Diversicare Healthcare Services, Inc. - FORM 10-Q

Attached files

file	filename
EXCEL - IDEA: XBRL DOCUMENT - Diversicare Healthcare Services, Inc.	Financial_Report.xls
EX-31.1 - EXHIBIT - Diversicare Healthcare Services, Inc.	dvcr-ex311x93014certificat.htm
EX-32 - EXHIBIT - Diversicare Healthcare Services, Inc.	dvcr-ex32x93014certificati.htm
EX-31.2 - EXHIBIT - Diversicare Healthcare Services, Inc.	dvcr-ex312x93014certificat.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________________________

FORM 10-Q

________________________________

CHECK ONE:



ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended: September 30, 2014



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission file No.: 1-12996

________________________________

Diversicare Healthcare Services, Inc.

(exact name of registrant as specified in its charter)

________________________________



Delaware		62-1559667
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

1621 Galleria Boulevard, Brentwood, TN 37027

(Address of principal executive offices) (Zip Code)

(615) 771-7575

(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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and a “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	¨	Accelerated filer	¨

Non-accelerated filer	¨	Smaller reporting Company	ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý

6,156,332

(Outstanding shares of the issuer’s common stock as of October 31, 2014)

Part I. FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED BALANCE SHEETS

(in thousands)



	September 30, 2014			December 31, 2013
	(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents	$	3,855		$	3,781
Receivables, less allowance for doubtful accounts of $5,333 and $3,879, respectively	42,067			32,658
Other receivables	899			1,118
Prepaid expenses and other current assets	2,339			2,442
Income tax refundable	515			763
Current assets of discontinued operations	390			2,870
Deferred income taxes	7,757			6,579
Total current assets	57,822			50,211
PROPERTY AND EQUIPMENT, at cost	97,605			93,572
Less accumulated depreciation and amortization	(53,288		)	(48,516		)
Discontinued operations, net	600			8,987
Property and equipment, net	44,917			54,043
OTHER ASSETS:
Deferred income taxes	12,130			15,912
Deferred financing and other costs, net	1,839			1,914
Investment in unconsolidated affiliate	399			487
Other noncurrent assets	6,180			5,698
Acquired leasehold interest, net	7,940			8,228
Noncurrent assets of discontinued operations	4			1,251
Total other assets	28,492			33,490
	$	131,231		$	137,744

The accompanying notes are an integral part of these interim consolidated financial statements.

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

(continued)



	September 30, 2014			December 31, 2013
	(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt and capitalized lease obligations	$	7,208		$	4,549
Trade accounts payable	7,863			7,177
Current liabilities of discontinued operations	136			1,359
Accrued expenses:
Payroll and employee benefits	14,200			12,255
Self-insurance reserves, current portion	12,159			11,711
Other current liabilities	6,024			5,116
Total current liabilities	47,590			42,167
NONCURRENT LIABILITIES:
Long-term debt and capitalized lease obligations, less current portion	42,851			43,552
Self-insurance reserves, noncurrent portion	15,378			16,375
Noncurrent liabilities of discontinued operations	—			5,952
Other noncurrent liabilities	13,875			15,214
Total noncurrent liabilities	72,104			81,093
COMMITMENTS AND CONTINGENCIES
SERIES C REDEEMABLE PREFERRED STOCK
$.10 par value, 5,000 shares authorized and issued, and 0 and 5,000 shares outstanding, respectively	—			4,918
SHAREHOLDERS’ EQUITY:
Series A preferred stock, authorized 200,000 shares, $.10 par value, none issued and outstanding	—			—
Common stock, authorized 20,000,000 shares, $.01 par value, 6,388,000 and 6,307,000 shares issued, and 6,156,000 and 6,075,000 shares outstanding, respectively	64			63
Treasury stock at cost, 232,000 shares of common stock	(2,500		)	(2,500		)
Paid-in capital	19,891			19,570
Accumulated deficit	(5,450		)	(8,435		)
Accumulated other comprehensive loss	(468		)	(569		)
Total shareholders’ equity of Diversicare Healthcare Services, Inc.	11,537			8,129
Noncontrolling interest	—			1,437
Total shareholders’ equity	11,537			9,566
	$	131,231		$	137,744

The accompanying notes are an integral part of these interim consolidated financial statements.

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts, unaudited)



	Three Months Ended September 30,
	2014			2013
PATIENT REVENUES, net	$	90,331		$	64,631
EXPENSES:
Operating	73,006			54,186
Lease and rent expense	6,876			4,817
Professional liability	1,743			947
General and administrative	5,582			5,006
Depreciation and amortization	1,812			1,634
Restructuring	—			944
Total expenses	89,019			67,534
OPERATING INCOME (LOSS)	1,312			(2,903		)
OTHER INCOME (EXPENSE):
Equity in net income (loss) of unconsolidated affiliate	(30		)	63
Interest expense, net	(916		)	(855		)
Total other expense	(946		)	(792		)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	366			(3,695		)
BENEFIT (PROVISION) FOR INCOME TAXES	(147		)	1,374
INCOME (LOSS) FROM CONTINUING OPERATIONS	219			(2,321		)
INCOME (LOSS) FROM DISCONTINUED OPERATIONS:
Operating loss, net of tax of $384 and $1,435, respectively	(585		)	(2,444		)
Gain on disposal, net of tax of $(3,009) and $0, respectively	4,513			—
Income (loss) from discontinued operations	3,928			(2,444		)
NET INCOME (LOSS)	4,147			(4,765		)
Less: (income) loss attributable to noncontrolling interests	—			(17		)
NET INCOME (LOSS) ATTRIBUTABLE TO DIVERSICARE HEALTHCARE SERVICES, INC.	4,147			(4,782		)
PREFERRED STOCK DIVIDENDS	(48		)	(86		)
NET INCOME (LOSS) FOR DIVERSICARE HEALTHCARE SERVICES, INC. COMMON SHAREHOLDERS	$	4,099		$	(4,868	)
NET INCOME (LOSS) PER COMMON SHARE FOR DIVERSICARE HEALTHCARE SERVICES, INC. SHAREHOLDERS:
Per common share – basic
Continuing operations	$	0.03		$	(0.41	)
Discontinued operations	0.65			(0.42		)
	$	0.68		$	(0.83	)
Per common share – diluted
Continuing operations	$	0.03		$	(0.41	)
Discontinued operations	0.63			(0.42		)
	$	0.66		$	(0.83	)
COMMON STOCK DIVIDENDS DECLARED PER SHARE OF COMMON STOCK	$	0.055		$	0.055
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic	6,020,000			5,892,000
Diluted	6,248,000			5,892,000

The accompanying notes are an integral part of these interim consolidated financial statements.

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands and unaudited)



	Three Months Ended September 30,
	2014			2013
NET INCOME (LOSS)	$	4,147		$	(4,765	)
OTHER COMPREHENSIVE INCOME (LOSS):
Change in fair value of cash flow hedge, net of tax	254			100
Less: reclassification adjustment for amounts recognized in net income	(128		)	(135		)
Total other comprehensive income (loss)	126			(35		)
COMPREHENSIVE INCOME (LOSS)	4,273			(4,800		)
Less: comprehensive (income) loss attributable to noncontrolling interest	—			(17		)
COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO DIVERSICARE HEALTHCARE SERVICES, INC.	$	4,273		$	(4,817	)

The accompanying notes are an integral part of these interim consolidated financial statements.

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts, unaudited)



	Nine Months Ended September 30,
	2014			2013
PATIENT REVENUES, net	$	250,443		$	184,558
EXPENSES:
Operating	200,517			152,014
Lease and rent expense	19,094			14,398
Professional liability	5,360			4,212
General and administrative	16,077			15,769
Depreciation and amortization	5,252			4,572
Restructuring	—			944
Total expenses	246,300			191,909
OPERATING INCOME (LOSS)	4,143			(7,351		)
OTHER INCOME (EXPENSE):
Equity in net loss of unconsolidated affiliate	(89		)	(152		)
Interest expense, net	(2,757		)	(2,140		)
Debt retirement costs	—			(320		)
Total other income (expense)	(2,846		)	(2,612		)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	1,297			(9,963		)
BENEFIT (PROVISION) FOR INCOME TAXES	(538		)	3,947
INCOME (LOSS) FROM CONTINUING OPERATIONS	759			(6,016		)
INCOME (LOSS) FROM DISCONTINUED OPERATIONS:
Operating loss, net of tax of $732 and $1,101, respectively	(1,069		)	(1,875		)
Gain on disposal, net of taxes of $(3,009) and $0, respectively	4,513			—
Income (loss) from discontinued operations	3,444			(1,875		)
NET INCOME (LOSS)	4,203			(7,891		)
Less: (income) loss attributable to noncontrolling interests	25			(51		)
NET INCOME (LOSS) ATTRIBUTABLE TO DIVERSICARE HEALTHCARE SERVICES, INC.	4,228			(7,942		)
PREFERRED STOCK DIVIDENDS	(220		)	(258		)
NET INCOME (LOSS) FOR DIVERSICARE HEALTHCARE SERVICES, INC. COMMON SHAREHOLDERS	$	4,008		$	(8,200	)
NET INCOME (LOSS) PER COMMON SHARE FOR DIVERSICARE HEALTHCARE SERVICES, INC. SHAREHOLDERS:
Per common share – basic
Continuing operations	$	0.09		$	(1.07	)
Discontinued operations	0.57			(0.32		)
	$	0.66		$	(1.39	)
Per common share – diluted
Continuing operations	$	0.09		$	(1.07	)
Discontinued operations	0.56			(0.32		)
	$	0.65		$	(1.39	)
COMMON STOCK DIVIDENDS DECLARED PER SHARE OF COMMON STOCK	$	0.165		$	0.165
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic	6,004,000			5,878,000
Diluted	6,171,000			5,878,000

The accompanying notes are an integral part of these interim consolidated financial statements.

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands and unaudited)



	Nine Months Ended September 30,
	2014			2013
NET INCOME (LOSS)	4,203			(7,891		)
OTHER COMPREHENSIVE INCOME (LOSS):
Change in fair value of cash flow hedge, net of tax	478			469
Less: reclassification adjustment for amounts recognized in net income	(376		)	(226		)
Total other comprehensive income (loss)	102			243
COMPREHENSIVE INCOME (LOSS)	4,305			(7,648		)
Less: comprehensive (income) loss attributable to noncontrolling interest	25			(51		)
COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO DIVERSICARE HEALTHCARE SERVICES, INC.	$	4,330		$	(7,699	)

The accompanying notes are an integral part of these interim consolidated financial statements.

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands and unaudited)



	Nine Months Ended September 30,
	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	4,203			(7,891		)
Discontinued operations	3,444			(1,875		)
Income (loss) from continuing operations	759			(6,016		)
Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used in) operating activities:
Depreciation and amortization	5,252			4,572
Provision for doubtful accounts	4,235			2,785
Deferred income tax benefit	(467		)	(4,214		)
Provision for self-insured professional liability, net of cash payments	815			660
Stock-based compensation	441			809
Equity in net losses of unconsolidated affiliate, net of investment	88			(99		)
Debt retirement costs	—			320
Other	(468		)	(182		)
Changes in assets and liabilities affecting operating activities:
Receivables, net	(13,775		)	(5,551		)
Prepaid expenses and other assets	(323		)	(1,124		)
Trade accounts payable and accrued expenses	4,131			2,565
Net cash provided by (used in) continuing operations	688			(5,475		)
Discontinued operations	(600		)	5,117
Net cash provided by (used in) operating activities	88			(358		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(4,228		)	(4,109		)
Acquisition of property and equipment through business combination	—			(14,742		)
Change in restricted cash	33			(3,894		)
Proceeds from sale of discontinued operations	16,500			—
Deposits and other deferred balances	(64		)	—
Net cash provided by (used in) continuing operations	12,241			(22,745		)
Discontinued operations	(61		)	1,808
Net cash provided by (used in) investing activities	12,180			(20,937		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt obligations	(14,850		)	(28,757		)
Proceeds from issuance of debt	16,808			50,500
Financing costs	(180		)	(1,341		)
Issuance and redemption of employee equity awards	(30		)	28
Redemption of preferred stock	(4,918		)	—
Payment of common stock dividends	(993		)	(647		)
Payment of preferred stock dividends	(220		)	(258		)
Distributions to noncontrolling interest	(1,411		)	(158		)
Payment for preferred stock restructuring	(448		)	(434		)
Net cash provided by (used in) continuing operations	$	(6,242	)	$	18,933
Discontinued operations	(5,952		)	(150		)
Net cash provided by (used in) financing activities	(12,194		)	18,783

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands and unaudited)

(continued)



	Nine Months Ended September 30,
	2014		2013
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	$	74	$	(2,512	)
CASH AND CASH EQUIVALENTS, beginning of period	3,781		5,928
CASH AND CASH EQUIVALENTS, end of period	$	3,855	$	3,416
SUPPLEMENTAL INFORMATION:
Cash payments of interest, net of amounts capitalized	$	2,496	$	1,854
Cash payments of income taxes	$	66	$	74

The accompanying notes are an integral part of these interim consolidated financial statements.

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014 AND 2013


1.	BUSINESS

Diversicare Healthcare Services, Inc. (together with its subsidiaries, “Diversicare Healthcare Services” or the “Company”) provides long-term care services to nursing center patients in nine states, primarily in the Southeast, Midwest, and Southwest. The Company’s centers provide a wide range of health care services to their patients and residents that include nursing, personal care, and social services. In addition to the nursing, personal care and social services usually provided in long-term care centers, the Company’s nursing centers also offer a variety of comprehensive rehabilitation services, as well as nutritional support services. The Company's continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Missouri, Ohio, Tennessee, and Texas. The Company's operating results also include the results of certain discontinued operations that have been reclassified on the face of the financial statements to reflect the discontinued status of these operations.

As of September 30, 2014, the Company’s continuing operations consist of 51 skilled nursing and long-term care centers with 6,229 licensed beds. The Company owns 13 and leases 38 of its nursing centers.


