks that we do not presently know of or that we currently deem immaterial. If any of the risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our Common Stock could decline, and you may lose all or part of your investment. Given these risks and uncertainties, we can give no assurances that these forward-looking statements will, in fact, transpire and, therefore, caution investors not to place undue reliance on them.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
INTEREST RATE RISK
Our cash and cash equivalents consist of highly liquid investments with a maturity of less than three months. Approximately $8,260,000 of our notes receivable bear interest at fixed interest rates. As the interest rates on these notes receivable are fixed, a hypothetical 10% change would have no impact on our future earnings and cash flows related to these instruments. Approximately $5,197,000 of our notes receivable bear interest at variable rates (generally at prime plus 2%). Because the interest rate of these instruments are variable, a hypothetical 10% change in interest rates would result in a related increase or decrease in annual interest income of approximately $40,000.
As of March 31, 2005, all of our long-term debt ($15,725,000) bears interest at floating interest rates. Because the interest rates of these instruments are variable, a hypothetical 10% increase in interest rates would result in additional annual interest expense of $61,000 and a 10% reduction in interest rates would result in annual interest expense declining $61,000.
We currently do not use any derivative instruments to hedge our interest rate expense or for trading purposes. The use of such instruments would be subject to strict approvals by our senior officers. Therefore, our exposure related to such derivative instruments is not material to our financial position, results of operations or cash flows.
Equity Price Risk
We consider our 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% increase in quoted market prices would result in a related 10% increase in the fair value of our investments in marketable securities of approximately $585,000 and 10% reduction in quoted market prices would result in a related 10% decrease in the fair value of our investments in marketable securities of approximately $585,000.
Item 4. Controls and Procedures
As of March 31, 2005, an evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO") and Principal Accounting Officer ("PAO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and PAO, concluded that the Company's disclosure controls and procedures were effective as of March 31, 2005. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls during the quarterly period ended or subsequent to March 31, 2005.PART II. OTHER INFORMATION
Item 1. Legal Proceedings. None
Item 2. Unregistered sales of Equity Securities and Use of Proceeds. Not applicable
Item 3. Defaults Upon Senior Securities. None
Item 4. Submission of Matters to a Vote of Security Holders.
(a) The annual meeting of the shareholders was held on May 3, 2005.
(b) Matters voted upon at the meeting are as follows:
PROPOSAL NO. 1: To re-elect two directors and elect three additional independent directions. Re-election of W. Andrew Adams and Ernest G. Burgess, III to serve as directors for terms of three years or until their successors have been fully elected and qualified. Election of Dr. J. Paul Abernathy and Mr. Joel H. Jobe to serve as directors for terms of two years or until their successors have been fully elected and qualified and election of Richard F. LaRoche, Jr. to serve as director for a term of one year or until his successor has been fully elected and qualified.
| Withholding | ||
| Nominee | Voting For | Authority |
| W. Andrew Adams | 7,590,240 | 452,075 |
| Ernest G. Burgess, III | 7,574,918 | 467,397 |
| Dr. J. Paul Abernathy | 7,741,352 | 300,963 |
| Joel H. Jobe | 7,753,735 | 288,581 |
| Richard F. LaRoche, Jr. | 7,576,656 | 465,659 |
PROPOSAL NO. 2: To ratify the implementation of the 2005 Stock Option, Restricted Stock and Stock Appreciation Rights Plan, pursuant to which 1,000,000 shares will be available to grant for stock options.
| Voting For | Voting Against | Abstaining |
| 5,082,536 | 1,280,491 | 38,572 |
PROPOSAL NO. 3: To ratify the Audit Committee's selection of BDO Seidman, LLP as independent auditors for the year ending December 31, 2005.
| Voting For | Voting Against | Abstaining |
| 8,019,675 | 12,282 | 10,358 |
Item 5. Other Information. None
Item 6. Exhibits.
(a) List of exhibits
| Exhibit No. | Description |
| 31 | Rule 13a-14(a)/15d-14(a) Certifications |
| 302 Certification of Robert G. Adams | |
| 302 Certification of Donald K. Daniel | |
99 | Additional Exhibits |
| 906 Certification of Robert G. Adams | |
| 906 Certification of Donald K. Daniel |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| NATIONAL HEALTH REALTY, INC. | |
| (Registrant) | |
| Date May 10, 2005 | /s/Robert G. Adams |
| Robert G. Adams | |
| President | |
| Date May 10, 2005 | /s/Donald K. Daniel |
| Donald K. Daniel | |
| Principal Accounting Officer | |
Exhibit 31
CERTIFICATION
I, Robert G. Adams, certify that:
1. I have reviewed this quarterly report on Form 10-Q of National Health Realty, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function);
a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
| Date: May 10, 2005 | |
| /s/Robert G. Adams | |
| Robert G. Adams | |
| President | |
CERTIFICATION
I, Donald K. Daniel, certify that:
1. I have reviewed this quarterly report on Form 10-Q of National Health Realty, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function);
a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
| Date: May 10, 2005 | |
| /s/Donald K. Daniel | |
| Donald K. Daniel | |
| Senior Vice President and Controller | |
| Principal Accounting Officer |
Exhibit 99
| Certification of Quarterly Report on Form 10-Q |
| of National Health Realty, Inc. |
| For The Quarter Ended March 31, 2005 |
The undersigned hereby certify, pursuant to 18 U.S.C. Section 906 of the Sarbanes-Oxley Act of 2002, that, to the undersigned's best knowledge and belief, the Quarterly Report on Form 10-Q for National Health Realty, Inc. ("Issuer") for the period ending March 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"):
| (a) | fully complies with the requirements of section 13(a) or 15(d) of the |
| Securities Exchange Act of 1934; and | |
| (b) | the information contained in the Report fairly presents, in all material |
| respects, the financial condition and results of operations of the Issuer. | |
This Certification accompanies the Quarterly Report on Form 10-Q of the Issuer for the quarterly period ended March 31, 2005.
This Certification is executed as of May 10, 2005.
| /s/Robert G. Adams | |
| Robert G. Adams | |
| President | |
| /s/Donald K. Daniel | |
| Donald K. Daniel | |
| Principal Accounting Officer | |
A signed original of this written statement required by Section 906 has been provided to National Health Realty, Inc. and will be retained by National Health Realty, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.