| NATIONAL HEALTHCARE CORP Item 1A Risk Factors You should carefully consider the risk factors set forth below, as well as the other information contained in this Annual Report on Form 10-K The risks described below are not the only risks facing us |
| Additional risks and uncertainties that are not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations |
| Any of the following risks could materially adversely affect our business, financial condition or results of operations |
| Risks Relating to Our Company We depend on reimbursement from Medicare, Medicaid and other third-party payors and reimbursement rates from such payors may be reduced |
| — We derive a substantial portion of our revenue from third-party payors, including the Medicare and Medicaid programs |
| For the twelve months ended December 31, 2005, we derived approximately 61prca of our net revenues from the Medicare, Medicaid and other government programs |
| Third-party payor programs are highly regulated and are subject to frequent and substantial changes |
| Changes in the reimbursement rate or methods of payment from third-party payors, including the Medicare and Medicaid programs, or the implementation of other measures to reduce reimbursements for our services has in the past, and could in the future, result in a substantial reduction in our revenues and operating margins |
| Additionally, net revenue realizable under third-party payor agreements can change after examination and retroactive adjustment by payors during the claims settlement processes or as a result of post-payment audits |
| Payors may disallow requests for reimbursement based on determinations that certain costs are not reimbursable or reasonable because additional documentation is necessary or because certain services were not covered or were not reasonable and medically necessary |
| There also continue to be new legislative and regulatory proposals that could impose further limitations on government and private payments to health care providers |
| In some cases, states have enacted or are considering enacting measures designed to reduce their Medicaid expenditures and to make changes to private health care insurance |
| We cannot assure you that adequate reimbursement levels will continue to be available for the services provided by us, which are currently being reimbursed by Medicare, Medicaid or private third-party payors |
| Further limits on the scope of services reimbursed and on reimbursement rates could have a material adverse effect on our liquidity, financial condition and results of operations |
| It is possible that the effects of further refinements to PPS that result in lower payments to us or cuts in state Medicaid funding could have a material adverse effect on our results of operations |
| See Item 1, “Business — Government Health Care Reimbursement Programs” and “Medicare Legislation and Regulations” and “Medicaid Legislation and Regulations” |
| We conduct business in a heavily regulated industry, and changes in, or violations of, regulations may result in increased costs or sanctions that reduce our revenue and profitability |
| — In the ordinary course of our business, we are regularly subject to inquiries, investigations and audits by federal and state agencies to determine whether we are in compliance with regulations governing the operation of, and reimbursement for, skilled nursing, assisted living and independent living facilities, hospice, home health agencies and our other operating areas |
| These regulations include those relating to licensure, conduct of operations, ownership of facilities, construction of new and additions to existing facilities, allowable costs, services and prices for services |
| In particular, various laws, including federal and state anti-kickback and anti-fraud statutes, prohibit certain business practices and relationships that might affect the provision and cost of health care services reimbursable under federal and/or state health care programs such as Medicare and Medicaid, including the payment or receipt of remuneration for the referral of patients whose care will be paid by federal governmental programs |
| Sanctions for violating the anti-kickback and anti-fraud statutes include criminal penalties and civil sanctions, including fines and possible exclusion from governmental programs such as Medicare and Medicaid |
| In addition, the Stark Law broadly defines the scope of prohibited physician referrals under federal health care programs to providers with which they have ownership or other financial arrangements |
| Many states have adopted, or are considering, legislative proposals similar to these laws, some of which extend beyond federal health care programs, to prohibit the payment or receipt of remuneration for the referral of patients and physician referrals regardless of the 14 _________________________________________________________________ [56]Table of Contents source of the payment for the care |
| These laws and regulations are complex and limited judicial or regulatory interpretation exists |
| We cannot assure you that governmental officials charged with responsibility for enforcing the provisions of these laws and regulations will not assert that one or more of our arrangements are in violation of the provisions of such laws and regulations |
| The regulatory environment surrounding the long-term care industry has intensified, particularly for larger for-profit, multi-facility providers like us |