2.	CONSOLIDATION AND BASIS OF PRESENTATION OF FINANCIAL STATEMENTS

The interim consolidated financial statements include the operations and accounts of Diversicare Healthcare Services and its subsidiaries, all wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation. Any variable interest entities (“VIEs”) in which the Company has an interest are consolidated when the Company identifies that it is the primary beneficiary. The Company had one variable interest entity related to a nursing center in West Virginia that was dissolved in the first quarter of 2014 as a result of the asset purchase of the Rose Terrace nursing center as further described in Note 8, and is no longer consolidated into the interim consolidated financial statements of the Company. The investment in an unconsolidated affiliate (a 50 percent-owned joint venture partnership) is accounted for using the equity method and is described in Note 9.

The interim consolidated financial statements for the three and nine month periods ended September 30, 2014 and 2013, included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management of the Company, the accompanying interim consolidated financial statements reflect all normal, recurring adjustments necessary to present fairly the Company’s financial position at September 30, 2014, and the results of operations for the three month and nine month periods ended September 30, 2014 and 2013, and cash flows for the nine month periods ended September 30, 2014 and 2013. The Company’s balance sheet information at December 31, 2013, was derived from its audited consolidated financial statements as of December 31, 2013.

The results of operations for the periods ended September 30, 2014 and 2013, are not necessarily indicative of the operating results that may be expected for a full year. These interim consolidated financial statements should be read in connection with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013.


3.	RECENT ACCOUNTING GUIDANCE

In February 2013, the FASB issued Accounting Standards Update ("ASU") 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The amendments in this update require an entity to provide information about the amounts reclassified from accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the income statement or in the notes, significant amounts reclassified from accumulated other comprehensive income by the net income line item. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity changing the criteria for reporting discontinued operations. The ASU states that only those disposed components (or components held-for-sale) representing a strategic shift that have a significant effect on operations and financial results will be reported in discontinued operations. The ASU also required expanded disclosures about discontinued operations in the financial statement notes. The ASU is effective for disposals (or classifications as held-for-sale) that occur within annual periods beginning on or after December 15, 2014 and interim periods within those annual periods. Early application is permitted, but only for those disposals that have not been reported in financial statements previously issued or available for issuance. We have chosen to

early adopt this ASU and have applied the new criteria in determining the accounting treatment for the nursing centers exited during 2014. The adoption of this guidance did not have a material impact on the Company's consolidated financial results.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.


4.	LONG-TERM DEBT AND INTEREST RATE SWAP

The Company has agreements with a syndicate of banks for a mortgage term loan ("Original Mortgage Loan") and the Company’s revolving credit agreement ("Original Revolver"). On May 1, 2013, the Company executed an Amended and Restated Credit Agreement (the "Credit Agreement") which modified the terms of the Original Mortgage Loan and the Original Revolver Agreements dated February 28, 2011. The Credit Agreement increases the Company's borrowing capacity to $65,000,000 allocated between a $45,000,000 Mortgage Loan ("Amended Mortgage Loan") and a $20,000,000 Revolver ("Amended Revolver"). Loan acquisition costs associated with the Amended Mortgage Loan and the Amended Revolver were capitalized in the amount of $1,341,000 and are being amortized over the five-year term of the agreements.

Under the terms of the amended agreements, the syndicate of banks provided the Amended Mortgage Loan with an original balance of $45,000,000 with a five-year maturity through April 30, 2018, and a $20,000,000 Amended Revolver through April 30, 2018. The Amended Mortgage Loan has a term of five years, with principal and interest payable monthly based on a 25-year amortization. Interest is based on LIBOR plus 4.5%. A portion of the Amended Mortgage Loan is effectively fixed at 6.87% pursuant to an interest rate swap with a notional amount of $21,847,000. As of September 30, 2014, the interest rate related to the Amended Mortgage Loan was 4.65%. The Amended Mortgage Loan is secured by thirteen owned nursing centers, related equipment and a lien on the accounts receivable of these centers. The Amended Mortgage Loan and the Amended Revolver are cross-collateralized. The Company’s Amended Revolver has an interest rate of LIBOR plus 4.5% and is secured by accounts receivable and is subject to limits on the maximum amount of loans that can be outstanding under the revolver based on borrowing base restrictions.

Effective March 31, 2014, the Company entered into the Second Amendment to the Amended and Restated Revolver ("Second Amendment"). The Second Amendment temporarily increased the Amended Revolver capacity from the $20,000,000 in the original Amended Revolver to $27,500,000 through September 30, 2014, as a result of the increase in receivables related to new facilities that continue to progress through the change in ownership process. Effective July 1, 2014, the Company entered into the Third Amendment to the Amended and Restated Revolver ("Third Amendment"). The Third Amendment makes the previously temporary increase to the Amended Revolver capacity from the $20,000,000 in the original Amended Revolver to $27,500,000, a permanent change to the borrowing capacity as a result of the increase in receivables related to new facilities that continue to progress through the change in ownership process.

As of September 30, 2014, the Company had $6,000,000 borrowings outstanding under the revolving credit facility compared to $3,000,000 outstanding as of December 31, 2013. The outstanding borrowings on the revolver primarily reflect the Company's approach to accumulated Medicaid and Medicare receivables at recently acquired facilities as these facilities proceed through the change in ownership process with CMS. Annual fees for letters of credit issued under this Revolver are 3.00% of the amount outstanding. The Company has ten letters of credit with a total value of $7,991,000 outstanding as of September 30, 2014. Considering the balance of eligible accounts receivable, the letter of credit, the amounts outstanding under the revolving credit facility and the maximum loan amount of $27,500,000, the balance available for borrowing under the revolving credit center is $12,728,000 at September 30, 2014.

Effective March 27, 2014, the Company executed its purchase option to acquire all assets associated with the Rose Terrace nursing center in Culloden, West Virginia from Milton Holdings, LLC which was considered a variable interest entity ("VIE") by the Company and consolidated prior to the date of this transaction. See Note 8 for further information on the VIE considerations. In conjunction with the purchase of the assets, the Company entered into an interest-only $8,000,000 term loan ("Rose Terrace Note") with a maturity date of March 27, 2015. The structure of the Rose Terrace Note reflected the Company's intent to sell the property and transfer operations to an unrelated third-party operator as further disclosed in Note 11. This transaction closed on July 1, 2014, at which time the Rose Terrace Note was paid in full.

The Company’s debt agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. The Company is in compliance with all such covenants at September 30, 2014.

Interest Rate Swap Transaction

As part of the debt agreements entered into in March 2011, the Company entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The Company designated its interest rate swap as a cash flow hedge and the earnings component of the hedge, net of taxes, is reflected as a component of other comprehensive income (loss). In conjunction with the amendment to the credit facility, the Company retained the previously agreed upon interest rate swap terms, and redesignated the interest rate swap as a cash flow hedge. The interest rate swap agreement requires the Company to make fixed rate payments to the bank calculated on the applicable notional amount of $21,847,000 at an annual fixed rate of 6.87% while the bank is obligated to make payments to the Company based on LIBOR on the same notional amounts.

The Company assesses the effectiveness of its interest rate swap on a quarterly basis, and at September 30, 2014, the Company determined that the interest rate swap was effective. The interest rate swap valuation model indicated a net liability of $755,000 at September 30, 2014. The fair value of the interest rate swap is included in “other noncurrent liabilities” on the Company’s interim consolidated balance sheet. The balance of accumulated other comprehensive loss at September 30, 2014 is $468,000 and reflects the liability related to the interest rate swap, net of the income tax benefit of $287,000. As the Company’s interest rate swap is not traded on a market exchange, the fair value is determined using a valuation based on a discounted cash flow analysis. This analysis reflects the contractual terms of the interest rate swap agreement and uses observable market-based inputs, including estimated future LIBOR interest rates. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy, in accordance with the FASB guidance set forth in ASC 820, Fair Value Measurement.


5.	INSURANCE MATTERS

Professional Liability and Other Liability Insurance

The Company has professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. Effective July 1, 2013, the Company established a wholly-owned, consolidated offshore limited purpose insurance subsidiary, SHC Risk Carriers, Inc. (“SHC”) which has issued a policy insuring claims made against all of the Company's nursing centers in Florida and Tennessee, the Company’s formerly operated Arkansas and West Virginia facilities, and several of the Company’s nursing centers in Alabama, Kentucky, Ohio, and Texas. The SHC policy provides coverage limits of either $500,000 or $1,000,000 per medical incident with a sublimit per center of $1,000,000 and total annual aggregate policy limits of $5,000,000. All other centers within the Company’s portfolio are covered through various commercial insurance policies which provide similar coverage limits per medical incident, per location, and on an aggregate basis for covered centers. These policies provide coverage limits of $1,000,000 per claim and have sublimits of $3,000,000 per center, with varying aggregate policy limits.

Reserve for Estimated Self-Insured Professional Liability Claims

Because the Company’s actual liability for existing and anticipated professional liability and general liability claims will likely exceed the Company’s limited insurance coverage, the Company has recorded total liabilities for reported and estimated future claims of $26,377,000 as of September 30, 2014. This accrual includes estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, actual liabilities related to settlements, including settlements to be paid over time, and estimates of legal costs related to these claims. All losses are projected on an undiscounted basis and are presented without regard to any potential insurance recoveries. Amounts are added to the accrual for estimates of anticipated liability for claims incurred during each period, and amounts are deducted from the accrual for settlements paid on existing claims during each period.

The Company evaluates the adequacy of this liability on a quarterly basis. Semi-annually, the Company retains a third-party actuarial firm to assist in the evaluation of the current portion of this reserve. Merlinos & Associates, Inc. (“Merlinos”) assisted management in the preparation of an estimate of the appropriate accrual for the current claims period and for incurred, but not reported, general and professional liability claims based on data furnished as of May 31, 2014. The Company used this estimate from Merlinos in the preparation of its estimate of liability for incurred, but unreported professional liability claims as of September 30, 2014.

On a quarterly basis, the Company obtains reports of asserted claims and lawsuits incurred. These reports, which are provided by the Company’s insurers and a third-party claims administrator, contain information relevant to the actual expense already incurred with each claim as well as the third-party administrator’s estimate of the anticipated total cost of the claim. This information is reviewed by the Company quarterly and provided to the actuary semi-annually. Based on the Company’s evaluation of the actual claim information obtained, the semi-annual estimates received from the third-party actuary, the amounts paid and committed for settlements of claims and on estimates regarding the number and cost of additional claims anticipated in the future, the reserve estimate for a particular period may be revised upward or downward on a quarterly basis. Any increase in the accrual decreases results of operations in the period and any reduction in the accrual increases results of operations during the period.

As of September 30, 2014, the Company is engaged in 48 professional liability lawsuits. Seven lawsuits are currently scheduled for trial or arbitration during the next twelve months, and it is expected that additional cases will be set for trial or hearing. The Company’s cash expenditures for self-insured professional liability costs from continuing operations were $3,641,000 and $3,005,000 for the nine months ended September 30, 2014 and 2013, respectively.

The Company follows current accounting guidance set forth in FASB ASU 2010-24, “Presentation of Insurance Claims and Related Insurance Recoveries,” that clarifies that a health care entity should not net insurance recoveries against a related professional liability claim, and that the amount of the claim liability should be determined without consideration of insurance recoveries. Accordingly, the Company has recorded assets and equal liabilities of $217,000 at September 30, 2014 and $440,000 at December 31, 2013, respectively.

Although the Company adjusts its accrual for professional and general liability claims on a quarterly basis and retains a third-party actuarial firm semi-annually to assist management in estimating the appropriate accrual, professional and general liability claims are inherently uncertain, and the liability associated with anticipated claims is very difficult to estimate. Professional liability cases have a long cycle from the date of an incident to the date a case is resolved, and final determination of the Company’s actual liability for claims incurred in any given period is a process that takes years. As a result, the Company’s actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given period. Each change in the amount of this accrual will directly affect the Company’s reported earnings and financial position for the period in which the change in accrual is made.

Other Insurance

With respect to workers’ compensation insurance, substantially all of the Company’s employees became covered under either an indemnity insurance plan or state-sponsored programs in May 1997. The Company is completely self-insured for workers’ compensation exposures prior to May 1997. The Company has been and remains a non-subscriber to the Texas workers’ compensation system and is, therefore, completely self-insured for employee injuries with respect to its Texas operations. From June 30, 2003 until June 30, 2007, the Company’s workers’ compensation insurance programs provided coverage for claims incurred with premium adjustments depending on incurred losses. For the period from July 1, 2008 through September 30, 2014, the Company is covered by a prefunded deductible policy. Under this policy, the Company is self-insured for the first $500,000 per claim, subject to an aggregate maximum of $3,000,000. The Company funds a loss fund account with the insurer to pay for claims below the deductible. The Company accounts for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred. The liability for workers’ compensation claims is $261,000 at September 30, 2014. The Company has a non-current receivable for workers’ compensation policies covering previous years of $1,183,000 as of September 30, 2014. The non-current receivable is a function of payments paid to the Company’s insurance carrier in excess of the estimated level of claims expected to be incurred.

As of September 30, 2014, the Company is self-insured for health insurance benefits for certain employees and dependents for amounts up to $175,000 per individual annually. The Company provides reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate. The liability for reported claims and estimates for incurred but unreported claims is $899,000 at September 30, 2014. The differences between actual settlements and reserves are included in expense in the period finalized.


6.	STOCK-BASED COMPENSATION

Overview of Plans

In December 2005, the Compensation Committee of the Board of Directors adopted the 2005 Long-Term Incentive Plan (“2005 Plan”). The 2005 Plan allows the Company to issue stock options and other share and cash based awards. Under the 2005 Plan, 700,000 shares of the Company's common stock have been reserved for issuance upon exercise of equity awards granted thereunder. All grants under this plan expire 10 years from the date the grants were authorized by the Board of Directors.

