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EX-32 - EXHIBIT 32 - Diversicare Healthcare Services, Inc.dvcrex32certificationofthe.htm
EX-31.2 - EXHIBIT 31.2 - Diversicare Healthcare Services, Inc.dvcrex312cfocertification1.htm
EX-31.1 - EXHIBIT 31.1 - Diversicare Healthcare Services, Inc.dvcrex311ceocertification1.htm
EX-23.1 - EXHIBIT 23.1 - Diversicare Healthcare Services, Inc.dvcrex231-123116.htm
EX-21 - EXHIBIT 21 - Diversicare Healthcare Services, Inc.dvcrex21-subsidiarieslisti.htm
EX-10.57 - EXHIBIT 10.57 - Diversicare Healthcare Services, Inc.dvcrex1057amendedandrestat.htm
EX-10.56 - EXHIBIT 10.56 - Diversicare Healthcare Services, Inc.dvcrex1056goldenlivingmast.htm
EX-10.55 - EXHIBIT 10.55 - Diversicare Healthcare Services, Inc.dvcrex1055thirdamendmentto.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________ 
FORM 10-K
________________________________ 
CHECK ONE:
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             .

Commission file 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)

Registrant's telephone number, including area code: (615) 771-7575

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Name of each Exchange on which registered
Common Stock, $0.01 par value per share
The NASDAQ Capital Market

Securities registered pursuant to Section 12(g) of the Act:

None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨ No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨ No þ

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 þ 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 þ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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 “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company þ

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

The aggregate market value of Common Stock held by non-affiliates on June 30, 2016 (based on the closing price of such shares on the NASDAQ Capital Market) was approximately $34,068,000. For purposes of the foregoing calculation only, all directors, named executive officers and persons known to the registrant to be holders of 5% or more of the registrant's Common Stock have been deemed affiliates of the registrant.

On February 15, 2017, 6,360,676 shares of the registrant's $0.01 par value Common Stock were outstanding.

Documents Incorporated by Reference

Registrant's definitive proxy materials for its 2017 annual meeting of shareholders are incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

 





Table of Contents
 
 
 
Page
Part I
  
 
 
Item 1.
  
Business
Item 1A.
  
Risk Factors
Item 1B.
  
Unresolved Staff Comments
Item 2.
  
Properties
Item 3.
  
Legal Proceedings
Item 4.
  
Mine Safety Disclosures
 
 
 
Part II
  
 
 
Item 5.
  
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.
  
Selected Consolidated Financial Data
Item 7.
  
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
  
Quantitative and Qualitative Disclosures about Market Risk
Item 8.
  
Financial Statements and Supplementary Data
Item 9.
  
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
  
Controls and Procedures
Item 9B.
  
Other Information
 
 
 
Part III
  
 
 
Item 10.
  
Directors, Executive Officers and Corporate Governance
Item 11.
  
Executive Compensation
Item 12.
  
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
  
Certain Relationships and Related Transactions, and Director Independence
Item 14.
  
Principal Accountant Fees and Services
 
 
 
Part IV
  
 
 
Item 15.
  
Exhibits and Financial Statement Schedules
Item 16.
 
Form 10-K Summary
 





PART 1

ITEM 1. BUSINESS

Introductory Summary.
Diversicare Healthcare Services, Inc. provides post-acute care services to skilled nursing facility, referred to as"skilled nursing center", "nursing center", or "center", patients and residents in ten states, primarily in the Southeast, Midwest, and Southwest United States. Unless the context indicates otherwise, references herein to “Diversicare,” “the Company,” “we,” “us” and “our” include Diversicare Healthcare Services, Inc. and all of our consolidated subsidiaries. Diversicare Healthcare Services, Inc. was incorporated as a Delaware corporation in 1994.
The post-acute care profession encompasses a broad range of non-institutional and institutional services. For those among the aging, infirmed, or disabled requiring temporary or limited special services, a variety of home care options exist. As the need for assistance in activities of daily living develop, assisted living centers become the most viable and cost effective option. For those amongst the aging, disabled, or infirmed requiring more extensive assistance and intensive care, skilled nursing center care may become the only viable option. We have chosen to focus our business primarily on the skilled nursing centers sector and to specialize in this aspect of the post-acute care continuum.

Principal Address and Website.
Our principal executive offices are located at 1621 Galleria Boulevard, Brentwood, Tennessee 37027. Our telephone number at that address is 615.771.7575, and our facsimile number is 615.771.7409. Our website is located at www.dvcr.com. The information on our website does not constitute part of this Annual Report on Form 10-K.

Operating and Growth Strategy.
Our operating objective is to optimize market position in the delivery of health care and related services to the patients and residents in need of post-acute care in the communities in which we operate. Our strategic operations development plan focuses on (i) providing a broad range of high quality, cost-effective post-acute care services; (ii) improving skilled mix in our nursing centers via enhanced capabilities for rehabilitation and transitional care; (iii) building clinical competencies and programs consistent with marketplace needs; and (iv) clustering our operations on a regional basis. Interwoven into our objectives and operating strategy is our mission:
• Improve Every Life We Touch
• Provide Exceptional Healthcare
• Exceed Expectations
• Increase Shareholder Value
Strategic operating initiatives. Our key strategic operating initiatives include improving skilled mix in our nursing centers by enhancing our staffing complement to address the increased medical complexity of certain patients, increasing clinical competencies, and adding clinical programs. The investments in nursing and clinical care have been implemented in concert with additional investments in nursing center-based sales representatives to cultivate referral and Managed Care relationships. These investments have positioned us and are expected to continue to position us to be a destination for patients covered by Medicare and Managed Care as well as certain private pay individuals. These enhancements and investments have positioned us to admit higher acuity patients.
Another strategic operating initiative was to implement an Electronic Medical Records (“EMR”) platform. See description of our EMR implementation below. We completed the implementation of Electronic Medical Records in all our nursing centers in December 2011, and implement EMR at all new centers near the time we commence operations.
To achieve our objectives, we:
Provide a broad range of quality cost-effective services. Our objective is to provide a variety of services to meet the needs of the increasing post-acute care population requiring skilled nursing and rehabilitation care. Our service offerings currently include skilled nursing, comprehensive rehabilitation services, programming for Life Steps and Memory Care units (described below) and other specialty programming. By addressing varying levels of acuity, we work to meet the needs of the population we serve. We seek to establish a reputation as the provider of choice in each of our markets. Furthermore, we believe we are able to deliver quality services cost-effectively, compared to other healthcare providers along the spectrum of care, thereby expanding the population base that can benefit from our services.

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Improve skilled mix in our nursing centers. By enhancing our registered nurse coverage and adding specialized clinical care, we believe we can admit patients with more medically complex conditions, thereby improving skilled mix and reimbursement. The investments in nursing and clinical care are being conducted in concert with additional investments in nursing center-based sales representatives to develop referral and Managed Care relationships. These investments will better attract quality payor sources for patients covered by Medicare, Managed Care and Medicare replacement payors as well as certain private pay individuals. We will also continue our program for the renovation and improvement of our nursing centers to attract and retain patients and residents.
Cluster operations on a regional basis. We have developed regional concentrations of operations in order to achieve operating efficiencies, generate economies of scale and capitalize on marketing opportunities created by having multiple operations in a regional market area.
Key elements of our growth strategy are to:
Increase revenues and profitability at existing nursing centers. Our strategy includes increasing center revenues and profitability through improving payor mix, providing an increasing level of higher acuity care, obtaining appropriate reimbursement for the care we provide, and providing high quality patient care. Ongoing investments are being made in expanded nursing and clinical care. We continue to enhance center-based marketing initiatives to promote higher occupancy levels and improved skilled mix at our nursing centers.
Development of additional specialty services. Our strategy includes the development of additional specialty units and programming in nursing centers that could benefit from these services. The specialty programming will vary depending on the needs of the specific market, and may include complex medical and rehabilitation services, as well as memory care units and other specialty programming. These services allow our centers to meet market needs while improving census and payor mix. A center specific assessment of the market and the current programming being offered is conducted related to specialty programming to determine if unmet needs exist as a predictor of the success of particular niche offerings and services.
Acquisition, leasing and development of new centers. We continue to pursue and investigate opportunities to acquire, lease or develop new centers, focusing primarily on opportunities that can leverage our existing infrastructure.

Nursing Centers and Services.
Diversicare provides a broad range of post-acute care services to patients and residents including skilled nursing, ancillary health care services and assisted living. In addition to the nursing and social services usually provided in long-term care centers, we offer a variety of rehabilitative, nutritional, respiratory, and other specialized ancillary services. As of December 31, 2016, our continuing operations consist of 76 nursing centers with 8,453 licensed skilled nursing beds. Our nursing centers range in size from 48 to 320 licensed nursing beds. The licensed nursing bed count does not include 496 licensed assisted living beds. Our continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Mississippi, Missouri, Ohio, Tennessee, and Texas.

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The following table summarizes certain information with respect to the nursing centers we own or lease as of December 31, 2016:

 
Number of
Centers
 
Licensed Nursing
Beds (1)
 
Available Nursing
Beds (1)
Operating Locations:
 
 
 
 
 
Alabama
19

 
2,282

 
2,203

Florida
1

 
79

 
79

Indiana
1

 
158

 
158

Kansas
6

 
464

 
464

Kentucky
13

 
1,127

 
1,123

Mississippi
10

 
1,138

 
1,103

Missouri
3

 
339

 
289

Ohio
5

 
404

 
393

Tennessee
5

 
617

 
537

Texas
13

 
1,845

 
1,571

 
76

 
8,453

 
7,920

Classification:
 
 
 
 
 
Owned
17

 
1,504

 
1,266

Leased
59

 
6,949

 
6,654

Total
76

 
8,453

 
7,920

____________
(1)
The number of Licensed Nursing Beds is based on the regulatory licenses for the nursing center. The Company reports its occupancy based on licensed nursing beds. The number of Available Nursing Beds represents Licensed Nursing Beds reduced by beds removed from service. Available Nursing Beds is subject to change based upon the needs of the centers, including configuration of patient rooms, common usage areas and offices, status of beds (private, semi-private, ward, etc.) and renovations. The number of Licensed and Available Nursing Beds does not include 496 Licensed Assisted Living/Residential Beds, all of which are also available, and the number of centers excludes one stand-alone Assisted Living Facility in Ohio. These beds are excluded from the bed counts as our operating statistics such as occupancy are calculated using Nursing Beds only.
Our nursing centers provide skilled nursing health care services, including nutrition services, recreational therapy, social services, housekeeping and laundry services. Skilled nursing care is provided for post-acute patients and residents with comorbidities. This care includes assessment using evidence based tools; individualized care plan development based on identified areas of risk and care needs; and skilled interventions such as IV services. We also provide for the delivery of ancillary medical services at the nursing centers we operate. These specialty services include rehabilitation therapy services, such as audiology, speech, occupational and physical therapies, which are provided through licensed therapists and registered nurses, and the provision of medical supplies, nutritional support, infusion therapies and related clinical services. The majority of these services are provided using our internal resources and clinicians.
Within the framework of a nursing center, we may provide other specialty care, including:
Transitional Care Unit. Many of our nursing centers have units designated as transitional care units, our designation for patients requiring transitional care following an acute stay in the hospital. These units specialize in short-term nursing and rehabilitation with the goal of returning the patient to their highest potential level of functionality. These units provide enhanced services with emphasis on upgraded amenities. The design and programming of the units generally appeal to the clinical and hospitality needs of individuals as they progress to the next appropriate level of care. Specialized therapeutic treatment regimens include orthopedic rehabilitation, neurological rehabilitation and complex medical rehabilitation. While these patients generally have a shorter length of stay, the intensive level of nursing and rehabilitation required by these patients typically results in higher levels of reimbursement.
Memory Care Unit. Like our transitional care units, many of our nursing centers have memory care units, our designation for advanced care for dementia-related disorders including Alzheimer's disease. The goal of the units is to provide a safe, homelike and supportive environment for cognitively impaired patients, utilizing an interdisciplinary team approach. Family and community involvement complement structured programming in the secure environment instrumental in fostering as much resident independence and purposeful quality of life as long as possible despite diminished capacity.

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Enhanced Therapy Services. We have complemented our traditional therapy services with programs that provide electrotherapy, vital stimulation, ultrasound and shortwave diathermy therapy treatments that promote pain management, wound healing, muscle strengthening, and/or contractures management, improving outcomes for our patients and residents receiving therapy treatments.
Other Specialty Programming. We implement other specialty programming based on a center's specific needs. We have developed two adult day care centers on nursing center campuses. We have developed specialty programming for bariatric patients (generally, patients weighing more than 350 pounds) at one of these centers as these individuals have unique psychosocial and equipment needs.
Quality Assurance and Performance Improvement. We have in place a Quality Assurance and Performance Improvement (“QAPI”) program, which is focused on monitoring and improving all aspects of the care provided in a center by identifying outcomes and acting on areas of improvement. The QAPI program in our centers addresses all systems of care and management practices. Key quality indicators are determined and performance goals and benchmarks are established based on industry research standards via a Balanced Scorecard. Gaps and opportunities in performance versus benchmarks are addressed with analysis and performance improvement plans. Outcomes from each center in the areas of quality, employee workplace, customer satisfaction, and stewardship are collected monthly and overseen by regional and company quality committees.
Implement Electronic Medical Records. We completed the initial implementation of EMR in our nursing centers in December 2011. EMR improves our ability to accurately record the care provided to our patients and quickly respond to areas of need. We now implement the use of EMR near the time of acquisition for new centers. EMR improves customer and employee satisfaction, nursing center regulatory compliance and provides real-time monitoring and scheduling of care delivery. We believe our EMR system supports our quality initiatives and positions us for higher acuity service offerings. Our EMR system is comprehensive in its functionality, providing key components, such as:
Tracking Activities of Daily Living (“ADLs”). ADLs are the functions that each person must perform on a daily basis including, but not limited to, getting dressed, bathing, and eating. ADL tracking allows us to capture the provision of care provided by our nursing, dietary and housekeeping staff in assisting with ADLs quickly, efficiently and electronically.
Progress Notes. Progress notes are an important component of our medical records. Licensed nursing professionals provide documentation reflecting assessment of each patient's condition and intervention of skilled care provided. The EMR system provides means for a comprehensive chronological record resulting in improved capture, monitoring and review of documentation of condition and care provided.
Medications. Our patients receive a number of daily medications. This module assists with electronic tracking and documenting of required medications and treatments. This provides a more accurate and efficient care system for our nurses and patients.
Wound Module. This allows for an evidence-based risk assessment to drive patient specific interventions to prevent skin breakdown. When skin abnormalities are present, it provides for accurate depiction of anatomical location and description which drives individualized care treatments.
Incident Module. Allows for capturing any event, such as a fall, and provides quality assurance steps for root cause and patient-specific care plans.
For all modules, the EMR system provides a dashboard that can be reviewed at a number of kiosks throughout the nursing center, allowing our staff to securely access a list of upcoming patient care tasks and providing supervisors a tool to help manage and monitor staff performance. We believe the EMR system provides better support, efficiency, and improves the quality of care for our patients. We originally invested approximately $112,000 per nursing center to deploy EMR in all our centers at the time of implementation. We currently implement EMR at each of the centers we acquire or at which time we assume operations during the transition process.
Organization. Our nursing centers are currently organized into ten regions, each of which is supervised by a regional vice president. The regional vice president is generally supported by specialists in several functions, including clinical, human resources, marketing, revenue cycle management and administration, all of whom are employed by us. The day-to-day operations of each of our nursing centers are led by an on-site, licensed administrator. The administrator of each nursing center is supported by other professional personnel, including a medical director, who assists in the medical management of the nursing center, and a director of nursing, who supervises a team of registered nurses, licensed practical nurses and nurse aides. Other personnel include those providing therapy, dietary, activities and social service, housekeeping, laundry, maintenance and office services. The majority of personnel at our nursing centers, including the administrators, are our employees.



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Marketing.
We believe that skilled nursing care is fundamentally a local business in which both patients and their referral sources are typically based in the immediate geographic area in which the nursing center is located. Our marketing plan and related support activities emphasize the role and contributions of the administrators, admissions coordinators and clinical liaisons of each nursing center, all of whom are responsible for developing relationships with various referral sources such as doctors, hospitals, hospital case managers and discharge planners, and various healthcare and community organizations. Training, sales tools and job aids are provided for the sales and marketing teams for the product knowledge, market knowledge, and selling skills necessary to support their efforts in the field. As part of our business strategy, we have dedicated sales and marketing personnel who develop strong partnerships with physicians and hospital executives as well as Accountable Care Organizations ("ACO"), Bundled Payments Initiatives ("BPI"), and Managed Care organizations. We believe these relationships will be mutually beneficial, providing the community with high quality healthcare while helping customers to navigate choices, manage transitions, and control costs.

At the local level, our sales and marketing efforts are designed to:

Identify and develop strong healthcare partnerships
Help facilitate smooth transitions between care settings
Promote collaboration with ACOs, BPIs, and healthcare organizations
Educate referral sources and community on our key differentiators and capabilities
Position ourselves as a valuable resource and healthcare partner
Enhance the customer experience
Contribute to a strong community presence
Promote higher occupancy levels
Foster optimal payor mix

In addition to soliciting admissions from current and potential referral sources, we emphasize involvement in community and healthcare events and opportunities to promote a public awareness of our nursing centers and services. Activities include ongoing family councils and community based “family night” functions, providing the opportunity to educate the public on various topics such as Medicare benefits, powers of attorney, and other topics of interest. We also promote a positive customer experience, best practices, strong surveys, and a high Star Rating; we seek feedback through third-party resident and family surveys. We host tour and “open house” opportunities, where members of the local community are invited to visit the center to see any improvements or to better understand our environment and services. We look for ways to offer increased clinical capabilities and services to better meet the needs of the community and referral sources. In addition, we have regional oversight to support the overall marketing strategies in each local center, in order to promote higher occupancy levels and improved payor and case mixes at our nursing centers. We offer the resources and metrics for strong healthcare partnerships with our referral sources, including ACOs and other Managed Care partners. Our support center marketing personnel support regional and local marketing personnel and efforts.

We have monthly marketing programs and ongoing marketing initiatives, developed internally, that focus on educating and meeting the needs of our customers while growing our business. Resources are also available to assist each nursing center administrator in analysis of local demographics and competition with a view toward complementary service development. We consider the primary referral area in long-term care to generally lie within a five-to-fifteen-mile radius of each nursing center depending on population density; consequently, we focus on local marketing efforts rather than broad-based advertising.

Acquisitions, Significant Transactions and Divestitures.
Acquisitions
On February 26, 2016, the Company exercised its purchase options to acquire the real estate assets for Diversicare of Hutchinson in Hutchinson, Kansas and Clinton Place in Clinton, Kentucky for $4,250,000 and $3,300,000, respectively. The Company has operated these centers since February 2015 and April 2012, respectively. Hutchinson is an 85-bed skilled nursing center and Clinton is an 88-bed skilled nursing center. As a result of the consummation of the Agreements, the Company allocated the purchase price and acquisition costs among the assets acquired. The allocation of the purchase price was determined with the assistance of HealthTrust LLC, a third-party real estate valuation firm.
On November 1, 2015, the Company entered into an Asset Purchase Agreement with Haws Fulton Investors, LLC to acquire a 60-bed skilled nursing center in Fulton, Kentucky, for an aggregate purchase price of $3,900,000. As a result of this business combination transaction, the Company allocated the purchase price of $3,900,000 among the assets based on the fair value of the acquired net assets.
On February 1, 2015, the Company entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Barren County Health Care Center, Inc. to acquire a 94-bed skilled nursing center in Glasgow, Kentucky, for an aggregate purchase price of

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$7,000,000, partially financed through a $5,000,000 mortgage loan with The PrivateBank with the balance paid in cash consideration. As a result of this business combination transaction, the Company allocated the purchase price of $7,000,000 among the assets based on the fair value of the acquired net assets.

Golden Living Transaction
On August 15, 2016, the Company entered into an Operation Transfer Agreement with Golden Living (the "Lessor") to assume the operations of 22 centers in Alabama and Mississippi. On October 1, 2016, the Company entered into a Master Lease Agreement (the "Lease") with Golden Living to directly lease 8 centers located in Mississippi from the Lessor. The Company also assumed individual leases of two centers in Mississippi from third parties. On November, 1 2016, the Company amended and restated the Lease ("Amended Lease") with the Lessor to directly lease an additional twelve centers located in Alabama. Refer to the chart below for a complete listing of these centers' locations and number of licensed beds.
Lease Agreements and Assumption of Operations
During 2016 and 2015, the Company assumed operations at 23 centers comprising a total increase of 2,647 licensed beds. See table below for details of the 2016 and 2015 operations acquired by the Company:
Center
Location
Effective Date
Licensed Bed Count
Diversicare of Hutchinson*
Hutchinson, Kansas
February 1, 2015
73

Diversicare of Amory
Amory, Mississippi
October 1, 2016
152

Diversicare of Batesville
Batesville, Mississippi
October 1, 2016
130

Diversicare of Brookhaven
Brookhaven, Mississippi
October 1, 2016
58

Diversicare of Carthage
Carthage, Mississippi
October 1, 2016
99

Diversicare of Eupora
Eupora, Mississippi
October 1, 2016
119

Diversicare of Meridian
Meridian, Mississippi
October 1, 2016
120

Diversicare of Ripley
Ripley, Mississippi
October 1, 2016
140

Diversicare of Southaven
Southaven, Mississippi
October 1, 2016
140

Diversicare of Tupelo
Tupelo, Mississippi
October 1, 2016
120

Diversicare of Tylertown
Tylertown, Mississippi
October 1, 2016
60

Diversicare of Arab
Arab, Alabama
November 1, 2016
87

Diversicare of Bessemer
Bessemer, Alabama
November 1, 2016
180

Diversicare of Riverchase
Birmingham, Alabama
November 1, 2016
132

Diversicare of Boaz
Boaz, Alabama
November 1, 2016
100

Diversicare of Foley
Foley, Alabama
November 1, 2016
154

Baron House of Hueytown
Hueytown, Alabama
November 1, 2016
50

Diversicare of Lanett
Lanett, Alabama
November 1, 2016
85

Diversicare of Montgomery
Montgomery, Alabama
November 1, 2016
138

Diversicare of Oneonta
Oneonta, Alabama
November 1, 2016
120

Diversicare of Oxford
Oxford, Alabama
November 1, 2016
173

Diversicare of Pell City
Pell City, Alabama
November 1, 2016
94

Diversicare of Winfield
Winfield, Alabama
November 1, 2016
123

*Diversicare of Hutchinson was later purchased in February 2016. Refer to our disclosure above.
Lease Termination
Effective May 31, 2016, the Company entered into an Agreement with Avon Ohio, LLC to amend the original lease agreement, thus terminating the Company's right of possession of the center. As a result, the Company incurred lease termination costs of $2,008,000 in the second quarter of 2016. Under the amended agreement, the Company is required to pay $300,000 per year through the term of the original lease agreement, July 31, 2024. For accounting purposes, this transaction was not reported as a discontinued operation, which is in accordance with the modified authoritative guidance for reporting discontinued operations, effective January 1, 2015. A disposal is now required to be reported in discontinued operations only if the disposal represents a strategic shift that has (or will have) a major effect on the Company's operations and financial results.

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Pharmacy Partnership
Effective October 28, 2016, the Company and its partners entered into an asset purchase agreement to sell the pharmacy joint venture. The sale resulted in a $1,366,000 recorded gain on the sale of the Company's interest in the joint venture during the year ended December 31, 2016. The transaction also resulted in an immaterial gain contingency, which has not been recorded and income has not been recognized.
Discontinued Operations
Effective April 3, 2014, the Company entered into an asset purchase agreement with Rose Terrace Acq., LLC to sell its skilled center 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 centers in West Virginia, state licensure and regulatory approval.
Effective July 1, 2014, the Company completed the transaction with Rose Terrace Acq., LLC to sell Rose Terrace, a 90-bed skilled nursing center in Culloden, West Virginia for a sales price of $16,500,000. The Company also entered into the Fifteenth Amendment to the Master Lease with Omega to terminate the lease only with respect to two other skilled nursing centers in Danville and Ivydale, West Virginia, and concurrently entered into an operations transfer agreement with American Health Care Management, LLC, an affiliate of the purchaser with respect to the two skilled nursing centers located in Danville and Ivydale, West Virginia. The amendment effectively reduced the annual rent payments due under the Master Lease by $1,900,000. 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 center. The Company will continue to defend, and make cash payments related to professional liability claims asserted against these nursing centers for events occurring prior to July 1, 2014.

Nursing Center Industry.
We believe there are a number of significant trends within the post-acute care industry that will support the continued growth of the nursing center profession. These trends are also likely to impact our business. These factors include:
Demographic trends. The primary market for our post-acute health care services is comprised of persons aged 75 and older. This age group is one of the fastest growing segments of the United States population. As the number of persons aged 75 and over continues to grow, we believe that there will be corresponding increases in the number of persons who need skilled nursing care.
Cost containment pressures. In response to rapidly rising health care costs, governmental and other third-party payors have adopted cost-containment measures to reduce admissions and encourage reduced lengths of stays in hospitals and other acute care settings. As a result, hospitals are discharging patients earlier and referring elderly patients, who may be too sick or frail to manage their lives without assistance, to nursing centers where the cost of providing care is typically lower than hospital care.
Limited supply of centers. As the nation's population of seniors continues to grow, life expectancy continues to expand, and there continue to be limitations on granting Certificates of Need (“CON”) for new skilled nursing centers, so we believe that there will be continued demand for skilled nursing beds in the markets in which we operate. CON laws generally require a state agency to determine public need for any construction or expansion of healthcare facilities. We believe that the CON process tends to restrict the supply and availability of licensed skilled nursing center beds. High construction costs, limitations on state and federal government reimbursement for the full costs of construction, and start-up expenses also act to restrict growth in the supply for such centers.
Reduced reliance on family care. Historically, the family has been the primary provider of care for seniors. We believe that the increase in the percentage of dual income families, the reduction of average family size and the increased mobility in society will reduce the role of the family as the traditional care-giver for aging parents. We believe that this trend will make it necessary for many seniors to look outside the family for assistance as they age.

Competition.
The post-acute care business is highly competitive. We face direct competition for additional centers, and our centers face competition for employees and patients. Some of our present and potential competitors for acquisitions are significantly larger and have or may obtain greater financial and marketing resources. Competing companies may offer new or more modern centers or new or different services that may be more attractive to patients than some of the services we offer.
The nursing centers operated by us compete with other centers in their respective markets, including rehabilitation hospitals and other skilled and personal care residential centers. In the few urban markets in which we operate, some of the long-term care

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providers with which our centers compete are significantly larger and have or may obtain greater financial and marketing resources than our centers. Some of these providers are not-for-profit organizations with access to sources of funds not available to our centers. Construction of new long-term care centers near our existing centers could adversely affect our business. We believe that the most important competitive factors in the long-term care business are: a nursing center's local reputation with referral sources, such as acute care hospitals, physicians, religious groups, other community organizations, Managed Care organizations, and a patient's family and friends; physical plant condition; the ability to identify and meet particular care needs in the community; the availability of qualified personnel to provide the requisite care; and the rates charged for services. There is limited, if any, price competition with respect to Medicaid and Medicare patients, since revenues for services to such patients are strictly controlled and are based on fixed rates and cost reimbursement principles. Although the degree of success with which our centers compete varies from location to location, we believe that our centers generally compete effectively with respect to these factors.

Revenue Sources
We classify our revenues from patients and residents into four major categories: Medicare, Medicaid, managed care, and private pay and other. Medicaid revenues are those received under the traditional Medicaid program, which provides 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. Managed Care revenues are received from insurance entities, including third-party plans that administer Medicare benefits, known as Medicare Advantage plans. 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 category 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 revenues related to our continuing operations by payor source for the periods presented (dollar amounts in thousands):
 
Year Ended December 31,
 
2016

2015

2014
Medicaid
$
215,381

 
50.6
%
 
$
188,323

 
48.6
%
 
$
166,497

 
48.4
%
Medicare
117,143

 
27.5
%
 
112,305

 
29.0
%
 
101,806

 
29.6
%
Managed Care
29,066

 
6.8
%
 
27,856

 
7.2
%
 
23,178

 
6.7
%
Private Pay and other
64,473

 
15.1
%
 
59,111

 
15.2
%
 
52,711

 
15.3
%
Total
$
426,063

 
100.0
%
 
$
387,595

 
100.0
%
 
$
344,192

 
100.0
%

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The following table sets forth average daily skilled nursing census by payor source for our continuing operations for the periods presented:
 
Year Ended December 31,
 
2016
 
2015
 
2014
Medicaid
3,448

 
68.1
%
 
3,104

 
67.1
%
 
2,844

 
67.0
%
Medicare
591

 
11.7
%
 
577

 
12.5
%
 
540

 
12.7
%
Managed Care
178

 
3.5
%
 
173

 
3.7
%
 
151

 
3.6
%
Private Pay and other
844

 
16.7
%
 
772

 
16.7
%
 
709

 
16.7
%
Total
5,061

 
100.0
%
 
4,626

 
100.0
%
 
4,244

 
100.0
%
Consistent with the nursing center industry in general, changes in the mix of a center's patient population among Medicaid, Medicare, Managed Care, and private pay and other can significantly affect the profitability of the center's operations. 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.