| The federal government has imposed extensive enforcement policies resulting in a significant increase in the number of inspections, citations of regulatory deficiencies and other regulatory sanctions, including terminations from the Medicare and Medicaid programs, denials of payment for new Medicare and Medicaid admissions and civil monetary penalties |
| If we fail to comply, or are perceived as failing to comply, with the extensive laws and regulations applicable to our business, we could become ineligible to receive government program reimbursement, be required to refund amounts received from Medicare, Medicaid or private payors, suffer civil or criminal penalties, suffer damage to our reputation in various markets or be required to make significant changes to our operations |
| We are also subject to federal and state laws that govern financial and other arrangements between health care providers |
| These laws often prohibit certain direct and indirect payments or fee-splitting arrangements between health care providers that are designed to induce the referral of patients to a particular provider for medical products and services |
| Possible sanctions for violation of any of these restrictions or prohibitions include loss of eligibility to participate in reimbursement programs and/or civil and criminal penalties |
| Furthermore, some states restrict certain business relationships between physicians and other providers of health care services |
| Many states prohibit business corporations from providing, or holding themselves out as a provider of, medical care |
| From time to time, we may seek guidance as to the interpretation of these laws; however, there can be no assurance that such laws will ultimately be interpreted in a manner consistent with our practices |
| In addition, we could be forced to expend considerable resources responding to an investigation or other enforcement action under these laws or regulations |
| Furthermore, should we lose licenses or certifications for a number of our facilities as a result of regulatory action or otherwise, we could be deemed in default under some of our agreements, including agreements governing outstanding indebtedness |
| We also are subject to potential lawsuits under a federal whistle-blower statute designed to combat fraud and abuse in the health care industry |
| These lawsuits can involve significant monetary awards to private plaintiffs who successfully bring these suits |
| We have established policies and procedures that we believe are sufficient to ensure that our facilities will operate in substantial compliance with these anti-fraud and abuse requirements |
| While we believe that our business practices are consistent with Medicare and Medicaid criteria, those criteria are often vague and subject to change and interpretation |
| Aggressive anti-fraud actions, however, have had and could have an adverse effect on our financial position, results of operations and cash flows |
| We face additional federal requirements that mandate major changes in the transmission and retention of health information |
| HIPAA was enacted to ensure, first, that employees can retain and at times transfer their health insurance when they change jobs, and second, to simplify health care administrative processes |
| This simplification includes expanded protection of the privacy and security of personal medical data and requires the adoption of standards for the exchange of electronic health information |
| Among the standards that the Secretary of Health and Human Services has adopted pursuant to HIPAA are standards for the following: electronic transactions and code sets, unique identifiers for providers, employers, health plans and individuals, security and electronic signatures, privacy and enforcement |
| Although HIPAA was intended to ultimately reduce administrative expenses and burdens faced within the health care industry, we believe that implementation of this law has resulted and will continue to result in additional costs |
| We are unable to predict the future course of federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations, or the intensity of federal and state enforcement actions |
| Our failure to obtain or renew required regulatory approvals or licenses or to comply with applicable regulatory requirements, the suspension or revocation of our licenses or our disqualification from participation in certain federal and state reimbursement programs, or the imposition of other harsh enforcement sanctions could have a material adverse effect upon our operations and financial condition |
| 15 _________________________________________________________________ [57]Table of Contents Significant legal actions, which are commonplace in our industry, could subject us to increased operating costs and substantial uninsured liabilities, which would materially and adversely affect our liquidity and financial condition |
| — As is typical in the health care industry, we are subject to claims that our services have resulted in resident injury or other adverse effects |
| We, like our industry peers, have experienced an increasing trend in the frequency and severity of professional liability, workers’ compensation, and health insurance claims and litigation asserted against us |
| In some states in which we have significant operations, insurance coverage for the risk of punitive damages arising from professional liability claims and/or litigation may not, in certain cases, be available due to state law prohibitions or limitations of availability |