In June 2008, the Company adopted the Advocat Inc. 2008 Stock Purchase Plan for Key Personnel (“Stock Purchase Plan”). The Stock Purchase Plan provides for the granting of rights to purchase shares of the Company's common stock to directors and officers and 150,000 shares of the Company's common stock has been reserved for issuance under the Stock Purchase Plan. The Stock Purchase Plan allows participants to elect to utilize a specified portion of base salary, annual cash bonus, or director compensation to purchase restricted shares or restricted share units (“RSU's”) at 85% of the quoted market price of a share of the Company's common stock on the date of purchase. The restriction period under the Stock Purchase Plan is generally two years from the date of purchase and during which the shares will have the rights to receive dividends, however, the restricted share certificates will not be delivered to the shareholder and the shares cannot be sold, assigned or disposed of during the restriction period. No grants can be made under the Stock Purchase Plan after April 25, 2018.

In April 2010, the Compensation Committee of the Board of Directors adopted the 2010 Long-Term Incentive Plan (“2010 Plan”), followed by approval by the Company's shareholders in June 2010. The 2010 Plan allows the Company to issue stock appreciation rights, stock options and other share and cash based awards. Under the 2010 Plan, 380,000 shares of the Company's common stock have been reserved for issuance upon exercise of equity awards granted.

Equity Grants and Valuations

During 2014 and 2013, the Compensation Committee of the Board of Directors approved grants totaling approximately 68,000 and 69,000 shares of restricted common stock to certain employees and members of the Board of Directors, respectively. The fair value of restricted shares are determined as the quoted market price of the underlying common shares at the date of the grant. The restricted shares typically vest 33% on the first, second and third anniversaries of the grant date. Unvested shares may not be sold or transferred. During the vesting period, dividends accrue on the restricted shares, but are paid in additional shares of common stock upon vesting, subject to the vesting provisions of the underlying restricted shares. The restricted shares are entitled to the same voting rights as other common shares. Upon vesting, all restrictions are removed. In addition to the shares of restricted common stock granted in 2013, the Compensation Committee of the Board of Directors also approved grants of approximately 55,000 unrestricted shares of common stock to certain employees. These shares were granted without restrictions and considered fully vested upon the date of the grant.

Summarized activity of the equity compensation plans is presented below:



			Weighted
			Average
	Shares		Exercise Price
Outstanding, December 31, 2013	333,000		$	6.64
Granted	—		—
Exercised	(22,000	)	4.54
Expired or cancelled	(36,000	)	7.87
Outstanding, September 30, 2014	275,000		$	6.65

Exercisable, September 30, 2014	244,000		$	6.77



			Weighted
			Average
	Restricted		Grant Date
	Shares		Fair Value
Outstanding, December 31, 2013	118,000		$	5.41
Granted	68,000		5.51
Dividend Equivalents	3,000		7.72
Vested	(57,000	)	5.61
Cancelled	(2,000	)	5.47
Outstanding September 30, 2014	130,000		$	5.43

Summarized activity of the Restricted Share Units for the Stock Purchase Plan is as follows:



			Weighted
			Average
	Restricted		Grant Date
	Share Units		Fair Value
Outstanding, December 31, 2013	41,000		$	5.35
Granted	25,000		5.51
Dividend Equivalents	1,000		6.86
Vested	(21,000	)	5.70
Cancelled	—		—
Outstanding September 30, 2014	46,000		$	5.30

Prior to 2013, the Compensation Committee of the Board of Directors also approved grants of Stock Only Stock Appreciation Rights (“SOSARs”) and Stock Options at the market price of the Company's common stock on the grant date. The SOSARs and Options vest 33% on the first, second and third anniversaries of the grant date, and expire 10 years from the grant date. The SOSARs and Options were valued and recorded in the same manner, and will be settled with issuance of new stock for the difference between the market price on the date of exercise and the exercise price. The Company estimated the total recognized and unrecognized compensation using the Black-Scholes-Merton equity grant valuation model.

In computing the fair value estimates using the Black-Scholes-Merton valuation model, the Company took into consideration the exercise price of the equity grants and the market price of the Company's stock on the date of grant. The Company used an expected volatility that equals the historical volatility over the most recent period equal to the expected life of the equity grants. The risk free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. The Company used the expected dividend yield at the date of grant, reflecting the level of annual cash dividends currently being paid on its common stock.

While no SOSARs or Options were granted during 2014 and 2013, previously granted SOSARs and Options remain outstanding as of September 30, 2014. The following table summarizes information regarding stock options and SOSAR grants outstanding as of September 30, 2014:



	Weighted
	Average		Intrinsic		Intrinsic
Range of	Exercise	Grants	Value-Grants	Grants	Value-Grants
Exercise Prices	Prices	Outstanding	Outstanding	Exercisable	Exercisable
$10.40 to $11.59	11.11	57,000	1,000	57,000	1,000
$2.37 to $6.21	5.49	218,000	1,145,000	187,000	994,000
		275,000		244,000

Stock-based compensation expense is non-cash and is included as a component of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. The Company recorded total stock-based compensation expense of $441,000 and $809,000 in the nine month periods ended September 30, 2014 and 2013, respectively.


7.	EARNINGS (LOSS) PER COMMON SHARE

Information with respect to basic and diluted net earnings (loss) per common share is presented below in thousands, except per share:



	Three Months Ended September 30,						Nine Months Ended September 30,

	2014			2013			2014			2013
Numerator: Income (loss) amounts attributable to Diversicare Healthcare Services, Inc. common shareholders:
Income (loss) from continuing operations	$	219		$	(2,321	)	$	759		$	(6,016	)
Less: income (loss) attributable to noncontrolling interests	—			(17		)	25			(51		)
Income (loss) from continuing operations attributable to Diversicare Healthcare Services, Inc.	219			(2,338		)	784			(6,067		)
Preferred stock dividends	(48		)	(86		)	(220		)	(258		)
Income (loss) from continuing operations attributable to Diversicare Healthcare Services, Inc. common shareholders	171			(2,424		)	564			(6,325		)
Income (loss) from discontinued operations, net of income taxes	3,928			(2,444		)	3,444			(1,875		)
Net income (loss) attributable to Diversicare Healthcare Services, Inc. common shareholders	$	4,099		$	(4,868	)	$	4,008		$	(8,200	)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Net income (loss) per common share:
Per common share – basic
Income (loss) from continuing operations	$	0.03		$	(0.41	)	$	0.09		$	(1.07	)
Income (loss) from discontinued operations
Operating income (loss), net of taxes	(0.10		)	(0.42		)	(0.18		)	(0.32		)
Gain on disposal, net of taxes	0.75			—			0.75			—
Discontinued operations, net of taxes	0.65			(0.42		)	0.57			(0.32		)
Net income (loss) per common share – basic	$	0.68		$	(0.83	)	$	0.66		$	(1.39	)
Per common share – diluted
Income (loss) from continuing operations	$	0.03		$	(0.41	)	$	0.09		$	(1.07	)
Income (loss) from discontinued operations
Operating income (loss), net of taxes	(0.10		)	(0.42		)	(0.17		)	(0.32		)
Gain on disposal, net of taxes	0.73			—			0.73			—
Discontinued operations, net of taxes	0.63			(0.42		)	0.56			(0.32		)
Net income (loss) per common share - diluted	$	0.66		$	(0.83	)	$	0.65		$	(1.39	)
Denominator: Weighted Average Common Shares Outstanding:
Basic	6,020			5,892			6,004			5,878
Diluted	6,248			5,892			6,171			5,878

The effects of 228,000 SOSARs and options outstanding were excluded from the computation of diluted earnings per common share for the three-month and nine-month periods ended September 30, 2013, because these securities would have been anti-dilutive due to the net loss. The weighted average common shares for basic and diluted earnings for common shares were the same due to the year-to-date loss in these periods.


8.	VARIABLE INTEREST ENTITY

Accounting guidance requires that a variable interest entity (“VIE”) must be consolidated by the primary beneficiary in accordance with the provisions set forth in FASB ASC 810, Consolidation, as mentioned in Note 2 above. The primary beneficiary is the party that has both the power to direct activities of a VIE that most significantly impact the entity's economic performance and the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. We perform an ongoing qualitative analysis to determine if we are the primary beneficiary of a VIE. The Company had one variable interest entity related to a nursing center in West Virginia that was dissolved in the first quarter of 2014 as a result of the asset purchase of the Rose Terrace nursing center, and is no longer consolidated into the interim consolidated financial statements of the Company.

Rose Terrace Health and Rehabilitation Center

On December 28, 2011, the Company completed construction of Rose Terrace Health and Rehabilitation Center (“Rose Terrace”), its third health care center in West Virginia. The 90-bed skilled nursing center is located in Culloden, West Virginia, along the Huntington-Charleston corridor, and offers 24-hour skilled nursing care designed to meet the care needs of both short and long-term nursing patients. The Rose Terrace nursing center utilizes a Certificate of Need the Company obtained in June 2009, when the Company completed the acquisition of certain assets of a skilled nursing center in West Virginia.

The Company initially entered into a lease agreement with the real estate developer that constructed, furnished, and equipped Rose Terrace. The agreement included the right to purchase the center and all associated assets beginning at the end of the first year of the initial term of the lease and continuing through the fifth year for a purchase price ranging from 110% to 120% of the total project cost. On March 27, 2014, the Company exercised this purchase option and acquired the land, building, and all other assets of the Rose Terrace nursing center from the real estate developer for the contractually agreed upon price of $7,693,000.

Prior to the exercise of the purchase option, the Company had determined it was the primary beneficiary of the VIE based on the ownership of the Certificate of Need, the fixed price purchase option described above, the Company’s ability to direct the activities that most significantly impact the economic performance of the VIE, and the right to receive potentially significant benefits from the VIE. Accordingly, as the primary beneficiary, the Company consolidated the balance sheet and results of operations of the VIE for periods prior to the exercise of the purchase option. However, after the exercise of the purchase option, the previous owners paid the outstanding debt related to the entity in full. Subsequently, as further disclosed in Note 11, the Company sold the Rose Terrace facility and all assets associated with the facility. As a result of these events, the entity is no longer considered a VIE.

9. EQUITY METHOD INVESTMENT

The investment in unconsolidated affiliate reflected on the interim consolidated balance sheet relates to a pharmacy joint venture partnership in which the Company owns 50%. The joint venture was initially funded by the Company and its partner and began operations during 2012. This investment in unconsolidated affiliate is accounted for using the equity method as the Company exerts significant influence, but does not control or otherwise consolidate the entity. The investment in unconsolidated affiliate balance at September 30, 2014, was $399,000 as compared to $487,000 at December 31, 2013. Additionally, the Company's share of the net profits and losses of the unconsolidated affiliate are reported in equity in net earnings or losses of unconsolidated affiliate in our statement of operations. The Company's equity in the net losses of unconsolidated affiliate for the nine month period ended September 30, 2014, was $89,000 as compared to $152,000 for the nine month period ended September 30, 2013.


10.	BUSINESS DEVELOPMENT

Acquisitions

On March 6, 2013, the Company entered into an asset purchase agreement ("the Agreement") with Cumberland & Ohio Co. of Texas, as receiver of the assets of SeniorTrust of Florida, Inc. to acquire certain land, improvements, furniture, fixtures and equipment, and personal property of five facilities, all located in Kansas, for an aggregate purchase price of $15,500,000. The purchase of the Kansas facilities was completed on May 1, 2013. The Company also incurred $338,000 in acquisition-related expenses associated with this transaction. The five facilities acquired under the Agreement include the following:


•	77-bed skilled nursing facility known as Chanute HealthCare Center


•	119-bed skilled nursing facility known as Haysville HealthCare Center


•	80-bed skilled nursing facility known as Larned HealthCare Center


•	62-bed skilled nursing facility known as Sedgwick HealthCare Center


•	80-bed skilled nursing facility known as Council Grove HealthCare Center

As a result of the consummation of the Agreement, the Company allocated the purchase price of $15,500,000 between the assets associated with the transaction based on the fair value of the acquired net assets. In addition to the assets acquired in the transaction, the Company also assumed liabilities of $758,000 which resulted in total cash outlay of $14,742,000. The allocation of the purchase price was determined with the assistance of HealthTrust LLC, a third-party real estate valuation firm. The allocation for the net assets acquired is as follows:



	As of May 1, 2013
Purchase Price	$	15,500,000

Land	$	2,130,000
Buildings	12,127,000
Furniture, fixtures, and equipment	1,200,000
Inventory	43,000

Less: Liabilities assumed	$	758,000

Total cash paid	$	14,742,000

Lease Agreements and Assumption of Operations

On August 1, 2014, the Company completed a transaction to assume operations of two centers in Ohio. The centers included in this transaction are a 142-bed skilled nursing facility and a 42-bed assisted living center. The lease provides for an initial lease term of 10 years. The centers were already operating and treating patients on the transition date. There was no purchase price paid to enter into the lease agreement for these skilled nursing centers.

On July 1, 2014, the Company completed a transaction to enter the state of Missouri through the assumption of operations of three facilities totaling 339 skilled nursing beds. The nursing centers are owned by a real estate investment trust ("REIT"), and the lease provides for an initial 15-year lease term with a 5-year renewal option. The centers were already operating and treating patients on the transition date. There was no purchase price paid to enter into the lease agreement for these skilled nursing centers.

On June 1, 2014, the Company assumed operations at Diversicare of Nicholasville, an existing 73-bed facility in Nicholasville, Kentucky. The nursing center is owned by a real estate investment trust ("REIT"), and the lease provides for an initial 15-year lease term with a 5-year renewal option. The center was already operating and treating patients on the transition date. There was no purchase price paid to enter into the lease agreement for this skilled nursing center.

On March 1, 2014, the Company assumed operations at Diversicare of Big Springs, an existing 135-bed facility in Huntsville, Alabama. The nursing center is owned by an unrelated third-party and the lease provides for an initial 10-year lease term with two additional 5-year renewal options. The additional skilled nursing center increases the Company's footprint in Alabama to seven centers, and the third center in the Huntsville market. The center was already operating and treating patients on the transition date. There was no purchase price paid to enter into the lease agreement for this skilled nursing center.