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.
Medicare
Medicare is a federally-funded and administered health insurance program for the aged and for certain chronically disabled individuals. Part A of the Medicare program covers certain services furnished by skilled nursing centers and other institutional providers and inpatient hospital services. Part B covers physician services, durable medical equipment, various outpatient services and certain ancillary services. Medicare generally covers skilled nursing center services for beneficiaries who require nursing care or rehabilitation services after a qualifying hospital stay. Medicare pays a per diem rate for each beneficiary, adjusted for patient acuity and additional factors such as geographic differences in wage rates. The payment rates are set forth under a prospective payment system that uses nursing and therapy indexes to assign a payment rate to each beneficiary. The Centers for Medicare & Medicaid Services (“CMS”) updates the rates annually. The payment rates cover all services to be provided to a beneficiary, including room and board, skilled nursing care, therapy, and medications.
In July 2016, CMS issued its final rule outlining Medicare payment rates and policies for skilled nursing centers for federal fiscal year 2017, which began October 1, 2016. CMS projects that aggregate payments to skilled nursing centers will increase by a net 2.4% for fiscal year 2017. This reflects a 2.7% market basket increase, reduced by a 0.3% multi-factor productivity adjustment required by Patient Protection and Affordable Care Act ("PPACA"). The payment rates for fiscal year 2016, which were projected to increase aggregate payments to skilled nursing centers by 1.2%, reflected a 0.6% forecast error reduction and the 0.5% productivity reduction required by PPACA. For fiscal year 2018, the Medicare Access and CHIP Reauthorization Act of 2015 (“MACRA”) requires the payment update for skilled nursing centers to be 1%.
In addition to the adjustments described above, payment rates are reduced pursuant to ongoing sequestration. The Budget Control Act of 2011 (“BCA”) requires automatic spending reductions to reduce the federal deficit, including Medicare spending reductions of up to 2% per fiscal year, with a uniform percentage reduction across all Medicare programs. CMS began imposing a 2% reduction on Medicare claims in April of 2013. These reductions have been extended through 2025.
CMS has increasingly introduced policies intended to shift Medicare to value-based payment methodologies, tying reimbursement to quality of care rather than quantity. For example, CMS has implemented the Quality Reporting Program, under which skilled nursing centers are required to report quality data. Beginning in fiscal year 2018, skilled nursing centers that fail to submit required data will be subject to a 2% reduction to the annual market basket update. The Skilled Nursing Facility Value-Based Purchasing (“SNF VBP”) Program, which begins on October 1, 2018, will make incentive payments available to skilled nursing centers based on their past performance on a specified quality measure. The first measure under this program is the 30-day potentially preventable readmission measure, which assesses the rate of unplanned, potentially preventable hospital readmissions for skilled nursing center patients within 30 days of discharge from a prior admission to a hospital. CMS will fund the SNF VPB Program incentive payment pool by withholding and then redistributing 2% of skilled nursing center payments, beginning in fiscal year 2019.

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In addition, CMS has established the Five-Star Quality Rating System to assist the public in choosing a skilled care provider. Each nursing home is given a rating between 1 and 5 stars, which is published on the Nursing Home Compare website. The overall star rating is determined by three components: information from the last three years of health inspections, staffing information, and quality measures. The rating is based, in part, on the quality data nursing centers are required to report. For example, nursing centers must report the percentage of short-stay residents who are successfully discharged into the community and the percentage who had an outpatient emergency department visit. We remain diligent in continuing to provide outstanding patient care to achieve high rankings for our centers, as well as assuring that our rankings are correct and appropriately reflect our quality results.
Therapy Services. Reimbursement for physical therapy, occupational therapy, and speech-language pathology services covered under Medicare Part B is determined according to the Medicare Physician Fee Schedule (“MPFS”), which is updated annually. If a beneficiary receives multiple therapy treatments in one day, Medicare Part B pays the full rate for the therapy unit of service that has the highest Practice Expense (“PE”) component. A multiple procedure payment reduction is applied to the second and subsequent therapy units, reducing reimbursement to 50% of the applicable PE component.
Therapy services covered under Medicare Part B are subject to an annual dollar-amount payment cap per beneficiary. These limitations on reimbursement are determined on a calendar year basis. For 2017, the limit on incurred expenses is $1,980 per patient for physical and speech therapy services combined, and a separate $1,980 per patient limit applies for occupational therapy services. Deductible and coinsurance amounts paid by the beneficiary for therapy services count toward the amount applied to the limit.
A temporary two-tier exceptions process permits providers to request reimbursement of therapy services beyond the caps in certain situations. The MACRA extended the exceptions process through December 31, 2017. The first tier, the automatic exceptions process, can be used for claims beyond the caps, up to a $3,700 threshold. The second tier, a targeted review process, may apply when a beneficiary’s incurred expenses exceed a $3,700 threshold. MACRA eliminated a previous requirement for manual medical review of all claims exceeding the $3,700 threshold, instead providing for a targeted post-payment reviews to be conducted by Supplemental Medical Review Contractors. These claim reviews focus on providers with a high percentage of patients receiving therapy beyond the threshold and on therapy provided in specified settings, including skilled nursing centers.
MACRA also provides for a 0.5% increase to the MPFS rates each calendar year through 2019, subject to other adjustments. It required the establishment of the Quality Payment Program (“QPP”), a payment methodology intended to reward high-quality patient care. Beginning in 2017, physicians and certain other clinicians are required to participate in one of two QPP tracks, which will affect Medicare payments in 2019. The Advanced Alternative Payment Model (“Advanced APM”) track makes incentive payments available for participation in specific innovative payment models approved by CMS. A provider with sufficient participation in an Advanced APM is exempt from the reporting requirements and payment adjustments imposed under the second track, the Merit-Based Incentive Payment System (“MIPS”). Providers electing to participate in MIPS will tie payment to performance with respect to clinical quality, resource use, clinical improvement activities, and meaningful use of electronic health records. MIPS will consolidate components of three existing incentive programs, including the Value-Based Payment Modifier program and the Physician Quality Reporting System.

Medicaid
Medicaid is a medical assistance program for the indigent that is funded jointly by the federal and state governments and administered by the states. Federal law requires states to cover certain nursing center services for Medicaid-eligible individuals when other payment options are unavailable. However, Medicaid eligibility requirements and benefits vary by state, and states may impose limitations on nursing services. States may also establish levels of service or payment methodologies by acuity or specialization of a nursing center.
PPACA, as currently structured, requires states to expand Medicaid coverage by adjusting eligibility requirements such as income thresholds. However, the future of the Medicaid expansion is uncertain as a result of the 2016 federal elections. Further, a number of states have opted out of the Medicaid expansion provisions. Some states that opted out of the expansion provisions are evaluating alternatives such as waiver plans to extend or replace existing supplemental payment programs.
For example, effective February 1, 2015, the Company began participating in Indiana's Upper Payment Limit ("UPL") supplemental payment program, which provides supplemental Medicaid payments for skilled nursing centers that are licensed to non-state government entities such as county hospital districts. One skilled nursing center previously operated by the Company entered into a transaction with one such hospital district participating in the UPL program, providing for the transfer of the license from the Company to the hospital district. The Company's operating subsidiary retained the management of the center on behalf of the hospital district. The agreement between the hospital district and the Company is terminable by either party. Termination would fully restore the prior license status.
We receive the majority of our annual Medicaid rate increases during the third quarter of each year. The rate changes received in 2016 and 2015, along with increased Medicaid acuity in our acuity based states, were the primary contributor to our 2.3% increase

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in average rate per day for Medicaid patients in 2016 compared to 2015. Based on the rate changes received during the third quarter of 2016, we expect a favorable impact to our rate per day for Medicaid patients as we move into 2017 due to modest rate increases in many of the states within which we operate.
Several states in which we operate face budget shortfalls, which could result in reductions in Medicaid funding for nursing centers. Pressures on state budgets are expected to continue in the future. Certain of the states in which we operate are actively seeking ways to reduce Medicaid spending for nursing center care by such methods as capitated payments and substantial reductions in reimbursement rates. Some states are promoting alternatives such as community and home-based services. 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 year ended December 31, 2016, we derived 27.5% and 50.6% 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 financial position and profitability. 

Employees.
As of February 2, 2017, we employed approximately 7,400 employees, referred to as "team members", in connection with our continuing operations, approximately 6,700 of which are considered full-time team members. We believe that our team member relations are good. Approximately 843 of our team members are represented by a labor union.
Although we believe we are able to employ sufficient nurses and therapists to provide our services, a shortage of health care professional personnel in any of the geographic areas in which we operate could affect our ability to recruit and retain qualified team members and could increase our operating costs. We compete with other health care providers for both professional and non-professional team members and with non-health care providers for non-professional team members. This competition contributed to a significant increase in the salaries that we had to pay to hire and retain these team members. As is common in the health care industry, we expect the salary and wage increases for our skilled healthcare providers will continue to be higher than average salary and wage increases nationally.
Supplies and Equipment.
We purchase drugs, solutions and other materials and lease certain equipment required in connection with our business from many suppliers. We have not experienced, and do not anticipate that we will experience, any significant difficulty in purchasing supplies or leasing equipment from current suppliers. In the event that such suppliers are unable or fail to sell us supplies or lease equipment, we believe that other suppliers are available to adequately meet our needs at comparable prices. National purchasing contracts are in place for all major supplies, such as food, linens and medical supplies. These contracts assist in maintaining quality, consistency and efficient pricing. Based on contract pricing for food and other supplies, we expect cost increases in 2017 to be relatively the same or slightly lower than the increases we experienced in 2016.

Government Regulation.
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 patient 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 statutes and regulations, false claims statutes, HIPAA violations, 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.
Licensure and Certification.
All 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 CON 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 nursing 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

11



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 centers or that we will not be required to expend significant sums in order to comply with regulatory requirements.
Health care and health insurance reform.
In March 2010, significant legislation concerning health care and health insurance was passed, including the “Patient Protection and Affordable Care Act” (“Patient Protection 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 in a variety of ways. Some aspects of these new laws have been implemented while others will be phased in over the next several years when all mandates become effective. This Legislation significantly changes the future responsibility of employers with respect to providing health care coverage to employees in the United States. 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 anticipate this Legislation will continue to impact our Medicaid and Medicare reimbursement as well, though the timing and ultimate level of that impact is currently unknown as we anticipate that many of the provisions of the Legislation may be subject to further clarification and modification through the rule making process. The Legislation expands the role of home-based and community services, which may place downward pressure on our sustaining population of Medicaid patients. These reforms include the possible modifications to the conditions of qualification for payment, bundling of payments to cover both acute and post-acute care and the imposition of enrollment limitations on new providers. The provisions of the Legislation discussed above are examples of recently-enacted federal health reform provisions that we believe may have a material impact on the long-term care industry and on our business. However, the foregoing discussion is not intended to constitute, nor does it constitute, an exhaustive review and discussion of the Legislation.
Skilled nursing centers are required to bill Medicare on a consolidated basis for certain items and services that they furnish to patients, regardless of the cost to deliver these services. This consolidated billing requirement essentially makes the skilled nursing center responsible for billing Medicare for all care services delivered to the patient during the length of stay.
CMS has instituted a number of new exploratory test programs designed to extend the reimbursement and financial responsibilities under consolidated billing beyond the traditional discharge date to include a broader set of bundled services. Such examples may include, but are not exclusive to, home health, durable medical equipment, home and community based services, and the cost of re-hospitalizations during a specified bundled period. Today, these test programs for bundled reimbursement are confined to a small set of clinical conditions. This bundled form of reimbursement could be extended to a broader range of diagnosis related conditions in the future. Because of the untested nature of this new form of reimbursement, the potential impact on skilled nursing center utilization and reimbursement is currently unknown. The process for defining bundled services has not been fully determined by CMS and therefore is subject to change during the rule making process.
Health Insurance Portability and Accountability Act of 1996 Compliance. The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) has mandated an extensive set of regulations to standardize electronic patient health, administrative and financial data transactions and to protect the privacy of individually identifiable health information. We have a HIPAA compliance committee and designated privacy and security officers.
The HIPAA transaction standards are intended to simplify the electronic claims process and other healthcare transactions by encouraging electronic transmission rather than paper submission. These regulations provide for uniform standards for data reporting, formatting and coding that we must use in certain transactions with health plans. The HIPAA security regulations establish detailed requirements for safeguarding protected health information that is electronically transmitted or electronically stored. Some of the security regulations are technical in nature, while others are addressed through policies and procedures. We implemented or upgraded computer and information systems as we believe necessary to comply with the new regulations.
The HIPAA regulations related to privacy establish comprehensive federal standards relating to the use and disclosure of individually identifiable health information (“protected health information”). The privacy regulations establish limits on the use and disclosure of protected health information, provide for patients' rights, including rights to access, to request amendment of, and to receive an accounting of certain disclosures of protected health information, and require certain safeguards for protected health information. In addition, each covered entity must contractually bind individuals and entities that furnish services to the covered entity or perform a function on its behalf, and to which the covered entity discloses protected health information, to restrictions on the use

12



and disclosure of that protected health information. In general, the HIPAA regulations do not supersede state laws that are more stringent or grant greater privacy rights to individuals. Thus, we must reconcile the HIPAA regulations and other state privacy laws.
Although we believe that we are in material compliance with these HIPAA regulations, inadvertent violations of these regulations may occur in the course of our business. For this and other reasons, the HIPAA regulations are expected to continue to impact us operationally and financially and may pose increased regulatory risk.
Self-Referral and Anti-Kickback Legislation.
The health care industry is subject to state and federal laws which regulate the relationships of providers of health care services, physicians and other clinicians. These self-referral laws impose restrictions on physician referrals to any entity with which they have a financial relationship, which is a broadly defined term. We believe our relationships with physicians are in compliance with the self-referral laws. Failure to comply with self-referral laws could subject us to a range of sanctions, including civil monetary penalties and possible exclusion from government reimbursement programs. There are also federal and state laws making it illegal to offer anyone anything of value in return for referral of patients. These laws, generally known as “anti-kickback” laws, are broad and subject to interpretations that are highly fact dependent. Given the lack of clarity of these laws, there can be no absolute assurance that any health care provider, including us, will not be found in violation of the anti-kickback laws in any given factual situation. Strict sanctions, including fines and penalties, exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for violation of the anti-kickback laws.
Reporting Obligations under Section 111 of the Medicare, Medicaid and SCHIP Extension Act of 2007 (“MMSEA”).
Since January 1, 2010, we have reported specific information regarding all claimants and claim settlements involving Medicare participants so CMS can recover Medicare funds expended to provide healthcare treatment to the claimant. The requirements are to ensure that CMS is notified so that it may recoup the amounts paid for services from the settlement proceeds. This does not result in us making additional payments to CMS for these services provided and does not result in an incremental cost to us. Strict sanctions, including fines and penalties, exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for non-compliance with these reporting obligations.

Available Information.
We file reports with the Securities and Exchange Commission (“SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. Copies of our reports filed with the SEC may be obtained by the public at the SEC's Public Reference Room located at 100 F Street, NE, Washington, DC 20549 on official business days during the hours of 10 a.m. to 3 p.m. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains electronic versions of the Company's reports on its website at www.sec.gov. We also make available, free of charge through our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and other materials filed with the SEC as soon as reasonably practical after such material is electronically filed with or furnished to the SEC via a link to the SEC's EDGAR system. Our website address is www.dvcr.com. The information provided on our website is not part of this report, and is therefore not incorporated by reference unless such information is otherwise specifically referenced elsewhere in this report.
In addition, copies of the Company's annual report will be made available, free of charge, upon written request.

Corporate Governance Principles.
The Company has adopted Corporate Governance Principles relating to the conduct and operations of the Board of Directors. The Corporate Governance Principles are posted on the Company's website (www.dvcr.com) and are available in print to any stockholder who requests a copy.
Committee Charters.
The Board of Directors has an Audit Committee, Compensation Committee, Corporate Governance Committee, Risk Management Committee, and Executive Committee. The Board of Directors has adopted written charters for each committee, except for the Executive Committee, which are posted on the Company's website (www.dvcr.com) and are available in print to any stockholder who requests a copy.



13



ITEM 1A. RISK FACTORS
There have been a number of material developments both within the Company and the long-term care industry. These developments have had and are likely to continue to have a material impact on us. This section summarizes these developments, as well as other risks that should be considered by our shareholders and prospective investors.
Risks Related to our Operations
We are substantially self-insured and have significant potential professional liability exposure.
The provision of health care services entails an inherent risk of liability. Participants in the health care industry are subject to an increasing number of lawsuits alleging malpractice, negligence, product liability or related 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. We expect to continue to be subject to such suits as a result of the nature of our business. See “Item 3. Legal Proceedings” for further descriptions of pending claims and see “Item 7. Management's Discussion and Analysis of Financial Condition - Accounting Policies and Judgments - Professional Liability and Other Self-Insurance Reserves” for discussion of our reserve for self-insured claims and of our ability to meet our anticipated cash needs.
We have professional liability insurance coverage for our nursing centers that, based on historical claims experience, is likely to be substantially less than the amount required to satisfy claims that are expected to be incurred.
We may have substantial adjustments to our accrual for professional liability claims which could cause significant changes in our net earnings.
Each year, we record adjustments to our accrual for self-insured risks associated with professional liability claims. While these adjustments to the accrual result in changes to reported expenses and income, they are not directly related to changes in cash because the accrual is not funded. These self-insurance reserves are assessed on a quarterly basis, with changes in estimated losses being recorded in the consolidated statements of operations in the period identified. Any increase in the accrual decreases income in the period, and any reduction in the accrual increases income during the period. Our actual professional liabilities may vary significantly from the accrual due to an increase in the number of claims asserted or claim costs in excess of estimates, and the amount of the accrual has and may continue to fluctuate by a material amount in any given quarter. For the years ended December 31, 2016, 2015 and 2014, we recorded professional liability expense of $8.5 million, $8.1 million and $7.2 million, respectively.
Our outstanding indebtedness is subject to various financial covenants and floating rates of interest which could be subject to fluctuations based on changing interest rates.
We have long-term indebtedness of $80.1 million at December 31, 2016. Certain of our debt agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. As of December 31, 2016, we were in compliance with these financial covenants. Our failure to comply with those covenants could result in an event of default, which, if not cured or waived, could result in the acceleration of some or all of our debts. Such non-compliance could result in a material adverse impact to our financial position, results of operations and cash flows. See “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” for additional discussion of our covenants.
In connection with the refinancing transaction in February 2016 discussed in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources,” we entered into an interest rate swap with respect to a portion of the mortgage loan to mitigate the floating interest rate risk of such borrowing. The interest rate swap converted the variable rate on our mortgage indebtedness to a fixed interest rate for the five year term of this indebtedness, decreasing our exposure to risks of variable rates of interest. While limiting our risk to increases in interest rates by utilizing the interest rate swap, we forgo benefits that might result from downward fluctuations in interest rates. We also are exposed to the risk that our counterpart to the swap agreement will default on its obligations.
Our accrual for professional liability claims is not funded, and if a material judgment is entered against us in any lawsuit, we may lack adequate cash to pay the judgment.
As of December 31, 2016, we are engaged in 67 professional liability lawsuits. 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.

14



The U.S. Department of Justice has commenced a civil investigation of potential violations of the False Claims Act, which could adversely affect our operations and financial condition.
Our business is currently under investigation for potential violations of the False Claims Act (FCA).  See Legal Proceedings for further information regarding this investigation. Any finding that we are not in compliance with these laws could require us to change our operations or could subject us to treble damages, penalties and/or make us ineligible to participate in certain government funded healthcare programs, any of which could in turn significantly harm our business and financial condition.
Our operational and strategic flexibility is limited due to the number of our centers that are leased from third parties.
A substantial majority of our centers are leased from third parties. The loss or deterioration of our relationship with any of our landlords may adversely affect our business. The terms of such leases generally require us to operate such centers as skilled nursing centers, and generally do not allow us to assign the lease to a third party without the applicable landlord’s consent. Therefore, our ability to divest such leased properties is limited, and we may be forced to continue operating such centers as skilled nursing centers even if doing so becomes unprofitable.
While we expect to renew or extend our leases in the normal course of business, there can be no assurance that these rights will be exercised in the future or that we will be able to satisfy the conditions precedent to exercising any such renewal or extension, to the extent that such provisions exist in our leases. In addition, if we are unable to renew or extend any of our master leases, we may lose all of the facilities subject to that master lease agreement. If we are not able to renew or extend our leases at or prior to the end of the existing lease terms, or if the terms of such options are unfavorable or unacceptable to us, our business, financial condition and results of operation could be adversely affected.
Our failure to pay the rent or otherwise comply with the provisions of any of our lease agreements could result in an “event of default” under such lease agreement and also could result in a cross default under other master lease agreements and the agreements for our indebtedness. Upon an event of default, remedies available to our landlords generally include, without limitation, terminating such lease agreement, repossessing and reletting the leased properties and requiring us to remain liable for all obligations under such lease agreement, including the difference between the rent under such lease agreement and the rent payable as a result of reletting the leased properties, or requiring us to pay the net present value of the rent due for the balance of the term of such lease agreement. The exercise of such remedies would have a material adverse effect on our business, financial position, results of operations and liquidity.
Our failure to pay rent or otherwise comply with the provisions of any of our Master Lease Agreements could materially adversely affect our business, financial position, results of operations, and liquidity.
Many of our facilities are under a Master Lease Agreement. Our failure to pay the rent or otherwise comply with the provisions of any of our Master Lease Agreements would result in an “Event of Default” under such Master Lease Agreement and also could result in a default under the Credit Facilities and, if repayment of the borrowings under the Credit Facilities were accelerated, also under the indentures governing our outstanding notes. The exercise of remedies by any of our landlords would have a material adverse effect on our business, financial position, results of operations, and liquidity.
We are highly dependent on reimbursement by third-party payors and delays in reimbursement for any reason may cause liquidity problems.
Substantially all of our nursing center revenues are directly or indirectly dependent upon reimbursement from third-party payors, including the Medicare and Medicaid programs, and private insurers. For the year ended December 31, 2016, our patient revenues from continuing operations derived from Medicaid, Medicare, Managed Care and private pay (including private insurers) sources were approximately 50.6%, 27.5%, 6.8%, and 15.1%, respectively. Changes in the mix of our patients among Medicare, Medicaid, Managed Care and private pay categories and among different types of private pay sources may affect our net revenues and profitability. Our net revenues and profitability are also affected by the continuing efforts of all payors to contain or reduce the costs of health care. Efforts to impose reduced payments, greater discounts and more stringent cost controls by government and other payors are expected to continue.
The Federal Government makes frequent changes to the reimbursement provided under the Medicare program and future changes could significantly reduce the reimbursement we receive. Also, a number of state governments, including several of the states in which we operate, have announced projected budget shortfalls and/or deficit spending situations. Possible actions by these states include reductions of Medicaid reimbursement to providers such as us or the failure to increase Medicaid reimbursements to cover increased operating costs, or implementation of alternatives to long-term care, such as community and home-based services.

15



Any changes in reimbursement levels or in the timing of payments under Medicare, Medicaid or private pay programs and any changes in applicable government regulations could have a material adverse effect on our net revenues, net income (loss) and cash flows. We are unable to predict what reform proposals or reimbursement limitations will be adopted in the future or the effect such changes will have on our operations. We are limited in our ability to reduce the direct costs of providing care when decreases in reimbursement rates are imposed. No assurance can be given that such reforms will not have a material adverse effect on us. See “Item 1. Business - Government Regulation and Reimbursement.”
If we have information systems problems or payment or other issues arise with Medicare, Medicaid or other payors that affect the amount or timeliness of reimbursements, we may encounter delays in our payment cycle. Any significant payment timing delay could cause us to experience working capital shortages. As a result, working capital management, including prompt and diligent billing and collection, is an important factor in our consolidated results of operations and liquidity. Our working capital management procedures may not successfully mitigate the effects of any delays in our receipt of payments or reimbursements. Accordingly, such delays could have an adverse effect on our liquidity and financial condition.
We operate in an industry that is highly competitive.
The long-term care industry generally, and the nursing home business particularly, is highly competitive. We face direct competition for the acquisition of centers. In turn, our centers face competition for patients. Our ability to compete is based on several factors and include, but are not limited to building age, appearance, reputation, relationships with referral sources, availability of patients, survey history and CMS rankings. Some of our present and potential competitors are significantly larger and have or may obtain greater financial and marketing resources than we can. Some hospitals that provide long-term care services are also a potential source of competition. Certain of our competitors are operated by not-for-profit, non-taxpaying or governmental agencies that can finance capital expenditures on a tax exempt basis and receive funds and charitable contributions unavailable to us. In addition, we may encounter substantial competition from new market entrants. Consequently, there can be no assurance that we will not encounter increased competition in the future, which could limit our ability to attract patients or expand our business, and could materially and adversely affect our business or decrease our market share.
We may have difficulty attracting and retaining qualified nurses, therapists, healthcare professionals and other key personnel, which, along with a growing number of minimum wage and compensation related regulations, can increase our costs related to these employees.
Our team members are essential to our business. We rely on our ability to attract and retain qualified nurses, therapists and other healthcare professionals. The market for these key personnel is highly competitive, and we could experience significant increases in our operating costs due to shortages in their availability. Like other healthcare providers, we have at times experienced difficulties in attracting and retaining qualified personnel. We may continue to experience increases in our labor costs, primarily due to higher wages and greater benefits required to attract and retain qualified healthcare personnel, and such increases may adversely affect our profitability. Furthermore, while we attempt to manage overall labor costs in the most efficient way, our efforts to manage them through wage freezes and similar means may have limited effectiveness and may lead to increased turnover and other challenges.
Tight labor markets and high demand for such team members can contribute to high turnover among clinical professional staff. A shortage of qualified personnel at a facility could result in significant increases in labor costs and increased reliance on overtime and expensive temporary staffing agencies, and could otherwise adversely affect operations at the affected centers. If we are unable to attract and retain qualified professionals, our ability to adequately provide services to our residents and patients may decline and our ability to grow may be constrained.
Our cost of labor may be influenced by unanticipated factors in certain markets or, with respect to collective bargaining agreements that we are a party to, we may experience above-market increases. A substantial number of our team members are hourly team members whose wage rates are affected by increases in the federal or state minimum wage rate. As collective bargaining agreements are renegotiated or minimum wage rates increase we may need to increase the wages paid to team members. This may be applicable to not only minimum wage team members but also to team members at wage rates which are currently above the minimum wage.
The Department of Labor recently issued rule changes to the Fair Labor Standards Act that would increase the minimum salary threshold for team members exempt from overtime along with an automatic annual increase to this salary threshold. The future of these rule changes, as well as other potential changes, remains uncertain given the recent change in Presidential administrations. However, these rule changes could increase our cost of services provided.