| We cannot assure you that we will not be liable for punitive damage awards that are either not covered or are in excess of our insurance policy limits |
| We also believe that there have been, and will continue to be, governmental investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims, as well as an increase in enforcement actions resulting from these investigations |
| Insurance is not available to cover such losses |
| Any adverse determination in a legal proceeding or governmental investigation, whether currently asserted or arising in the future, could have a material adverse effect on our financial condition |
| Due to the rising cost and limited availability of professional liability, workers’ compensation and health insurance, we are largely self-insured on all of these programs and as a result, there is no limit on the maximum number of claims or amount for which we or our insured subsidiary can be liable in any policy period |
| Although we base our loss estimates on independent actuarial analyses using the information we have to date, the amount of the losses could exceed our estimates |
| In the event our actual liability exceeds our estimates for any given period, our results of operations and financial condition could be materially adversely impacted |
| In addition, our insurance coverage might not cover all claims made against us |
| If we are unable to maintain our current insurance coverage, if judgments are obtained in excess of the coverage we maintain, if we are required to pay uninsured punitive damages, or if the number of claims settled within the self-insured retention currently in place significantly increases, we could be exposed to substantial additional liabilities |
| We cannot assure you that the claims we pay under our self-insurance programs will not exceed the reserves we have set aside to pay claims |
| Recent legislation and the increasing costs of being publicly owned are likely to impact our future consolidated financial position and results of operations |
| — In connection with the Sarbanes-Oxley Act of 2002, we are subject to rules requiring our management to report on the effectiveness of our internal controls over financial reporting, and further requiring our independent auditor to attest similarly to such effectiveness |
| If we fail to have effective internal controls and procedures for financial reporting in place, we could be unable to provide timely and reliable financial information which could, in turn, have an adverse effect on our business, results of operations, financial condition and cash flows |
| Significant regulatory changes, including the Sarbanes-Oxley Act and rules and regulations promulgated as a result of the Sarbanes-Oxley Act, have increased, and in the future are likely to further increase, general and administrative costs |
| In order to comply with the Sarbanes-Oxley Act of 2002, the listing standards of the American Stock exchange, and rules implemented by the Securities and Exchange Commission (SEC), we have had to hire additional personnel and utilize additional outside legal, accounting and advisory services, and may continue to require such additional resources |
| Moreover, in the rapidly changing regulatory environment in which we now operate, there is significant uncertainty as to what will be required to comply with many of the new rules and regulations |
| As a result, we may be required to spend substantially more than we currently estimate, and may need to divert resources from other activities, as we develop our compliance plans |
| New accounting pronouncements or new interpretations of existing standards could require us to make adjustments in our accounting policies that could affect our financial statements |
| — The Financial Accounting Standards Board, the SEC, or other accounting organizations or governmental entities issue new pronouncements or new interpretations of existing accounting standards that sometimes require us to change our accounting policies and procedures |
| Future pronouncements or interpretations could require us to change our policies or procedures and have a significant impact on our future statements |
| By undertaking to provide management services, advisory services, and/or financial services to other entities, we become at least partially responsible for meeting the regulatory requirements of those entities |
| — We provide 16 _________________________________________________________________ [58]Table of Contents management and/or financial services to health care centers, assisting living centers and independent living centers owned by third parties |
| At December 31, 2005, we perform management services (which include financial services) for 27 such centers and accounting and financial services for an additional 37 such centers |
| Furthermore, we provide advisory services to NHR, a publicly traded REIT and financial services to Management Advisory Source, LLC which company provides advisory services to NHI, a publicly traded REIT The “Risk Factors” contained herein as applying to us may in many instances apply equally to these other entities for which we provide services |
| We have in the past and may in the future be subject to claims from the entities to which we provide management, advisory or financial services, or to the claims of third parties to those entities |