On October 1, 2013, the Company assumed operations at four existing nursing centers, three in Ohio and one in Indiana. The nursing centers are owned by a REIT and the lease of these centers provides for an initial 15-year lease term with a 5-year renewal option. This transaction represents an increase in the Company's footprint in the Midwest, expanding into one new state, Indiana. All four of the centers were operating and treating patients on the transition date. There was no purchase price paid to enter into the lease agreement for these skilled nursing centers.

On August 1, 2013, the Company assumed operations at Seneca Place, an existing 107-bed facility in Louisville, Kentucky. The nursing center is owned by a REIT, and the lease provides for an initial 15-year lease term with a 5-year renewal option. The center was already operating and treating patients on the transition date. There was no purchase price paid to enter into the lease agreement for this skilled nursing center.


11.	DISCONTINUED OPERATIONS

West Virginia Disposition

only with respect to two other skilled nursing facilities in West Virginia, state licensure and regulatory approval. The Company concurrently entered into an operations transfer agreement with respect to the two other skilled nursing facilities located in Danville and Ivydale, West Virginia.

Effective July 1, 2014, the Company completed the transaction with Rose Terrace Acq., LLC to sell Rose Terrace, a 90-bed skilled nursing facility in Culloden, West Virginia for a sales price of $16,500,000. The Company also entered into the Fifteenth Amendment to Consolidated Amended and Restated Master Lease ("Master Lease") with Omega Health Investors, Inc. ("Omega") to terminate the lease only with respect to two other skilled nursing facilities in West Virginia, and concurrently entered into an operations transfer agreement with American Health Care Management, LLC, an affiliate of the purchaser with respect to two other skilled nursing facilities located in Danville and Ivydale, West Virginia. Upon completion of the transaction, Diversicare no longer operates any skilled nursing centers in the state of West Virginia. In conjunction with the closing of the sale, the Company paid the balance of the $8,000,000 mortgage loan outstanding on the Rose Terrace facility.

The transaction resulted in a gain on the disposition of West Virginia which, along with the results of operations for these nursing facilities, is presented within Discontinued Operations on the Interim Consolidated Statements of Operations. The pretax gain on the transaction was $7,522,000. The tax expense associated with the gain was $(3,009,000) for which the Company plans to apply net operating loss carryforwards from our deferred tax assets to substantially offset and minimize the cash outlay for this transaction.

These centers contributed revenues of $10,988,000 and $15,944,000 and net income of $165,000 and $680,000 during the nine months ended September 30, 2014 and 2013, respectively. The net income or loss for the nursing centers included in discontinued operations does not reflect any allocation of corporate general and administrative expense or any allocation of corporate interest expense. The Company considered these additional costs along with the centers' future prospects based upon operating history when determining the contribution of the skilled nursing centers to its operations.

Arkansas Lease Termination

Effective September 1, 2013, the Company entered into an agreement with Omega to terminate its lease with respect to eleven nursing centers and 1,181 licensed beds located in Arkansas and concurrently entered into operation transfer agreements to transfer the operations of each of those eleven centers to an operator selected by Omega. Upon the completion of the transaction, the Company no longer operates any skilled nursing centers in the State of Arkansas. In connection with the closing of this transaction, the Company and Omega entered into the Master Lease most recently amended on January 22, 2013. This amendment effectively modifies the terms of the Master Lease to terminate the terms surrounding the eleven nursing centers in Arkansas, and only as to those eleven centers, and effectively reduces the annual rent payable under the Master Lease by $5,000,000.

As a result of this transaction, the Company has reclassified the operations of these centers as discontinued operations for all periods presented in the accompanying interim consolidated financial statements. These centers contributed revenues of $0 and $40,161,000 and net loss of $935,000 and $2,432,000 during the nine months ended September 30, 2014 and 2013, respectively. The net loss in 2014 primarily relates to professional liability expense incurred during the first three quarters of 2014. The net income or loss for the nursing centers included in discontinued operations does not reflect any allocation of corporate general and administrative expense or any allocation of corporate interest expense. The Company considered these additional costs along with the centers' future prospects based upon operating history when determining the contribution of the skilled nursing centers to its operations.

The discontinued assets and liabilities of the disposed skilled nursing centers in Arkansas and West Virginia have been reclassified and are segregated in the interim consolidated balance sheets as assets and liabilities of discontinued operations. The current asset amounts, which are primarily composed of net accounts receivable of $390,000 and $2,870,000 at September 30, 2014 and December 31, 2013, respectively. The current liabilities are primarily composed of trade payables and various accrued expenses of $136,000 and $1,359,000 at September 30, 2014 and December 31, 2013, respectively. The Company expects to collect the balance of the accounts receivable and pay the remaining trade payables and accrued expenses in the ordinary course of business. The Company did not transfer the accounts receivable or liabilities to the new owners or operators of the facilities. Further, in accordance with Company accounting policy, the reserve for professional liability and workers' compensation will remain in the consolidated liability accounts as future payment of these liabilities will be paid through the Company's future operating cash flows.


12.	SUBSEQUENT EVENTS

Effective October 1, 2014, the Company completed a transaction to assume operations of a 62-bed skilled nursing facility in Greenville, Kentucky. This facility is expected to contribute in excess of $4.5 million in annual revenues with initial lease terms of 14 years.

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Diversicare Healthcare Services, Inc. provides long-term care services to nursing center patients in nine states, primarily in the Southeast, Midwest and Southwest. Our centers provide a range of health care services to their patients and residents that include nursing, personal care, and social services. In addition to the services usually provided in long-term care centers, we also offer a variety of comprehensive rehabilitation services as well as nutritional support services. As of September 30, 2014, the Company’s continuing operations consist of 51 skilled nursing and long-term care centers with 6,229 licensed beds. The Company owns 13 and leases 38 of its nursing centers.

The nursing center and licensed bed count includes the following recent business development activity:


•	Effective August 1, 2014, the Company completed a transaction to assume operations of two centers in Ohio. The centers included in this transaction are a 142-bed skilled nursing facility and a 42-bed assisted living center. The Medicaid and Medicare certification processes for these facilities are currently underway, and are expected to be completed in the fourth quarter of 2014.


•	Three facilities totaling 339 skilled nursing beds in Missouri for which the Company entered into a lease agreement and assumed operations effective July 1, 2014. The Medicaid and Medicare certification processes for these facilities are currently underway, and are expected to be completed in the fourth quarter of 2014.


•	The 73-bed facility in Nicholasville, Kentucky, for which the Company entered into a lease agreement and assumed operations effective June 1, 2014. The Medicaid and Medicare certification processes for this facility are currently underway, and are expected to be completed in the fourth quarter of 2014.


•	The 135-bed facility in Huntsville, Alabama, for which the Company entered into a lease agreement and assumed operations effective March 1, 2014. The Medicaid and Medicare certification processes for this facility were completed in the third quarter of 2014, and billing and collections commenced in the fourth quarter of 2014.

•

The 442 licensed nursing beds at the four recently leased skilled nursing centers, three in Ohio and one in Indiana, which we have operated since October 1, 2013. The Medicaid and Medicare certification processes were completed for these four leased facilities in the first quarter of 2014. In addition to the licensed nursing beds, these four centers also include 270 licensed assisted living beds which are not included in the licensed nursing bed count.


•	The 107-bed facility in Louisville, Kentucky, for which the Company entered into a lease agreement in August 2013. The Medicare certification process for this facility was completed in the first quarter of 2014. The Medicaid certification process was completed in the second quarter of 2014.


•	The Kansas centers acquired in May 2013, which comprise five skilled nursing centers and 418 licensed beds. The Medicaid certification process was completed for these facilities during the second quarter of 2013, and the Medicare certification process was completed for these facilities during the third quarter of 2013.

Our continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Missouri, Ohio, Tennessee, and Texas.

Discontinued Operations

Effective April 3, 2014, the Company entered into an asset purchase agreement with Rose Terrace Acq., LLC (“Purchaser”) to sell its skilled nursing facility in Culloden, West Virginia. The original asset purchase agreement was subject to a number of conditions including an amendment to the Master Lease with Omega Health Investors, Inc. ("Omega") to terminate the lease only with respect to two other skilled nursing facilities in West Virginia, state licensure and regulatory approval. The Company concurrently entered into an operations transfer agreement with respect to the two other skilled nursing facilities located in Danville and Ivydale, West Virginia. Effective July 1, 2014, the Company finalized the transaction under the terms of the purchase agreement. As a result, the three facilities with 240 licensed beds are reflected as discontinued operations for all periods in the accompanying interim financial statements.

Effective September 1, 2013, the Company finalized an agreement with Omega to terminate its lease with respect only to eleven nursing centers with 1,181 licensed beds located in Arkansas and to concurrently transfer operations to an operator selected by Omega. The completion of this transaction represents disposal of all of the Company's operations in the state of Arkansas.

The net income for the nursing centers included in discontinued operations does not reflect any allocation of regional or corporate general and administrative expense or any allocation of corporate interest expense. We considered these additional

costs along with the future prospects of these nursing centers when determining the contribution of the skilled nursing centers to our operations.

The assets and liabilities of the disposed skilled nursing centers have been reclassified and are segregated in the interim consolidated balance sheets as assets and liabilities of discontinued operations. The current asset amounts are primarily composed of net accounts receivable and the current liabilities consist primarily of accounts payable. The Company expects to collect the balance of the accounts receivable and pay the remaining trade payables and taxes in the ordinary course of business. The Company did not transfer the accounts receivable or liabilities to the new operators of these centers. Further, in accordance with Company accounting policy, the reserve for professional liability and workers' compensation will remain in the consolidated liability accounts as future payment of these liabilities will be paid through the Company's future operating cash flows.

Strategic Operating Initiatives

During the third quarter of 2010, we identified several key strategic objectives to increase shareholder value through improved operations and business development. These strategic operating initiatives included: improving skilled mix in our nursing centers, improving our average Medicare rate, implementing Electronic Medical Records (“EMR”), and completing strategic acquisitions. We have experienced success in these initiatives and expect to continue to build on these improvements. We describe each of these below as well as provide metrics for our most recent quarter versus the third quarter of 2010, the quarter before we embarked on our strategic operating initiatives.

Improving skilled mix and average Medicare rate:

Our strategic operating initiatives of improving our skilled mix and our average Medicare rate by accurately capturing the delivery of care required investing in nursing and clinical care to treat more acute patients along with nursing center based sales representatives to attract these patients. These initiatives developed referral and Managed Care relationships that have attracted and are expected to continue to attract patients whose stay in the centers is covered by Medicare and Managed Care. A comparison of our most recent quarter versus the third quarter of 2010, the quarter before we embarked on our strategic operating initiatives, reflects our success with these strategic operating initiatives:



	Three Months Ended
	September 30, 2014			September 30, 2010
As a percent of total census:
Medicare census	12.3		%	12.3		%
Managed Care census	3.4		%	1.3		%
Total skilled mix census	15.7		%	13.6		%
As a percent of total revenues:
Medicare revenues	29.2		%	29.3		%
Managed Care revenues	6.6		%	2.8		%
Total skilled mix revenues	35.8		%	32.1		%
Medicare average rate per day:	$	446.75		$	394.23

The initiatives have developed positive results in growing our skilled patient population, increasing the Managed Care census to 3.4% of total census in the third quarter of 2014, as compared to 1.3% in the third quarter of 2010, and total skilled mix census from 13.6% to 15.7% over the same period.

Implementing Electronic Medical Records:

As another part of our strategic operating initiative, we implemented EMR to improve documentation of the delivery of care. We completed the implementation of EMR in all our nursing centers in December 2011, on time and under budget. A comparison of our most recent quarter versus the third quarter of 2010 reflects the increase in our average Medicaid rate per day:



	Three Months Ended
	September 30, 2014		September 30, 2010
Medicaid average rate per day:	$	161.43	$	147.93

Completing strategic acquisitions:

Our strategic operating initiatives include a renewed focus on completing strategic acquisitions. We continue to pursue and investigate opportunities to acquire, lease or develop new centers, focusing primarily on opportunities within our existing areas of operation. We expect to announce additional development projects in the near future. Since September 30, 2010, the Company has added four skilled nursing centers in Kentucky, five in Ohio, one in Indiana, one in Alabama, three in Missouri, and five in Kansas.

As part of our strategic efforts, we have also performed a thorough analysis on our existing centers in order to determine whether continuing operations within certain markets or regions was in line with the short-term and long-term strategy of the business. As a result, we disposed of an owned building in Arkansas in 2012, and reached an agreement to terminate our lease for eleven other facilities in Arkansas in 2013. Additionally, we reached an agreement to dispose of the owned Rose Terrace facility in West Virginia and transfer operations of the other two facilities we operated in West Virginia. This transaction was effective July 1, 2014. As a result of these transactions, we no longer operate within the states of Arkansas or West Virginia.

Basis of Financial Statements

Our patient revenues consist of the fees charged for the care of patients in the nursing centers we own and lease. Our operating expenses include the costs, other than lease, professional liability, depreciation and amortization expenses, incurred in the operation of the nursing centers we own and lease. Our general and administrative expenses consist of the costs of the corporate office and regional support functions. Our interest, depreciation and amortization expenses include all such expenses across the range of our operations.

Critical Accounting Policies and Judgments

A “critical accounting policy” is one which is both important to the understanding of our financial condition and results of operations and requires management’s most difficult, subjective or complex judgments often involving estimates of the effect of matters that are inherently uncertain. Actual results could differ from those estimates and cause our reported net income or loss to vary significantly from period to period. Our critical accounting policies are more fully described in our 2013 Annual Report on Form 10-K.

Revenue Sources

We classify our revenues from patients and residents into four major categories: Medicaid, Medicare, Managed Care, and Private Pay and other. Medicaid revenues are composed of the traditional Medicaid program established to provide benefits to those in need of financial assistance in the securing of medical services. Medicare revenues include revenues received under both Part A and Part B of the Medicare program. Managed Care revenues include payments for patients who are insured by a third-party entity, typically called a Health Maintenance Organization, often referred to as an HMO plan, or are Medicare beneficiaries who assign their Medicare benefits to a Managed Care replacement plan often referred to as Medicare replacement products. The Private Pay and other revenues are composed primarily of individuals or parties who directly pay for their services. Included in the Private Pay and other are patients who are hospice beneficiaries as well as the recipients of Veterans Administration benefits. Veterans Administration payments are made pursuant to renewable contracts negotiated with these payors.