16



Because we are largely funded by government programs, we do not have an ability to pass such wage increases through to revenue sources. Any such mandated wage increases could have a material adverse effect on our results of operations, liquidity and financial condition.
Possible changes in the acuity of residents and patients, as well as payor mix and payment methodologies, may significantly affect our profitability.
The sources and amount of our revenues are determined by a number of factors, including the occupancy rates of our facilities, the length of stay, the payor mix of residents and patients, rates of reimbursement among payors, and patient acuity. Changes in patient acuity as well as payor mix among private pay, Medicare, and Medicaid may significantly affect our profitability. In particular, any significant decrease in our population of high-acuity patients or any significant increase in our Medicaid population could have a material adverse effect on our business, financial position, results of operations, and liquidity, especially if state Medicaid programs continue to limit, or more aggressively seek limits on, reimbursement rates or service levels.
Our systems are subject to security breaches and other cybersecurity incidents.
While we maintain information technology security and safeguards, complex medical systems can be targeted for cyber attacks, and as a result, the potential exists for unauthorized parties to obtain access to our computer systems and networks. Such cyber attacks could result in the misappropriation of our patient information protected by privacy laws, private employee information, proprietary business information and technology or result in interruptions to our business. The reliability and security of our information technology infrastructure is critical to our business. To the extent that any disruptions or security breaches result in significant loss or damage to our data, or inappropriate disclosure of significant proprietary information, it could require notice to state and federal agencies of such a breach, cause damage to our reputation and affect our relationships with our patients, may result in civil and/or criminal fines and penalties or related class action litigation, any of which could have a material adverse effect on our business, results of operations and financial condition.
The success of previous and future acquisitions cannot be guaranteed and such acquisitions may consume substantial capital and other resources and could expose us to unforeseen liabilities and integration risks.
We have in the past and plan to in the future make investments in additional centers, whether by opening new centers or acquiring existing centers. Such acquisitions may involve significant cash expenditures, debt incurrence, operating losses and additional expenses that could have a material adverse effect on our financial position, results of operations and liquidity. Acquisitions involve numerous risks, including:
difficulties integrating acquired operations, personnel and accounting and information systems, or in realizing projected efficiencies and cost savings;
diversion of management's attention from other business concerns;
potential loss of key team members or customers of acquired companies;
entry into markets in which we may have limited or no experience;
increased indebtedness and reduced ability to access additional capital when needed;
assumption of unknown liabilities or regulatory issues of acquired companies, including failure to comply with healthcare regulations or to establish internal financial controls; and
straining of our resources, including internal controls relating to information and accounting systems, regulatory compliance, logistics and others.
Furthermore, certain of the foregoing risks could be exacerbated when combined with other growth measures that we may pursue.
Investing in our business initiatives and development could adversely impact our results of operations and financial condition.
We plan to invest in business initiatives and development that will increase our operating expenses. These initiatives may or may not be successful in growing our census or revenues. There is typically a time delay between incurring such expenses and the attaining of revenues and cash flows expected from these initiatives and development. As a result, our revenue and operating cash flow may not increase enough during a reporting period to cover these increased expenses. Such additional revenues may not materialize to the level we anticipate, if at all.

17



Disasters and similar events may seriously harm our business.
Natural and man-made disasters and similar events, including terrorist attacks and acts of nature such as hurricanes, tornados, earthquakes and wildfires, may cause damage or disruption to us, our employees and our centers, which could have an adverse impact on our patients and our business.  In order to provide care for our patients, we are dependent on consistent and reliable delivery of food, pharmaceuticals, utilities and other goods to our centers, and the availability of employees to provide services at our centers.  If the delivery of goods or the ability of employees to reach our centers were interrupted in any material respect due to a natural disaster or other reasons, it would have a significant impact on our centers and our business.  Furthermore, the impact, or impending threat, of a natural disaster has in the past and may in the future require that we evacuate one or more centers, which would be costly and would involve risks, including potentially fatal risks, for the patients.  The impact of disasters and similar events is inherently uncertain.  Such events could harm our patients and employees, severely damage or destroy one or more of our centers, harm our business, reputation and financial performance, or otherwise cause our business to suffer in ways that we currently cannot predict.
New accounting pronouncements or new interpretations of existing standards could require us to make adjustments in our accounting policies that could affect our financial statements.
The Financial Accounting Standards Board, the SEC, or other accounting organizations or governmental entities issue new pronouncements or new interpretations of existing accounting standards that sometimes require us to change our accounting policies and procedures. Future pronouncements or interpretations could require us to change our policies or procedures and have a significant impact on our future financial statements.
Risks Related to Government Regulations
We are subject to significant government regulation.
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, protection of patient health information, reimbursement for patient services, quality of patient care and Medicare and Medicaid fraud and abuse. Various federal and state laws regulate relationships among providers of services, including employment or service contracts and investment relationships. The operation of long-term care centers and the provision of services are also subject to extensive federal, state, and local laws relating to, among other things, the adequacy of medical care, distribution of pharmaceuticals, equipment, personnel, operating policies, environmental compliance, compliance with the Americans with Disabilities Act, fire prevention and compliance with building codes.
Long-term care facilities are subject to periodic inspection to assure continued compliance with various standards and licensing requirements under state law, as well as with Medicare and Medicaid conditions of participation. The failure to obtain or renew any required regulatory approvals or licenses could adversely affect our growth and could prevent us from offering our existing or additional services. In addition, health care is an area of extensive and frequent regulatory change. Changes in the laws or new interpretations of existing laws can have a significant effect on methods and costs of doing business and amounts of payments received from governmental and other payors. Our operations could be adversely affected by, among other things, regulatory developments such as mandatory increases in the scope and quality of care to be afforded patients and revisions in licensing and certification standards. We attempt at all times to comply with all applicable laws; however, there can be no assurance that we will remain in compliance at all times with all applicable laws and regulations or that new legislation or administrative or judicial interpretation of existing laws or regulations will not have a material adverse effect on our operations or financial condition. Federal or state proceedings seeking to impose fines and penalties for violations of applicable laws and regulations, as well as federal and state changes in these laws and regulations, may negatively impact us. See “Item 1. Business - Government Regulation.” See also “Item 3. Legal Proceedings.”
The health care industry has been the subject of increased regulatory scrutiny recently.
The Office of Inspector General (“OIG”), the enforcement arm of the Medicare and Medicaid programs, formulates a formal work plan each year for nursing centers. The OIG's most recent work plan indicates that quality of care, assessment and monitoring, poorly performing nursing facilities, hospitalizations, criminal background checks, Medicare part B services, accuracy of nursing facilities Minimum Data, transparency of ownership, and civil monetary penalty funds will be the investigative focus in 2017. We cannot predict the likelihood, scope or outcome of any such investigations on our centers.

18



We are subject to claims under the self-referral, false claims, and anti-kickback legislation.
Federal and state false claims act statutes provide a mechanism for private individuals and governmental entities to seek to recover significant sums for alleged violations of the federal and state laws governing reimbursement for services provided. At least one false claims act case is pending against us, and there can be no assurance that our operations will not be subject to review, scrutiny, penalties or enforcement actions under these laws, or that these laws will not change in the future. Violations of these laws may result in substantial damage awards, civil or criminal penalties for individuals or entities, including large civil monetary penalties and exclusion from participation in the Medicare or Medicaid programs. Such awards, exclusion or penalties, if applied to us, could have a material adverse effect on our financial position and profitability.
In the United States, various state and federal laws regulate the relationships between providers of health care services, physicians, and other clinicians. These self-referral laws impose restrictions on physician referrals for designated health services to entities with which they have financial relationships. These laws also prohibit the offering, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare or state health care program patients or patient care opportunities for the purchase, lease or order of any item or service that is covered by the Medicare and Medicaid programs. Federal and state laws prohibit the submission of false claims and other acts that are considered fraudulent, wasteful or abusive. Under the federal False Claims Act (FCA), actions against a provider can be initiated by the federal government or by a private party on behalf of the federal government. These private parties, who are often referred to as “qui tam relators” or “relators,” are entitled to share in any amounts recovered by the government. Both direct enforcement activity by the government and qui tam relator actions have increased significantly in recent years. The use of private enforcement actions against healthcare providers has increased dramatically, in part because the relators are entitled to share in a portion of any settlement or judgment.
A FCA violation occurs when a provider knowingly submits a claim for items or services not provided. The Fraud Enforcement and Recovery Act of 2009 expanded the scope of the FCA by creating liability for knowingly retaining an overpayment received from the government and broadening protections for whistleblowers. The submission of false claims or the failure to timely repay overpayments may lead to the imposition of significant CMPs, significant criminal fines and imprisonment, and/or exclusion from participation in state and federally-funded healthcare programs, including the Medicare and Medicaid programs.
Allegations of poor quality of care can also lead to FCA actions under a theory of worthless services. Worthless services cases allege that although care was provided it was so deficient that it was tantamount to no service at all.
In recent years, prosecutors and relators are increasingly bringing FCA claims based on the implied certification theory as an expansion of the scope of the FCA. Under the implied certification theory, a violation of the FCA occurs when a provider’s request for payment implies a certification of compliance with the applicable statutes, regulations or contract provisions that are preconditions to payment. This development has increased the risk that a healthcare company will have to defend a false claims action, pay fines and treble damages or settlement amounts or be excluded from the federal and state healthcare programs as a result of an investigation arising out of the FCA. Many states have enacted similar laws providing for imposition of civil and criminal penalties for the filing of fraudulent claims.
Because we submit thousands of claims to Medicare each year, and there is a relatively long statute of limitations under the FCA, there is a risk that intentional, or even negligent or recklessly submitted claims that prove to be incorrect, or even billing errors, cost reporting errors or lapses in statutory or regulatory compliance with regard to the provision of healthcare services (including, without limitation the Anti-Kickback Statue and the federal self-referral law discussed above), could result in significant civil or criminal penalties against us. Any such penalties or allegations, whether valid or not, could have a significant impact on our business. To the extent that we, any of our centers through which we do business, or any of the owners or directors have a financial relationship with each other or with other health care entities providing services to long-term care patients, such relationships could be subject to increased scrutiny.
We are subject to laws governing the confidentiality of patient health information.
Both federal and state laws impose certain requirements regarding maintaining the confidentiality of patient health information. In particular, HIPAA rules and regulations require us to protect the medical records and other personal health information of our patients, limit our use of and ability to disclose such information except under certain circumstances, and give patients a right to access and amend their personal health information. A violation of HIPAA or any other federal or state laws regarding the confidentiality or use of such information could subject us to civil or criminal penalties, and could in turn damage our reputation, affect our ability to attract new patients, and thereby have a material adverse effect on our revenues, financial position, results of operations and cash flows.

19



Healthcare reform legislation could adversely affect our revenue and financial condition.
In recent years, there have been initiatives on the federal and state levels for comprehensive reforms affecting the availability, payment and reimbursement of healthcare services in the United States. In March 2010, significant legislation concerning health care and health insurance was passed which will significantly change the future of health care in the United States, including the Affordable Care Act (the “Affordable Care Act”), which has affected comprehensive health insurance reform, including the creation of health insurance exchanges, among other reforms. However, as has been widely publicized, the Affordable Care Act has been fraught with challenges. In addition, it is possible that changes in administration and policy, including the potential repeal of all or parts of the Affordable Care Act, resulting from the recent U.S. presidential election could result in additional proposals and continued developments with respect to healthcare reform. Significant changes to, or repeal of, the Affordable Care Act or other healthcare legislation could materially and adversely our business.
State efforts to regulate or deregulate the healthcare services industry or the construction or expansion of healthcare facilities could impair our ability to expand our operations, or could result in increased competition.
Some states require healthcare providers to obtain prior approval, known as a certificate of need, for:
the purchase, construction or expansion of healthcare facilities;
capital expenditures exceeding a prescribed amount; or
changes in services or bed capacity.
In addition, other states that do not require certificates of need have effectively barred the expansion of existing facilities and the development of new ones by placing partial or complete moratoria on the number of new Medicaid beds they will certify in certain areas or in the entire state. Other states have established such stringent development standards and approval procedures for constructing new healthcare facilities that the construction of new facilities, or the expansion or renovation of existing facilities, may become cost prohibitive or extremely time-consuming. In addition, some states the acquisition of a facility being operated by a non-profit organization requires the approval of the state Attorney General.
Our ability to acquire or construct new facilities or expand or provide new services at existing facilities would be adversely affected if we are unable to obtain the necessary approvals, if there are changes in the standards applicable to those approvals, or if we experience delays and increased expenses associated with obtaining those approvals. We may not be able to obtain licensure, certificate of need approval, Medicaid certification, Attorney General approval or other necessary approvals for future expansion projects. Conversely, the elimination or reduction of state regulations that limit the construction, expansion or renovation of new or existing facilities could result in increased competition to us or result in overbuilding of facilities in some of our markets. If overbuilding in the healthcare industry in the markets in which we operate were to occur, it could reduce the occupancy rates of existing facilities and, in some cases, might reduce the private rates that we charge for our services.
Risks Related to our Common Stock
Our ability and intent to pay cash dividends in the future may be limited.
We currently pay a $0.055 quarterly dividend on our common shares, and 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, our financial condition, funds from operations, the level of our capital expenditures and future business prospects. The Company is restricted by its debt agreements in its ability to pay dividends.
We have a number of policies in place that could be considered anti-takeover protections.
Our Certificate of Incorporation (the “Certificate”) provided for the classification of our Board into three classes, with each class of directors serving staggered terms of three years. Although the classification of our Board has been eliminated, all directors will not be up for election each year until the 2018 annual meeting. Our Certificate requires the approval of the holders of two-thirds of the outstanding shares to amend certain provisions of the Certificate. Section 203 of the Delaware General Corporate Law restricts the ability of a Delaware corporation to engage in any business combination with an interested shareholder. We are also authorized to issue up to 795,000 shares of preferred stock, the rights of which may be fixed by our Board without shareholder approval. Provisions in certain of our executive officers' employment agreements provide for post-termination compensation, including payment of amounts up to two times their annual salary, following certain changes in control (as defined in such agreements). Our stock incentive plans provide for the acceleration of the vesting of options in the event of certain changes in control (as defined in such plans). Certain changes in control

20



also constitute an event of default under our bank credit facility. The foregoing matters may, together or separately, have the effect of discouraging or making more difficult an acquisition or change of control of the company.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.

ITEM 2. PROPERTIES
We own 17 and lease 59 long-term care centers as discussed in “Item 1 Business - Nursing Centers and Services.” See further details below.

Our current operations include 59 nursing centers subject to operating leases, including 35 owned by Omega, 20 owned by Golden Living and four owned by other parties. Effective April 1, 2015, Omega acquired Aviv REIT, who owned 12 of our centers at the time of acquisition, which subsequently are owned by Omega. In our role as lessee, we are responsible for the day-to-day operations of all operated centers. These responsibilities include recruiting, hiring and training all nursing and other personnel, and providing patient care, nutrition services, marketing, quality improvement, accounting, and data processing services for each center. The lease agreements pertaining to our 59 leased centers are “triple net” leases, requiring us to maintain the premises, provide insurance, pay taxes and pay for all utilities. The average remaining term of our lease agreements, including renewal options, is approximately 17 years. See the table below for a summary of owned and leased beds operated by the Company.
State
 
Centers
 
Leased Beds
 
Owned Beds
 
Total Operational Beds
Alabama
 
19

 
2,079

 
203

 
2,282

Florida
 
1

 
79

 

 
79

Indiana
 
1

 
172

 

 
172

Kansas
 
6

 

 
490

 
490

Kentucky
 
13

 
917

 
252

 
1,169

Mississippi
 
10

 
1,138

 

 
1,138

Missouri
 
3

 
455

 

 
455

Ohio
 
5

 
702

 

 
702

Tennessee
 
5

 
497

 
120

 
617

Texas
 
13

 
1,370

 
475

 
1,845

Total
 
76

 
7,409

 
1,540

 
8,949

Brentwood Support Center and Regional Offices
We lease approximately 29,000 square feet of office space in Brentwood, Tennessee that houses our executive offices, and centralized management support functions. Lease periods on these centers range up to three years. Regional executives for Kansas work from an office of approximately 1,500 square feet. We believe that our leased properties are adequate for our present needs and that suitable additional or replacement space will be available as required.

ITEM 3. 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, negligence, violations of false claims acts, product liability, or related 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 regulatory actions seeking fines and penalties for alleged violations of health care laws and are potentially subject to the increased scrutiny of regulators for issues related to compliance with health care fraud and abuse laws and with respect to the quality of care provided to residents of our center. Like 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 December 31, 2016, we are engaged in 67 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. We have limited, and sometimes no, professional liability insurance with regard to most of these claims. 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).

21



In October 2014, the Company learned that the investigation was started by the filing under seal of a false claims action against the two centers that were the subject of the original civil investigative demand ("CID"). In connection with this matter, between July 2013 and early February 2016, the Company has received three civil investigative demands (a form of subpoena) for documents and information relating to our practices and policies for rehabilitation, and other services, our preadmission evaluation forms ("PAEs") required by TennCare and our Pre-Admission Screening and Resident Reviews ("PASRRs"). We have responded to those requests. The DOJ has also issued CID’s for testimony from current and former employees of the Company. The DOJ’s civil investigation of the Company’s practices and policies for rehabilitation now covers all of the Company’s centers, but thus far only documents from six of our centers have been requested.
In June 2016, the Company received an authorized investigative demand (a form of subpoena) for documents in connection with a criminal investigation by the DOJ related to our practices with respect to PAEs and PASRRs, and the Company has provided documents responsive to this subpoena and continues to provide additional information as requested. The Company cannot predict the outcome of these investigations or the related lawsuits, and the outcome could have a materially adverse effect on the Company, including the imposition of treble damages, criminal charges, fines, penalties and/or a corporate integrity agreement. The Company is committed to provide caring and professional services to its patients and residents in compliance with applicable laws and regulations.
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 “Center”). The complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Center 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 pending DOJ investigation or the purported class action against the Arkansas centers. 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 4. MINE SAFETY DISCLOSURES
Not applicable.



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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information. Our common stock is traded on the NASDAQ Capital Market and began trading there on September 12, 2006 under the symbol “AVCA.” Effective March 15, 2013, the Company changed its name from Advocat Inc. to Diversicare Healthcare Services, Inc. as a result of a merger of the Company and a wholly-owned subsidiary. In connection with the name change, the Company changed its NASDAQ ticker symbol from “AVCA” to “DVCR” effective with the market open on
Monday, March 18, 2013. The following table sets forth the high and low bid prices of our common stock, as reported by NASDAQ.com, for each quarter in 2016 and 2015:

Period
High
Low
Dividends
2015
1st  
Quarter
$
13.95

$
8.46

$
0.055

2015
2nd  
Quarter
$
17.15

$
11.89

$
0.055

2015
3rd  
Quarter
$
13.00

$
8.14

$
0.055

2015
4th   
Quarter
$
10.59

$
6.45

$
0.055

2016
1st  
Quarter
$
9.95

$
6.75

$
0.055

2016
2nd  
Quarter
$
8.90

$
7.00

$
0.055

2016
3rd  
Quarter
$
10.07

$
6.41

$
0.055

2016
4th   
Quarter
$
12.82

$
9.98

$
0.055


Our common stock has been traded since May 10, 1994. On February 15, 2017, the closing price for our common stock was $9.27, as reported by NASDAQ.com.
Holders. On February 15, 2017, there were approximately 264 holders of record. Most of our shareholders have their holdings in the street name of their broker/dealer.
Dividends. For each of the two most recent fiscal years, we have paid a quarterly dividend of $0.055 per common share. While the Board of Directors intends to continue 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. The Company is restricted by its debt agreements in its ability to pay dividends.



23



ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data of Diversicare presented in the following table has been derived from our consolidated financial statements, and should be read in conjunction with the annual financial statements and related notes and Management's Discussion and Analysis of Financial Condition and Results of Operations. This selected financial data for all periods shown has been reclassified to present the effects of certain divestitures as discontinued operations.

24



 
 
Year Ended December 31,
 
 
2016
 
2015
 
2014
 
2013
 
2012
Statement of Operations Data
 
 
 
(in thousands, except per share amounts)
 
 
REVENUES:
 
 
 
 
 
 
 
 
 
 
Patient revenues, net
 
$
426,063

 
$
387,595

 
$
344,192

 
$
260,221

 
$
231,047

EXPENSES:
 
 
 
 
 
 
 
 
 
 
Operating
 
342,932

 
311,035

 
275,605

 
213,064

 
186,958

Lease
 
33,364

 
28,690

 
26,151

 
20,396

 
18,018

Professional liability
 
8,456

 
8,122

 
7,216

 
5,666

 
4,304

General and administrative
 
30,271

 
24,793

 
22,133

 
20,940

 
19,515

Depreciation and amortization
 
8,292

 
7,524

 
7,078

 
6,363

 
5,758

Lease termination costs
 
2,008

 

 

 

 

Restructuring
 

 

 

 
1,446

 

 
 
425,323

 
380,164

 
338,183

 
267,875

 
234,553

OPERATING INCOME (LOSS)
 
740

 
7,431

 
6,009

 
(7,654
)
 
(3,506
)
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
 
 
 
Equity in net income (losses) of investment in unconsolidated affiliate
 
273

 
339

 
(5
)
 
(183
)
 
(280
)
Gain on sale of investment in unconsolidated affiliate
 
1,366

 

 

 

 

Interest expense, net
 
(4,802
)
 
(4,102
)
 
(3,697
)
 
(3,032
)
 
(2,232
)
Debt retirement costs
 
(351
)
 

 

 
(320
)
 

 
 
(3,514
)
 
(3,763
)
 
(3,702
)
 
(3,535
)
 
(2,512
)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
 
(2,774
)
 
3,668

 
2,307

 
(11,189
)
 
(6,018
)
BENEFIT (PROVISION) FOR INCOME TAXES
 
1,030

 
(916
)
 
(857
)
 
4,196

 
2,147

INCOME (LOSS) FROM CONTINUING OPERATIONS
 
(1,744
)
 
2,752

 
1,450

 
(6,993
)
 
(3,871
)
DISCONTINUED OPERATIONS, net of taxes
 
(67
)
 
(1,128
)
 
3,258

 
(1,469
)
 
951

NET INCOME (LOSS)
 
$
(1,811
)
 
$
1,624

 
$
4,708

 
$
(8,462
)
 
$
(2,920
)
INCOME (LOSS) PER COMMON SHARE:
 
 
 
 
 
 
 
 
 
 
Basic
 
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
(0.28
)
 
$
0.45

 
$
0.21

 
$
(1.26
)
 
$
(0.74
)
Discontinued operations
 
(0.01
)
 
(0.18
)
 
0.54

 
(0.25
)
 
0.16

Net income (loss) per common share
 
$
(0.29
)
 
$
0.27

 
$
0.75

 
$
(1.51
)
 
$
(0.58
)
Diluted
 
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
(0.28
)
 
$
0.44

 
$
0.20

 
(1.26
)
 
(0.74
)
Discontinued operations
 
(0.01
)
 
(0.18
)
 
0.52

 
(0.25
)
 
0.16

Net income (loss) per common share
 
$
(0.29
)
 
$
0.26

 
$
0.72

 
$
(1.51
)
 
$
(0.58
)
CASH DIVIDENDS DECLARED PER COMMON SHARE
 
$
0.22

 
$
0.22

 
$
0.22

 
$
0.22

 
$
0.22

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
 
 
 
 
 
 
 
Basic
 
6,199

 
6,100

 
6,011

 
5,899

 
5,821

Diluted
 
6,199

 
6,315

 
6,197

 
5,899

 
5,821



25



 
 
December 31,
 
 
2016
 
2015
 
2014
 
2013
 
2012
Balance Sheet Data
 
(in thousands)
Working capital
 
$
21,165

 
$
13,052

 
$
8,797

 
$
8,044

 
$
15,663

Total assets
 
$
163,051

 
$
137,084

 
$
129,089

 
$
137,744

 
$
114,963

Long-term debt and capitalized lease obligations, including current portion
 
$
82,133

 
$
60,867

 
$
48,265

 
$
53,577

 
$
29,462

Preferred Stock - Series C
 
$

 
$

 
$

 
$
4,918

 
$
4,918

Total Shareholders' Equity of Diversicare Healthcare Services, Inc.
 
$
11,420

 
$
13,267

 
$
11,754

 
$
8,129

 
$
17,178

Total Shareholders' Equity
 
$
11,420

 
$
13,267

 
$
11,754

 
$
9,566

 
$
18,751




26



ITEM 7. 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 ten states, primarily in the Southeast, Midwest and Southwest. Our centers provide a range of health care services to their patients and residents. In addition to the nursing, personal care and social services usually provided in long-term care centers, we offer a variety of comprehensive rehabilitation services as well as nutritional support services. As of December 31, 2016, our continuing operations consist of 76 nursing centers with 8,453 licensed skilled nursing beds and 496 assisted-living and other residential beds. We own 17 and lease 59 of our nursing centers included in continuing operations. The Company's continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Mississippi, Missouri, Ohio, Tennessee, and Texas.
Strategic Operating Initiatives
We identified several key strategic objectives to increase shareholder value through improved operations and business development. These strategic operating initiatives include: improving skilled mix in our nursing centers, improving our average Medicare rate, implementing and maintaining Electronic Medical Records (“EMR”) to improve Medicaid capture, and completing strategic acquisitions. We have experienced success in these initiatives and expect to continue to build on these improvements.
Improving skilled mix and average Medicare rate:
Our strategic operating initiatives of improving our skilled mix and our average Medicare rate required investing in nursing and clinical care to treat more acute patients along with nursing center-based marketing representatives to attract these patients. These initiatives developed referral and Managed Care relationships that have attracted and are expected to continue to attract payor sources for patients covered by Medicare and Managed Care. The Company's skilled mix for the periods ending December 31, 2016, 2015 and 2014 was 15.2%, 16.2% and 16.3%, respectively. The graph below illustrates our success with increasing our average Medicare rate per day: 
medicarerateperdaygrapha01.jpg
Implementing Electronic Medical Records to improve Medicaid acuity capture:
As another part of our strategic operating initiatives, we implemented EMR to improve Medicaid acuity capture, primarily in our states where the Medicaid payments are acuity based. We completed the implementation of EMR in all our nursing centers in December 2011, on time and under budget, and since implementation, have increased our average Medicaid rate despite rate cuts in certain acuity based states by accurate and timely capture of care delivery. The graph below illustrates our success with increasing our average Medicaid rate per day since implementation:

27



medicaidrateperdaygrapha02.jpg

28



Completing strategic transactions:
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 geographic areas of operation. We expect to announce additional development projects in the near future.
On October 1, 2016 and November 1, 2016, we assumed the operations of ten centers in Mississippi and 12 centers in Alabama, respectively, which is further discussed in Note 2 to the consolidated financial statements. The completion of this transaction brings the Company's operations to 76 nursing centers with 8,453 skilled nursings beds. These centers are expected to contribute in excess of $185 million in annual revenues.

Divestitures
As part of our strategic efforts, we have also performed 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, in May 2016, we ceased operations at our Avon, Ohio, facility, thus terminating our lease with Avon Ohio, LLC. This transaction was not reported as a discontinued operation as described in Note 2 to the consolidated financial statements. Additionally, in 2014, we disposed of all operations within the state of West Virginia, including the sale of Rose Terrace. More information on this divestiture is included below.
Effective July 1, 2014, the Company completed the transaction with Rose Terrace Acq., LLC to sell Rose Terrace, a 90-bed skilled nursing center 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 with Omega Health Investors, Inc. ("Omega") to terminate the lease only with respect to two other skilled nursing centers 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 centers located in Danville and Ivydale, West Virginia. The amendment effectively reduced the annual rent payments due under the Master Lease by $1,900,000. 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 center. The Company will continue to defend, and make cash payments related to professional liability claims asserted against these nursing centers for events occurring prior to July 1, 2014.

29



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, 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.

Selected Financial and Operating Data
The following table summarizes the Diversicare statements of continuing operations for the years ended December 31, 2016, 2015 and 2014, and sets forth this data as a percentage of revenues for the same year:

 
 
Year Ended December 31,
 
 
(Dollars in thousands)
 
 
2016
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
Patient revenues, net
 
$
426,063

 
100.0
 %
 
$
387,595

 
100.0
 %
 
$
344,192

 
100.0
 %
Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Operating
 
342,932

 
80.5
 %
 
311,035

 
80.2
 %
 
275,605

 
80.1
 %
Lease
 
33,364

 
7.8
 %
 
28,690

 
7.4
 %
 
26,151

 
7.6
 %
Professional liability
 
8,456

 
2.0
 %
 
8,122

 
2.1
 %
 
7,216

 
2.1
 %
General & administrative
 
30,271

 
7.1
 %
 
24,793

 
6.4
 %
 
22,133

 
6.4
 %
Depreciation and amortization
 
8,292

 
1.9
 %
 
7,524

 
1.9
 %
 
7,078

 
2.1
 %
Lease termination costs
 
2,008

 
0.5
 %
 

 
 %
 

 
 %
 
 
425,323

 
99.8
 %
 
380,164

 
98.0
 %
 
338,183

 
98.3
 %
Operating income (loss)
 
740

 
0.2
 %
 
7,431

 
2.0
 %
 
6,009

 
1.7
 %
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
Equity in net losses of unconsolidated affiliate
 
273

 
0.1
 %
 
339

 
0.1
 %
 
(5
)
 
 %
Gain on sale of unconsolidated affiliate
 
1,366

 
0.3
 %
 

 
 %
 

 
 %
Interest expense, net
 
(4,802
)
 
(1.1
)%
 
(4,102
)
 
(1.1
)%
 
(3,697
)
 
(1.1
)%
Debt retirement costs
 
(351
)
 
(0.1
)%
 

 
 %
 

 
 %
 
 
(3,514
)
 
(0.8
)%
 
(3,763
)
 
(1.0
)%
 
(3,702
)
 
(1.1
)%
Income (loss) from continuing operations before income taxes
 
(2,774
)
 
(0.6
)%
 
3,668

 
1.0
 %
 
2,307

 
0.6
 %
Benefit (provision) for income taxes
 
1,030

 
0.2
 %
 
(916
)
 
(0.2
)%
 
(857
)
 
(0.2
)%
Income (loss) from continuing operations
 
$
(1,744
)
 
(0.4
)%
 
$
2,752

 
0.8
 %
 
$
1,450

 
0.4
 %


The following table presents data about the centers we operated as part of our continuing operations as of the dates:
 
 
December 31,
 
 
2016
 
2015
 
2014
Licensed Nursing Center Beds:
 
 
 
 
 
 
Owned
 
1,504

 
1,370

 
1,220

Leased
 
6,949

 
4,690

 
4,605

Total
 
8,453

 
6,060

 
5,825

Facilities:
 
 
 
 
 
 
Owned
 
17

 
15

 
13

Leased
 
59

 
40

 
39

Total
 
76

 
55

 
52



30



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 of the need to make estimates about the effect of matters that are inherently uncertain. Actual results could differ from those estimates and cause our reported net income (loss) to vary significantly from period to period. Our accounting policies that fit this definition include the following:
Revenues
Patient Revenues, Net
The fees we charge patients in our nursing centers are recorded on an accrual basis. These rates are contractually adjusted with respect to individuals receiving benefits under federal and state-funded programs and other third-party payors. Our net revenues are derived substantially from Medicare, Medicaid and other government programs (approximately 78.1%, 77.6% and 78.0% for 2016, 2015, and 2014, respectively). Medicare intermediaries make retroactive adjustments based on changes in allowed claims. In addition, certain of the states in which we operate require complicated detailed cost reports which are subject to review and adjustments. In the opinion of management, adequate provision has been made for adjustments that may result from such reviews. Retroactive adjustments, if any, are recorded when objectively determinable, generally within three years of the close of a reimbursement year depending upon the timing of appeals and third-party settlement reviews or audits.
Allowance for Doubtful Accounts
We evaluate the collectibility of our accounts receivable by reviewing current aging summaries of accounts receivable, historical collections data and other factors. As a percentage of revenue, our provision for doubtful accounts was approximately 1.7%, 1.9%, and 1.7% for 2016, 2015, and 2014, respectively. Historical bad debts have generally resulted from uncollectible private pay balances, some uncollectible coinsurance and deductibles and other factors. Receivables that are deemed to be uncollectible are written off.