| Any adverse determination in any legal proceeding regarding such claims could have a material adverse effect on our business, our results of operation, our financial condition and cash flows |
| The cost to replace or retain qualified nurses, health care professionals and other key personnel may adversely affect our financial performance, and we may not be able to comply with certain states’ staffing requirements |
| — We could experience significant increases in our operating costs due to shortages in qualified nurses, health care professionals and other key personnel |
| The market for these key personnel is highly competitive |
| We, like other health care providers, have experienced difficulties in attracting and retaining qualified personnel, especially facility administrators, nurses, certified nurses’ aides and other important health care providers |
| There is currently a shortage of nurses, and trends indicate this shortage will continue or worsen in the future |
| The difficulty our skilled nursing facilities are experiencing in hiring and retaining qualified personnel has increased our average wage rate |
| We may continue to experience increases in our labor costs due to higher wages and greater benefits required to attract and retain qualified health care personnel |
| Our ability to control labor costs will significantly affect our future operating results |
| Certain states in which we operate skilled nursing facilities have adopted minimum staffing standards and additional states may also establish similar requirements in the future |
| Our ability to satisfy these requirements will depend upon our ability to attract and retain qualified nurses, certified nurses’ assistants and other staff |
| Failure to comply with these requirements may result in the imposition of fines or other sanctions |
| If states do not appropriate sufficient additional funds (through Medicaid program appropriations or otherwise) to pay for any additional operating costs resulting from minimum staffing requirements, our profitability may be adversely affected |
| Although we currently have no collective bargaining agreements with unions at our facilities, there is no assurance this will continue to be the case |
| If any of our facilities enter into collective bargaining agreements with unions, we could experience or incur additional administrative expenses associated with union representation or our employees |
| Future acquisitions may be difficult to complete, use significant resources, or be unsuccessful and could expose us to unforeseen liabilities |
| — We may selectively pursue acquisitions or new developments in our target markets |
| Acquisitions and new developments may involve significant cash expenditures, debt incurrence, capital expenditures, additional operating losses, amortization of the intangible assets of acquired companies, dilutive issuances of equity securities and other expenses that could have a material adverse effect on our financial condition and results of operations |
| Acquisitions also involve numerous other risks, including difficulties integrating acquired operations, personnel and information systems, diversion of management’s time from existing operations, potential losses of key employees or customers of acquired companies, assumptions of significant liabilities, exposure to unforeseen liabilities of acquired companies and increases in our indebtedness |
| We cannot assure you that we will succeed in obtaining financing for any acquisitions at a reasonable cost or that any financing will not contain restrictive covenants that limit our operating flexibility |
| We also may be unable to operate acquired facilities profitably or succeed in achieving improvements in their financial performance |
| We also may face competition in acquiring any facilities |
| Our competitors may acquire or seek to acquire many of the facilities that would be suitable acquisition candidates for us |
| This could limit our ability to grow by acquisitions or increase the cost of our acquisitions |
| Upkeep of healthcare properties is capital intensive, requiring us to continually direct financial resources to the maintenance and enhancement of our physical plant and equipment |
| — As of December 31, 2005, we leased or owned 17 _________________________________________________________________ [59]Table of Contents 48 skilled nursing centers, 22 assisted living centers, and four independent living centers |
| Our ability to maintain and enhance our physical plant and equipment in a suitable condition to meet regulatory standards, operate efficiently and remain competitive in our markets requires us to commit a substantial portion of our free cash flow to continued investment in our physical plant and equipment |
| Certain of our competitors may operate centers that are not as old as our centers, or may appear more modernized than our centers, and therefore may be more attractive to prospective customers |
| In addition, the cost to replace our existing centers through acquisition or construction is substantially higher than the carrying value of our centers |
| We are undertaking a process to allocate more aggressively capital spending within our owned and leased centers in an effort to address issues that arise in connection with an aging physical plant |