The following table sets forth net patient and resident revenues related to our continuing operations by payor source for the periods presented (dollar amounts in thousands):



	Three Months Ended September 30,								Nine Months Ended September 30,
	2014				2013				2014		2013
Medicaid	$	43,866	48.6	%	$	35,268	54.6	%	$121,376	48.5%	$98,644	53.4%
Medicare	26,348		29.2		17,169		26.6		74,387	29.7	51,229	27.8
Managed Care	5,926		6.6		3,685		5.7		16,643	6.6	11,096	6.0
Private Pay and other	14,191		15.6		8,509		13.1		38,037	15.2	23,589	12.8
Total	$	90,331	100.0	%	$	64,631	100.0	%	$250,443	100.0%	$184,558	100.0%

The following table sets forth average daily skilled nursing census by payor source for our continuing operations for the periods presented:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Medicaid	2,949	66.8	%	2,443	70.6	%	2,796	67.1	%	2,302	70.0	%
Medicare	544	12.3		374	10.8		536	12.9		380	11.6
Managed Care	152	3.4		100	2.9		147	3.5		100	3.0
Private Pay and other	769	17.5		543	15.7		687	16.5		507	15.4
Total	4,414	100.0	%	3,460	100.0	%	4,166	100.0	%	3,289	100.0	%

Consistent with the nursing home industry in general, changes in the mix of a facility’s patient population among Medicaid, Medicare, Managed Care, and Private Pay and other can significantly affect the profitability of the facility’s operations.

Health Care Industry

The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, quality of resident care and Medicare and Medicaid fraud and abuse. Over the last several years, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse laws and regulations as well as laws and regulations governing quality of care issues in the skilled nursing profession in general. Violations of these laws and regulations could result in exclusion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations is subject to ongoing government review and interpretation, as well as regulatory actions in which government agencies seek to impose fines and penalties. The Company is involved in regulatory actions of this type from time to time.

In March 2010, significant legislation concerning health care and health insurance was passed, including the “Patient Protection and Affordable Care Act,” (“Affordable Care Act”) along with the “Health Care and Education Reconciliation Act of 2010” (“Reconciliation Act”) collectively defined as the “Legislation.” We expect this Legislation to impact our Company, our employees and our patients and residents in a variety of ways. This Legislation significantly changes the future responsibility of employers with respect to providing health care coverage to employees in the United States. Two of the main provisions of the Legislation become effective in 2014 whereby most individuals will be required to either have health insurance or pay a fine and employers with 50 or more employees will either have to provide minimum essential coverage or will be subject to additional taxes. On July 2, 2013, the United States Treasury Department announced that it will delay the employer reporting mandate, which was to be effective for 2014, until 2015 to allow additional time for process improvement and system integration. We have not estimated the financial impact of the Legislation and the costs associated with complying with the increased levels of health insurance we will be required to provide our employees and their dependents in future years. We expect the Legislation will result in increased operating expenses.

We also expect for this Legislation to continue to impact our Medicaid and Medicare reimbursement as well, though the exact timing and level of that impact is currently unknown. The Legislation expands the role of home-based and community services, which may place downward pressure on our ability to maintain our population of Medicaid residents.

On June 28, 2012, the United States Supreme Court ruled that the enactment of the Affordable Care Act did not violate the Constitution of the United States. This ruling permits the implementation of most of the provisions of the Affordable Care Act to proceed. The provisions of the Affordable Care Act discussed above are only examples of federal health reform provisions that we believe may have a material impact on the long-term care industry and on our business. We anticipate that many of the provisions of the Legislation may be subject to further clarification and modification through the rule making process and could have a material adverse impact on our results of operations.

Medicare and Medicaid Reimbursement

A significant portion of our revenues are derived from government-sponsored health insurance programs. Our nursing centers derive revenues under Medicaid, Medicare, Managed Care, Private Pay and other third party sources. We employ third-party specialists in reimbursement and also use these services to monitor regulatory developments to comply with reporting requirements and to ensure that proper payments are made to our operated nursing centers. It is generally recognized that all government-funded programs have been and will continue to be under cost containment pressures, but the extent to which these pressures will affect our future reimbursement is unknown.

Medicare

Effective October 1, 2011, Medicare rates were reduced by a nationwide average of 11.1%, the net effect of a reduction to restore overall payments to their intended levels on a prospective basis and the application of a 2.7% market basket increase and a negative 1.0% productivity adjustment required by the Affordable Care Act. The final Centers for Medicare and Medicaid Services (“CMS”) rule also adjusts the method by which group therapy is counted for reimbursement purposes and, for patients receiving therapy, changes the timing of reassessment for purposes of determining patient RUG categories. These October 2011 Medicare reimbursement changes decreased our Medicare revenue and our Medicare rate per patient day. The new regulations also resulted in an increase in costs to provide therapy services to our patients.

The Budget Control Act of 2011 (“BCA”), enacted on August 2, 2011, increased the United States debt ceiling and linked the debt ceiling increase to corresponding deficit reductions through 2021. The BCA also established a 12 member joint committee of Congress known as the Joint Select Committee on Deficit Reduction (“Super Committee”). The Super Committee’s objective was to create proposed legislation to reduce the United States federal budget deficit by $1.5 trillion for fiscal years 2012 through 2021. Part of the BCA required this legislation to be enacted by December 23, 2011, or approximately $1.2 trillion in spending reductions would automatically begin through sequestration on January 1, 2013, split between domestic and defense spending. As no legislation was passed that would achieve the targeted savings outlined in the BCA, payments to Medicare providers have been reduced by 2% from planned levels effective April 1, 2013.

In July 2014, CMS issued Medicare payment rates, effective October 1, 2014, that increased reimbursement to skilled nursing centers by approximately 1.6% compared to the fiscal year ending September 30, 2014. The increase is the net effect of a 2.5% inflation increase as measured by the SNF market basket, offset by a 0.5% market basket update factor. The wage index budget neutrality factor resulted in an additional 0.4% downward adjustment in rates for the Company's facilities. This adjustment is further offset by the ongoing sequestration from the BCA as mentioned above. The 2% sequestration is not applied to the payment rate, but rather it is applied to Medicare claims after determining coinsurance, any applicable deductibles, and any applicable Medicare secondary payment adjustments.

Therapy Services. There are annual Medicare Part B reimbursement limits on therapy services that can be provided to an individual. The limits impose a $1,920 per patient annual ceiling on physical and speech therapy services, and a separate $1,920 per patient annual ceiling on occupational therapy services. CMS established an exception process to permit therapy services in certain situations and we provide services that are reimbursed under the exceptions process. The exceptions process has been extended several times, most recently by the Protecting Access to Medicare Act of 2014, which extended this exception process through March 31, 2015.

Related to the exceptions process discussed above, for services provided with dates of service between January 1, 2014, through March 31, 2015, providers are required to submit a request for an exception for therapy services above the threshold of $3,700 which will then be manually medically reviewed, consistent with the treatment of these services historically. Similar to the therapy cap exceptions process, the threshold process will have a $3,700 per patient threshold on physical and speech therapy services, and a separate $3,700 per patient threshold on occupational therapy services. The exception reviews were conducted by Medicare Administrative Contractors during this period.

It is unknown if any further extension of the therapy cap exceptions or the new threshold process will be included in future legislation or CMS policy decisions. If the exception process is discontinued or if the manual review process for therapy in excess of $3,700 negatively impacts our Medicare Part B reimbursement, we would likely see a reduction in our therapy revenues which would negatively impact our operating results and cash flows.

On November 2, 2010, CMS released a final proposed rule as part of the Medicare Physician Fee Schedule (“MPFS”) that was effective January 1, 2011. The policy impacts the reimbursement we receive for Medicare Part B therapy services in our facilities. The policy provides that Medicare Part B pay the full rate for the therapy unit of service that has the highest Practice Expense ("PE") component for each patient on each day they receive multiple therapy treatments. Reimbursement for the second and subsequent therapy units for each patient each day they receive multiple therapy treatments was reimbursed at a rate equal to 75% of the applicable PE component through March 31, 2013. Effective April 1, 2013, the rate at which these services are reimbursed was reduced to 50% of the applicable PE component.

Medicare Part B therapy services in our centers are determined according to MPFS. Annually since 1997, the MPFS has been subject to a Sustainable Growth Rate Adjustment (“SGR”) intended to keep spending growth in line with allowable spending. Each year since the SGR was enacted, this adjustment produced a scheduled negative update to payment for physicians, therapists and other healthcare providers paid under the MPFS. Congress has stepped in with so-called “doc fix” legislation numerous times to stop payment cuts to physicians, most recently by the Protecting Access to Medicare Act of 2014, which stopped these payment cuts through March 31, 2015.

The Protecting Access to Medicare Act of 2014 also extended several other elements of the Middle Class Tax Relief and Job Creation Act of 2012, including the reduction of bad debt treated as an allowable cost. Prior to this act, Medicare reimbursed providers for beneficiaries’ unpaid coinsurance and deductible amounts after reasonable collection efforts at a rate between 70 and 100 percent of beneficiary bad debt. This provision reduced bad debt reimbursement exposure for all providers to 65 percent.

Medicaid

We receive the majority of our annual Medicaid rate increases during the third quarter of each year. The rate changes received in the third quarter of 2013 and the third quarter of 2012, along with increased Medicaid acuity in our acuity based states, was the primary contributor to our 2.9% increase in average rate per day for Medicaid patients in 2014 compared to 2013. Based on the rate changes received during the third quarter of 2014, we expect a favorable impact to our rate per day for Medicaid patients as we move into 2015 due to modest rate decreases in many of the states within which we operate.

We are unable to predict what, if any, reform proposals or reimbursement limitations will be implemented in the future, or the effect such changes would have on our operations. For the nine months ended September 30, 2014, we derived 29.2% and 48.6% of our total patient revenues related to continuing operations from the Medicare and Medicaid programs, respectively. Any health care reforms that significantly limit rates of reimbursement under these programs could, therefore, have a material adverse effect on our profitability.

We will attempt to increase revenues from non-governmental sources to the extent capital is available to do so. However, private payors, including Managed Care payors, are increasingly 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, which can result in significant losses to health care providers if patients require expensive treatment not adequately covered by the capitated rate.

Licensure and Other Health Care Laws

All of our nursing centers must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing centers are subject to certificate of need laws, which require us to obtain government approval for the construction of new nursing centers or the addition of new licensed beds to existing centers. Our nursing centers must comply with detailed statutory and regulatory requirements on an ongoing basis in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid certification are similar and relate to quality and adequacy of personnel, quality of medical care, record keeping, dietary services, patient rights, and the physical condition of the center and the adequacy of the equipment used therein. Each center is subject to periodic inspections, known as “surveys” by health care regulators, to determine compliance with all applicable licensure and certification standards. Such requirements are both subjective and subject to change. If the survey concludes that there are deficiencies in compliance, the center is subject to various sanctions, including, but not limited to, monetary fines and penalties, suspension of new admissions, non-payment for new admissions and loss of licensure or certification. Generally, however, once a center receives written notice of any compliance deficiencies, it may submit a written plan of correction and is given a reasonable opportunity to correct the deficiencies. There can be no assurance that, in the future, we will be able to maintain such licenses and certifications for our facilities or that we will not be required to expend significant sums in order to comply with regulatory requirements.

Contractual Obligations and Commercial Commitments

We have certain contractual obligations of continuing operations as of September 30, 2014, summarized by the period in which payment is due, as follows (dollar amounts in thousands):



Contractual Obligations	Total		Less than 1 year		1 to 3 Years		3 to 5 Years		After 5 Years
Long-term debt obligations ⁽¹⁾	$	60,126	$	9,938	$	8,031	$	42,157	$	—
Settlement obligations ⁽²⁾	7,165		7,165		—		—		—
Elimination of Preferred Stock Conversion feature ⁽³⁾	2,748		687		1,374		687		—
Operating leases ⁽⁴⁾	590,431		30,579		61,892		63,955		434,005
Required capital expenditures under operating leases ⁽⁵⁾	5,717		240		480		480		4,517
Total	$	666,187	$	48,609	$	71,777	$	107,279	$	438,522


(1)	Long-term debt obligations include scheduled future payments of principal and interest of long-term debt and amounts outstanding on our capital lease obligations.


(2)	Settlement obligations relate to professional liability cases that the Company is obligated to pay within the next twelve months. The professional liabilities are included in our current portion of self-insurance reserves.


(3)	Payments to Omega Health Investors ("Omega"), from which we lease 23 nursing centers, for the elimination of the preferred stock conversion feature in connection with restructuring the preferred stock and master lease agreements. Monthly payments of approximately $57,000 will be made through the end of the initial lease period that ends in September 2018.


(4)	Represents lease payments under our operating lease agreements. Assumes all renewal periods are enacted.


(5)	Includes annual expenditure requirements under operating leases.

We have employment agreements with certain members of management that provide for the payment to these members of amounts up to two times their annual salary in the event of a termination without cause, a constructive discharge (as defined therein), or upon a change of control of the Company (as defined therein). The maximum contingent liability under these agreements is approximately $1,610,000 as of September 30, 2014. The terms of such agreements are for one year and automatically renew for one year if not terminated by us or the employee. In addition, upon the occurrence of any triggering event, those certain members of management may elect to require that we purchase equity awards granted to them for a purchase price equal to the difference in the fair market value of our common stock at the date of termination versus the stated equity award exercise price. Based on the closing price of our common stock on September 30, 2014, the potential contingent liability for the repurchase of the equity grants is $496,000.

Results of Operations

The results of operations presented have been reclassified to present the effects of certain divestitures discussed in the overview to "Management's Discussion and Analysis of Financial Condition and Results of Operations."