Professional Liability and Other Self-Insurance Reserves
Accrual for Professional and General Liability Claims
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 centers, and several of the Company’s nursing centers in Alabama, Kentucky, Ohio, and Texas. The insurance coverage provided for these centers under the SHC policy include coverage limits of $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 coverage limits of $1,000,000 per claim and have sublimits of $3,000,000 per center, with varying aggregate policy limits and deductibles. 
Because our actual liability for existing and anticipated professional liability and general liability claims will exceed our limited insurance coverage, we have recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $20.0 million as of December 31, 2016, including $1.4 million for settlements that are expected to be paid in 2017, estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, and estimates of related legal costs incurred and expected to be incurred. All losses are projected on an undiscounted basis.
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 this reserve. Since May 2012, Merlinos & Associates, Inc. (“Merlinos”) has assisted management in the preparation of the appropriate accrual for incurred but not reported general and professional liability claims based on data furnished as of May 31 and November 30 of each year. Merlinos primarily utilizes historical data regarding the frequency and cost of the Company's past claims over a multi-year period, industry data and information regarding the number of occupied beds to develop its estimates of the Company's ultimate professional liability cost for current periods.
On a quarterly basis, we obtain reports of asserted claims and lawsuits from our insurers and a third party claims administrator. These reports contain information relevant to the liability actually incurred to date with that claim as well as the third-party administrator's estimate of the anticipated total cost of the claim. This information is reviewed by us quarterly and provided to the actuary semi-annually. We use this information to determine the timing of claims reporting and the development of reserves and compare the information obtained to our previously recorded estimates of liability. Based on the actual claim information obtained, on the semi-annual estimates received from the actuary 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. Final determination of our actual liability for claims incurred in any given period is a process that takes years.

31



The Company's cash expenditures for self-insured professional liability costs from continuing operations were $4.5 million, $3.3 million and $4.8 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Although we retain a third-party actuarial firm to assist us, 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 our actual liability for claims incurred in any given period is a process that takes years. As a result, our 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 quarter due to the significance of judgments and estimates.
Professional liability costs are material to our financial position, and changes in estimates, as well as differences between estimates and the ultimate amount of loss, may cause a material fluctuation in our reported results of operations. Our professional liability expense was $8.5 million, $8.1 million and $7.2 million for the years ended December 31, 2016, 2015 and 2014, respectively. These amounts are material in relation to our reported income (loss) from continuing operations for the related periods of $(1.7) million, $2.8 million and $1.5 million, respectively. The total liability recorded at December 31, 2016 was $20.0 million, compared to current assets of $79.3 million and total assets of $163.1 million.
Accrual for Other Self-Insured Claims
With respect to workers' compensation insurance, substantially all of our employees became covered under either an indemnity insurance plan or state-sponsored programs in May 1997. We are completely self-insured for workers' compensation exposures prior to May 1997. We have been and remain a non-subscriber to the Texas workers' compensation system and are, therefore, completely self-insured for employee injuries with respect to our Texas operations. From June 30, 2003 until June 30, 2007, our workers' compensation insurance programs provided coverage for claims incurred with premium adjustments depending on incurred losses. For the period from July 1, 2007 until June 30, 2008, the Company is completely self-insured for workers' compensation exposure. For the period from July 1, 2008 through December 31, 2016, we are covered by a prefunded deductible policy. Under this policy, we are self-insured for the first $500,000 per claim, subject to an aggregate maximum of $3,000,000. We fund a loss fund account with the insurer to pay for claims below the deductible. We account for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred.
We are self-insured for health insurance benefits for certain employees and dependents for amounts up to $175,000 per individual annually. We provide reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate, based on known claims and estimates of unknown claims based on historical information. The differences between actual settlements and reserves are included in expense in the period finalized. Our reserves for health insurance benefits can fluctuate materially from one year to the next depending on the number of significant health issues of our covered employees and their dependents.

Asset Impairment
We evaluate our property, equipment and other long-lived assets on a quarterly basis to determine if facts and circumstances suggest that the assets may be impaired or that the estimated depreciable life of the asset may need to be changed for significant physical changes in the property, or significant adverse changes in general economic conditions, and significant deteriorations of the underlying cash flows or fair values of the property if impairment indicators exist. The need to recognize impairment is based on estimated undiscounted future cash flows from a property compared to the carrying value of that property. If recognition of impairment is necessary, it is measured as the amount by which the carrying amount of the property exceeds the fair value of the property.
No impairment of long lived assets was recognized during 2016, 2015, or 2014. If our estimates or assumptions with respect to a property change in the future, we may be required to record additional impairment charges for our assets.

Business Combinations
For business combination transactions, we recognize and measure the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, as well as the goodwill acquired or gain recognized in a bargain purchase, and we make certain valuations to determine the fair value of assets acquired and the liabilities assumed. These valuations are subject to retroactive adjustment during the twelve-month period subsequent to the acquisition date. Such valuations require us to make significant estimates, judgments and assumptions, including projections of future events and operating performance.

Stock-Based Compensation
We recognize compensation cost for all share-based payments granted on a straight-line basis over the vesting period. We calculated the recognized and unrecognized stock-based compensation for options and stock-only stock appreciation rights ("SOSARs")

32



using the Black-Scholes-Merton option valuation method, which requires us to use certain key assumptions to develop the fair value estimates. These key assumptions include expected volatility, risk-free interest rate, expected dividends and expected term. For restricted shares, we utilize the market price at the grant date in order to calculate the stock-based compensation expense to be recognized during the vesting period. During the years ended December 31, 2016, 2015, and 2014, we recorded charges of approximately $1.0 million, $1.2 million and $0.6 million in stock-based compensation, respectively. Stock-based compensation expense is a non-cash expense and such amounts are included as a component of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees.

Income Taxes
We determine deferred tax assets and liabilities based upon differences between financial reporting and tax bases of assets and liabilities and measure them using the enacted tax laws that will be in effect when the differences are expected to reverse. We maintain a valuation allowance of approximately $(0.7) million to reduce the deferred tax assets to amounts we believe can be realized on a more likely than not basis in accordance with generally accepted accounting principles. In future periods, we will continue to assess the need for and adequacy of the remaining valuation allowance. We follow the relevant guidance found in the FASB codification, ASC 740: Accounting for Uncertainty in Income Taxes. The guidance provides information and procedures for financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns.

Contractual Obligations and Commercial Commitments
We have certain contractual obligations of continuing operations as of December 31, 2016, 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)
 
$
95,263

 
$
10,786

 
$
20,889

 
$
63,588

 
$

Settlement obligations (2)
 
1,398

 
1,398

 

 

 

Elimination of Preferred Stock Conversion feature (3)
 
1,202

 
687

 
515

 

 

Operating leases (4)
 
1,131,816

 
57,051

 
117,240

 
121,423

 
836,102

Required capital expenditures under operating leases (5)
 
13,260

 
1,379

 
2,736

 
2,720

 
6,425

Total
 
$
1,242,939

 
$
71,301

 
$
141,380

 
$
187,731

 
$
842,527

 
(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. Our long-term debt obligations increased $20.6 million between December 31, 2015 and December 31, 2016, which is related to assumption of operations for the Golden Living centers and our Amended and Restated Credit agreements. See Note 6, "Long-Term Debt and Interest Rate Swap," to the consolidated financial statements included in this report for additional information.
(2)
Settlement obligations relate to professional liability cases that are expected to be paid 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 whom we lease 35 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 renewals periods are enacted. Our operating lease obligations increased $558.9 million between December 31, 2015 and December 31, 2016, which is related to our assumption of the Golden Living centers.
(5)
Includes annual expenditure requirements under operating leases. Our required capital expenditures increased $10.1 million between December 31, 2015 and December 31, 2016, which is related to our assumption of the Golden Living centers.
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), or upon a change of control of the Company (as defined). The maximum contingent liability under these agreements is approximately $1.8 million as of December 31, 2016. 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

33



our common stock on December 31, 2016, there is $0.5 million in contingent liabilities for the repurchase of the equity grants. No amounts have been accrued for these contingent liabilities.

Results of Operations
As discussed in the overview at the beginning of Management's Discussion and Analysis of Financial Condition and Results of Operations, we have completed certain divestitures, acquisitions and entered several new lease agreements. We have reclassified our Consolidated Financial Statements to present certain divestitures as discontinued operations for all periods presented.

(in thousands)
 
Year Ended December 31,
 
 
2016
 
2015
 
Change
 
%
PATIENT REVENUES, net
 
$
426,063

 
$
387,595

 
$
38,468

 
9.9
 %
EXPENSES:
 
 
 
 
 
 
 
 
Operating
 
342,932

 
311,035

 
31,897

 
10.3
 %
Lease
 
33,364

 
28,690

 
4,674

 
16.3
 %
Professional liability
 
8,456

 
8,122

 
334

 
4.1
 %
General and administrative
 
30,271

 
24,793

 
5,478

 
22.1
 %
Depreciation and amortization
 
8,292

 
7,524

 
768

 
10.2
 %
Lease termination costs
 
2,008

 

 
2,008

 
100.0
 %
Total expenses
 
425,323

 
380,164

 
45,159

 
11.9
 %
OPERATING INCOME
 
740

 
7,431

 
(6,691
)
 
(90.0
)%
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
 
Equity in net income (losses) of investment in unconsolidated affiliate
 
273

 
339

 
(66
)
 
(19.5
)%
Gain on sale of investment in unconsolidated affiliate
 
1,366

 

 
1,366

 
100.0
 %
Interest expense, net
 
(4,802
)
 
(4,102
)
 
(700
)
 
(17.1
)%
Debt retirement costs
 
(351
)
 

 
(351
)
 
(100.0
)%
 
 
(3,514
)
 
(3,763
)
 
249

 
6.6
 %
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
 
(2,774
)
 
3,668

 
(6,442
)
 
(175.6
)%
BENEFIT (PROVISION) FOR INCOME TAXES
 
1,030

 
(916
)
 
1,946

 
212.4
 %
INCOME (LOSS) FROM CONTINUING OPERATIONS
 
$
(1,744
)
 
$
2,752

 
$
(4,496
)
 
(163.4
)%



34



(in thousands)
 
Year Ended December 31,
 
 
2015
 
2014
 
Change
 
%
PATIENT REVENUES, net
 
$
387,595

 
$
344,192

 
$
43,403

 
12.6
 %
EXPENSES:
 
 
 
 
 
 
 
 
Operating
 
311,035

 
275,605

 
35,430

 
12.9
 %
Lease
 
28,690

 
26,151

 
2,539

 
9.7
 %
Professional liability
 
8,122

 
7,216

 
906

 
12.6
 %
General and administrative
 
24,793

 
22,133

 
2,660

 
12.0
 %
Depreciation and amortization
 
7,524

 
7,078

 
446

 
6.3
 %
Total expenses
 
380,164

 
338,183

 
41,981

 
12.4
 %
OPERATING INCOME (LOSS)
 
7,431

 
6,009

 
1,422

 
23.7
 %
OTHER EXPENSE:
 
 
 
 
 
 
 
 
Equity in net losses of investee
 
339

 
(5
)
 
344

 
6,880.0
 %
Interest expense, net
 
(4,102
)
 
(3,697
)
 
(405
)
 
(11.0
)%
 
 
(3,763
)
 
(3,702
)
 
(61
)
 
(1.6
)%
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
 
3,668

 
2,307

 
1,361

 
59.0
 %
PROVISION FOR INCOME TAXES
 
(916
)
 
(857
)
 
(59
)
 
(6.9
)%
INCOME FROM CONTINUING OPERATIONS
 
$
2,752

 
$
1,450

 
$
1,302

 
89.8
 %

Year Ended December 31, 2016 Compared With Year Ended December 31, 2015
Patient Revenues
Patient revenues were $426.1 million in 2016 and $387.6 million in 2015, an increase of $38.5 million or 9.9%. This increase is primarily attributable to the acquisition of Golden Living operations in Alabama and Mississippi during the fourth quarter of 2016. The following table summarizes the revenue increases attributable to our portfolio growth (in thousands):
 
Year Ended
December 31,
 
2016

2015

Change
Same-store revenue
$
372,452


$
376,497


$
(4,045
)
2015 acquisition revenue
16,438

 
11,098


5,340

2016 acquisition revenue
37,173




37,173

Total revenue
$
426,063


$
387,595


38,468


The overall increase in revenue of $38.5 million is primarily attributable to revenue contributions from the acquisition of Golden Living operations in Alabama and Mississippi during the fourth quarter of 2016 of $37.2 million. Additionally, the 2015 acquisitions experienced an incremental increase in revenues of $5.3 million as a result of having a full year in operations during 2016. The increase from the acquisition activity was partially offset by a decrease in same-store revenue of $4.0 million which is explained in more detail below.

35



The following table summarizes key revenue and census statistics for continuing operations for each period:
 
 
Year Ended
December 31,
 
2016
 
 
 
2015
Skilled nursing occupancy
78.1
%
 

 
77.1
%
As a percent of total census:
 
 
 
 
 
Medicaid census
68.1
%
 
 
 
67.1
%
Medicare census
11.7
%
 
 
 
12.5
%
Managed Care census
3.5
%
 
 
 
3.7
%
As a percent of total revenues:
 
 
 
 
 
Medicaid revenues
50.6
%
 
 
 
48.6
%
Medicare revenues
27.5
%
 
 
 
29.0
%
Managed Care revenues
6.8
%
 
 
 
7.2
%
Average rate per day:
 
 
 
 
 
Medicare
$
456.30

 
  
 
$
455.24

Medicaid
$
169.91

 
  
 
$
166.16

Managed Care
$
385.71

 
  
 
$
389.73


The average Medicaid rate per patient day for same-store nursing centers in 2016 increased 1.2% compared to 2015, resulting in an increase in revenue of $2.2 million. This average rate per day for Medicaid patients is the result of rate increases in certain states and increasing patient acuity levels. The average Medicare rate per patient day for same-store nursing centers in 2016 increased 1.0% compared to 2015, resulting in an increase in revenue of $0.9 million also related to our ability to attract and provide care for patients with increased acuity levels. Same-store Private payors rate per patient day for 2016 also experienced favorable results compared to 2015 resulting in a $1.0 million increase in revenue.
Our total average daily census increased by approximately 9.4% for the full portfolio compared to 2015 on a consolidated basis, but was primarily attributable to the aforementioned acquisition activity. On a same-store basis, our Medicare and Medicaid average daily census for 2016 decreased compared to 2015, resulting in decreases in revenue of $7.5 million and $0.8 million, respectively.

36



Operating Expense
Operating expense increased to $342.9 million in 2016 from $311.0 million in 2015, driven primarily by the $28.0 million in operating costs at the Golden Living nursing centers added in 2016, and $3.6 million incremental increase from the centers acquired in 2015 due to a full year of operations. Operating expense increased to 80.5% of revenue in 2016, compared to 80.2% of revenue in 2015.
 
Year Ended
December 31,
 
2016
 
2015
 
Change
Same-store operating expenses
$
301,991

 
$
301,720

 
$
271

2015 acquisition operating expenses
12,953

 
9,315

 
3,638

2016 acquisition operating expenses
27,988

 

 
27,988

Total operating expenses
$
342,932

 
$
311,035

 
31,897

The largest component of operating expenses is wages, which increased to $199.6 million in 2016 from $180.8 million in 2015, an increase of $18.8 million, or 10.4%. On a same-store basis, wages were controlled and increased by $0.4 million to $175.8 million in 2016 from $175.4 million in 2015, which is a direct result from our decrease in same-store revenues during 2016.
Other factors driving the fluctuation in operating expenses at the same-store nursing centers include an increase in health insurance premiums by $1.2 million, which was offset by a $1.2 million decrease in nursing and ancillary related expenses. Bad debt expenses decreased by $0.3 million. This fluctuation was driven significantly by the growth in Medicare and Medicaid patients undergoing the initial qualification process.
Lease Expense
Lease expense increased to $33.4 million in 2016 from $28.7 million in 2015, an increase of $4.7 million, or 16.3%. The increase in lease expense was driven by $5.7 million from the assumption of the Golden Living centers in the fourth quarter of 2016. This was slightly offset from the purchase of Clinton and Hutchinson in February 2016, and the termination of the Avon, Ohio lease in May 2016.
Professional Liability
Professional liability expense was $8.5 million in 2016 compared to $8.1 million in 2015, an increase of $0.4 million, or 4.1%. As centers have been acquired in 2015 and 2016, the Company has accessed commercial insurance markets, which accounts for a significant portion of the growth in professional liability expense in the current year. We were engaged in 67 professional liability lawsuits as of December 31, 2016, compared to 55 as of December 31, 2015. Our cash expenditures for professional liability costs of continuing operations were $4.5 million and $3.3 million for 2016 and 2015, 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, the premium costs of purchased insurance, 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 expenses were approximately $30.3 million in 2016 compared to $24.8 million in 2015, an increase of $5.5 million, or 22.1%. The overall increase in general and administrative expenses were attributable to a $1.6 million increase in salaries and related expenses associated with continued growth at the regional level, as well as additional corporate infrastructure to support the on-going growth of the portfolio. Legal and consulting fees experienced an increase of $1.2 million and $1.3 million, respectively, related to regulatory and acquisition expenses.
Depreciation and Amortization
Depreciation and amortization expense was approximately $8.3 million in 2016 and $7.5 million in 2015. The increase in 2016 is primarily due to $0.4 million of depreciation associated with the purchases of Hutchinson and Clinton in February 2016. Additionally, the Company incurred an increase of $0.3 million in depreciation and amortization expenses related to the assumed Golden Living operations in the fourth quarter of 2016.
Lease termination costs
Lease termination costs were $2.0 million in 2016 due to the termination of the Avon, Ohio operating lease in May 2016.

37



Gain on sale of investment in unconsolidated affiliate
Gain on the sale of the pharmacy joint venture was $1.4 million, which occurred in the fourth quarter of 2016. This transaction also resulted in an immaterial gain contingency, which has not been recorded and income has not been recognized.
Interest Expense, Net
Interest expense has increased to $4.8 million in 2016 compared to $4.1 million in 2015, an increase of $0.7 million. The increase was primarily attributable to higher debt balances in 2016 as a result of higher outstanding borrowings on the revolving credit facility from the purchase of Hutchinson and Clinton during the first quarter of 2016, as well as a result of the change in ownership processes for the newly acquired Golden Living centers.
Debt retirement costs
Debt retirement costs were $0.4 million in 2016, which relates to the write off of our term loan deferred financing costs, as a result of our debt refinance that took place in February 2016.
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 a loss before taxes of $2.8 million in 2016, as compared to income of $3.7 million in 2015. The benefit for income taxes was $1.0 million in 2016, an effective rate of 37.1% and the provision for income taxes was $0.9 million in 2015, an effective rate of 25.0%. The increase in our effective tax rate is due to an increase in our Work Opportunity Tax Credit ("WOTC") and the valuation allowance. The basic and diluted loss per common share from continuing operations were $0.28 and $0.28 in 2016, respectively, compared to a basic and diluted income per common share from continuing operations of $0.45 and $0.44 in 2015, respectively.

38



Year Ended December 31, 2015 Compared With Year Ended December 31, 2014
Patient Revenues
Patient revenues were $387.6 million in 2015 and $344.2 million in 2014, an increase of $43.4 million or 12.6%. This increase is primarily attributable to the acquisition of new operations during the period. The following table summarizes the revenue increases attributable to our portfolio growth (in thousands):
 
Year Ended
December 31,
 
2015
 
2014
 
Change
Same-store revenue
$
329,463

 
$
318,096

 
$
11,367

2014 acquisition revenue
47,034

 
26,096

 
20,938

2015 acquisition revenue
11,098

 

 
11,098

Total revenue
$
387,595

 
$
344,192

 
$
43,403


The overall increase in revenue of $43.4 million is primarily attributable to revenue contributions from acquisition activity in 2015 of $11.1 million, as well as an incremental increase in revenues from 2014 acquisitions of $20.9 million as a result of having a full year in operations during 2015. The balance of the increase in revenues year-over-year is attributable to increases in same-store revenue of $11.4 million which is explained in more detail below.

The following table summarizes key revenue and census statistics for continuing operations for each period:
 
 
Year Ended
December 31,
 
2015
 
 
 
2014
Skilled nursing occupancy
77.1
%
 
 
 
77.5
%
As a percent of total census:
 
 
 
 
 
Medicaid census
67.1
%
 
 
 
67.0
%
Medicare census
12.5
%
 
 
 
12.7
%
Managed Care census
3.7
%
 
 
 
3.6
%
As a percent of total revenues:
 
 
 
 
 
Medicaid revenues
48.6
%
 
 
 
48.4
%
Medicare revenues
29.0
%
 
 
 
29.6
%
Managed Care revenues
7.2
%
 
 
 
6.7
%
Average rate per day:
 
 
 
 
 
Medicare
$
455.24

 
  
 
$
444.63

Medicaid
$
166.16

 
  
 
$
160.43

Managed Care
$
389.73

 
  
 
$
383.44

The average Medicaid rate per patient day for same-store nursing centers in 2015 increased 3.6% compared to 2014, resulting in an increase in revenue of $6.2 million. This average rate per day for Medicaid patients is the result of rate increases in certain states and increasing patient acuity levels. The average Medicare rate per patient day for same-store nursing centers in 2015 increased 2.4% compared to 2014, resulting in an increase in revenue of $1.6 million also related to our ability to attract and provide care for patients with increased acuity levels. Same-store Managed Care rate per patient day for 2015 also experienced favorable results compared to 2014 resulting in a $0.4 million increase in revenue as we continue to see growth in this portion of our patient population.
Our total average daily census increased by approximately 9.0% for the full portfolio compared to 2014 on a consolidated basis, but was primarily attributable to the aforementioned acquisition activity. On a same-store basis, our Medicare and Medicaid average daily census for 2015 decreased compared to 2014, resulting in decreases in revenue of $1.4 million and $0.2 million, respectively. Offsetting these decreases, Managed Care census increased at our same-store nursing centers resulting in a revenue increase of $2.3 million compared to 2014.
In addition to the revenue changes driven by rate and census, the same-store group experienced additional revenue variances from ancillary services and participation in an inter-governmental transfer (IGT) program. Ancillary services at same-store centers

39



increased $1.9 million in 2015 as compared to 2014, while revenue related to the IGT program in Indiana resulted in $1.1 million in additional revenue in 2015.
Operating Expense
Operating expense increased to $311.0 million in 2015 from $275.6 million in 2014, driven primarily by the $9.3 million in operating costs at the nursing centers added in 2015, and $18.5 million incremental increase from the centers acquired in 2014 due to a full year of operations. Operating expense increased to 80.2% of revenue in 2015, compared to 80.1% of revenue in 2014.
 
Year Ended
December 31,
 
2015
 
2014
 
Change
Same-store operating expenses
$
262,378

 
$
254,769

 
$
7,609

2014 acquisition operating expenses
39,342

 
20,836

 
18,506

2015 acquisition operating expenses
9,315

 

 
9,315

Total revenue
$
311,035

 
$
275,605

 
$
35,430

The largest component of operating expenses is wages, which increased to $180.8 million in 2015 from $160.4 million in 2014, an increase of $20.4 million, or 12.7%. On a same-store basis, wages increased by $5.6 million to $154.1 million in 2015 from $148.5 million in 2014, which is a direct result from our increase in same-store revenues during 2015.
Other factors driving the increase in operating expenses at the same-store nursing centers include bad debt and Medicare crossover claims expense. The expense increased approximately $1.8 million in 2015 compared to 2014 driven significantly by the growth in Medicare and Medicaid patients undergoing the initial qualification process. Provider taxes increased $0.5 million in 2015 compared to 2014 primarily driven by rate increases in Tennessee.
Lease Expense
Lease expense increased to $28.7 million in 2015 from $26.2 million in 2014, an increase of $2.5 million, or 9.7%. The increase in lease expense was primarily driven by $2.3 million in combined lease expense for the newly leased nursing centers acquired in 2014 as a result of a full year of operations. The remaining increase was the result of regular rent adjustments at existing centers.
Professional Liability
Professional liability expense was $8.1 million in 2015 compared to $7.2 million in 2014, an increase of $0.9 million. As centers have been acquired in 2014 and 2015, the Company has accessed commercial insurance markets, which accounts for a significant portion of the growth in professional liability expense in the current year. We were engaged in 55 professional liability lawsuits as of December 31, 2015, compared to 51 as of December 31, 2014. Our cash expenditures for professional liability costs of continuing operations were $3.3 million and $4.8 million for 2015 and 2014, 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, the premium costs of purchased insurance, 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 expenses were approximately $24.8 million in 2015 compared to $22.1 million in 2014, an increase of $2.7 million. The overall increase in general and administrative expenses were attributable to a $1.2 million increase in salaries and related expenses associated with continued growth at the regional level, as well as additional corporate infrastructure to support the on-going growth of the portfolio. Stock-based incentive expenses experienced a corresponding increase of $0.6 million. As previously noted, the Company began participating in an inter-governmental transfer program in Indiana during 2015. Certain costs associated with our participation in this program are recorded within general and administrative expense and resulted in $0.3 million of additional costs during 2015.
Depreciation and Amortization
Depreciation and amortization expense was approximately $7.5 million in 2015 and $7.1 million in 2014. The increase in 2015 is primarily due to $0.3 million of depreciation associated with the Glasgow center purchased in February 2015.

40



Interest Expense, Net
Interest expense has increased to $4.1 million in 2015 compared to $3.7 million in 2014, an increase of $0.4 million. The increase was primarily attributable to higher debt balances in 2015 on the Revolver as a result of on-going change in ownership processes for newly acquired nursing centers, as well as interest on the debt associated with the two buildings purchased in 2015.
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 taxes of $3.7 million in 2015, as compared to $2.3 million in 2014. The provision for income taxes was $0.9 million in 2015, an effective rate of 25.0% and $0.9 million in 2014, an effective rate of 37.1%. The decrease in our effective tax rate is due to an decrease in our WOTC and the valuation allowance. The basic and diluted income per common share from continuing operations were $0.45 and $0.44 in 2015, respectively, compared to a basic and diluted income per common share from continuing operations of $0.21 and $0.20 in 2014, respectively.