| If factors, including factors indicated in these “Risk Factors” and other factors beyond our control, render us unable to direct the necessary financial and human resources to the maintenance, upgrade and modernization of our physical plant and equipment, our business, results of operations, financial condition and cash flow could be adversely impacted |
| Provision for losses in our financial statements may not be adequate |
| — Loss provisions in our financial statements for self-insured programs are made on an undiscounted basis in the relevant period |
| These provisions are based on internal and external evaluations of the merits of individual claims, analysis of claims history and independent actuarially determined estimates |
| The external analysis is completed by a certified actuary with extensive experience in the long-term care industry |
| Our management reviews the methods of determining these estimates and establishing the resulting accrued liabilities frequently, with any material adjustments resulting therefrom being reflected in current earnings |
| Although we believe that our provisions for self-insured losses in our financial statements are adequate, the ultimate liability may be in excess of the amounts recorded |
| In the event the provisions for loss reflected in our financial statements are inadequate, our financial condition and results of operations may be materially affected |
| Implementation of a new information technology infrastructure could cause business interruptions and negatively affect our profitability and cash flows |
| — We continue to refine and implement our information technology to improve customer service, enhance operating efficiencies and provide more effective management of business operations |
| Implementation of the new system and software and refinement of existing software carries risks such as cost overruns, project delays and business interruptions and delays |
| If we experience a material business interruption as a result of the implementation of our existing or future information technology infrastructure or are unable to obtain the projected benefits of this new infrastructure, it could adversely affect us and could have a material adverse effect on our business, results of operations, financial condition and cash flows |
| If we fail to compete effectively with other health care providers, our revenues and profitability may decline |
| — The long-term health care services industry is highly competitive |
| Our skilled nursing health care centers, assisted living centers, independent living facilities, home care services and other operations compete on a local and regional basis with other nursing centers, health care providers, and senior living service providers |
| Some of our competitors’ facilities are located in newer buildings and may offer services not provided by us or are operated by entities having greater financial and other resources than us |
| Our skilled nursing facilities face competition from skilled nursing, assisted living, independent living facilities, homecare services, and other operations that provide services comparable to those offered by our skilled nursing facilities |
| Many competing general acute care hospitals are larger and more established than our facilities |
| The long-term care industry is divided into a variety of competitive areas that market similar services |
| These competitors include skilled nursing, assisted living, independent living facilities, homecare services, hospice providers and other operations |
| Our facilities generally operate in communities that also are served by similar facilities operated by our competitors |
| Certain of our competitors are operated by not-for-profit, non-taxpaying or governmental agencies that can finance capital expenditures on a tax exempt basis and that receive funds and charitable contributions unavailable to us |
| Our facilities compete based on factors such as our reputation for quality care; the commitment and expertise of our staff; the quality and comprehensiveness of our treatment programs; the physical appearance, location and condition of our facilities and to a limited extend, the charges for services |
| In addition, we compete with other long-term care providers for customer referrals from hospitals |
| As a result, a failure to compete effectively with respect to referrals may have an adverse impact on our business |
| Many of these competing companies have greater financial and other resources 18 _________________________________________________________________ [60]Table of Contents than we have |
| We cannot assure you that increased competition in the future will not adversely affect our financial condition and results of operations |
| Possible changes in the case mix of patients as well as payor mix and payment methodologies may significantly affect our profitability |
| — The sources and amounts of our patient revenues will be determined by a number of factors, including licensed bed capacity and occupancy rates of our facilities, the mix of patients and the rates of reimbursement among payors |
| Likewise, reimbursement for therapy services will vary based upon payor and payment methodologies |
| Changes in the case mix of the patients as well as payor mix among private pay, Medicare and Medicaid will significantly affect our profitability |
| Particularly, any significant increase in our Medicaid population could have a material adverse effect on our financial position, results of operations and cash flow, especially if states operating these programs continue to limit, or more aggressively seek limits on, reimbursement rates |