The following tables present the unaudited interim statements of operations and related data for the three and nine month periods ended September 30, 2014 and 2013:



(in thousands)	Three Months Ended September 30,
	2014			2013			Change			%
PATIENT REVENUES, net	$	90,331		$	64,631		$	25,700		39.8	%
EXPENSES:
Operating	73,006			54,186			18,820			34.7	%
Lease and rent expense	6,876			4,817			2,059			42.7	%
Professional liability	1,743			947			796			84.1	%
General and administrative	5,582			5,006			576			11.5	%
Depreciation and amortization	1,812			1,634			178			10.9	%
Restructuring	—			944			(944		)	(100.0	)%
Total expenses	89,019			67,534			21,485			31.8	%
OPERATING INCOME (LOSS)	1,312			(2,903		)	4,215			145.2	%
OTHER INCOME (EXPENSE):
Equity in net income (loss) of unconsolidated affiliate	(30		)	63			(93		)	(147.6	)%
Interest expense, net	(916		)	(855		)	(61		)	7.1	%
Debt retirement costs	—			—			—			—	%
	(946		)	(792		)	(154		)	(19.4	)%
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	366			(3,695		)	4,061			109.9	%
BENEFIT (PROVISION) FOR INCOME TAXES	(147		)	1,374			(1,521		)	(110.7	)%
INCOME (LOSS) FROM CONTINUING OPERATIONS	$	219		$	(2,321	)	$	2,540		109.4	%



(in thousands)	Nine Months Ended September 30,
	2014			2013			Change			%
PATIENT REVENUES, net	$	250,443		$	184,558		$	65,885		35.7	%
EXPENSES:
Operating	200,517			152,014			48,503			31.9	%
Lease and rent expense	19,094			14,398			4,696			32.6	%
Professional liability	5,360			4,212			1,148			27.3	%
General and administrative	16,077			15,769			308			2.0	%
Depreciation and amortization	5,252			4,572			680			14.9	%
Restructuring	—			944			(944		)	(100.0	)%
Total expenses	246,300			191,909			54,391			28.3	%
OPERATING INCOME (LOSS)	4,143			(7,351		)	11,494			156.4	%
OTHER INCOME (EXPENSE):
Equity in net income (loss) of unconsolidated affiliate	(89		)	(152		)	63			41.4	%
Interest expense, net	(2,757		)	(2,140		)	(617		)	(28.8	)%
Debt retirement costs	—			(320		)	320			100.0	%
	(2,846		)	(2,612		)	(234		)	(9.0	)%
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	1,297			(9,963		)	11,260			113.0	%
BENEFIT (PROVISION) FOR INCOME TAXES	(538		)	3,947			(4,485		)	(113.6	)%
INCOME (LOSS) FROM CONTINUING OPERATIONS	$	759		$	(6,016	)	$	6,775		112.6	%



Percentage of Net Revenues	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
PATIENT REVENUES, net	100.0	%	100.0	%	100.0	%	100.0	%
EXPENSES:
Operating	80.8		83.8		80.1		82.4
Lease and rent expense	7.6		7.5		7.6		7.8
Professional liability	1.9		1.5		2.1		2.3
General and administrative	6.2		7.7		6.4		8.5
Depreciation and amortization	2.0		2.5		2.1		2.5
Restructuring	—		1.5		—		0.5
Total expenses	98.5		104.5		98.3		104.0
OPERATING INCOME (LOSS)	1.5		(4.5	)	1.7		(4.0	)
OTHER INCOME (EXPENSE):
Equity in net losses of unconsolidated affiliate	—		0.1		—		(0.1	)
Interest expense, net	(1.0	)	(1.3	)	(1.1	)	(1.2	)
Debt retirement costs	—		—		—		(0.2	)
	(1.0	)	(1.2	)	(1.1	)	(1.5	)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	0.5		(5.7	)	0.6		(5.5	)
BENEFIT (PROVISION) FOR INCOME TAXES	(0.2	)	2.1		(0.2	)	2.1
INCOME (LOSS) FROM CONTINUING OPERATIONS	0.3	%	(3.6	)%	0.4	%	(3.4	)%

Three Months Ended September 30, 2014 Compared With Three Months Ended September 30, 2013

Patient Revenues

Patient revenues were $90.3 million for the three months ended September 30, 2014, as compared to $64.6 million in the three months ended September 30, 2013. This increase is primarily attributable to the acquisition of new facilities during the period. The following table summarizes the revenue increases attributable to our portfolio growth (in thousands):



	Three Months Ended September 30,
	2014		2013		Change
Same-store revenue	$	61,709	$	57,514	$	4,195
2013 acquisition revenue	18,593		7,117		11,476
2014 acquisition revenue	10,029		—		10,029
Total revenue	$	90,331	$	64,631	$	25,700

The overall increase in revenue of $25.7 million is primarily attributable to revenue contributions from acquisition activity in 2013 of $11.5 million, as well as the $10.0 million contribution from the seven newly leased nursing centers in 2014.

The same-store revenues increased by $4.2 million in 2014 compared to the same period in 2013 primarily attributable to improved census. The largest driver for the increase in same-store revenues is the increase in Medicare census which increased 7.5% resulting in a $1.0 million increase in revenues for the three months ended September 30, 2014, as compared to the same period in 2013. Managed Care average daily census increased 18.5% resulting in a revenue increase at our same-store nursing centers of $0.6 million. Additionally, Medicaid census increased slightly in 2014 compared to the same period in 2013, resulting in an increase of $0.1 million to revenues. These increases were offset by a decline in private pay census during the period which resulted in a decrease of $0.5 million for the three months ended September 30, 2014 compared to the same period in 2013.

The average Medicare rate per patient day at same-store nursing centers for the three months ended September 30, 2014 increased 3.4% compared to the same period in 2013, resulting in an increase in revenue of $0.5 million. The average rate per day for Medicaid patients also increased during the period by 2.5% resulting in an increase in revenue of $0.8 million.

The following table summarizes key revenue and census statistics for continuing operations for each period:



	Three Months Ended September 30,
	2014			2013
Skilled nursing occupancy	77.2		%	75.1		%
As a percent of total census:
Medicare census	12.3		%	10.8		%
Managed Care census	3.4		%	2.9		%
As a percent of total revenues:
Medicare revenues	29.2		%	26.6		%
Medicaid revenues	48.6		%	54.6		%
Managed Care revenues	6.6		%	5.7		%
Average rate per day:
Medicare	$	446.75		$	429.23
Medicaid	$	161.43		$	156.85
Managed Care	$	384.45		$	379.52

Operating Expense

Operating expense increased in the third quarter of 2014 to $73.0 million as compared to $54.2 million in the third quarter of 2013, driven primarily by the $9.1 million increase in operating costs attributable to the nursing center operations acquired in 2013, as well as $8.0 million of operating expense associated with the nursing center operations assumed in 2014. The following table summarizes the expense increases attributable to our portfolio growth (in thousands):



	Three Months Ended September 30,
	2014		2013		Change
Same-store operating expense	$	49,372	$	47,645	$	1,727
2013 acquisition expense	15,647		6,541		9,106
2014 acquisition expense	7,987		—		7,987
Total expense	$	73,006	$	54,186	$	18,820

Operating expense decreased as a percentage of revenue at 80.8% for the third quarter of 2014 as compared to 83.8% for the third quarter of 2013. The largest component of operating expenses is wages. Considering the aforementioned addition of the new centers, we experienced an increase to $42.9 million in the third quarter of 2014 as compared to $32.0 million in the third quarter of 2013, an increase of $10.9 million, or 34.2%. While wages increased overall, wages as a percentage of revenue decreased in the third quarter of 2014 to 47.5% as compared to 49.5% in the third quarter of 2013, a decrease of 2.0%.

Lease Expense

Lease expense increased in the third quarter of 2014 to $6.9 million as compared to $4.8 million in the third quarter of 2013. The increase in lease expense was primarily attributable to $1.1 million in combined lease expense for the seven newly leased nursing centers in 2014. Additionally, the five nursing centers leased in 2013 contributed $1.0 million in expense during the period.

Professional Liability

Professional liability expense was $1.7 million in the third quarter of 2014 compared to $0.9 million in the third quarter of 2013, an increase of $0.8 million. We were engaged in 48 professional liability lawsuits as of September 30, 2014, compared to 54 as of December 31, 2013. Our quarterly cash expenditures for professional liability costs of continuing operations were $1.4 million and $0.9 million for 2014 and 2013, respectively. Professional liability expense and cash expenditures fluctuate from year to year based respectively on the results of our third-party professional liability actuarial studies and on the costs incurred in defending and settling existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.

General and Administrative Expense

General and administrative expense was $5.6 million in the third quarter of 2014 as compared to $5.0 million in the third quarter of 2013, an increase of $0.6 million, but decreased as a percentage of revenue from 7.7% in 2013 to 6.2% in 2014. The increase in general and administrative expense is primarily attributable to expansion of regional operating teams in new operating regions as a result of acquisition and growth.

Depreciation and Amortization

Depreciation and amortization expense was approximately $1.8 million in the third quarter of 2014 as compared to $1.6 million in 2013. The increase in depreciation expense relates to fixed assets at the newly leased and acquired centers.

Interest Expense, Net

Interest expense was $0.9 million in the third quarter of 2014 and 2013. The balance remained flat as the impact of the higher debt balances as a result of the amended Mortgage Loan was factored into both the prior and current years for the full quarter.

Income (Loss) from Continuing Operations before Income Taxes; Income (Loss) from Continuing Operations per Common Share

As a result of the above, continuing operations reported income before income taxes of $0.4 million for the third quarter of 2014 as compared to a loss of $3.7 million for the third quarter of 2013. The provision for income taxes was $0.1 million in the third quarter of 2014 as compared to a benefit for income taxes of $1.4 million in the third quarter of 2013. The basic and diluted income per common share from continuing operations was $0.03 for the third quarter of 2014, as compared to a loss per common share from continuing operations of $0.41 in the third quarter of 2013.

Nine Months Ended September 30, 2014 Compared With Nine Months Ended September 30, 2013

Patient Revenues

Patient revenues were $250.4 million for the nine months ended September 30, 2014, as compared to $184.6 million in the nine months ended September 30, 2013. This increase is primarily attributable to the acquisition of new facilities during the period. The following table summarizes the revenue increases attributable to our portfolio growth (in thousands):



	Nine Months Ended September 30,
	2014		2013		Change
Same-store revenue	$	181,296	$	173,546	$	7,750
2013 acquisition revenue	54,893		11,012		43,881
2014 acquisition revenue	14,254		—		14,254
Total revenue	$	250,443	$	184,558	$	65,885

The overall increase in revenue of $65.9 million is primarily attributable to increased revenue contributions from acquisition activity in 2013 of $43.9 million, as well as the $14.3 million contribution from the seven newly leased nursing centers in 2014.

The same-store revenues increased by $7.8 million in the nine months ended September 30, 2014 compared to the same period in 2013 primarily attributable to improved census. One driver for the increase in same-store revenues is the increase in Medicaid census which increased 1.8% resulting in a $1.7 million increase in revenues for the nine months ended September 30, 2014, as compared to the same period in 2013. Medicare census also increased by 4.9% resulting in a $2.1 million increase in revenues in 2014 as compared to 2013. Additionally, Managed Care average daily census increased 11.8% resulting in a revenue increase at our same-store nursing centers of $1.2 million. These increases were offset by a decline in private pay census during the period which resulted in a decrease of $1.6 million in 2014 compared to the same period in 2013.

The average Medicare rate per patient day at same-store nursing centers for the nine months ended September 30, 2014 increased 2.0% compared to the same period in 2013, resulting in an increase in revenue of $0.9 million. This average rate per day for Medicaid patients also increased during the period by 1.4% resulting in increased revenue of $1.4 million.

The following table summarizes key revenue and census statistics for continuing operations for each period:



	Nine Months Ended September 30,
	2014			2013
Skilled nursing occupancy	77.7		%	75.2		%
As a percent of total census:
Medicare census	12.9		%	11.6		%
Managed Care census	3.5		%	3.0		%
As a percent of total revenues:
Medicare revenues	29.7		%	27.8		%
Medicaid revenues	48.5		%	53.4		%
Managed Care revenues	6.6		%	6.0		%
Average rate per day:
Medicare	$	441.05		$	430.67
Medicaid	$	159.32		$	156.51
Managed Care	$	380.35		$	380.62

Operating Expense

Operating expense increased in 2014 to $200.5 million as compared to $152.0 million in 2013, driven primarily by the $35.7 million increase in operating costs attributable to the nursing center operations acquired in 2013, as well as $10.9 million of operating expense associated with the nursing center operations assumed in 2014. The following table summarizes the expense increases attributable to our portfolio growth (in thousands):



	Nine Months Ended September 30,
	2014		2013		Change
Same-store operating expense	$	143,787	$	141,970	$	1,817
2013 acquisition expense	45,781		10,044		35,737
2014 acquisition expense	10,949		—		10,949
Total expense	$	200,517	$	152,014	$	48,503

Operating expense decreased as a percentage of revenue at 80.1% for 2014 as compared to 82.4% for 2013. The largest component of operating expenses is wages. Considering the aforementioned addition of the new centers, we experienced an increase to $116.9 million in 2014 as compared to $90.6 million in 2013, an increase of $26.3 million, or 29.0%. While wages increased overall, wages as a percentage of revenue decreased in 2014 to 46.7% as compared to 49.1% in 2013, a decrease of 2.4%.

Lease Expense

Lease expense increased in 2014 to $19.1 million as compared to $14.4 million in 2013. The increase in lease expense was primarily attributable to $3.4 million in combined lease expense for the five newly leased nursing centers in 2013. Additionally, the seven nursing centers leased in 2014 contributed $1.5 million in expense during the period.