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, repurchase of additional shares of our common stock, acquisitions, and payment of existing debt obligations, 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 used in operating activities of continuing operations totaled $2.1 million in 2016, compared to net cash provided by operating activities of continuing operations of $10.3 million and $6.0 million in 2015 and 2014, respectively. One primary driver of the decline in cash provided by operating activities from continuing operations is the acquisition activity throughout the year. The Company is required to complete a Change in Ownership ("CHOW") process for each of the nursing centers for which we assumed operations during the year which results in limited cash inflows from the operations at these centers during this initial process. As of December 31, 2016, the twenty-two centers for which we assumed operation from Golden Living during 2016 continue to progress through the CHOW process, and we expect this process to be completed in mid-2017. Operating activities of discontinued operations used cash of $3.5 million, $7.0 million and $3.0 million in 2016, 2015 and 2014, respectively.
Our cash expenditures related to professional liability claims of continuing operations were $4.5 million, $3.3 million and $4.8 million for 2016, 2015 and 2014, respectively. We also continue to experience cash expenditures related to professional liability claims of discontinued operations. Our cash expenditures related to professional liability claims of discontinued operations were $3.6 million, $8.2 million, and $5.5 million for 2016, 2015 and 2014, respectively. The Company will continue to defend, and make cash payments when required related to, professional liability claims asserted against 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 used cash of $9.8 million and $13.1 million in 2016 and 2015, respectively, as compared to cash provided of $11.6 million 2014. The cash used in 2016 was the result of the purchase of Hutchinson and Clinton for $4.3 million and $3.3 million, respectively, and cash used to assume the operations of the twenty-two Golden living centers in the fourth quarter of 2016. The cash used in 2015 is primarily attributable to the $7.0 million and $3.9 million of assets purchased in the Glasgow and Fulton transactions, respectively. The cash provided in 2014 was the result of the sale of Rose Terrace and disposition of West Virginia operations which provided $16.5 million, and was offset by cash used of $5.5 million for the purchase of property and equipment. We have used $6.0 million, $4.6 million, and $5.5 million in 2016, 2015 and 2014, respectively, for capital expenditures of continuing operations.
Financing activities of continuing operations provided cash of $15.1 million and $10.6 million in 2016 and 2015, respectively, compared to cash used of $8.5 million in 2014. Cash provided by in 2016 is primarily attributable to the proceeds received from refinancing our credit facility resulting in proceeds of $92.8 million, offset by the repayment of the existing mortgage loan and other debt payments during the year of $73.4 million. Financing activities in 2015 reflect the proceeds received from refinancing our credit facility resulting in proceeds of $27.9 million, offset by the repayment of the existing mortgage loan and other debt payments during the year of $15.3 million. Cash used in 2014 primarily resulted from the $4.9 million in the redemption of preferred stock. Financing activities reflect common stock and preferred stock dividends of $1.4 million 2016, $1.3 million in 2015, and $1.5 million in 2014.

41



Dividends
On February 24, 2017, the Board of Directors declared a quarterly dividend on common shares of $0.055 per share. 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. The Company is restricted by its debt agreements in its ability to pay dividends.
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. 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. 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, consolidated offshore limited purpose insurance subsidiary,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 centers, and several of the Company’s nursing centers in Alabama, Kentucky, Ohio, and Texas. The insurance coverage provided for these centers under the SHC policy include coverage limits of $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 coverage limits of $1,000,000 per claim and have sublimits of $3,000,000 per center, with varying aggregate policy limits and deductibles. 
As of December 31, 2016, we have recorded total liabilities for reported professional liability claims and estimates for incurred, but unreported claims of $20.0 million. Our calculation of this estimated liability is based on the Company's best estimates of the likelihood of severely adverse judgments 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 December 31, 2016, we had $82.1 million of outstanding long-term debt and capital lease obligations. The $82.1 million total includes $2.1 million in capital lease obligations. The balance of the long-term debt is comprised of $58.8 million owed on our collateralized mortgage debt, $15.0 million currently outstanding on the revolving credit facility, and $6.3 million on the acquisition loan facility.
Under the terms of the agreements, the syndicate of banks provided the Amended Mortgage Loan with an original balance of $72.5 million with a five year maturity through February 26, 2021, consisting of $60.0 million term and $12.5 million acquisition loan facilities, and a $52.3 million Amended Revolver through February 26, 2021. The Amended Mortgage Loan has a term of five years, with principal and interest payable monthly based on a 25 year amortization. Interest on the term and acquisition loan facilities are based on LIBOR plus 4.0% and 4.75%, respectively. A portion of the Amended Mortgage Loan is effectively fixed at 5.79% pursuant to an interest rate swap with an initial notional amount of $30.0 million. As of December 31, 2016, the interest rate related to the Amended Mortgage Loan is 4.75%. The Amended Mortgage Loan is secured by 17 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 and cross-defaulted. The Company's Amended Revolver has an interest rate of LIBOR plus 4.0% 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. Eligible accounts receivable are calculated as defined and consider 80% of certain net receivables while excluding receivables from private pay patients, those pending approval by Medicaid and receivables greater than 120 days.
As of December 31, 2016, the Company had $15.0 million borrowings outstanding under the Amended Revolver compared to $12.9 million outstanding as of December 31, 2015. The outstanding borrowings on the revolver primarily reflect the Company's approach to accumulated Medicaid and Medicare receivables at recently acquired centers as these centers proceed through the change in ownership process with CMS. Annual fees for letters of credit issued under the Amended Revolver are 3.0% of the amount outstanding. The Company has letters of credit of $4.8 million and $2.1 million to serve as a security deposit for our Omega and Golden Living leases, respectively. We also have a $1.0 million letter of credit outstanding related to the Company's wholly-owned captive insurance entity. Finally, we have nine other letters of credit, totaling $2.4 million, to serve as security

42



deposits at certain centers. Considering the balance of eligible accounts receivable at December 31, 2016, the letters of credit, the amounts outstanding under the revolving credit facility and the maximum loan amount of $42.7 million, the balance available for borrowing under the Amended Revolver is $14.4 million at December 31, 2016.
Our lending agreements contain various financial covenants, the most restrictive of which relate to debt service coverage ratios. We are in compliance with all such covenants at December 31, 2016.
Our calculated compliance with financial covenants is presented below:
 
 
Requirement
  
Level at
December 31, 2016
Minimum fixed charge coverage ratio
1.00:1.00
  
1.16:1.00
Minimum adjusted EBITDA
$9.5 million
  
$13.3 million
EBITDAR (mortgaged centers)
$10.0 million
  
$14.4 million
Current ratio (as defined in agreement)
1.00:1.00
 
1.49:1.00
As part of the debt agreements entered into in February 2016, the Company 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 an initial notional amount of $30.0 million. The interest rate swap agreement requires the Company to make fixed rate payments to the bank calculated on the applicable notional amount at an annual fixed rate of 5.79% 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.

Capitalized Lease Obligations
Upon acquisition of certain centers, we assume certain leases, primarily related to equipment, that constitute capital leases. Additionally, the Company leases certain technology equipment that supports the clinical systems, including electronic medical records, at our nursing centers that constitute capital leases.
As a result of the lease agreements above, we have recorded the underlying lease assets and capitalized lease obligations of $2.1 million, $0.6 million, and $0.3 million as of December 31, 2016, 2015, and 2014, respectively. These lease agreements provide terms of three to five years.

Receivables
Our operations could be adversely affected if we experience significant delays in reimbursement from Medicare, Medicaid and 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 financial position.
Accounts receivable attributable to patient services of continuing operations totaled $72.5 million at December 31, 2016 compared to $52.0 million at December 31, 2015, representing approximately 47 days and 45 days revenue in accounts receivable, respectively. The increase in accounts receivable is due primarily to accounts associated with centers still in the change in ownership process, which is addressed below. We have adjusted the days of revenue in the accounts receivable calculation to remove the impact of the receivables related to these change in ownerships.
Our accounts receivable at December 31, 2016, reflects the change in ownership of the twenty-two newly leased Golden Living centers in Alabama and Mississippi. The Company has entered into an agreement with Golden Living to utilize their billing credentials in order to perform the billing of the Medicare and Medicaid receivables until the change in ownership process has been completed. This agreement allows the Medicare and Medicaid receivables to be billed and collected in the interim. Payer sources could be delayed due to setting up new agreements and credentialing with those payers.
The allowance for bad debt was $10.3 million and $8.2 million at December 31, 2016 and 2015, respectively, which is commensurate with our overall revenue and receivables growth. 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,

43



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.

Inflation
Based on contract pricing for food and other supplies and recent market conditions, we expect cost increases in 2017 to be relatively the same or slightly lower than the increases in 2016. We expect salary and wage increases for our skilled health care providers to continue to be higher than average salary and wage increases, as is common in the healthcare industry.

Off-Balance Sheet Arrangements
We have twelve letters of credit outstanding totaling approximately $10.2 million as of December 31, 2016. Eleven of these letters of credit serve as a security deposits for certain center leases, while one was issued in conjunction with the initial funding of our wholly-owned captive insurance company. The 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. Forward-looking statements are predictive in nature and are frequently identified by the use of terms such as "may," "will," "should," "expect," "believe," "estimate," "intend," and similar words indicating possible future expectations, events or actions. 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 integrate the operations of our new nursing centers in Alabama, Mississippi, Kansas and Kentucky, as well as successfully operate all of our centers, our ability to increase census at our centers, changes in governmental reimbursement, including the impact of the CMS final rule that has resulted in a reduction in Medicare reimbursement 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 extend or replace our current credit facility, 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 HIPAA and 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 “Part I. Item 1A. Risk Factors” 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 7A. 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 December 31, 2016, we had outstanding borrowings of approximately $80.1 million, $50.6 million of which were subject to variable interest rates. In connection with February 2016 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 $0.5 million annually, representing the impact of increased or decreased interest expense on variable rate debt.


44



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Audited financial statements are contained on pages F-1 through F-33 of this Annual Report on Form 10-K and are incorporated herein by reference. Audited supplemental schedule data is contained on pages S-1 through S-2 of this Annual Report on Form 10-K and is incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.

ITEM 9A. CONTROLS AND PROCEDURES
Diversicare, with the participation of our principal executive and financial officers, has evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of December 31, 2016. Based on this evaluation, the principal executive and financial officers have determined that such disclosure controls and procedures are effective to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Our review excluded the centers assumed from Golden Living during 2016, whose consolidated assets of approximately $6.6 million and whose  revenues of approximately $37.2 million, were included in the Company’s consolidated balance sheet and statement of operations as of and for the year ended December 31, 2016. Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2016. Management reviewed the results of its assessment with our Audit Committee.
Changes in Internal Control over Financial Reporting
There has been no change (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal control over financial reporting that has occurred during our fiscal quarter ended December 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Our management does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefit of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

ITEM 9B. OTHER INFORMATION
None.



45



PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning our Directors, Executive Officers and Corporate Governance is incorporated herein by reference to our definitive proxy statement for our 2017 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning Executive Compensation is incorporated herein by reference to our definitive proxy statement for our 2017 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
Information concerning Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters is incorporated herein by reference to our definitive proxy statement for our 2017 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information concerning Certain Relationships and Related Transactions, and Director Independence is incorporated herein by reference to our definitive proxy statement for our 2017 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning the fees and services provided by our principal accountant is incorporated herein by reference to our definitive proxy statement for our 2017 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.



46



PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The Financial statements and schedule for us and our subsidiaries required to be included in Part II, Item 8 are listed below.

 
Form 10-K
Pages
Financial Statements
 
Report of Independent Registered Public Accounting Firm
  F-1
Consolidated Balance Sheets as of December 31, 2016 and 2015
  F-2
Consolidated Statements of Operations for the Years Ended December 31, 2016, 2015 and 2014
  F-3
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2016, 2015 and 2014
  F-4
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2016, 2015 and 2014
  F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014
  F-6
Notes to Consolidated Financial Statements as of December 31, 2016, 2015 and 2014
  F-8 to F-33
Financial Statement Schedule
 
Schedule II - Valuation and Qualifying Accounts
  S-1 to S-2

Exhibits
The exhibits filed as part of this Report on Form 10-K are listed in the Exhibit Index immediately following the financial statement pages.


47




SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

DIVERSICARE HEALTHCARE SERVICES, INC.

/s/ Chad A. McCurdy
Chad A. McCurdy
Chairman of the Board
March 2, 2017

/s/ Kelly J. Gill    
Kelly J. Gill
President and Chief Executive Officer
(Principal Executive Officer)
March 2, 2017

/s/ James R. McKnight, Jr.
James R. McKnight, Jr.
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
March 2, 2017

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/ Chad A. McCurdy
/s/ Robert Z. Hensley
Chad A. McCurdy
Robert Z. Hensley
Chairman of the Board and Director
Director
March 2, 2017
March 2, 2017
 
 
/s/ Wallace E. Olson
/s/ William C. O'Neil, Jr.
Wallace E. Olson
William C. O'Neil, Jr.
Director
Director
March 2, 2017
March 2, 2017
 
 
/s/ Kelly J. Gill
/s/ Richard M. Brame
Kelly J. Gill
Richard M. Brame
President and Chief Executive Officer
Director
Director
March 2, 2017
March 2, 2017
 
 
 
/s/ Robert A. McCabe, Jr.
 
Robert A. McCabe, Jr.
 
Director
 
March 2, 2017
 


48



DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES


Consolidated Financial Statements
For the Years Ended December 31, 2016, 2015 and 2014    
Together with Report of Independent Registered Public Accounting Firm

49





INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


        

                



50



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




Board of Directors and Shareholders
Diversicare Healthcare Services, Inc.
Brentwood, Tennessee

We have audited the accompanying consolidated balance sheets of Diversicare Healthcare Services, Inc. and subsidiaries as of December 31, 2016 and 2015 and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2016. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Diversicare Healthcare Services, Inc. and subsidiaries at December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

         
/s/ BDO USA, LLP

Nashville, Tennessee
March 2, 2017

F-1

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2016 AND 2015


ASSETS
 
2016
 
2015
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
2016
 
2015
 
 
 
 
 
 
 
 
 
 
 
CURRENT ASSETS:
 
 
 
 
 
CURRENT LIABILITIES:
 
 
 
 
Cash and cash equivalents
 
$
4,263,000

 
$
4,585,000

 
Current portion of long-term debt and capitalized lease obligations, net
 
$
7,715,000

 
$
6,603,000

Receivables, less allowance for doubtful accounts of $10,326,000 and $8,180,000, respectively
 
62,152,000

 
43,819,000

 
Trade accounts payable
 
12,972,000

 
10,136,000

Other receivables
 
1,193,000

 
1,407,000

 
Current liabilities of discontinued operations
 
427,000

 
345,000

Prepaid expenses and other current assets
 
3,623,000

 
2,223,000

 
Accrued expenses:
 
 
 
 
Income tax refundable
 
431,000

 
347,000

 
Payroll and employee benefits
 
20,108,000

 
14,404,000

Current assets of discontinued operations
 
28,000

 
36,000

 
Self-insurance reserves, current portion
 
9,401,000

 
10,224,000

Deferred income taxes
 
7,644,000

 
7,999,000

 
Provider taxes
 
3,114,000

 
1,603,000

Total current assets
 
79,334,000

 
60,416,000

 
Other current liabilities
 
4,432,000

 
4,049,000

 
 
 
 
 
 
Total current liabilities
 
58,169,000

 
47,364,000

 
 
 
 
 
 
NONCURRENT LIABILITIES:
 


 


PROPERTY AND EQUIPMENT, at cost
 
128,822,000

 
114,383,000

 
Long-term debt and capitalized lease obligations, less current portion, net
 
72,145,000

 
53,297,000

Less accumulated depreciation and amortization
 
(69,022,000
)
 
(62,110,000
)
 
Self-insurance reserves, noncurrent portion
 
11,766,000

 
12,344,000


 
59,800,000

 
52,273,000

 
Other noncurrent liabilities
 
9,551,000

 
10,812,000


 
 
 
 
 
Total noncurrent liabilities
 
93,462,000

 
76,453,000

 
 
 
 
 
 
COMMITMENTS AND CONTINGENCIES
 


 


OTHER ASSETS:
 

 

 
SHAREHOLDERS’ EQUITY:
 
 
 
 
Deferred income taxes
 
13,541,000

 
11,762,000

 
Common stock, authorized 20,000,000 shares, $.01 par value, 6,592,000 and 6,513,000 shares issued, and 6,361,000 and 6,281,000 shares outstanding, respectively
 
66,000

 
65,000

Deferred financing and other costs, net
 
193,000

 
382,000

 
Treasury stock at cost, 232,000 shares of common stock
 
(2,500,000
)
 
(2,500,000
)
Investment in unconsolidated affiliate
 

 
798,000

 
Paid-in capital
 
21,935,000

 
21,142,000

Other noncurrent assets
 
3,108,000

 
3,994,000

 
Accumulated deficit
 
(8,276,000
)
 
(5,053,000
)
Acquired leasehold interest, net
 
7,075,000

 
7,459,000

 
Accumulated other comprehensive income (loss)
 
195,000

 
(387,000
)
Total other assets
 
23,917,000

 
24,395,000

 
Total shareholders’ equity
 
11,420,000

 
13,267,000

 
 
$
163,051,000

 
$
137,084,000

 
 
 
$
163,051,000

 
$
137,084,000


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

F-2



DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
 
Years Ended December 31,
 
2016
 
2015
 
2014
PATIENT REVENUES, net
$
426,063,000

 
$
387,595,000

 
$
344,192,000

EXPENSES:
 
 
 
 
 
Operating
342,932,000

 
311,035,000

 
275,605,000

Lease and rent expense
33,364,000

 
28,690,000

 
26,151,000

Professional liability
8,456,000

 
8,122,000

 
7,216,000

General and administrative
30,271,000

 
24,793,000

 
22,133,000

Depreciation and amortization
8,292,000

 
7,524,000

 
7,078,000

Lease termination costs
2,008,000

 

 

Total expenses
425,323,000

 
380,164,000

 
338,183,000

OPERATING INCOME
740,000

 
7,431,000

 
6,009,000

OTHER INCOME (EXPENSE):
 
 
 
 
 
Equity in net income (losses) of investment in unconsolidated affiliate
273,000

 
339,000

 
(5,000
)
Gain on sale of investment in unconsolidated affiliate
1,366,000

 

 

Interest expense, net
(4,802,000
)
 
(4,102,000
)
 
(3,697,000
)
Debt retirement costs
(351,000
)
 

 

 
(3,514,000
)
 
(3,763,000
)
 
(3,702,000
)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(2,774,000
)
 
3,668,000

 
2,307,000

BENEFIT (PROVISION) FOR INCOME TAXES
1,030,000

 
(916,000
)
 
(857,000
)
INCOME (LOSS) FROM CONTINUING OPERATIONS
(1,744,000
)
 
2,752,000

 
1,450,000

INCOME (LOSS) FROM DISCONTINUED OPERATIONS:
 
 
 
 
 
Operating loss, net of income tax benefit of $41,000, $375,000 and $878,000, respectively
(67,000
)
 
(1,128,000
)
 
(1,486,000
)
Gain on disposal, net of income tax provision of $0, $0 and $2,802,000, respectively

 

 
4,744,000

INCOME (LOSS) FROM DISCONTINUED OPERATIONS
(67,000
)
 
(1,128,000
)
 
3,258,000

NET INCOME (LOSS)
(1,811,000
)
 
1,624,000

 
4,708,000

Less: net (income) loss attributable to noncontrolling interests

 

 
25,000

NET INCOME (LOSS) ATTRIBUTABLE TO DIVERSICARE HEALTHCARE SERVICES, INC.
(1,811,000
)
 
1,624,000

 
4,733,000

PREFERRED STOCK DIVIDENDS

 

 
(220,000
)
NET INCOME (LOSS) FOR DIVERSICARE HEALTHCARE SERVICES, INC. COMMON SHAREHOLDERS
$
(1,811,000
)
 
$
1,624,000

 
$
4,513,000

NET INCOME (LOSS) PER COMMON SHARE FOR DIVERSICARE HEALTHCARE SERVICES, INC. COMMON SHAREHOLDERS:
 
 
 
 
 
Per common share – basic
 
 
 
 
 
Continuing operations
$
(0.28
)
 
$
0.45

 
$
0.21

Discontinued operations
(0.01
)
 
(0.18
)
 
0.54

 
$
(0.29
)
 
$
0.27

 
$
0.75

Per common share – diluted
 
 
 
 
 
Continuing operations
$
(0.28
)
 
$
0.44

 
$
0.20

Discontinued operations
(0.01
)
 
(0.18
)
 
0.52

 
$
(0.29
)
 
$
0.26

 
$
0.72

DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
$
0.22

 
$
0.22

 
$
0.22

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
 
 
Basic
6,199,000

 
6,100,000

 
6,011,000

Diluted
6,199,000

 
6,315,000

 
6,197,000

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

F-3



DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
 
Years Ended December 31,
 
2016
 
2015
 
2014
NET INCOME (LOSS)
$
(1,811,000
)
 
$
1,624,000

 
$
4,708,000

OTHER COMPREHENSIVE INCOME (LOSS):
 
 
 
 
 
Change in fair value of cash flow hedge, net of tax
1,082,000

 
556,000

 
368,000

Less: reclassification adjustment for amounts recognized in net income
(500,000
)
 
(448,000
)
 
(294,000
)
Total other comprehensive income
582,000

 
108,000

 
74,000

COMPREHENSIVE INCOME (LOSS)
(1,229,000
)
 
1,732,000


4,782,000

Less: comprehensive loss attributable to noncontrolling interest

 

 
25,000

COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO DIVERSICARE HEALTHCARE SERVICES, INC.
$
(1,229,000
)
 
$
1,732,000

 
$
4,807,000

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

F-4

DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

 
Common Stock
 
Treasury Stock
 
Paid-in Capital
 
Accumulated Deficit
 
Accumulated
Other
Comprehensive Income (Loss)
 
Total
Shareholders'
Equity of Diversicare Healthcare Services, Inc.
 
Non-
Controlling Interests
 
Total
Shareholders' Equity
 
Shares Issued
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2013
6,307,000

 
$
63,000

 
232,000

 
$
(2,500,000
)
 
$
19,570,000

 
$
(8,435,000
)
 
$
(569,000
)
 
$
8,129,000

 
$
1,437,000

 
$
9,566,000

Net income (loss)

 

 

 

 

 
4,733,000

 

 
4,733,000

 
(25,000
)
 
4,708,000

Preferred stock dividends

 

 

 

 

 
(220,000
)
 

 
(220,000
)
 

 
(220,000
)
Common stock dividends declared

 

 

 

 
41,000

 
(1,363,000
)
 

 
(1,322,000
)
 

 
(1,322,000
)
Issuance/redemption of equity grants, net
81,000

 
1,000

 

 

 
(49,000
)
 

 

 
(48,000
)
 

 
(48,000
)
Interest rate cash flow hedge

 

 

 

 

 

 
74,000

 
74,000

 

 
74,000

Tax impact of equity grant exercises

 

 

 

 
(10,000
)
 

 

 
(10,000
)
 

 
(10,000
)
Deconsolidation of noncontrolling interest

 

 

 

 

 

 

 

 
(1,412,000
)
 
(1,412,000
)
Stock based compensation

 

 

 

 
418,000

 

 

 
418,000

 

 
418,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2014
6,388,000

 
64,000

 
232,000

 
(2,500,000
)
 
19,970,000

 
(5,285,000
)
 
(495,000
)
 
11,754,000

 

 
11,754,000

Net income

 

 

 

 

 
1,624,000

 

 
1,624,000

 

 
1,624,000

Common stock dividends declared

 

 

 

 
45,000

 
(1,392,000
)
 

 
(1,347,000
)
 

 
(1,347,000
)
Issuance/redemption of equity grants, net
125,000

 
1,000

 

 

 
78,000

 

 

 
79,000

 

 
79,000

Interest rate cash flow hedge

 

 

 

 

 

 
108,000

 
108,000

 

 
108,000

Tax impact of equity grant exercises

 

 

 

 
62,000

 

 

 
62,000

 

 
62,000

Stock based compensation

 

 

 

 
987,000

 

 

 
987,000

 

 
987,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2015
6,513,000

 
65,000

 
232,000

 
(2,500,000
)
 
21,142,000

 
(5,053,000
)
 
(387,000
)
 
13,267,000

 

 
13,267,000

Net loss

 

 

 

 

 
(1,811,000
)
 

 
(1,811,000
)
 

 
(1,811,000
)
Common stock dividends declared

 

 

 

 
46,000

 
(1,412,000
)
 

 
(1,366,000
)
 

 
(1,366,000
)
Issuance/redemption of equity grants, net
79,000

 
1,000

 

 

 
(106,000
)
 

 

 
(105,000
)
 

 
(105,000
)
Interest rate cash flow hedge

 

 

 

 

 

 
582,000

 
582,000

 

 
582,000

Tax impact of equity grant exercises

 

 

 

 
65,000

 

 

 
65,000

 

 
65,000

Stock based compensation

 

 

 

 
788,000

 

 

 
788,000

 

 
788,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2016
6,592,000

 
$
66,000

 
232,000

 
$
(2,500,000
)
 
$
21,935,000

 
$
(8,276,000
)
 
$
195,000

 
$
11,420,000

 
$

 
$
11,420,000

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

F-5



DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Years Ended December 31,
 
2016
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
 
Net income (loss)
$
(1,811,000
)
 
$
1,624,000

 
$
4,708,000

Discontinued operations
(67,000
)
 
(1,128,000
)
 
3,258,000

Income (loss) from continuing operations
(1,744,000
)
 
2,752,000

 
1,450,000

Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
8,292,000

 
7,524,000

 
7,078,000

Provision for doubtful accounts
7,163,000

 
7,507,000

 
5,710,000

Deferred income tax provision (benefit)
(1,569,000
)
 
(1,222,000
)
 
837,000

Provision for self-insured professional liability, net of cash payments
1,968,000

 
3,200,000

 
1,173,000

Stock based compensation
1,012,000

 
1,152,000

 
580,000

Debt retirement costs
351,000

 

 

Provision for leases net of cash payments
(1,773,000
)
 
(1,749,000
)
 
(1,180,000
)
Lease termination costs, net of cash payments
1,863,000

 

 

Equity in net income of investment in unconsolidated affiliate
(271,000
)
 
(335,000
)
 

Gain on sale of investment in unconsolidated affiliate
(1,366,000
)
 

 

Deferred bonus
350,000

 

 

Other
576,000

 
396,000

 
316,000

Changes in other assets and liabilities affecting operating activities:
 
 
 
 
 
Receivables, net
(25,551,000
)
 
(9,883,000
)
 
(14,592,000
)
Prepaid expenses and other assets
(1,620,000
)
 
(60,000
)
 
(184,000
)
Trade accounts payable and accrued expenses
10,224,000

 
1,009,000

 
4,771,000

Net cash provided by (used in) continuing operations
(2,095,000
)
 
10,291,000

 
5,959,000

Net cash used in discontinued operations
(3,523,000
)
 
(7,014,000
)
 
(2,978,000
)
Net cash provided by (used in) operating activities
(5,618,000
)
 
3,277,000

 
2,981,000

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
 
Purchases of property and equipment
(6,022,000
)
 
(4,646,000
)
 
(5,494,000
)
Property acquisitions
(7,550,000
)
 

 

Acquisition of property and equipment through business combination

 
(10,900,000
)
 

Proceeds from sale of discontinued operations

 

 
17,124,000

Proceeds from sale of unconsolidated affiliate
2,068,000

 

 

Change in restricted cash
1,658,000

 
2,489,000

 
31,000

Deposits and other deferred balances

 
(9,000
)
 
(64,000
)
Net cash provided by (used in) continuing operations
(9,846,000
)
 
(13,066,000
)
 
11,597,000

Net cash used in discontinued operations

 

 
(61,000
)
Net cash provided by (used in) investing activities
(9,846,000
)
 
(13,066,000
)
 
11,536,000

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
 
Repayment of debt obligations
(73,374,000
)
 
(15,342,000
)
 
(21,645,000
)
Proceeds from issuance of debt
92,789,000

 
27,945,000

 
21,808,000

Financing costs
(2,162,000
)
 
(160,000
)
 
(195,000
)
Issuance and redemption of employee equity awards
(105,000
)
 
79,000

 
(47,000
)
Redemption of preferred stock

 

 
(4,918,000
)
Payment of common stock dividends
(1,366,000
)
 
(1,347,000
)
 
(1,322,000
)
Payment of preferred stock dividends

 

 
(220,000
)
Deconsolidation of noncontrolling interests, net of income taxes

 

 
(1,385,000
)
Payment for preferred stock restructuring
(640,000
)
 
(619,000
)
 
(600,000
)
Net cash provided by (used in) continuing operations
15,142,000

 
10,556,000

 
(8,524,000
)
Net cash used in discontinued operations

 

 
(5,956,000
)
Net cash provided by (used in) financing activities
15,142,000

 
10,556,000

 
(14,480,000
)
(Continued)

F-6



DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
 
 
Years Ended December 31,
 
2016
 
2015
 
2014
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
$
(322,000
)
 