| Private third-party payors continue to try to reduce health care costs |
| — Private third-party payors are continuing their efforts to control health care costs through direct contracts with health care providers, increased utilization review and greater enrollment in managed care programs and preferred provider organizations |
| These private payors increasingly are demanding discounted fee structures and the assumption by health care providers of all or a portion of the financial risk |
| We could be adversely affected by the continuing efforts of private third-party payors to limit the amount of reimbursement we receive for health care services |
| We cannot assure you that reimbursement payments under private third-party payor programs will remain at levels comparable to present levels or will be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to such programs |
| Future changes in the reimbursement rates or methods of private or third-party payors, including the Medicare and Medicaid programs, or the implementation of other measures to reduce reimbursement for our services could result in a substantial reduction in our net operating revenues |
| Finally, as a result of competitive pressures, our ability to maintain operating margins through price increases to private patients is limited |
| We are exposed to market risk due to the fact that outstanding debt and future borrowings are or will be subject to wide fluctuations based on changing interest rates |
| — Market risk is the risk of loss arising from adverse changes in market rates and prices such as interest rates, foreign currency exchange rates and commodity prices |
| Our primary exposure to market risk is interest rate risk associated with variable rate borrowings |
| Although we do not currently have a bank credit facility, we may be in the future as we resume development and acquisitions |
| Any future credit facility will provide for variable rates and if market interest rates rise, so will our required interest payments on any future borrowings under the credit facility |
| Although we currently have a modest amount of debt outstanding, we expect to borrow in the future to fund development and acquisitions |
| In the event we incur substantial indebtedness, this could have important consequences to you |
| For example, it could: • make it more difficult for us to satisfy our financial obligations; • increase our vulnerability to general adverse economic and industry conditions, including material adverse regulatory changes such as reductions in reimbursement; • limit our ability to obtain additional financing to fund future working capital, capital expenditures and other general corporate requirements, or to carry out other aspects of our business plan; • require us to dedicate a substantial portion of our cash flow from operations to payments on indebtedness, thereby reducing the availability of such cash flow to fund working capital, capital expenditures or other general corporate purposes, or to carry out other aspects of our business plan; • require us to pledge as collateral substantially all of our assets; • require us to maintain certain debt coverage and financial ratios at specified levels, thereby reducing our financial flexibility; 19 _________________________________________________________________ [61]Table of Contents • limit our ability to make material acquisitions or take advantage of business opportunities that may arise; • expose us to fluctuations in interest rates, to the extend our borrowings bear variable rates of interest; • limit our flexibility in planning for, or reacting to, changes in our business and the industry; and • place us at a competitive disadvantage compared to our competitors that have less debt |
| In addition, loan agreements governing our debt contain and may in the future contain financial and other restrictive covenants limiting our ability to engage in activities that may be in our long-term best interests |
| Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of some or all of our debts |
| We are permitted to incur substantially more debt, which could further exacerbate the risks described above |
| — We and our subsidiaries may be able to incur substantial additional indebtedness in the future |
| The terms of our current debt do not completely prohibit us or our subsidiaries from incurring additional indebtedness |
| If new debt is added to our current debt levels, the related risks that we now face could intensify |
| To service our indebtedness, we will require a significant amount of cash, the availability of which depends on many factors beyond our control |
| — Our ability to make payments on and to refinance our indebtedness, including our present indebtedness , and to fund planned capital expenditures, will depend on our ability to generate cash in the future |
| This, to a certain extend, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control |
| — We cannot assure you that our business will generate cash flow from operations, that anticipated revenue growth and improvement of operating efficiencies will be realized or that future borrowings will be available to us in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs |
| We may need to refinance all or a portion of our indebtedness on or before maturity, sell assets or curtain discretionary capital expenditures |