Professional Liability

Professional liability expense was $5.4 million in 2014 compared to $4.2 million in 2013, a increase of $1.2 million. We were engaged in 48 professional liability lawsuits as of September 30, 2014, compared to 54 as of December 31, 2013. Our cash expenditures for professional liability costs of continuing operations were $3.6 million and $3.0 million for 2014 and 2013, respectively. Professional liability expense and cash expenditures fluctuate from year to year based respectively on the results of our third-party professional liability actuarial studies and on the costs incurred in defending and settling existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.

General and Administrative Expense

General and administrative expense was $16.1 million in 2014 as compared to $15.8 million in 2013, an increase of $0.3 million, but decreased as a percentage of revenue from 8.5% in 2013 to 6.4% in 2014. The decrease in general and administrative expense as a percent of revenues is primarily attributable to a decrease in non-recurring, acquisition-related expenses of $0.2 million in 2013 related to the acquisition of the Kansas portfolio, but also increased incremental revenue as mentioned above from new facility operations.

Depreciation and Amortization

Depreciation and amortization expense was approximately $5.3 million in 2014 as compared to $4.6 million in 2013. The increase in depreciation expense relates to fixed assets at the newly leased and acquired centers, and primarily driven by an increase of $0.3 million in depreciation expense for the Kansas portfolio.

Interest Expense, Net

Interest expense was $2.8 million in 2014 and $2.1 million in 2013, an increase of $0.7 million. The increase was primarily attributable to higher debt balances in 2014 as a result of the amended Mortgage Loan, which increased the balance of outstanding debt as a result of the acquisition of the Kansas centers, as well as the outstanding balance of the amended Revolver as a result of the on-going CHOW process at newly leased facilities.

Income (Loss) from Continuing Operations before Income Taxes; Income (Loss) from Continuing Operations per Common Share

As a result of the above, continuing operations reported income before income taxes of $1.3 million for the nine months ended September 30, 2014, as compared to a loss of $10.0 million for the same period in 2013. The provision for income taxes was $0.5 million for the nine months ended September 30, 2014, as compared to a benefit for income taxes of $3.9 million for the nine months ended September 30, 2013. The basic and diluted income per common share from continuing operations were both $0.09 for the nine months ended September 30, 2014, as compared to a loss per common share from continuing operations of $1.07 for the same period in 2013.

Liquidity and Capital Resources

Liquidity

Our primary source of liquidity is the net cash flow provided by the operating activities of our centers. We believe that these internally generated cash flows will be adequate to service existing debt obligations, fund required capital expenditures as well as provide cash flows for investing opportunities. In determining priorities for our cash flow, we evaluate alternatives available to us and select the ones that we believe will most benefit us over the long-term. Options for our cash include, but are not limited to, capital improvements, dividends, purchase of additional shares of our common stock, acquisitions, payment of existing debt obligations, preferred stock redemptions as well as initiatives to improve nursing center performance. We review these potential uses and align them to our cash flows with a goal of achieving long-term success.

Net cash provided by operating activities of continuing operations totaled $0.7 million in the nine months ended September 30, 2014, as compared to cash used by operating activities of $5.5 million in the same period of 2013.

Our cash expenditures related to professional liability claims of continuing operations were $3.6 million and $3.0 million for nine months ended September 30, 2014 and 2013, respectively. We will also have on-going cash expenditures related to professional liability claims remaining against our discontinued operations. Although we work diligently to limit the cash required to settle and defend professional liability claims, a significant judgment entered against us in one or more legal actions could have a material adverse impact on our cash flows and could result in our being unable to meet all of our cash needs as they become due.

Investing activities of continuing operations provided cash of $12.2 million in 2014 and used cash of $22.7 million in 2013. The cash provided in 2014 is a result of the gain on sale for West Virginia during the third quarter, while the decrease in 2013 is a result of the Kansas asset purchase that occurred in the second quarter.

Financing activities of continuing operations used cash of $6.2 million in 2014 as compared to cash provided of $18.9 million in 2013. The cash used in 2014 is primarily attributable to the redemption of preferred shares of $4.9 million, as well as normal debt repayments on the Company's revolving credit facility. The cash provided in 2013 is primarily due to the Company's debt restructuring associated with the Kansas acquisition in the second quarter from which additional proceeds were received from the restructured term loan.

Dividends

On November 5, 2014, the Board of Directors declared a quarterly dividend of $0.055 per common share payable to shareholders of record as of December 31, 2014, to be paid on January 14, 2015. While the Board of Directors intends to pay quarterly dividends, the Board will make the determination of the amount of future cash dividends, if any, to be declared and paid based on, among other things, the Company’s financial condition, funds from operations, the level of its capital expenditures and its future business prospects and opportunities.

Redeemable Preferred Stock

Effective August 14, 2014, the Company redeemed all of its outstanding shares of Series C Preferred Stock (“Preferred Stock”) from the holder, Omega Health Investors, Inc. (“Omega”). The redemption was affected as a result of Omega’s exercise of its pre-existing option to require the Company to redeem the Preferred Stock as provided in the Company’s Certificate of Designation. As previously disclosed, the Preferred Stock has been redeemable at Omega’s option since September 30, 2010 at a stated value of approximately $4.9 million plus accrued, but unpaid, dividends. The Preferred Stock was issued to Omega in 2006 and is not convertible, but has been redeemable at its stated value at Omega’s option since September 30, 2010, and since September 30, 2007 has been redeemable at its stated value at our option. Following the redemption, the Company no longer has any Series C Preferred Stock outstanding.

Professional Liability

The Company has professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. Effective July 1, 2013, the Company established a wholly-owned, offshore limited purpose insurance subsidiary, SHC Risk Carriers, Inc. (“SHC”), to replace some of the expiring commercial policies. SHC covers losses up to specified limits per occurrence. On a per claim basis, coverage for losses in excess of those covered by SHC are maintained through unaffiliated commercial reinsurance carriers. All of the Company's nursing centers in Florida and Tennessee are now covered under the captive insurance policies along with most of the nursing centers in Alabama, Kentucky, Ohio, and Texas. This policy also covers claims related to our discontinued operations in West Virginia and Arkansas. The insurance coverage provided for these centers under the SHC policy include coverage limits of $0.5 million per medical incident with a sublimit per center of $1.0 million and total annual aggregate policy

limits of $5.0 million. All other centers within the Company’s portfolio are covered through various commercial insurance policies which provide similar coverage limits per medical incident, per location, and on an aggregate basis for covered centers.

As of September 30, 2014, we have recorded total liabilities for reported and settled professional liability claims and estimates for incurred, but unreported claims of $26.4 million. Our calculation of this estimated liability is based on an assumption that the Company will not incur a severely adverse judgment with respect to any asserted claim; however, a significant judgment could be entered against us in one or more of these legal actions, and such a judgment could have a material adverse impact on our financial position and cash flows.

Capital Resources

As of September 30, 2014, we had $50.1 million of outstanding long-term debt and capital lease obligations. The $50.1 million total includes $0.4 million in capital lease obligations, and $6.0 million currently outstanding on the revolving credit facility. The balance of the long-term debt is comprised of $43.7 million owed on our mortgage loan.

On May 1, 2013, the Company executed an Amended and Restated Credit Agreement (the "Credit Agreement") which modified the terms of the Original Mortgage Loan and the Original Revolver Agreements dated February 28, 2011. The Credit Agreement increases the Company's borrowing capacity to $65.0 million allocated between a $45 million Mortgage Loan ("Amended Mortgage Loan") and a $20.0 million Revolver ("Amended Revolver"). Loan acquisition costs associated with the Amended Mortgage Loan and the Amended Revolver were capitalized in the amount of $1.3 million and are being amortized over the five-year term of the agreements. Loan acquisition costs of $320,000 associated with the Original Mortgage Loan were written off in conjunction with this restructuring and are recorded in Debt Retirement Costs in the Interim Consolidated Statement of Operations for the nine-month period ended September 30, 2013.

Under the terms of the amended agreements, the syndicate of banks provided the Amended Mortgage Loan with an original balance of $45.0 million with a five-year maturity through April 30, 2018, and a $20.0 million Amended Revolver through April 30, 2018. The Amended Mortgage Loan has a term of five years, with principal and interest payable monthly based on a 25-year amortization. Interest is based on LIBOR plus 4.5%, which was 4.65% at September 30, 2014, but a portion of the outstanding principal balance under the Amended Mortgage Loan is effectively fixed at 6.87% as a result of the interest rate swap described below. The Amended Mortgage Loan is secured by thirteen owned nursing centers, related equipment and a lien on the accounts receivable of these centers. The Amended Mortgage Loan and the Amended Revolver are cross-collateralized. The Company’s Amended Revolver has an interest rate of LIBOR plus 4.5%, which resulted in an interest rate of 4.65% as of September 30, 2014.

Effective March 31, 2014, the Company entered into the Second Amendment to the Amended and Restated Revolver ("Second Amendment"). The Second Amendment temporarily increased the Amended Revolver capacity from the $20.0 million in the original Amended Revolver to $27.5 million through September 30, 2014, as a result of the increase in receivables related to new facilities that continue to progress in the change in ownership process. The Second Amendment also provided for a permanent increase in the Amended Revolver capacity to $22.5 million beginning October 1, 2014 through the original maturity date of April 30, 2018, to reflect the expansion of the Company's business through new facility acquisitions. Effective July 1, 2014, the Company entered into the Third Amendment to the Amended and Restated Revolver ("Third Amendment"). The Third Amendment makes the previously temporary increase to the Amended Revolver capacity from the $20.0 million in the original Amended Revolver to $27.5 million as defined in the Second Amendment, a permanent change to the borrowing capacity as a result of the increase in receivables related to new facilities that continue to progress through the change in ownership process.

As of September 30, 2014, the Company had $6.0 million borrowings outstanding under the revolving credit facility. The outstanding borrowings on the revolver primarily reflect the Company's approach to accumulated Medicaid and Medicare receivables at recently acquired facilities as these facilities proceed through the change in ownership process with CMS. Annual fees for letters of credit issued under this Revolver are 3.00% of the amount outstanding. The Company has ten letters of credit with a total value of $8.0 million outstanding as of September 30, 2014. Considering the balance of eligible accounts receivable, the letter of credit, the amounts outstanding under the revolving credit facility and the maximum loan amount of $27.5 million, the balance available for borrowing under the revolving credit center is $12.7 million at September 30, 2014.

Effective March 27, 2014, the Company executed its purchase option to acquire all assets associated with the Rose Terrace nursing center in Culloden, West Virginia from Milton Holdings, LLC which was considered a variable interest entity ("VIE") by the Company and consolidated prior to the date of this transaction. See Note 8 to the Interim Consolidated Financial Statements under Item 1 above (the "Financial Statements") for further information on the VIE considerations. In conjunction with the purchase of the assets, the Company entered into an interest-only $8.0 million term loan ("Rose Terrace Note") with a maturity date of March 27, 2015. The structure of the Rose Terrace Note reflected the Company's intent to sell the property and transfer operations to an unrelated third-party operator. Effective July 1, 2014, the Company completed the transaction with Rose Terrace Acq., LLC to sell Rose Terrace, a 90-bed skilled nursing facility in Culloden, West Virginia for a sales price of

$16.5 million. The Company also agreed to an amendment to the Master Lease with Omega Health Investors, Inc. to terminate the lease only with respect to two other skilled nursing facilities in West Virginia, and concurrently entered into an operations transfer agreement with American Health Care Management, LLC, an affiliate of the purchaser with respect to these two other skilled nursing facilities located in Danville and Ivydale, West Virginia. Upon completion of the transaction, Diversicare no longer operates any skilled nursing centers in the state of West Virginia. In conjunction with the closing of the sale, the Company paid the balance of the $8.0 million mortgage loan outstanding on the Rose Terrace facility.

Our lending agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. We are in compliance with all such covenants at September 30, 2014.

Our calculated compliance with financial covenants is presented below:



	Requirement	Level at September 30, 2014
Minimum fixed charge coverage ratio	1.10:1.00	1.28:1.00
Minimum adjusted EBITDA	$10.00 million	$16.31 million
EBITDAR (mortgaged centers)	$6.150 million	$9.267 million

As part of the debt agreements entered into in March 2011, we entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The interest rate swap agreement has the same effective date and maturity date as the Amended Mortgage Loan, and carries a notional equivalent to half of the outstanding principal on the Amended Mortgage Loan. The interest rate swap agreement requires us to make fixed rate payments to the bank calculated on the applicable notional amount at an annual fixed rate of 6.87% while the bank is obligated to make payments to us based on LIBOR on the same notional amounts. We entered into the interest rate swap agreement to mitigate the variable interest rate risk on our outstanding mortgage borrowings.

Receivables

Our operations could be adversely affected if we experience significant delays in reimbursement from Medicare, Medicaid or other third-party revenue sources. Our future liquidity will continue to be dependent upon the relative amounts of current assets (principally cash, accounts receivable and inventories) and current liabilities (principally accounts payable and accrued expenses). In that regard, accounts receivable can have a significant impact on our liquidity. Continued efforts by governmental and third-party payors to contain or reduce the acceleration of costs by monitoring reimbursement rates, by increasing medical review of bills for services, or by negotiating reduced contract rates, as well as any delay by us in the processing of our invoices, could adversely affect our liquidity and results of operations.

Accounts receivable attributable to patient services of continuing operations totaled $47.2 million at September 30, 2014 compared to $36.6 million at December 31, 2013, representing approximately 42 days and 43 days revenue in accounts receivable, respectively. The increase in accounts receivable is due to increases in payor sources with longer payment cycles, including Managed Care payors, as well as an increase in Medicaid patients undergoing the initial qualification process.

Our accounts receivable included approximately $8.3 million and $5.1 million at September 30, 2014 and December 31, 2013, respectively of unbilled accounts, primarily attributable to newly acquired facilities. During the change of ownership process, we were required to hold these accounts while waiting for final Medicare and Medicaid approvals.

The allowance for bad debt was $5.3 million at September 30, 2014 as compared to $3.9 million at December 31, 2013. We continually evaluate the adequacy of our bad debt reserves based on patient mix trends, aging of older balances, payment terms and delays with regard to third-party payors, collateral and deposit resources, as well as other factors. We continue to evaluate and implement additional procedures to strengthen our collection efforts and reduce the incidence of uncollectible accounts.