$
767,000

 
$
37,000

CASH AND CASH EQUIVALENTS, beginning of period
4,585,000

 
3,818,000

 
3,781,000

CASH AND CASH EQUIVALENTS, end of period
$
4,263,000

 
$
4,585,000

 
$
3,818,000

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
 
 
Cash payments of interest, net of amounts capitalized
$
3,965,000

 
$
3,629,000

 
$
3,324,000

Cash payments of income taxes
$
549,000

 
$
205,000

 
$
84,000

SUPPLEMENTAL INFORMATION ON NON-CASH INVESTING AND FINANCING TRANSACTIONS:
 
 
 
 
 
Acquisition of equipment through capital lease
$
1,851,000

 
$

 
$

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

F-7



DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2016, 2015, and 2014

1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Diversicare Healthcare Services, Inc. ("Diversicare" or the "Company") provides a broad range of post-acute care services to patients and residents including skilled nursing, ancillary health care services and assisted living. In addition to the nursing and social services usually provided in long-term care centers, we offer a variety of rehabilitative, nutritional, respiratory, and other specialized ancillary services.
As of December 31, 2016, our continuing operations consist of 76 nursing centers with 8,453 licensed skilled nursing beds. Our nursing centers range in size from 48 to 320 licensed nursing beds. The licensed nursing bed count does not include 496 licensed assisted living beds. Our continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Mississippi, Missouri, Ohio, Tennessee, and Texas.
Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the financial position, operations and accounts of Diversicare 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 through 2014 and it related to a nursing center in West Virginia described in Note 7, "Variable Interest Entity".
Any joint ventures are accounted for using the equity method, which is an investment in an entity over which the Company lacks control, but otherwise has the ability to exercise significant influence over operating and financial policies. The Company had one equity method investee through the fourth quarter of 2016. The investment in unconsolidated affiliate reflected on the 2015 consolidated balance sheet related to a pharmacy joint venture partnership in which the Company owned a 50% interest. The Company’s share of the profits and losses from this investment are reported in equity in earnings of investment in unconsolidated affiliate and the proceeds received from the sale are reported in gain on sale of investment in unconsolidated affiliate in the accompanying consolidated statement of operations.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition
The fees charged by the Company to patients in its nursing centers are recorded on an accrual basis. These rates are contractually adjusted with respect to individuals receiving benefits under federal and state-funded programs and other third-party payors. Rates under federal and state-funded programs are determined prospectively for each center and may be based on the acuity of the care and services provided. These rates may be based on a center's actual costs subject to program ceilings and other limitations or on established rates based on acuity and services provided as determined by the federal and state-funded programs. Amounts earned under federal and state programs with respect to nursing home patients are subject to review by the third-party payors which may result in retroactive adjustments. In the opinion of management, adequate provision has been made for any adjustments that may result from such reviews. Retroactive adjustments, if any, are recorded when objectively determinable, generally within three years of the close of a reimbursement year depending upon the timing of appeals and third-party settlement reviews or audits. During the years ended December 31, 2016, 2015 and 2014, the Company recorded $38,000, $141,000 and $298,000 of net unfavorable estimated settlements from federal and state programs for periods prior to the beginning of fiscal 2016, 2015 and 2014, respectively.
Allowance for Doubtful Accounts
The Company's allowance for doubtful accounts is estimated utilizing current agings of accounts receivable, historical collections data and other factors. Management monitors these factors and determines the estimated provision for doubtful accounts. Historical bad debts have generally resulted from uncollectible private balances, some uncollectible coinsurance and deductibles and other

F-8



factors. Receivables that are deemed to be uncollectible are written off. The allowance for doubtful accounts balance is assessed on a quarterly basis, with changes in estimated losses being recorded in the Consolidated Statements of Operations in the period identified.
The Company includes the provision for doubtful accounts in operating expenses in its Consolidated Statements of Operations. The provisions for doubtful accounts of continuing operations were $7,163,000, $7,507,000, and $5,710,000 for 2016, 2015 and 2014, respectively. The provision for doubtful accounts of continuing operations was 1.7%, 1.9%, and 1.7% of net revenue during 2016, 2015, and 2014, respectively.
Lease Expense
As of December 31, 2016, the Company operates 59 nursing centers under operating leases, including 35 owned by Omega, 20 owned by Golden Living and four owned by other parties. The Company's operating leases generally require the Company to pay stated rent, subject to increases based on changes in the Consumer Price Index, a minimum percentage increase, or increases in the net revenues of the leased properties. The Company's Omega and Golden Living leases require the Company to pay certain scheduled rent increases. Such scheduled rent increases are recorded as additional lease expense on a straight-line basis recognized over the term of the related leases and the difference between the amounts recorded for rent expense as compared to rent payments as an accrued liability.
See Note 2, "Business Development and Other Significant Transactions", Note 3, "Discontinued Operations", and Note 11, "Commitments and Contingencies" for a discussion regarding the Company's Master Leases with Omega and Golden Living, the termination of leases for certain centers, and the addition of certain leased centers.
Classification of Expenses
The Company classifies all expenses (except lease, interest, depreciation and amortization expenses) that are associated with its corporate and regional management support functions as general and administrative expenses. All other expenses (except lease, professional liability, interest, depreciation and amortization expenses) incurred by the Company at the center level are classified as operating expenses.
Property and Equipment
Property and equipment are recorded at cost or at fair value determined on the respective dates of acquisition for assets obtained in a business combination, with depreciation and amortization being provided over the shorter of the remaining lease term (where applicable) or the assets' estimated useful lives on the straight-line basis as follows:
        
Buildings and improvements
-
5 to 40 years
Leasehold improvements
-
2 to 10 years
Furniture, fixtures and equipment
-
2 to 15 years
Interest incurred during construction periods for qualifying expenditures is capitalized as part of the building cost. Maintenance and repairs are expensed as incurred, and major betterments and improvements are capitalized.
The Company routinely evaluates the recoverability of the carrying value of its long-lived assets, including when significant adverse changes in the general economic conditions and significant deteriorations of the underlying undiscounted cash flows or fair values of the property indicate that the carrying amount of the property may not be recoverable. If circumstances suggest that the recorded amounts are not recoverable based upon estimated future undiscounted cash flows, the carrying values of such assets are reduced to fair value.
Cash and Cash Equivalents
Cash and cash equivalents include cash on deposit with banks and all highly liquid investments with original maturities of three months or less when purchased. Our cash on deposit with banks was subject to the Federal Deposit Insurance Corporation ("FDIC") minimum insurance levels. Effective January 1, 2013, the coverage provided by the FDIC that had been unlimited under the Dodd-Frank Deposit Insurance Provision is limited to the legal maximum, which is generally $250,000 per ownership category.
Deferred Financing and Other Costs
The Company records deferred financing and lease costs for direct and incremental expenditures related to entering into or amending debt and lease agreements. These expenditures include lenders and attorneys fees. Financing costs are amortized using the effective interest method over the term of the related debt. The amortization is reflected as interest expense in the accompanying consolidated statements of operations. Deferred lease costs are amortized on a straight-line basis over the term of the related leases. See Note

F-9



6, "Long-term Debt, Interest Rate Swap and Capitalized Lease Obligations" for further discussion. As a result of our adoption of ASU No. 2015-03, which is further discussed below, the Company nets long-term debt and deferred financing costs in the consolidated balance sheets.
Acquired Leasehold Interest
The Company has recorded an acquired leasehold interest intangible asset related to an acquisition completed during 2007. The intangible asset is accounted for in accordance with the FASB's guidance on goodwill and other intangible assets, and is amortized on a straight-line basis over the remaining life of the acquired lease, including renewal periods, the original period of which is approximately 28 years from the date of acquisition. The lease terms for the seven centers this intangible relates to provide for an initial term and renewal periods at the Company's option through May 31, 2035. As the renewal periods of the acquired leased centers are solely based on the Company's option, it is expected that costs (if any) to renew the lease through its current amortization period would be nominal and the decision to continue to lease the acquired centers lies solely within the Company's intent to continue to operate the seven centers. Any renewal costs would be included in deferred lease costs and amortized over the renewal period. Amortization expense of approximately $384,000 related to this intangible asset was recorded during each of the years ended December 31, 2016, 2015 and 2014, respectively.
The carrying value of the acquired leasehold interest intangible and the accumulated amortization are as follows:
 
December 31,
 
2016
 
2015
Intangible assets
$
10,652,000

 
$
10,652,000

Accumulated amortization
(3,577,000
)
 
(3,193,000
)
Net intangible assets
$
7,075,000

 
$
7,459,000

The Company evaluates the recoverability of the carrying value of the acquired leasehold intangible in accordance with the FASB's guidance on accounting for the impairment or disposal of long-lived assets. Included in this evaluation is whether significant adverse changes in general economic conditions, and significant deteriorations of the underlying cash flows or fair values of the intangible asset, indicate that the carrying amount of the intangible asset may not be recoverable. The need to recognize an impairment charge is based on estimated future undiscounted cash flows from the asset compared to the carrying value of that asset. If recognition of an impairment charge is necessary, it is measured as the amount by which the carrying amount of the intangible asset exceeds the fair value of the intangible asset.
The expected amortization expense for the acquired leasehold interest intangible asset is as follows:
2017
 
$
384,000

2018
 
384,000

2019
 
384,000

2020
 
384,000

2021
 
384,000

Thereafter
 
5,155,000

 
 
$
7,075,000

Self-Insurance
Self-insurance liabilities primarily represent the unfunded accrual for self insured risks associated with general and professional liability claims, employee health insurance and workers' compensation. The Company's health insurance liability is based on known claims incurred and an estimate of incurred but unreported claims determined by an analysis of historical claims paid. The Company's workers' compensation liability relates primarily to periods of self insurance prior to May 1997 and consists of an estimate of the future costs to be incurred for the known claims.
Final determination of the Company's actual liability for incurred general and professional liability claims is a process that takes years. 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 this unfunded accrual. Since May 2012, Merlinos & Associates, Inc. (“Merlinos”) has assisted management in the preparation of the appropriate accrual for incurred but not reported general and professional liability claims based on data furnished by the Company. Merlinos primarily utilizes historical data regarding the frequency and cost of the Company's past claims over a multi-year period, industry data and information regarding the number of occupied beds to develop its estimates of the Company's ultimate professional liability cost for current periods.

F-10



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 has an unfavorable impact on results of operations in the period and any reduction in the accrual increases results of operations during the period.
All losses are projected on an undiscounted basis. The self-insurance liabilities include 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 related legal costs incurred and expected to be incurred.
One of the key assumptions in the actuarial analysis is that historical losses provide an accurate forecast of future losses. Changes in legislation such as tort reform, changes in our financial condition, changes in our risk management practices and other factors may affect the severity and frequency of claims incurred in future periods as compared to historical claims.
The facts and circumstances of each claim vary significantly, and the amount of ultimate liability for an individual claim may vary due to many factors, including whether the case can be settled by agreement, the quality of legal representation, the individual jurisdiction in which the claim is pending, and the views of the particular judge or jury deciding the case.
Although the Company adjusts its unfunded 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 unfunded 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 results of operations and financial position for the period in which the change in accrual is made.
Income Taxes
The Company follows the FASB's guidance on Accounting for Income Taxes, which requires the asset and liability method of accounting for income taxes whereby deferred income taxes are recorded for the future tax consequences attributable to differences between the financial statement and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are provided against any estimated non-realizable deferred tax assets where necessary.

Where the Company believes that a tax position is supportable for income tax purposes, the item is included in its income tax returns. Where treatment of a position is uncertain, liabilities are recorded based upon the Company’s evaluation of the “more likely than not” outcome considering the technical merits of the position. While the judgments and estimates made by the Company are based on management’s evaluation of the technical merits of a matter, historical experience and other assumptions that management believes are appropriate and reasonable under current circumstances, actual resolution of these matters may differ from recorded estimated amounts, resulting in charges or credits that could materially affect future financial statements. See Note 10, "Income Taxes" for additional information related to the provision for income taxes.
Disclosure of Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants. In calculating fair value, a company must maximize the use of observable market inputs, minimize the use of unobservable market inputs and disclose in the form of an outlined hierarchy the details of such fair value measurements. The carrying amounts of cash and cash equivalents, receivables, trade accounts payable and accrued expenses approximate fair value because of the short-term nature of these accounts. The Company's self-insurance liabilities are reported on an undiscounted basis as the timing of estimated settlements cannot be determined.
The Company follows the FASB's guidance on Fair Value Measurements and Disclosures which provides rules for using fair value to measure assets and liabilities as well as a fair value hierarchy that prioritizes the information used to develop the measurements. It applies whenever other guidance requires (or permits) assets or liabilities to be measured at fair value and gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).

F-11



A summary of the fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels is described below:
Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
As further discussed in Note 6, "Long-term Debt, Interest Rate Swap and Capitalized Lease Obligations", in conjunction with the debt agreements entered into in February 2016, the Company entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The applicable guidance requires companies to recognize all derivative instruments as either assets or liabilities at fair value in a company's balance sheets.
As the Company's interest rate swap, a cash flow hedge, is not traded on a market exchange, the fair value is determined using a valuation model 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 fair value of the Company's interest rate swap is the net difference in the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates and are observable inputs available to a market participant. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy. The debt balances as presented in the consolidated balance sheets approximate the fair value of the respective instruments as the debt is at a variable rate, the estimates of which are considered Level 2 fair value calculations within the fair value hierarchy.
The following table presents by level, within the fair value hierarchy, assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 and 2015:
December 31, 2016
 
Fair Value Measurements - Assets (Liabilities)
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Interest rate swap
 
$
(129,000
)
 
$

 
$
(129,000
)
 
$

 
 
 
 
 
 
 
 
 
December 31, 2015
 
Fair Value Measurements - Assets (Liabilities)
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Interest rate swap
 
$
(625,000
)
 
$

 
$
(625,000
)
 
$

The change in fair value of the Company's cash flow hedge is detailed in the Company's Consolidated Statements of Comprehensive Income (Loss).
Net Income (Loss) per Common Share
The Company follows the FASB's guidance on Earnings Per Share for the financial reporting of net income (loss) per common share. Basic earnings per common share excludes dilution and restricted shares and is computed by dividing income available to common shareholders by the weighted-average number of common shares, excluding restricted shares, outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or otherwise resulted in the issuance of common stock that then shared in the earnings of the Company. See Note 9, "Net Income (Loss) per Common Share" for additional disclosures about the Company's Net Income (Loss) per Common Share.
Stock Based Compensation
The Company follows the FASB's guidance on Stock Compensation to account for share-based payments granted to team members and recorded non-cash stock based compensation expense of $1,012,000, $1,152,000 and $580,000 during the years ended December 31, 2016, 2015 and 2014, respectively. Such amounts are included as components of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. See Note 8, "Shareholders' Equity, Stock Plans and Preferred Stock" for additional disclosures about the Company's stock based compensation plans.
Accumulated Other Comprehensive Income (Loss)

F-12



Accumulated other comprehensive income consists of other comprehensive income (loss). Comprehensive income (loss) is a more inclusive financial reporting method that includes disclosure of financial information that historically has not been recognized in the calculation of net income (loss). The Company has chosen to present the components of other comprehensive income in a separate statement of comprehensive income (loss). Currently, the Company's other comprehensive income (loss) consists of the change in fair value of the Company's interest rate swap transaction accounted for as a cash flow hedge.
Recent Accounting Guidance
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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.  In March 2016, the FASB issued an update to ASU No. 2014-09 in the form of ASU No. 2016-08, which amended the principal-versus-agent implementation guidance and illustrations in the new revenue guidance. The update clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. In April 2016, the FASB issued another update to the new revenue standard in the form of ASU No. 2016-10, which amends the guidance on identifying performance obligations and the implementation guidance on licensing. In May 2016, ASU No. 2016-12 was issued, which amends the new revenue recognition guidance on transition, collectibility, noncash consideration and the presentation of taxes. The new revenue standard (including updates) will be effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted only as of annual reporting periods beginning after December 15, 2016. The Company will adopt the requirements of this standard effective January 1, 2018. We are in the early stages of evaluating the expected adoption method of ASU No. 2014-09, and we are analyzing whether enhancements are needed to our business and accounting systems.
In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs (Topic 835), which amends and simplifies the presentation of debt issuance costs. The main provisions of the standard require that debt issuance costs related to a recognized liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, and amortization of the debt issuance costs continues to be reported as interest expense. The Company adopted ASU No. 2015-03 as of January 1, 2016. The new standard was applied on a retroactive basis. The adoption of this guidance resulted in a $967,000 reclass between deferred financing costs and long-term debt.
In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, which changes how deferred taxes are classified on the Company's balance sheets and is effective for financial statements issued for annual periods beginning after December 15, 2016, with early adoption permitted. ASU 2015-17 requires all deferred tax assets and liabilities to be classified as non-current. Upon adoption on January 1, 2017, the Company anticipates reclassifying deferred income taxes of approximately $7,644,000 from current to non-current assets.
In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Disclosures will be required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for building and equipment operating leases and will result in a significant increase in the assets and liabilities on the consolidated balance sheet.
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU was issued as part of the FASB Simplification Initiative and involves several aspects of accounting for shared-based payment transactions, including the income tax consequences and classification on the statement of cash flows. The guidance is effective for annual periods beginning after December 15, 2016, which will be the Company's fiscal year 2017, and interim periods within those annual periods. Early adoption is permitted. The Company is in the early stages of evaluating the impact this standard will have on our consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This update is intended to improve financial reporting by requiring timelier recognition of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. This update requires that financial statement assets measured at an amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. This standard is effective for the fiscal year beginning after December 15, 2019 with early adoption permitted. The Company is in the initial stages of evaluating the impact from the adoption of this new standard on the Consolidated Financial Statements and related notes.

F-13



In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). The ASU provides clarification regarding how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The ASU is effective for annual and interim periods beginning after December 15, 2017, which will require the Company to adopt these provisions in the first quarter of fiscal 2018 using a retrospective approach. Early adoption is permitted. The Company is currently evaluating the impact this standard will have on our consolidated financial statements.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that the Statement of Cash Flows explain the changes during the period of cash and cash equivalents inclusive of amounts categorized as Restricted Cash. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The standard is effective for periods beginning after December 15, 2017.
Reclassifications
As discussed above, the Company adopted ASU No. 2015-03 as of January 1, 2016, and was applied on a retroactive basis. We reclassified $967,000 of debt issuance costs to long-term debt as of December 31, 2015.
As discussed in Note 3, "Discontinued Operations" the consolidated financial statements of the Company have been retroactively reclassified for all periods presented to reflect as discontinued operations certain divestitures and lease terminations.

2. BUSINESS DEVELOPMENT AND OTHER SIGNIFICANT TRANSACTIONS
Golden Living Transaction
On August 15, 2016, the Company entered into an Operation Transfer Agreement with Golden Living (the "Lessor") to assume the operations of 22 centers in Alabama and Mississippi.
On October 1, 2016, the Company entered into a Master Lease Agreement (the "Lease") with Golden Living to directly lease eight centers located in Mississippi from the Lessor, which include: (i) a 152-bed skilled nursing center known as Golden Living Center - Amory; (ii) a 130-bed skilled nursing center known as Golden Living Center - Batesville; (iii) a 58-bed skilled nursing center known as Golden Living Center - Brook Manor; (iv) a 119-bed skilled nursing center known as Golden Living Center - Eupora; (v) a 140-bed skilled nursing center known as Golden Living Center - Ripley; (vi) a 140-bed skilled nursing center known as Golden Living Center - Southaven; (vii) a 120-bed skilled nursing center known as Golden Living Center - Eason Blvd; (viii) a 60-bed skilled nursing center known as Golden Living Center - Tylertown. The Lease is triple net and has an initial term of ten years with two separate five year options to extend the term. The Company also assumed the individual leases of a 120-bed center known as Broadmoor Nursing Home, with an initial lease term of ten years with first year rent of $540,000, escalating to $780,000 in the second year, and 2% annually thereafter, and a 99-bed skilled nursing center known as Leake County Nursing Home, with a lease term of two years with annual rent of $300,000.
On November, 1 2016, the Company amended and restated the Lease ("Amended Lease") with the Lessor to directly lease an additional twelve centers located in Alabama from the Lessor, which include: (i) a 87-bed skilled nursing center known as Golden Living Center - Arab; (ii) a 180-bed skilled nursing center known as Golden Living Center - Meadowood; (iii) a 132-bed skilled nursing center known as Golden Living Center - Riverchase; (iv) a 100-bed skilled nursing center known as Golden Living Center - Boaz; (v) a 154-bed skilled nursing center known as Golden Living Center - Foley; (vi) a 50-bed skilled nursing center known as Golden Living Center - Hueytown; (vii) a 85-bed skilled nursing center known as Golden Living Center - Lanett; (viii) a 138-bed skilled nursing center known as Golden Living Center - Montgomery; (ix) a 120-bed skilled nursing center known as Golden Living Center - Oneonta; (x) a 173-bed skilled nursing center known as Golden Living Center - Oxford; (xi) a 94-bed skilled nursing center known as Golden Living Center - Pell City; (xii) a 123-bed skilled nursing center known as Golden Living Center - Winfield. The Amended Lease is triple net and has an initial term of ten years with two separate five year options to extend the term. Base rent for the amended lease is $24,675,000 for the first year and escalates 2% annually thereafter.
2016 Acquisitions
On February 26, 2016, the Company exercised its purchase options to acquire the real estate assets for Diversicare of Hutchinson in Hutchinson, Kansas and Clinton Place in Clinton, Kentucky for $4,250,000 and $3,300,000, respectively. The Company has operated these centers since February 2015 and April 2012, respectively. Hutchinson is an 85-bed skilled nursing center and Clinton is an 88-bed skilled nursing center. As a result of the consummation of the Agreements, the Company allocated the purchase price and acquisition costs between the assets acquired. The relative fair value allocation of the purchase price was determined with the assistance of HealthTrust LLC, a third-party real estate valuation firm. The allocation for the assets acquired is as follows:

F-14



 
 
Hutchinson
 
Clinton Place
Purchase Price
 
4,250,000

 
3,300,000

Acquisition Costs
 
43,000

 
34,000

 
 
4,293,000

 
3,334,000

 
 
 
 
 
Allocation:
 
 
 
 
Buildings
 
3,443,000

 
2,898,000

Land
 
365,000

 
267,000

Furniture, Fixtures and Equipment
 
485,000

 
169,000

 
 
4,293,000

 
3,334,000

2015 Acquisitions
On February 1, 2015, the Company entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Barren County Health Care Center, Inc. to acquire a 94-bed skilled nursing center in Glasgow, Kentucky, for an aggregate purchase price of $7,000,000, partially financed through a $5,000,000 mortgage loan with The PrivateBank with the balance paid in cash consideration.
As a result of this business combination transaction, the Company allocated the purchase price of $7,000,000 based on the fair value of the acquired net assets. 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:

 
February 1, 2015
Purchase Price
$
7,000,000

 
 
Land
672,000

Buildings
5,778,000

Furniture, Fixtures, and Equipment
550,000

 
$
7,000,000


On November 1, 2015, the Company entered into an Asset Purchase Agreement with Haws Fulton Investors, LLC to acquire a 60-bed skilled nursing center in Fulton, Kentucky, for an aggregate purchase price of $3,900,000. As a result of this business combination transaction, the Company allocated the purchase price of $3,900,000 based on the fair value of the acquired net assets. The allocation for the net assets acquired is as follows:
 
November 1, 2015
Purchase Price
$
3,900,000

 
 
Land
300,000

Buildings
3,338,000

Furniture, Fixtures, and Equipment
262,000

 
$
3,900,000

2015 Lease Agreement
On February 1, 2015, the Company assumed operations of a 85-bed skilled nursing center in Hutchinson, Kansas. This center has an initial lease term of 10 years, and included an option to purchase exercisable after the first year of operations. The center was already operating and treating patients on the transition date. There was no purchase price paid to enter into the lease agreement. As disclosed above, the Company purchased this center on February 26, 2016.
2016 Lease Termination

F-15



On May 31, 2016, the Company entered into an Agreement with Avon Ohio, LLC to amend the original lease agreement, thus terminating the Company's right of possession of the center. As a result, the Company incurred lease termination costs of $2,008,000 in the second quarter of 2016. Under the amended agreement, the Company is required to pay $300,000 per year through the term of the original lease agreement, July 31, 2024. For accounting purposes, this transaction was not reported as a discontinued operation, which is in accordance with the modified authoritative guidance for reporting discontinued operations, effective January 1, 2015. A disposal is now required to be reported in discontinued operations only if the disposal represents a strategic shift that has (or will have) a major effect on the Company's operations and financial results.
2016 Sale of Investment in Unconsolidated Affiliate
On October 28, 2016, the Company and its partners entered into an asset purchase agreement to sell the pharmacy joint venture. The sale resulted in a $1,366,000 recorded gain for the Company for the year ended December 31, 2016. The transaction also resulted in an immaterial gain contingency. The Company accounts for gain contingencies in accordance with the provisions of ASC 450, Contingencies, and, therefore, we do not record gain contingencies and recognize income until realized.

3. DISCONTINUED OPERATIONS
West Virginia Disposition
Effective April 3, 2014, the Company entered into an asset purchase agreement with Rose Terrace Acq., LLC (“Purchaser”) to sell its skilled nursing center in Culloden, West Virginia. The original asset purchase agreement was subject to a number of conditions including an amendment to the Consolidated Amended and Restated Master Lease ("Master Lease") with Omega to terminate the lease only with respect to two other skilled nursing centers in West Virginia, state licensure and regulatory approval.
Effective July 1, 2014, the Company completed the transaction with Rose Terrace Acq., LLC to sell Rose Terrace, a 90-bed skilled nursing center in Culloden, West Virginia for a sales price of $16,500,000. The Company also entered into the Fifteenth Amendment to the Master Lease with Omega to terminate the lease only with respect to two other skilled nursing centers 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 centers located in Danville and Ivydale, West Virginia. The amendment effectively reduced the annual rent payments due under the Master Lease by $1,900,000. 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 center.
The transaction resulted in a gain on the disposition of Rose Terrace which, along with the results of operations for these nursing centers, is presented within Discontinued Operations on the Consolidated Statements of Operations. The pretax gain on the transaction was $7,522,000. The tax expense associated with the gain was $2,793,000 for which the Company applied 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 $0, $0, and $10,961,000 and net loss of $51,000, $225,000, and $26,000 during the years ended December 31, 2016, 2015, and 2014, respectively.  In addition to the West Virginia centers, other discontinued operations that were disposed of prior to 2014 contributed net income (loss) of $(16,000), $(903,000), and $3,284,000 during the years ended December 31, 2016, 2015, and 2014, 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.
4. RECEIVABLES
Receivables, before the allowance for doubtful accounts, consist of the following components:
 
December 31,
 
2016
 
2015
 
 
 
 
Medicare
$
20,402,000

 
$
14,415,000

Medicaid and other non-federal government programs
31,208,000

 
20,133,000

Other patient and resident receivables
20,868,000

 
17,451,000

   
$
72,478,000

 
$
51,999,000

Other receivables and advances
$
1,193,000

 
$
1,407,000


F-16



The other receivables and advances balance include of $474,000 and $938,000 related to renovation projects to be funded by Omega at December 31, 2016 and 2015, respectively. See Note 11, "Commitments and Contingencies" for additional discussion of these receivables and leased center construction projects.
Our accounts receivable at December 31, 2016, reflects the change in ownership of the twenty-two newly leased Golden Living centers in Alabama and Mississippi. The Company has entered into an agreement with Golden Living to utilize their billing credentials in order to perform the billing of the Medicare and Medicaid receivables until the change in ownership process has been completed. This agreement allows the Medicare and Medicaid receivables to be billed and collected in the interim. Payer sources could be delayed due to setting up new agreements and credentialing with those payers.
The Company provides credit for a substantial portion of its revenues and continually monitors the credit worthiness and collectability from its patients, including proper documentation of third-party coverage. The Company is subject to accounting losses from uncollectible receivables in excess of its reserves.
Substantially all receivables are pledged as collateral on the Company's debt obligations.

5. PROPERTY AND EQUIPMENT

Property and equipment, at cost, consists of the following:
 
December 31,
 
2016

2015
 
 
 
 
Land
$
5,761,000

 
$
4,859,000

Buildings and leasehold improvements
85,660,000

 
76,025,000

Furniture, fixtures and equipment
37,401,000

 
33,499,000

 
128,822,000

 
114,383,000

Less: accumulated depreciation
(69,022,000
)
 
(62,110,000
)
Net property and equipment
$
59,800,000

 
$
52,273,000


As discussed further in Note 6, "Long-term Debt, Interest Rate Swap and Capitalized Lease Obligations", the property and equipment of certain skilled nursing centers are pledged as collateral for mortgage debt obligations. In addition, the Company has assets recorded as capital leased assets purchased through capitalized lease obligations. The Company capitalizes leasehold improvements which will revert back to the lessor of the property at the expiration or termination of the lease, and depreciates these improvements over the shorter of the remaining lease term or the assets' estimated useful lives.
6. LONG-TERM DEBT, INTEREST RATE SWAP AND CAPITALIZED LEASE OBLIGATIONS
Long-term debt consists of the following:
 
December 31,
 
2016
 
2015
Mortgage loan with a syndicate of banks; issued in March 2011, amended May 2013; and further amended February 2016; payable monthly, interest at 4.0% above LIBOR, a portion of which is fixed at 5.79% based on the interest rate swap described below.
$
58,792,000

 
$
47,401,000

Acquisition loan with The PrivateBank, issued in February 2016, interest at 4.75% above LIBOR.
6,289,000

 

Revolving credit facility borrowings payable to a bank; entered into in March 2010; amended in March 2011 and further amended May 2013, March 2014, February 2016 and October 2016; secured by receivables of the Company; interest at 4.0% above LIBOR.
15,000,000

 
12,900,000

 
80,081,000

 
60,301,000

Less current portion
(6,663,000
)
 
(6,276,000
)
 
$
73,418,000

 
$
54,025,000

As of December 31, 2016, the Company's weighted average interest rate on long-term debt, including the impact of the interest rate swap, was approximately 5.17%.

F-17



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 February 26, 2016, 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 April 30, 2013. The Credit Agreement increases the Company's borrowing capacity to $100,000,000 allocated between a $72,500,000 Mortgage Loan ("Amended Mortgage Loan") and a $27,500,000 Revolver ("Amended Revolver"). The Amended Mortgage Loan consists of $60,000,000 term and $12,500,000 acquisition loan facilities. Loan acquisition costs associated with the Amended Mortgage Loan and the Amended Revolver were capitalized in the amount of $2,162,000 and are being amortized over the five-year term of the agreements. Additionally, the Glasgow term loan balance of $5,000,000 was consolidated into the new Credit Agreement.
Under the terms of the amended agreements, the syndicate of banks provided the Amended Mortgage Loan with an original balance of $72,500,000 with a five-year maturity through February 26, 2021, and a $27,500,000 Amended Revolver through February 26, 2021. The Amended Mortgage Loan has a term of five years, with principal and interest payable monthly based on a 25-year amortization. Interest on the term and acquisition loan facilities are based on LIBOR plus 4.0% and 4.75%, respectively. A portion of the Amended Mortgage Loan is effectively fixed at 5.79% pursuant to an interest rate swap with an initial notional amount of $30,000,000. As of December 31, 2016, the interest rate related to the Amended Mortgage Loan was 4.75%. The Amended Mortgage Loan is secured by 17 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 and cross-defaulted. The Company’s Amended Revolver has an interest rate of LIBOR plus 4.0% 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 October 3, 2016, the Company entered into the Second Amendment to the Third Amended and Restated Revolver ("Second Amendment"). The Second Amendment increased the Amended Revolver capacity from the $27,500,000 in the original Amended Revolver to $52,250,000; provided that the maximum revolving facility be reduced to $42,250,000 on August 1, 2017. The change to the borrowing capacity is a result of the increase in receivables related to new centers that continue to progress through the change in ownership process.
On December 29, 2016, the Company executed a Third Amendment to the Third Amended and Restated Revolver ("Third Amendment"). The Third Amendment modifies the terms of the Loan Agreement by increasing the Company’s letter of credit sublimit from $10,000,000 to $15,000,000.
As of December 31, 2016, the Company had $15,000,000 in borrowings outstanding under the Amended Revolver compared to $12,900,000 outstanding as of December 31, 2015. The outstanding borrowings on the Amended Revolver primarily reflect the Company's approach to accumulated Medicaid and Medicare receivables at recently acquired centers as these centers proceed through the change in ownership process with CMS. Annual fees for letters of credit issued under the Amended Revolver are 3.0% of the amount outstanding. The Company has 12 letters of credit with a total value of $10,230,000 outstanding as of December 31, 2016. Considering the balance of eligible accounts receivable, the letter of credit, the amounts outstanding under the Amended Revolver and the maximum loan amount of $42,674,000, the balance available for borrowing under the Amended Revolver is $14,443,000 at December 31, 2016.
The Company’s debt agreements contain various financial covenants, the most restrictive of which relates to debt service coverage ratios. The Company is in compliance with all such covenants at December 31, 2016.
In connection with the Company's 2016 and 2015 financing agreements, the Company recorded the following deferred loan costs related to the new financing agreements as a reduction of the debt balances discussed above:
 
2016
 
2015
Write-off of deferred financing costs
$
351,000

 
$

Deferred financing costs capitalized
$
2,162,000

 
$
160,000

The deferred financing costs included in the current and long-term balances were $2,273,000 at December 31, 2016 and $967,000 at December 31, 2015.
Scheduled principal payments of long-term debt are as follows:

F-18



2017
$
6,663,000

2018
6,740,000

2019
6,820,000

2020
8,196,000

2021
$
51,662,000

Total
$
80,081,000

Interest Rate Swap Cash Flow Hedge
As part of the debt agreements entered into in April 2013, the Company entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The Company entered into the interest rate swap agreement to mitigate the variable interest rate risk on its outstanding mortgage borrowings. The Company designated its interest rate swap as a cash flow hedge and the effective portion of the hedge, net of taxes, is reflected as a component of other comprehensive income (loss). In conjunction with the aforementioned amendment to the Credit Agreement that occurred in February 2016, the Company retained the previously agreed upon interest rate swap modifying the terms of the swap to reflect the amended Credit Agreement. The Company redesignated the interest rate swap as a cash flow hedge. The interest rate swap agreement has the same effective date and maturity date as the Amended Mortgage Loan, and has an amortizing notional amount that was $29,329,000 as of December 31, 2016. The interest rate swap agreement requires the Company to make fixed rate payments to the bank calculated on the applicable notional amount at an annual fixed rate of 5.79% while the bank is obligated to make payments to the Company based on LIBOR on the same notional amounts. The applicable guidance requires companies to recognize all derivative instruments as either assets or liabilities at fair value in a company's balance sheets.
The Company assesses the effectiveness of its interest rate swap on a quarterly basis and at December 31, 2016, the Company determined that the interest rate swap was effective. The interest rate swap valuation model indicated a net liability of $129,000 at December 31, 2016. The fair value of the interest rate swap is included in “other noncurrent liabilities” on the Company's consolidated balance sheets. The liability related to the change in the interest rate swap included in accumulated other comprehensive income at December 31, 2016 is $80,000, net of income tax benefit of $49,000. As the Company's interest rate swap is not traded on a market exchange, the fair value is determined using a valuation model 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 fair value of the Company's interest rate swap is the net difference in the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates and are observable inputs available to a market participant. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy, in accordance with the FASB's guidance on Fair Value Measurements and Disclosures.
Capitalized Lease Obligations
Upon acquisition of some centers, we assumed certain leases, primarily related to equipment, that constitute capital leases. As a result, we have recorded the underlying lease assets and capitalized lease obligations of $2,052,000 and $566,000 as of December 31, 2016 and 2015, respectively. These lease agreements provide three to five year terms.
Scheduled payments of the capitalized lease obligations are as follows:
2017
$
1,133,000

2018
955,000

2019
75,000

Total
2,163,000

Amounts related to interest
(111,000
)
Principal payments on capitalized lease obligation
$
2,052,000


7. VARIABLE INTEREST ENTITY
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 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

F-19



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 variable interest entity ("VIE") that developed the Rose Terrace nursing center 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 3, "Discontinued Operations", the Company sold the Rose Terrace facility and all assets associated with the facility. As a result of these events, the real estate development entity is no longer consolidated.

8. SHAREHOLDERS' EQUITY, STOCK PLANS AND PREFERRED STOCK

Shareholders' Rights Plan
On May 7, 2014, the Company entered into a fourth amendment (the “Fourth Amendment”) to the Amended and Restated Rights Agreement, dated as of December 7, 1998, as amended March 19, 2005, August 15, 2008, and August 14, 2009 between the Company (formerly Advocat Inc.) and ComputerShare Trust Company, N.A., as successor to SunTrust Bank, as Rights Agent. In the Fourth Amendment, the Company changed the Expiration Date of the preferred share purchase rights (the “Rights”) under the Rights Agreement from August 2, 2018 to May 15, 2014. As a result of the Fourth Amendment, the Rights Agreement terminated by its terms and is of no further force and effect and the Rights expired at the close of business on May 15, 2014.

Stock Based Compensation Plans
The Company follows the FASB's guidance on Stock Compensation to account for stock-based payments granted to employees and non-employee directors.

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 and are subject to forfeiture. In June 2016, our shareholders approved an amendment to the Stock Purchase Plan to increase the number of shares of our common stock authorized under the Plan from 150,000 shares to 350,000 shares. No grants can be made under the Stock Purchase Plan after April 25, 2028.
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 2016 and 2015, the Compensation Committee of the Board of Directors approved grants totaling approximately 83,000 and 74,000, respectively, shares of restricted common stock to certain employees and members of the Board of Directors. These restricted shares vest one-third 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.

F-20



The Company recorded non-cash stock-based compensation expense from continuing operations for equity grants and RSU's issued under the Plans of $1,012,000, $1,152,000, and $580,000 during the years ended December 31, 2016, 2015, and 2014, respectively. Such amounts are included as components of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. As of December 31, 2016, there was $537,000 in unrecognized compensation costs related to stock-based compensation to be recognized over the applicable remaining vesting periods. The Company estimated the total recognized and unrecognized compensation for all options and SOSARs using the Black-Scholes-Merton equity grant valuation model. Restricted stock awards are valued using the market price on the grant date.
The table below shows the weighted average assumptions the Company used to develop the fair value estimates under its option valuation model:
 
Year Ended December 31,
 
2016
 
2015
 
2014
Expected volatility (range)
N/A(1)
 
44%-49%
 
N/A(1)
Risk free interest rate (range)
N/A(1)
 
1.52%-1.87%
 
N/A(1)
Expected dividends
N/A(1)
 
2.15%
 
N/A(1)
Weighted average expected term (years)
N/A(1)
 
6
 
N/A(1)
___________
(1)
The Company did not issue any options or other equity grants that would require application of the Black-Scholes-Merton equity grant valuation model during the years ended December 31, 2016 and 2014. All equity grants during these periods were restricted common shares which are valued using an intrinsic valuation method based on market price.
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.
In computing the fair value of these equity grants, the Company estimated the equity grants' expected term based on the average of the vesting term and the original contractual terms of the grants, consistent with the Securities and Exchange Commission's interpretive guidance often referred to as the “Simplified Method.” The Company's recent exercise history is primarily from options granted in 2005 that were vested at grant date and were significantly in-the-money due to an increase in stock price during the period between grant date and formal approval by shareholders, and from older options granted several years ago that had fully vested.
The table below describes the resulting weighted average grant date fair values calculated as well as the intrinsic value of options exercised under the Company's equity awards during each of the following years:
 
 
Year Ended
December 31,
 
 
    2016(1)
 
2015
 
    2014(1)
Weighted average grant date fair value
 

 
$
3.78

 
$

Total intrinsic value of exercises
 
$
3,000

 
$
249,000

 
$
126,000

___________
(1)
The Company did not issue any options or other equity grants that would require application of the Black-Scholes-Merton equity grant valuation model during the years ended December 31, 2016 and 2014. All equity grants during this period were restricted common shares which are valued using an intrinsic valuation method based on market price.

The following table summarizes information regarding stock options and SOSAR grants outstanding as of December 31, 2016:

F-21



 
 
Weighted
 
 
 
 
 
 
 
 
 
 
Average
 
 
 
Intrinsic
 
 
 
Intrinsic
Range of
 
Exercise
 
Grants
 
Value-Grants
 
Grants
 
Value-Grants
Exercise Prices
 
Prices
 
Outstanding
 
Outstanding
 
Exercisable
 
Exercisable
$10.21 to $11.59
 
$
10.88

 
62,000

 
$
3,000

 
57,000

 
$

$2.37 to $6.21
 
$
5.54

 
169,000

 
822,000

 
169,000

 
822,000

 
 
 
 
231,000

 
 
 
226,000

 
 

As of December 31, 2016, the outstanding equity grants have a weighted average remaining life of 3.94 and those outstanding equity grants that are exercisable have a weighted average remaining life of 3.84. During the year ended December 31, 2016, approximately 1,000 stock option and SOSAR grants were exercised under these plans. All of the equity grants exercised were net settled. The net proceeds from equity grants exercised in 2016 was $(105,000).

Summarized activity of the equity compensation plans is presented below:
 
 
 
Weighted
 
SOSARs/
 
Average
 
Options
 
Exercise Price
Outstanding, December 31, 2015
232,000

 
$
6.97

Granted

 

Exercised
(1,000
)
 
7.24

Expired or cancelled

 

Outstanding, December 31, 2016
231,000

 
$
6.97

 
 
 
 
Exercisable, December 31, 2016
226,000

 
$
6.90


 
 
 
Weighted
 
 
 
Average
 
Restricted
 
Grant Date
 
Shares
 
Fair Value
Outstanding, December 31, 2015
141,000

 
$
9.07

Granted
83,000

 
8.87

Dividend Equivalents
4,000

 
9.21

Vested
(68,000
)
 
7.85

Cancelled
(7,000
)
 
9.80

Outstanding December 31, 2016
153,000

 
$
9.47


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, 2015
62,000

 
$
9.58

Granted
17,000

 
8.87

Dividend Equivalents
2,000

 
9.19

Vested
(27,000
)
 
6.13

Cancelled

 

Outstanding December 31, 2016
54,000

 
$
11.10




F-22



Series A Preferred Stock
The Company is authorized to issue up to 200,000 shares of Series A Preferred Stock. The Company's Board of Directors is authorized to establish the terms and rights of each series, including the voting powers, designations, preferences, and other special rights, qualifications, limitations, or restrictions thereof.

Series B and Series C Redeemable Preferred Stock
As part of the consideration paid to Omega for restructuring the terms of the Omega Master Lease in November 2000, the Company issued to Omega 393,658 shares of the Company's Series B Redeemable Convertible Preferred Stock (“Series B Preferred Stock”) with a stated value of $3,300,000 and an annual dividend rate of 7% of the stated value. In October 2006, the Company and Omega entered into a Restructuring Stock Issuance and Subscription Agreement (“Restructuring Agreement”) to restructure the Series B Preferred Stock, eliminating the option of Omega to convert the Series B Preferred Stock into shares of Diversicare (formerly Advocat) common stock.
At the time of the Restructuring Agreement, the Series B Preferred Stock had a recorded value (including accrued dividends) of approximately $4,918,000 and was convertible into approximately 792,000 shares of common stock. The Company issued 5,000 shares of a new Series C Redeemable Preferred Stock (“Series C Preferred Stock”) to Omega in exchange for the 393,658 shares of Series B Preferred Stock held by Omega. The Series C Preferred Stock had a stated value of approximately $4,918,000 and an annual dividend rate of 7% of its stated value payable quarterly in cash. The Series C Preferred Stock was not convertible, but was redeemable at its stated value at Omega's option since September 30, 2010, and since September 30, 2007, was redeemable at its stated value at the Company's option.
In connection with the termination of the conversion feature, the Company agreed to pay Omega an additional $687,000 per year under the Lease Amendment. The additional annual payments of $687,000 were discounted over the twelve year term of the renewal to arrive at a net present value of $6,701,000, the preferred stock premium. The Company recorded the fair value of the elimination of the conversion feature as a reduction in Paid In Capital with an offsetting increase to record a premium on the Series C Preferred Stock. As a result, the Series C Preferred Stock was initially recorded at a total value of $11,619,000, equal to the stated value of the Series B Preferred Stock, $4,918,000, plus the value of the conversion feature, $6,701,000 which was fully amortized in 2010. The stated value of the preferred stock was classified as temporary equity and the additional obligation was classified as a noncurrent in the accompanying consolidated balance sheet. As the related cash payments were made, the preferred stock premium was reduced and interest expense was recorded.
Effective August 14, 2014, the Company redeemed all of its outstanding shares of Series C Preferred Stock for approximately $4,918,000 from the holder. 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 a result of the redemption, the Company no longer has any Series C Preferred Stock outstanding. The following table reflects activity in the Series C Preferred Stock:
Series C Preferred Stock
 
 
2016
 
2015
 
2014
Balance at the beginning of the period
 
$

 
$

 
$
4,918,000

Redemption of preferred stock
 

 

 
(4,918,000
)
Balance at the end of the period
 
$

 
$

 
$

9.
NET INCOME (LOSS) PER COMMON SHARE
Information with respect to the calculation of basic and diluted net income (loss) per common share is presented below:

F-23



 
 
Years Ended December 31,
 
 
2016
 
2015
 
2014
Numerator: Income (loss) attributable to Diversicare Healthcare Services, Inc. common shareholders:
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
(1,744,000
)
 
$
2,752,000

 
$
1,450,000

Less: net loss attributable to noncontrolling interests
 

 

 
25,000

Income (loss) from continuing operations attributable to Diversicare Healthcare Services, Inc.
 
(1,744,000
)
 
2,752,000

 
1,475,000

Preferred stock dividends
 

 

 
(220,000
)
Income (loss) from continuing operations attributable to Diversicare Healthcare Services, Inc. common shareholders
 
(1,744,000
)
 
2,752,000

 
1,255,000

Income (loss) from discontinued operations, net of income taxes
 
(67,000
)
 
(1,128,000
)
 
3,258,000

Net income (loss) attributable to Diversicare Healthcare Services, Inc. common shareholders
 
$
(1,811,000
)
 
$
1,624,000

 
$
4,513,000

 
 
 
 
 
 
 
Denominator: Basic Weighted Average Common Shares Outstanding:
 
6,199,000

 
6,100,000

 
6,011,000

 
 
 
 
 
 
 
Basic net income per common share
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
(0.28
)
 
$
0.45

 
$
0.21

Income (loss) from discontinued operations
 
 
 
 
 
 
Operating loss, net of taxes
 
(0.01
)
 
(0.18
)
 
(0.25
)
Gain on disposal, net of taxes
 

 

 
0.79

Discontinued operations, net of taxes
 
(0.01
)
 
(0.18
)
 
0.54

Basic net income (loss) per common share
 
$
(0.29
)
 
$
0.27

 
$
0.75

 
 
2016
 
2015
 
2014
Numerator: Income (loss) from continuing operations attributable to Diversicare Healthcare Services, Inc. common shareholders
 
(1,744,000
)
 
2,752,000

 
1,255,000

Income (loss) from discontinued operations, net of income taxes
 
(67,000
)
 
(1,128,000
)
 
3,258,000

Net income (loss) attributable to Diversicare Healthcare Services, Inc. common shareholders
 
$
(1,811,000
)
 
$
1,624,000

 
$
4,513,000

 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
6,199,000

 
6,100,000

 
6,011,000

Incremental shares from assumed exercise of options, SOSARS and Restricted Stock Units
 

 
215,000

 
186,000

Denominator: Diluted Weighted Average Common Shares Outstanding:
 
6,199,000

 
6,315,000

 
6,197,000

 
 
 
 
 
 
 
Diluted net income per common share
 
 
 
 
 
 
Income (loss) from continuing operations
 
$
(0.28
)
 
$
0.44

 
$
0.20

Income (loss) from discontinued operations
 
 
 
 
 
 
Operating loss, net of taxes
 
(0.01
)
 
(0.18
)
 
(0.25
)
Gain on disposal, net of taxes
 

 

 
0.77

Discontinued operations, net of taxes
 
(0.01
)
 
(0.18
)
 
0.52

Diluted net income (loss) per common share
 
$
(0.29
)
 
$
0.26

 
$
0.72



F-24



The dilutive effects of the Company's stock options, SOSARs, Restricted Shares and Restricted Share Units are included in the computation of diluted income per common share during the periods they are considered dilutive.

The following table reflects the weighted average outstanding SOSARs and Options that were excluded from the computation of diluted earnings per share, as they would have been anti-dilutive:
 
2016
 
2015
 
2014
SOSARs/Options Excluded
31,000
 
62,000
 
57,000
The weighted average common shares for basic and diluted earnings for common shares was the same due to the losses in 2016.
10. INCOME TAXES

Overview
For the year ended December 31, 2016, the Company recorded a benefit for income taxes from continuing operations of $1,030,000, and a provision for income taxes from continuing operations of $916,000 and $857,000 for the years ended December 31, 2015 and 2014, respectively . The provision (benefit) for income taxes of continuing operations is composed of the following components:
 
 
Year Ended December 31,
 
 
2016
 
2015
 
2014
Current provision (benefit) :
 
 
 
 
 
 
Federal
 
$
17,000

 
$
1,191,000

 
$
10,000

State
 
522,000

 
947,000

 
10,000

 
 
539,000

 
2,138,000

 
20,000

Deferred provision (benefit):
 
 
 
 
 
 
Federal
 
(1,284,000
)
 
(783,000
)
 
798,000

State
 
(285,000
)
 
(439,000
)
 
39,000

 
 
(1,569,000
)
 
(1,222,000
)
 
837,000

Provision (benefit) for income taxes of continuing operations
 
$
(1,030,000
)
 
$
916,000

 
$
857,000


A reconciliation of taxes computed at statutory income tax rates on income (loss) from continuing operations is as follows:
 
 
Year Ended December 31,
 
 
2016
 
2015
 
2014
Provision (benefit) for federal income taxes at statutory rates
 
$
(889,000
)
 
$
1,247,000

 
$
784,000

Provision for state income taxes, net of federal benefit
 
120,000

 
688,000

 
76,000

Valuation allowance changes affecting the provision for income taxes
 
(45,000
)
 
(534,000
)
 
(66,000
)
Employment tax credits
 
(529,000
)
 
(1,249,000
)
 
(169,000
)
Nondeductible expenses
 
453,000

 
862,000

 
123,000

Stock based compensation expense
 
(62,000
)
 
(105,000
)
 
3,000

Other
 
(78,000
)
 
7,000

 
106,000

Provision (benefit) for income taxes of continuing operations
 
$
(1,030,000
)
 
$
916,000

 
$
857,000



F-25



Deferred Taxes
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets are reduced by a valuation allowance if, based upon the weight of available evidence, it is more likely than not that we will realize only some portion of the deferred tax assets. The net deferred tax assets and liabilities, at the respective income tax rates, are as follows:
 
 
December 31,
 
 
2016
 
2015
Current deferred tax assets:
 
 
 
 
Allowance for doubtful accounts
 
3,772,000

 
3,049,000

Accrued liabilities
 
5,011,000

 
5,895,000

 
 
8,783,000

 
8,944,000

Less valuation allowance
 
(272,000
)
 
(319,000
)
 
 
8,511,000

 
8,625,000

Current deferred tax liabilities:
 
 
 
 
Prepaid expenses
 
(867,000
)
 
(626,000
)
 
 
$
7,644,000

 
$
7,999,000


 
 
December 31,
 
 
2016
 
2015
Noncurrent deferred tax assets:
 
 
 
 
Net operating loss and other carryforwards
 
$
1,260,000

 
$
1,040,000

Credit carryforwards
 
3,162,000

 
2,612,000

Deferred lease costs
 
107,000

 
167,000

Depreciation
 
2,122,000

 
1,184,000

Tax goodwill and intangibles
 
(1,296,000
)
 
(1,172,000
)
Stock-based compensation
 
629,000

 
534,000

Accrued rent
 
3,118,000

 
3,055,000

Kentucky and Kansas acquisition costs
 
6,000

 
113,000

Impairment of long-lived assets
 
269,000

 
267,000

Interest rate swap
 
49,000

 
237,000

Hedge Ineffectiveness
 
(69,000
)
 

Noncurrent self-insurance liabilities
 
4,633,000

 
4,185,000

Other
 
11,000

 

 
 
14,001,000

 
12,222,000

Less valuation allowance
 
(460,000
)
 
(460,000
)
 
 
$
13,541,000

 
$
11,762,000


Deferred Tax Valuation Allowance
The assessment of the amount of value assigned to our deferred tax assets under the applicable accounting standards is highly judgmental. We are required to consider all available positive and negative evidence in evaluating the likelihood that we will be able to realize the benefit of our deferred tax assets in the future. Such evidence includes scheduled reversals of deferred tax assets and liabilities, projected future taxable income, tax-planning strategies, and the results of recent operations. Since this evaluation requires consideration of historical and future events, there is significant judgment involved, and our conclusion could be materially different should certain of our expectations not transpire.
When assessing all available evidence, we consider the weight of the evidence, both positive and negative, based on the objectivity of the underlying evidence and the extent to which it can be verified. For the three-year period ended December 31, 2016, the Company has a cumulative pre-tax income from continuing operations of $3,201,000, which includes $2,774,000 of loss attributable to the year ended December 31, 2016. Additionally, the Company recognized governmental and regulatory changes have put downward revenue pressure on the long-term care industry as a piece of negative evidence in our analysis. As a result of this negative evidence, the Company performed a thorough assessment of the available positive and negative evidence in order to ascertain whether it is more-likely-than-not that in future periods the Company will generate sufficient pre-tax income to utilize

F-26



all of our federal deferred tax assets and our net operating loss and other carryforwards and credits. State deferred tax assets are considered for valuation separately and on a state-by-state basis.
The Company also identified several pieces of objective positive evidence which were considered and weighed in the analysis performed regarding the valuation of deferred tax assets, including, but not limited to the expected accretive strategic acquisitions completed by us during the three-year period, corporate and regional restructuring expected to reduce costs while maintaining revenue levels, the long-term expiration dates of a majority of the net operating losses and credits, our history of not having carryforwards or credits expire unutilized, and the completed divestiture of the centers in Ohio in 2016 and West Virginia in 2014. The operations in the state of West Virginia demonstrated a trend of growing losses in recent years primarily as a result of disproportionate amount of professional liability expense relative to the revenue contributed. Additionally, the net operating loss created in 2013 was fully utilized during 2014 as a result of the income produced from operations and the taxable gain on the sale of Rose Terrace.
In performing the analysis, the Company contemplated utilization of the deferred tax assets under multiple scenarios. After consideration of these factors, the Company determined that it was more likely than not that future taxable income would be sufficient to realize substantially all of the recorded value of the Company's deferred tax assets for federal income tax purposes.
Realization of the deferred tax assets is not assured and future events could result in a change in judgment. If future events result in a conclusion that realization is no longer more likely than not to occur, the Company would be required to establish a valuation allowance on the deferred tax assets at that time, which would result in a charge to income tax expense and a potentially material decrease in net income in the period in which the factors change our judgment.
At December 31, 2016, the Company had $7,385,000 of net operating losses, which expire at various dates beginning in 2019 and continue through 2036. The use of a portion of these loss carryforwards is limited by change in ownership provisions of the Federal tax code to a maximum of approximately $2,519,000. The Company has reduced the deferred tax asset and the corresponding valuation allowances for net operating loss deductions permanently lost as a result of the change in ownership provisions.
With respect to state deferred tax assets, the Company reduced the valuation allowance by approximately $47,000 in 2016, primarily related to the expectation that deferred tax assets for which valuation allowances had previously been applied would more-likely-than-not be utilized as a result of the increase in taxable income during the year ended December 31, 2016. In 2015 and 2014, the Company recorded a deferred tax provision to adjust approximately $315,000 and $215,000, respectively, of the valuation allowance on state deferred tax assets. The changes in valuation allowance were based on the Company's assessment of the realization of certain individual tax assets. The Company has recorded a total valuation allowance of approximately $732,000 at December 31, 2016 to reduce the deferred tax assets by the amount management believes is more likely than not to not be realized through the turnaround of existing temporary differences, future earnings, or a combination thereof.
Under the Work Opportunity Tax Credit ("WOTC") program, the Company recorded $550,000, $737,000 and $550,000 in Work Opportunity Tax Credits during 2016, 2015 and 2014, respectively. On December 19, 2014, the Tax Increase Prevention Act of 2012 (the "Act") was signed into law. The Act retroactively reinstated the federal Work Opportunity Tax Credit for qualifying costs paid during 2014. Pursuant to ASC 740-10-25-47, the effect of changes in the tax laws including retroactive changes are recognized in the period the law was enacted, and as a result of the retroactive treatment, the credit was recognized in the financial statements during the fourth quarter of 2014. The remaining WOTC credit carryforwards expire at various dates beginning in 2031 and continue through 2036.
The Company received a notice of an audit by the Internal Revenue Service related to the 2012 tax year, which was closed in 2015. As of December 31, 2016, the Company’s tax years for 2013 forward are subject to examination by tax authorities.