Off-Balance Sheet Arrangements

We have ten letters of credit outstanding with an aggregate value of approximately $8.0 million as of September 30, 2014, the first of which serves as a security deposit for our facility lease with Omega in the amount of $4.6 million. The second letter of credit serves our initial funding of insurance policies with a captive insurance company in the amount of $1.0 million. The balance of the outstanding letters of credit relate to deposits at various leased facilities where the Company opted to issue letters of credit as a deposit in lieu of cash. These letters of credit were issued under our revolving credit facility. Our accounts receivable serve as the collateral for this revolving credit facility.

Forward-Looking Statements

The foregoing discussion and analysis provides information deemed by management to be relevant to an assessment and understanding of our consolidated results of operations and financial condition. This discussion and analysis should be read in conjunction with our consolidated financial statements included herein. Certain statements made by or on behalf of us, including those contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those contemplated by the forward-looking statements made herein. In addition to any assumptions and other factors referred to specifically in connection with such statements, other factors, many of which are beyond our ability to control or predict, could cause our actual results to differ materially from the results expressed or implied in any forward-looking statements including, but not limited to, our ability to successfully operate the new nursing centers in Alabama, Kansas, Kentucky, Missouri, Ohio, and Indiana, our ability to increase census at our renovated centers, changes in governmental reimbursement, including the impact of the CMS final rule that has resulted in a reduction in Medicare reimbursement as of October 2012 and our ability to mitigate the impact of the revenue reduction, government regulation, the impact of the recently adopted federal health care reform or any future health care reform, any increases in the cost of borrowing under our credit agreements, our ability to comply with covenants contained in those credit agreements, the outcome of professional liability lawsuits and claims, our ability to control ultimate professional liability costs, the accuracy of our estimate of our anticipated professional liability expense, the impact of future licensing surveys, the outcome of proceedings alleging violations of state or Federal False Claims Acts, laws and regulations governing quality of care or other laws and regulations applicable to our business including laws governing reimbursement from government payors, impacts associated with the implementation of our electronic medical records plan, the costs of investing in our business initiatives and development, our ability to control costs, changes to our valuation of deferred tax assets, changes in occupancy rates in our centers, changing economic and competitive conditions, changes in anticipated revenue and cost growth, changes in the anticipated results of operations, the effect of changes in accounting policies as well as others. Investors also should refer to the risks identified in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as risks identified in “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2013, for a discussion of various risk factors of the Company and that are inherent in the health care industry. 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. These assumptions may not materialize to the extent assumed, and risks and uncertainties may cause actual results to be different from anticipated results. These risks and uncertainties also may result in changes to the Company’s business plans and prospects. Such cautionary statements identify important factors that could cause our actual results to materially differ from those projected in forward-looking statements. In addition, we disclaim any intent or obligation to update these forward-looking statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The chief market risk factor affecting our financial condition and operating results is interest rate risk. As of September 30, 2014, we had outstanding borrowings of approximately $49.7 million, $27.8 million of which was subject to variable interest rates. In connection with our May 2013 financing agreement, we entered into an interest rate swap with respect to one half of the Amended Mortgage Loan to mitigate the floating interest rate risk of such borrowing. In the event that interest rates were to change 1%, the impact on future pre-tax cash flows would be approximately $278,000 annually, representing the impact of increased or decreased interest expense on variable rate debt.

ITEM 4. CONTROLS AND PROCEDURES

As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the Exchange Act), our management, including our chief executive officer and chief financial officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of September 30, 2014. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act, such as this Quarterly Report on Form 10-Q, is properly recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission’s rules and forms. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can provide only reasonable assurance regarding management’s control objectives. Management does not expect that its disclosure controls and procedures will prevent all errors and fraud. A control system, irrespective of how well it is designed and operated, can only provide reasonable assurance, and cannot guarantee that it will succeed in its stated objectives.

Based on an evaluation of the effectiveness of the design and operation of disclosure controls and procedures, our chief executive officer and chief financial officer concluded that, as of September 30, 2014, our disclosure controls and procedures were effective in reaching a reasonable level of assurance that information required to be disclosed by us in the reports that we

file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

The provision of health care services entails an inherent risk of liability. Participants in the health care industry are subject to lawsuits alleging malpractice, product liability, violations of laws governing payments received from participation in the Medicare and Medicaid programs, and other legal theories, many of which involve large claims and significant defense costs. Like many other companies engaged in the long-term care profession in the United States, we have numerous pending liability claims, disputes and legal actions for professional liability and other related issues. It is expected that we will continue to be subject to such suits as a result of the nature of our business. Further, as with all health care providers, we are periodically subject to actions seeking fines and penalties for alleged violations of health care laws and are potentially subject to claims related to compliance with health care reimbursement and fraud and abuse laws and/or the quality of care provided to residents of our facility. As with other health care providers, in the ordinary course of our business, we are also subject to claims made by employees and other disputes and litigation arising from the conduct of our business.

As of September 30, 2014, we are engaged in 48 professional liability lawsuits. Seven lawsuits are currently scheduled for trial or arbitration during the next twelve months, and it is expected that additional cases will be set for trial or hearing. The ultimate results of any of our professional liability claims and disputes cannot be predicted with certainty. A significant judgment entered against us in one or more of these legal actions could have a material adverse impact on our financial position and cash flows.

In July 2013, the Company learned that the United States Attorney for the Middle District of Tennessee (DOJ) had commenced a civil investigation of potential violations of the False Claims Act (FCA) at two of the Company's facilities. Notice to the Company came in the form of a civil investigative demand (CID), a form of subpoena, to produce certain documents relating to our practices and policies for rehabilitation and other services since 2010 at those two facilities. The Company responded to this limited CID and has cooperated with the DOJ in connection with its investigation. In October 2014, the Company received a second CID indicating that the DOJ’s investigation now covers all of the Company’s facilities, but only directing the Company to produce material related to a total of six of the Company's facilities. The Company intends to respond to the most recent CID and to continue cooperating with the DOJ in its FCA investigation. The Company cannot predict the outcome of this investigation or any possible related proceedings, and the outcome could have a materially adverse effect on the Company, including the imposition of damages, fines, penalties and/or a corporate integrity agreement, but the Company is committed to provide caring and professional services to its patients and residents in compliance with applicable laws and regulations.

In November 2012, a purported stockholder class action complaint was filed in the Chancery Court for Williamson County, Tennessee (21st Judicial District) against the Company's Board of Directors. This action alleges that the Board of Directors breached its fiduciary duties to stockholders related to its response to certain expressions of interest in a potential strategic transaction from Covington Investments, LLC (“Covington”). The complaint asserts that the Board failed to negotiate or otherwise appropriately consider Covington's proposals. Plaintiff has filed a motion seeking to certify the action as a class action, which is not currently set for hearing. On May 23, 2014, the plaintiff and defendants entered into a memorandum of understanding outlining the terms of a settlement subject to the execution of definitive documentation and court approval. The agreement provides that the Company will adopt and maintain certain corporate governance procedures for a period of at least three years. This settlement has not yet been approved by the court.

In June 2012, a collective action complaint was filed in the U.S. District Court for the U.S. District Court for the Western District of Arkansas against us and certain of our subsidiaries. The complaint alleges that the defendants violated the Fair Labor Standards Act (FLSA) and seeks unpaid overtime wages as well as liquidated damages. The Court conditionally certified a nationwide class of all of the Company's hourly employees, but recently decertified the class. The Company intends to defend the lawsuit vigorously.

In January 2009, a purported class action complaint was filed in the Circuit Court of Garland County, Arkansas against the Company and certain of its subsidiaries and Garland Nursing & Rehabilitation Center (the “Facility”). The complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Facility over the five-year period prior to the filing of the complaints. The lawsuit remains in its early stages and has not yet been certified by the court as a class action. The Company intends to defend the lawsuit vigorously.

We cannot currently predict with certainty the ultimate impact of any of the above cases on our financial condition, cash flows or results of operations. Our reserve for professional liability expenses does not include any amounts for the collective actions, the pending DOJ investigation, the purported class action against the Arkansas facilities or the lawsuit filed against our directors. An unfavorable outcome in any of these lawsuits or any of our professional liability actions, any regulatory action,

any investigation or lawsuit alleging violations of fraud and abuse laws or of elderly abuse laws or any state or Federal False Claims Act case could subject us to fines, penalties and damages, including exclusion from the Medicare or Medicaid programs, and could have a material adverse impact on our financial condition, cash flows or results of operations.

ITEM 1A RISK FACTORS

The risks described in our Annual Report on Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently believe to be immaterial also may adversely affect our business, financial condition and/or operating results. This section updates our risk factors as stated in our Annual Report in Form 10-K to reflect material developments since our Form 10-K was filed.

The U.S. Department of Justice is conducting an investigation into the Company’s provision of rehabilitation services, which could adversely affect our operations and financial condition. In July 2013, the Company learned that the United States Attorney for the Middle District of Tennessee (DOJ) had commenced a civil investigation of potential violations of the False Claims Act (FCA) at two of the Company's facilities. Notice to the Company came in the form of a civil investigative demand (CID), a form of subpoena, to produce certain documents relating to our practices and policies for rehabilitation and other services since 2010 at those two facilities. The Company responded to this limited CID and has cooperated with the DOJ in connection with its investigation. In October 2014, the Company received a second CID indicating that the DOJ’s investigation now covers all of the Company’s facilities, but only directing the Company to produce material related to a total of six of the Company's facilities. The Company intends to respond to the most recent CID and to continue cooperating with the DOJ in its FCA investigation. The Company cannot predict the outcome of this investigation or any possible related proceedings, and the outcome could have a materially adverse effect on the Company, including the imposition of damages, fines, penalties and/or a corporate integrity agreement, but the Company is committed to provide caring and professional services to its patients and residents in compliance with applicable laws and regulations.

ITEM 6. EXHIBITS

The exhibits filed as part of this report on Form 10-Q are listed in the Exhibit Index immediately following the signature page.

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.




	Diversicare Healthcare Services, Inc.

November 6, 2014

	By:	/s/ Kelly J. Gill
		Kelly J. Gill
		President and Chief Executive Officer, Principal Executive Officer and
		An Officer Duly Authorized to Sign on Behalf of the Registrant

	By:	/s/ James R. McKnight, Jr.
		James R. McKnight, Jr.
		Executive Vice President and Chief Financial Officer and
		An Officer Duly Authorized to Sign on Behalf of the Registrant




Exhibit Number			Description of Exhibits
3.1			Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement No. 33-76150 on Form S-1).

3.2			Certificate of Designation of Registrant (incorporated by reference to Exhibit 3.5 to the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2006).

3.3			Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement No. 33-76150 on Form S-1).

3.4			Bylaw Amendment adopted November 5, 2007 (incorporated by reference to Exhibit 3.4 to the Company’s annual report on Form 10-K for the year ended December 31, 2007).

3.5			Amendment to Certificate of Incorporation dated March 23, 1995 (incorporated by reference to Exhibit A of Exhibit 1 to the Company’s Form 8-A filed March 30, 1995).

3.6			Certificate of Designation of Registrant (incorporated by reference to Exhibit 3.4 to the Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2001).

4.1			Form of Common Stock Certificate (incorporated by reference to Exhibit 4 to the Company’s Registration Statement No. 33-76150 on Form S-1).

4.2			Amended and Restated Rights Agreement dated as of December 7, 1998 (incorporated by reference to Exhibit 1 to Form 8-A/A filed December 7, 1998).

4.3			Amendment No. 1 to the Amended and Restated Rights Agreement, dated March 19, 2005, by and between the Company and SunTrust Bank, as Rights Agent (incorporated by reference to Exhibit 2 to Form 8-A/A filed on March 24, 2005).

4.4			Second Amendment to the Amended and Restated Rights Agreement, dated August 15, 2008, by and between the Company and ComputerShare Trust Company, N.A., as successor to SunTrust Bank (incorporated by reference to Exhibit 3 to Form 8-A/A filed on August 18, 2008).

4.5			Third Amendment to Amended and Restated Rights Agreement, dated August 14, 2009, between the Company and Computershare Trust Company, N.A, as successor to SunTrust Bank, (incorporated by reference to Exhibit 4 to the Company’s Registration Statement on Form 8-A/A filed on August 14, 2009).

4.6			Fourth Amendment to Amended and Restated Rights Agreement, dated May 7, 2014, between the Company and Computershare Trust Company, N.A, as successor to SunTrust Bank, as Rights Agent (incorporated by reference to Exhibit 5 to the Company's Registration Statement on Form 8-A/A filed on May 8, 2014).

10.1			Third Amendment to Amended and Restated Term Loan And Security Agreement dated as of July 1, 2014, by and among the Company and a syndicate of financial institutions and banks, including The PrivateBank as the Administering Agent (incorporated by reference to exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2014).

10.2			Third Amendment and Consent to Amended And Restated Revolving Loan and Security Agreement dated as of July 1, 2014 by and among the Company and a syndicate of financial institutions and banks, including The PrivateBank as the Administering Agent (incorporated by reference to exhibit 10.2 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2014).

10.3			Fifteenth Amendment to Consolidated Amended and Restated Master Lease dated as of June 30, 2014 by and between the Company and Sterling Acquisition Corp. (incorporated by reference to exhibit 10.3 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2014).

10.4			Asset Purchase Agreement dated April 3, 2014 by and between Diversicare Rose Terrace, LLC, and Rose Terrace Acq., LLC. (incorporated by reference to exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2014).

31.1			Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a).

31.2			Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a).

32			Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b).



101.INS			XBRL Instance Document

101.SCH			XBRL Taxonomy Extension Schema Document

101.CAL			XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB			XBRL Taxonomy Extension Labels Linkbase Document

101.PRE			XBRL Taxonomy Extension Presentation Linkbase Document

Attached files

Stock widget

Investing forum

Diversicare Healthcare Services, Inc. Reports

Also read