F-27



11. COMMITMENTS AND CONTINGENCIES

Lease Commitments
The Company is committed under long-term operating leases with various expiration dates and varying renewal options. Minimum annual rentals, including renewal option periods (exclusive of taxes, insurance, and maintenance costs) under these leases beginning January 1, 2017, are as follows:
2017
$
57,051,000

2018
58,076,000

2019
59,165,000

2020
60,231,000

2021
61,191,000

Thereafter
836,102,000

 
$
1,131,816,000


Under these lease agreements, the Company's lease payments are subject to periodic annual escalations as described below and in Note 1, "Business and Summary of Significant Accounting Policies". Total lease expense for continuing operations was $33,364,000, $28,690,000 and $26,151,000 for 2016, 2015 and 2014, respectively. The accrued liability related to straight line rent was $7,920,000 and $7,830,000 at December 31, 2016 and 2015, respectively, and is included in “Other noncurrent liabilities” on the accompanying consolidated balance sheets.

Omega Master Lease
The Company leases 35 nursing centers from Omega, 15 of which are subject to a Master Lease. On October 20, 2006, the Company and Omega entered into a Third Amendment to Consolidated Amended and Restated Master Lease (“Lease Amendment”) to extend the term of its centers leased from Omega. The Lease amendment extended the term to September 30, 2018 and provided a renewal option of an additional twelve years, and the Company must notify Omega by September 30, 2017 about exercising the renewal option. Consistent with prior terms, the lease provides for annual increases in lease payments equal to the lesser of two times the increase in the consumer price index or 3%. Under generally accepted accounting principles, the Company is required to report these scheduled rent increases on a straight line basis over the term of the lease including the 12 year term of the renewal period. These scheduled increases had no effect on cash rent payments at the start of the lease term and only result in additional cash outlay as the annual increases take effect each year.
The Company amended the Master Lease by entering into the Fifteenth Amendment to Consolidated Amended and Restated Master Lease as a result of the disposition and transfer of operations of the Company's West Virginia nursing centers. This amendment effectively modified the terms of the Master Lease to terminate the lease with regard to the two West Virginia nursing centers, and effectively reduced the annual rent payable under the Master Lease by $1,900,000.
The Master Lease requires the Company to fund annual capital expenditures related to the leased centers at an amount currently equal to $440 per licensed bed. These amounts are subject to adjustment for increases in the Consumer Price Index. The Company is in compliance with the capital expenditure requirements. Total required capital expenditures during the remaining lease term and renewal options are $1,700,000. These capital expenditures are being depreciated on a straight-line basis over the shorter of the asset life or the appropriate lease term.
Upon expiration of the Master Lease or in the event of a default under the Master Lease, the Company is required to transfer all of the leasehold improvements, equipment, furniture and fixtures of the leased centers to Omega. The assets to be transferred to Omega are being amortized on a straight-line basis over the shorter of the remaining lease term or estimated useful life, and will be fully depreciated upon the expiration of the lease. All of the equipment, inventory and other related assets of the centers leased pursuant to the Master Lease have been pledged as security under the Master Lease. In addition, the Company has a letter of credit of $4,792,000 as a security deposit for the Company's leases with Omega, as described in Note 6, "Long-term Debt, Interest Rate Swap and Capitalized Lease Obligations".

Renovation Funding
In January 2013, we entered into an amendment to the Master lease with Omega under which Omega agreed to provide an additional $5,000,000 to fund renovations to two nursing centers located in Texas that are leased from Omega. The annual base rent related to these centers will be increased to reflect the amount of capital improvements to the respective centers as the related expenditures are made. The increase is based on a rate of 10.25% per year of the amount financed under this amendment.

F-28



The Company completed an expansion to one of its centers by making use of fifteen licensed beds it acquired in 2005. This expansion project was funded by Omega with the renovation funding previously described. Accordingly, the costs incurred to expand the center are recorded as a leasehold improvement asset with the amounts reimbursed by Omega for this project included as a long-term liability and amortized to rent expense over the remaining term of the lease. The capitalized leasehold improvements and lessor reimbursed costs are being amortized over the initial lease term ending in September 2018. The leasehold improvement asset and accumulated amortization are as follows:
 
December 31
 
2016
 
2015
Leasehold improvement
$
921,000

 
$
921,000

Accumulated Amortization
(737,000
)
 
(631,000
)
Net
$
184,000

 
$
290,000


Golden Living Master Lease
The Company leases 20 nursing centers from Golden Living under a Master Lease. On October 1, 2016, the Company and Golden Living entered into a Master Lease agreement to lease eight centers located in Mississippi. On November 1, 2016, the Company and Golden Living entered into an Amended and Restated Master Lease ("Golden Living Lease Amendment") to extend the term of its centers leased from Golden Living and lease an additional twelve centers located in Alabama. The Amended Lease is triple net and has an initial term of ten years with two separate five year options to extend the term. Base rent for the amended lease is $24,675,000 for the first year and escalates 2% annually thereafter. Under generally accepted accounting principles, the Company is required to report these scheduled rent increases on a straight line basis over the term of the lease including the 10 year term of the renewal period. These scheduled increases had no effect on cash rent payments at the start of the lease term and only result in additional cash outlay as the annual increases take effect each year.
The Master Lease requires the Company to fund annual capital expenditures related to the leased centers at an amount currently equal to $500 per licensed bed. These amounts are subject to adjustment for increases in the Consumer Price Index. The Company is in compliance with the capital expenditure requirements. Total required capital expenditures during the remaining lease term and renewal options are $11,560,000. These capital expenditures are being depreciated on a straight-line basis over the shorter of the asset life or the appropriate lease term.
Upon expiration of the Master Lease or in the event of a default under the Master Lease, the Company is required to transfer all of the leasehold improvements, equipment, furniture and fixtures of the leased centers to Golden Living. The assets to be transferred to Golden Living are being amortized on a straight-line basis over the shorter of the remaining lease term or estimated useful life, and will be fully depreciated upon the expiration of the lease. All of the equipment, inventory and other related assets of the center leased pursuant to the Master Lease have been pledged as security under the Master Lease. In addition, the Company has a letter of credit of $2,056,000 as a security deposit for the Company's leases with Golden Living, as described in Note 6, "Long-term Debt, Interest Rate Swap and Capitalized Lease Obligations".
Other Operating Leases
In addition to the Omega and Golden Living Master Leases, the Company currently leases 24 other nursing centers which primarily operate under individual leases. The lease terms for these centers range from two years to twenty years including renewal options. While the individual lease terms vary from center to center, the majority of the leases include annual lease increases which are capped and, in most cases, are subject to adjustment for increases in the Consumer Price Index. All operating leases are accounted for using a straight-line rent methodology.


F-29



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, 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. All of the Company's nursing centers in Florida, Tennessee, and West Virginia are now covered under the captive insurance policies along with most of the nursing centers in Alabama, Kentucky, and Texas. The insurance coverage provided for these centers under the SHC policy includes coverage limits of at least $500,000 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. 

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 exceed the Company’s limited insurance coverage, the Company has recorded total liabilities for reported and incurred, but not reported claims of $19,977,000 as of December 31, 2016. 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 this reserve. Since May 2012, Merlinos & Associates, Inc. (“Merlinos”) has assisted management in the preparation of the appropriate accrual for incurred but not reported general and professional liability claims based on data furnished as of May 31 and November 30 of each year. Merlinos primarily utilizes historical data regarding the frequency and cost of the Company’s past claims over a multi-year period, industry data and information regarding the number of occupied beds to develop its estimates of the Company’s ultimate professional liability cost for current periods.
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.
The Company’s cash expenditures for self-insured professional liability costs from continuing operations were $4,456,000, $3,328,000, and $4,757,000 for the years ended December 31, 2016, 2015 and 2014, respectively.
The Company follows the FASB Accounting Standards Update, “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 estimated insurance recovery receivables are included within "Other Current Assets" on the Consolidated Balance Sheet. As of December 31, 2016 and 2015, there are no estimated insurance recovery receivables.
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.

F-30



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, 2007 until June 30, 2008, the Company is completely self-insured for workers' compensation exposure. For the period from July 1, 2008 through December 31, 2013, 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 $171,000 at December 31, 2016. The Company has a non-current receivable for workers’ compensation policies covering previous years of $1,310,000 as of December 31, 2016. 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 December 31, 2016, 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 $1,019,000 at December 31, 2016. The differences between actual settlements and reserves are included in expense in the period finalized.

Employment Agreements
The Company has employment agreements with certain members of management that provide for the payment to these members of amounts up to 2.0 times their annual salary in the event of a termination without cause, a constructive discharge (as defined in each employee agreement), or upon a change in control of the Company (as defined in each employee agreement). The maximum contingent liability under these agreements is $1,789,000 as of December 31, 2016. The terms of such agreements are from 1 to 3 years and automatically renew for 1 year if not terminated by the employee or the Company. In addition, upon the occurrence of any triggering event, these certain members of management may elect to require the Company to purchase equity awards granted to them for a purchase price equal to the difference in the fair market value of the Company's common stock at the date of termination versus the stated equity award exercise price. Based on the closing price of our common stock on December 31, 2016, there is $461,000 of contingent liabilities for the repurchase of the equity grants.
No amounts have been accrued for these contingent liabilities for members of management the Company currently employs.

Health Care Industry and 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, violations of false claims acts, product liability, or related 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 regulatory actions seeking fines and penalties for alleged violations of health care laws and are potentially subject to the increased scrutiny of regulators for issues related to compliance with health care fraud and abuse laws and with respect to the quality of care provided to residents of our center. Like 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 December 31, 2016, we are engaged in 67 professional liability lawsuits, which are reserved for as discussed above. 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. We have limited, and sometimes no, professional liability insurance with regard to most of these claims. 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).
In October 2014, the Company learned that the investigation was started by the filing under seal of a false claims action against the two centers that were the subject of the original CID. In connection with this matter, between July 2013 and early February 2016, the Company has received three civil investigative demands (a form of subpoena) for documents and information relating

F-31



to our practices and policies for rehabilitation, and other services, our preadmission evaluation forms ("PAEs") required by TennCare and our Pre-Admission Screening and Resident Reviews ("PASRRs"). We have responded to those requests. The DOJ has also issued CID’s for testimony from current and former employees of the Company. The DOJ’s civil investigation of the Company’s practices and policies for rehabilitation now covers all of the Company’s centers, but thus far only documents from six of our centers have been requested.
In June 2016, the Company received an authorized investigative demand (a form of subpoena) for documents in connection with a criminal investigation by the DOJ related to our practices with respect to PAEs and PASRRs, and the Company has provided documents responsive to this subpoena and continues to provide additional information as requested. The Company cannot predict the outcome of these investigations or the related lawsuits, and the outcome could have a materially adverse effect on the Company, including the imposition of treble damages, criminal charges, fines, penalties and/or a corporate integrity agreement. The Company is committed to provide caring and professional services to its patients and residents in compliance with applicable laws and regulations.
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 “Center”). The complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Center 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 pending DOJ investigation or the purported class action against the Arkansas centers. 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.

12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Selected quarterly financial information for each of the quarters in the years ended December 31, 2016 and 2015 is as follows:
 
 
Quarter
2016
 
First
 
Second
 
Third
 
Fourth
 
 
 
 
 
 
 
 
 
Patient revenues, net
 
$
97,945,000

 
$
95,805,000

 
$
97,313,000

 
$
135,000,000

Professional liability expense (1)
 
2,066,000

 
1,934,000

 
1,977,000

 
2,479,000

Income (loss) from continuing operations
 
(74,000
)
 
(2,150,000
)
 
(958,000
)
 
1,438,000

Loss from discontinued operations
 
(37,000
)
 

 
(17,000
)
 
(13,000
)
Net income (loss) attributable to Diversicare Healthcare Services, Inc. common shareholders
 
$
(111,000
)
 
$
(2,150,000
)
 
$
(975,000
)
 
$
1,425,000

 
Basic net income (loss) per common share for Diversicare Healthcare Services, Inc. common shareholders:
Income (loss) from continuing operations
 
$
(0.01
)
 
$
(0.35
)
 
$
(0.16
)
 
$
0.24

Loss from discontinued operations
 
(0.01
)
 

 

 

Net income (loss) per common share for Diversicare Healthcare Services, Inc. common shareholders
 
$
(0.02
)
 
$
(0.35
)
 
$
(0.16
)
 
$
0.24


F-32



Diluted net income (loss) per common share for Diversicare Healthcare Services, Inc. common shareholders:
Income (loss) from continuing operations
 
$
(0.01
)
 
$
(0.35
)
 
$
(0.16
)
 
$
0.24

Loss from discontinued operations
 
(0.01
)
 

 

 

Net income (loss) per common share for Diversicare Healthcare Services, Inc. common shareholders
 
$
(0.02
)
 
$
(0.35
)
 
$
(0.16
)
 
$
0.24


(1)
The Company's quarterly results are significantly affected by the amounts recorded for professional liability expense, as discussed further in Note 11, "Commitments and Contingencies". The amount of expense recorded for professional liability in each quarter of 2016 is set forth in the table above.

 
 
Quarter
2015
 
First
 
Second
 
Third
 
Fourth
 
 
 
 
 
 
 
 
 
Patient revenues, net
 
$
95,225,000

 
$
96,288,000

 
$
98,105,000

 
$
97,977,000

Professional liability expense (1)
 
2,155,000

 
1,926,000

 
2,069,000

 
1,972,000

Income (loss) from continuing operations
 
5,000

 
807,000

 
669,000

 
1,271,000

Loss from discontinued operations
 
(263,000
)
 
(299,000
)
 
(238,000
)
 
(328,000
)
Net income (loss) attributable to Diversicare Healthcare Services, Inc. common shareholders
 
$
(258,000
)
 
$
508,000

 
$
431,000

 
$
943,000

 
Basic net income (loss) per common share for Diversicare Healthcare Services, Inc. common shareholders:
Income from continuing operations
 
$

 
$
0.13

 
$
0.11

 
$
0.21

Loss from discontinued operations
 
(0.04
)
 
(0.05
)
 
(0.04
)
 
(0.05
)
Net income (loss) per common share for Diversicare Healthcare Services, Inc. common shareholders
 
$
(0.04
)
 
$
0.08

 
$
0.07

 
$
0.16


Diluted net income (loss) per common share for Diversicare Healthcare Services, Inc. common shareholders:
Income from continuing operations
 
$

 
$
0.13

 
$
0.11

 
$
0.20

Loss from discontinued operations
 
(0.04
)
 
(0.05
)
 
(0.04
)
 
(0.05
)
Net income (loss) per common share for Diversicare Healthcare Services, Inc. common shareholders
 
$
(0.04
)
 
$
0.08

 
$
0.07

 
$
0.15


(1)
The Company's quarterly results are significantly affected by the amounts recorded for professional liability expense, as discussed further in Note 11, "Commitments and Contingencies". The amount of expense recorded for professional liability in each quarter of 2015 is set forth in the table above.



F-33



DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
OF CONTINUING OPERATIONS
(in thousands)
Column A
 
Column B
 
Column C
 
Column D
 
Column E
 
 
 
 
Additions
 
Deductions
 
 
Description
 
Balance at
Beginning
of Period
Charged
to
Costs and
Expenses
 
Charged
to Other
Accounts
 
Other
(Write-offs)
net of
Recoveries
 
Balance at
End of
Period

Year ended
December 31, 2016: Allowance for doubtful accounts
 
$8,180
 
$7,163
 
$—
 
$—
 
$(5,017)
 
$10,326

Year ended
December 31, 2015: Allowance for doubtful accounts
 
$6,044
 
$7,507
 
$—
 
$—
 
$(5,371)
 
$8,180

Year ended
December 31, 2014: Allowance for doubtful accounts
 
$3,879
 
$5,710
 
$—
 
$—
 
$(3,545)
 
$6,044



S-1




DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Column A
 
Column B
 
Column C
 
Column D
 
Column E
 
 
 
 
 
 
Additions
 
 
 
Deductions
 
 
Description
 
Balance at
Beginning
of Period
 
Charged
to
Costs and
Expenses
 

Charged
to Other
Accounts (2)
 
Other
 

Payments (1)
 
Balance at
End of
Period
Year ended
December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
Professional Liability Reserve
 
$21,618

$6,423
 
$—
 
$114
 
$(8,178)
 
$19,977
Workers Compensation
Reserve
 
$227

$372
 
$—
 
$—
 
$(428)
 
$171
Health Insurance
Reserve
 
$686

$8,896
 
$—
 
$(137)
 
$(8,426)
 
$1,019
Year ended
December 31, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
Professional Liability Reserve
 
$25,163

$5,213
 
$1,010
 
$—
 
$(9,768)
 
$21,618
Workers Compensation
Reserve
 
$250

$364
 
$—
 
$—
 
$(387)
 
$227
Health Insurance
Reserve
 
$687

$6,294
 
$—
 
$—
 
$(6,295)
 
$686
Year ended
December 31, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
Professional Liability Reserve
 
$27,067

$5,930
 
$2,440
 
$—
 
$(10,274)
 
$25,163
Workers Compensation
Reserve
 
$176

$372
 
$—
 
$18
 
$(316)
 
$250
Health Insurance
Reserve
 
$843

$6,748
 
$237
 
$—
 
$(7,141)
 
$687

(1)
Payments for the Professional Liability Reserve include amounts paid for claims settled during the period as well as payments made under structured arrangements for claims settled in earlier periods.
(2)
As discussed in Note 3, "Discontinued Operations" of the Consolidated Financial Statements, the Company has presented the results of certain divestiture and lease termination transactions as discontinued operations. The amounts charged to Other Accounts represent the amounts charged to discontinued operations.



S-2



ITEM 16. FORM 10-K SUMMARY
None.


S-3



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).
 
 
 
3.7

 
Certificate of Ownership and Merger of Diversicare Healthcare Services, Inc. with and into Advocat Inc. (incorporated by reference to Exhibit 3.1 to the Company's current report on Form 8-K filed March 14, 2013).
 
 
 
3.8

 
Amendment to Certificate of Incorporation dated June 9, 2016 (incorporated by reference to Exhibit 3.8 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2016).
 
 
 
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).
 
 
 
*10.1

 
Master Agreement and Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.6 to the Company's Registration Statement No. 33-76150 on Form S-1).
 
 
 
10.2

 
Form of Director Indemnification Agreement (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement No. 33-76150 on Form S-1).
 
 
 
10.3

 
Advocat Inc. Guaranty in favor of Omega Healthcare Investors, Inc. dated May 10, 1994 (incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).
 
 
 
10.4

 
Settlement and Restructuring Agreement dated as of October 1, 2000 among Registrant, Diversicare Leasing Corp., Sterling Health Care Management, Inc., Diversicare Management Services Co., Advocat Finance, Inc., Omega Healthcare Investors, Inc. and Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.83 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
 

 
 
10.5

 
Consolidated Amended and Restated Master Lease dated November 8, 2000, effective October 1, 2000, between Sterling Acquisition Corp. (as Lessor) and Diversicare Leasing Corp. (as Lessee) (incorporated by reference to Exhibit 10.84 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
 
 
 
10.6

 
Management Agreement effective October 1, 2000, between Diversicare Leasing Corp. and Diversicare Management Services Co. (incorporated by reference to Exhibit 10.85 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
 
 
 
10.7

 
Amended and Restated Security Agreement dated as of November 8, 2000 between Diversicare Leasing Corp. and Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.86 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
 
 
 




10.8

 
Security Agreement dated as of November 8, 2000 between Sterling Health Care Management, Inc. and Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.87 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
 
 
 
10.9

 
Guaranty given as of November 8, 2000 by Registrant, Advocat Finance, Inc., and Diversicare Management Services Co., in favor of Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.88 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
 
 
 
10.10

 
First Amendment to Consolidated Amended and Restated Master Lease dated September 30, 2001 by and between Sterling Acquisition Corp. and Diversicare Leasing Corporation (incorporated by reference to Exhibit 10.126 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001).
 
 
 
10.11

 
Second Amendment to Consolidated Amended and Restated Master Lease dated as of June 15, 2005 by and between Sterling Acquisition Corp. and Diversicare Leasing Corporation (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2005).
 
 
 
10.12

 
Restructuring Stock Issuance and Subscription Agreement dated as of October 20, 2006 between Advocat Inc. and Omega Healthcare Investors, Inc. (incorporated by reference to Exhibit 10.1 to the Company's current report on Form 8-K filed October 24, 2006).
 
 
 
10.13

 
Third Amendment to Consolidated Amended and Restated Master Lease executed as of October 20, 2006, to be effective as of October 1, 2006 by and between Sterling Acquisition Corp. and Diversicare Leasing Corporation (incorporated by reference to Exhibit 10.2 to the Company's current report on Form 8-K filed October 24, 2006).
 
 
 
10.14

 
Subordinated Promissory Note in the amount of $2,533,614.53 issued to Omega HealthCare Investors Inc. dated as of October 1, 2006 (incorporated by reference to Exhibit 10.3 to the Company's current report on Form 8-K filed October 24, 2006).
 
 
 
10.15

 
Fourth Amendment to Consolidated Amended and Restated Master Lease executed and delivered as of April 1, 2007 by and between Sterling Acquisition Corp., a Kentucky corporation, and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2007).
 
 
 
10.16

 
Fifth Amendment to Consolidated Amended and Restated Master Lease dated as of August 10, 2007 by and between Sterling Acquisition Corp., a Kentucky corporation, and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.7 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 2007).
 
 
 
10.17

 
Sixth Amendment to Consolidated Amended and Restated Master Lease dated as of March 14, 2008 by and between Sterling Acquisition Corp., a Kentucky corporation, and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2008).
 
 
 
10.18

 
Seventh Amendment to Consolidated Amended and Restated Master Lease dated as of October 24, 2008 by and between Sterling Acquisition Corp., a Kentucky corporation, and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 2008).
 
 
 
*10.19

 
Advocat Inc. 2005 Long-Term Incentive Plan (incorporated by reference to Appendix A to the Company's Definitive Proxy Statement on Schedule 14A filed on April 20, 2006).
 
 
 
*10.20

 
First Amendment to the Advocat Inc. 2005 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.63 to the Company's annual report on Form 10-K for the year ended December 31, 2008).
 
 
 
*10.21

 
Advocat Inc. 2010 Long-Term Incentive Plan (incorporated by reference to Appendix A to the Company's Definitive Proxy Statement on Schedule 14A filed on April 28, 2010).
 
 
 
*10.22

 
Advocat Inc. 2008 Stock Purchase Plan for Key Personnel (incorporated by reference to Appendix A to the Company's Definitive Proxy Statement on Schedule 14A filed May 2, 2008).
 
 
 
10.23

 
Ninth Amendment to Consolidated Amended and Restated Master Lease dated as of May 5, 2009 by and between Sterling Acquisition Corp., a Kentucky corporation, and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2009).
 
 
 




10.24

 
Tenth Amendment to Consolidated Amended and Restated Master Lease dated as of September 8, 2009 by and between Sterling Acquisition Corp., a Kentucky corporation, and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 2009).
 
 
 
10.25

 
Lease Agreement dated as of July 14, 2010 by and between Diversicare Rose Terrace, LLC, a subsidiary of the registrant, and A.B.E., LLC (incorporated by reference to Exhibit 10.4 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2010).
 
 
 
10.26

 
Eleventh Amendment to the Amended and Restated Master Lease between the Company and Sterling Acquisition Corp., an affiliate of Omega Healthcare Investors, Inc. (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2011).
 
 
 
10.27

 
Swap Agreement between the Company and The PrivateBank and Trust Company dated as of March 1, 2011 (incorporated by reference to Exhibit 10.6 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2011).
 
 
 
*10.28

 
Amended and Restated Employment Agreement effective as of April 1, 2012, by and between Advocat Inc., a Delaware corporation, and Kelly Gill (incorporated by reference to Exhibit 10.2 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2012).
 
 
 
*10.29

 
Employment Agreement effective August 20, 2012, between James R. McKnight, Jr. and Advocat Inc. (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 2012).
 
 
 
*10.30

 
Employment Agreement effective January 1, 2013, between Leslie Campbell and Advocat Inc. (incorporated by reference to Exhibit 10.49 to the Company’s annual report on Form 10-K for the year ended December 31, 2012).
 
 
 
*10.31

 
Amendment No. 1 to Amended and Restated Employment Agreement effective as of March 1, 2013 by and between Advocat Inc., a Delaware corporation, and Kelly Gill (incorporated by reference to Exhibit 10.50 to the Company's annual report on Form 10-K for the year ended December 31, 2012).
 
 
 
10.32

 
Asset Purchase Agreement effective March 6, 2013 between the Company and Cumberland & Ohio Co. of Texas, as receiver of the assets of SeniorTrust of Florida, Inc. (incorporated by reference to Exhibit 10.3 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2013).
 
 
 
10.33

 
Operations Transfer Agreement effective March 6, 2013 by and between certain subsidiaries of the Company and the Cumberland & Ohio Co. of Texas, as receiver of the assets of SeniorTrust of Florida, Inc. (incorporated by reference to Exhibit 10.4 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2013).
 
 
 
10.34

 
Amended and Restated Revolving Loan and Security Agreement dated April 30, 2013 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, 2013).
 
 
 
10.35

 
Amended and Restated Term Loan and Security Agreement dated April 30, 2013 among the Company and a syndicate of financial institutions and banks, including The PrivateBank as the Administering Agent (incorporated by reference to Exhibit 10.6 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2013).
 
 
 
10.36

 
Amended and Restated Guaranty (Revolver) dated as of April 30, 2013, by the Company to and for the benefit of The PrivateBank in its capacity as administrative agent (incorporated by reference to Exhibit 10.7 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2013).
 
 
 
10.37

 
Amended and Restated Guaranty (Term Loan) dated as of April 30, 2013, by the Company to and for the benefit of The PrivateBank in its capacity as administrative agent (incorporated by reference to Exhibit 10.8 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2013).
 
 
 
10.38

 
Thirteenth Amendment to Consolidated Amended and Restated Master Lease effective September 1, 2013 by and between Sterling Acquisition Corp. and Diversicare Leasing Corp. (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 2013).




 
 
 
**10.39

 
First Amendment and Consent to Amended and Restated Revolving Loan and Security Agreement dated as of November 1, 2013 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 annual report on Form 10-K for the year ended Decemeber 31, 2014).
 
 
 
10.40

 
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).
 
 
 
10.41

 
Second Amendment and Consent to Amended and Restated Revolving Loan and Security Agreement dated as of March 31, 2014, 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 March 31, 2014).
 
 
 
10.42

 
Term Loan and Security Agreement effective as of March 27, 2014, by and between Diversicare Rose Terrace, LLC and The PrivateBank And Trust Company (incorporated by reference to exhibit 10.3 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2014).
 
 
 
10.43

 
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).
 
 
 
10.44

 
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).
 
 
 
10.45

 
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).
 
 
 
10.46

 
Asset Purchase Agreement dated February 1, 2015 by and between Diversicare Healthcare Services, Inc. and Barren County Health Care Center, Inc. (incorporated by reference to exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2015).

 
 
 
10.47

 
Term Loan and Security Agreement dated as of February 2, 2015 by and between Diversicare Glasgow Property, LLC and The PrivateBank And Trust Company (incorporated by reference to exhibit 10.2 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2015).

 
 
 
10.48

 
Asset Purchase Agreement dated November 1, 2015 by and between Diversicare Healthcare Services, Inc. and Haws Fulton Investors, LLC.

 
 
 
10.49

 
Second Amended and Restated Term Loan and Security Agreement dated February 26, 2016 (incorporated by reference to exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2016).
 
 
 
10.50

 
Third Amended and Restated Revolving Loan and Security Agreement dated February 26, 2016 (incorporated by reference to exhibit 10.2 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2016).
 
 
 
10.51

 
Amendment to Diversicare Healthcare Services, Inc. 2008 Employee Stock Purchase Plan for Key Personnel (incorporated by reference to exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2016).
 
 
 
10.52

 
First Amendment to Third Amended and Restated Revolving Loan and Security Agreement dated August 3, 2016 (incorporated by reference to exhibit 10.12 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2016).
 
 
 
10.53

 
First Amendment to Second Amended and Restated Term Loan and Security Agreement dated August 3, 2016 (incorporated by reference to exhibit 10.3 to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2016).
 
 
 
10.54

 
Second Amendment to Third Amended and Restated Revolving Loan and Security Agreement dated October 3, 2016 (incorporated by reference to exhibit 10.3 to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 2016).
 
 
 
10.55

 
Third Amendment to the Third Amended and Restated Revolving Loan and Security Agreement dated December 29, 2016.
 
 
 




10.56

 
Golden Living Master Lease Agreement dated October 1, 2016.
 
 
 
**10.57

 
Amended and Restated Golden Living Master Lease Agreement dated November 1, 2016.
 
 
 
21

 
Subsidiaries of the Registrant.
 
 
 
23.1

 
Consent of BDO USA, LLP.
 
 
 
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
 
 
 
 
*
Indicates management contract or compensatory plan or arrangement.
 
**
Confidential treatment has been requested for portions of this exhibit