UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________  
FORM 10-Q
________________________________ 
CHECK ONE:
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: June 30, 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)
(615) 771-7575
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ý     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ý     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and a “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨
Smaller reporting Company
 
ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   ý
6,361,331
(Outstanding shares of the issuer’s common stock as of July 29, 2016 )
 



Part I. FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS
DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED BALANCE SHEETS
(in thousands)
 
 
June 30,
2016
 
December 31,
2015
 
(Unaudited)
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
3,061

 
$
4,585

Receivables, less allowance for doubtful accounts of $9,176 and $8,180, respectively
40,075

 
43,819

Other receivables
2,085

 
1,407

Prepaid expenses and other current assets
2,922

 
2,223

Income tax refundable
321

 
347

Current assets of discontinued operations
44

 
36

Deferred income taxes
7,426

 
7,999

Total current assets
55,934

 
60,416

PROPERTY AND EQUIPMENT, at cost
123,856

 
114,383

Less accumulated depreciation and amortization
(65,393
)
 
(62,110
)
Property and equipment, net
58,463

 
52,273

OTHER ASSETS:
 
 
 
Deferred income taxes
14,238

 
11,762

Deferred lease and other costs, net
208

 
382

Investment in unconsolidated affiliate
859

 
798

Other noncurrent assets
2,162

 
3,994

Acquired leasehold interest, net
7,267

 
7,459

Total other assets
24,734

 
24,395

 
$
139,131

 
$
137,084

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

2


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(continued)
 
 
June 30,
2016
 
December 31,
2015
 
(Unaudited)
 
 
CURRENT LIABILITIES:
 
 
 
Current portion of long-term debt and capitalized lease obligations
$
7,385

 
$
6,603

Trade accounts payable
11,392

 
10,136

Current liabilities of discontinued operations
417

 
345

Accrued expenses:
 
 
 
Payroll and employee benefits
14,929

 
14,404

Self-insurance reserves, current portion
9,608

 
10,224

Other current liabilities
5,627

 
5,652

Total current liabilities
49,358

 
47,364

NONCURRENT LIABILITIES:
 
 
 
Long-term debt and capitalized lease obligations, less current portion and deferred financing costs
55,958

 
53,297

Self-insurance reserves, noncurrent portion
11,595

 
12,344

Other noncurrent liabilities
11,818

 
10,812

Total noncurrent liabilities
79,371

 
76,453

COMMITMENTS AND CONTINGENCIES

 

SHAREHOLDERS’ EQUITY:
 
 
 
Series A preferred stock, authorized 200,000 shares, $.10 par value, none issued and outstanding
—

 
—

Common stock, authorized 20,000,000 shares, $.01 par value, 6,593,000 and 6,513,000 shares issued, and 6,361,000 and 6,281,000 shares outstanding, respectively
66

 
65

Treasury stock at cost, 232,000 shares of common stock
(2,500
)
 
(2,500
)
Paid-in capital
21,472

 
21,142

Accumulated deficit
(8,020
)
 
(5,053
)
Accumulated other comprehensive loss
(616
)
 
(387
)
Total shareholders’ equity
10,402


13,267

 
$
139,131

 
$
137,084

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

3


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts, unaudited)
 
Three Months Ended June 30,
 
2016
 
2015
PATIENT REVENUES, net
$
95,805

 
$
96,288

EXPENSES:
 
 
 
Operating
78,385

 
76,652

Lease and rent expense
6,854

 
7,186

Professional liability
1,934

 
1,926

General and administrative
6,881

 
6,341

Depreciation and amortization
2,060

 
1,863

Lease termination costs
2,008

 
—

Total expenses
98,122

 
93,968

OPERATING INCOME (LOSS)
(2,317
)
 
2,320

OTHER EXPENSE:
 
 
 
Equity in net income of unconsolidated affiliate
28

 
75

Interest expense, net
(1,158
)
 
(1,049
)
Total other expense
(1,130
)
 
(974
)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(3,447
)
 
1,346

BENEFIT (PROVISION) FOR INCOME TAXES
1,297

 
(539
)
INCOME (LOSS) FROM CONTINUING OPERATIONS
(2,150
)
 
807

LOSS FROM DISCONTINUED OPERATIONS:
 
 
 
Operating loss, net of tax benefit of $0 and $224, respectively
—

 
(299
)
NET INCOME (LOSS)
(2,150
)
 
508

NET INCOME (LOSS) PER COMMON SHARE:
 
 
 
Per common share – basic
 
 
 
Continuing operations
$
(0.35
)
 
$
0.13

Discontinued operations
—

 
(0.05
)
 
$
(0.35
)
 
$
0.08

Per common share – diluted
 
 
 
Continuing operations
$
(0.35
)
 
$
0.13

Discontinued operations
—

 
(0.05
)
 
$
(0.35
)
 
$
0.08

COMMON STOCK DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
$
0.055

 
$
0.055

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
Basic
6,211

 
6,098

Diluted
6,211

 
6,327

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

4


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands and unaudited)
 
 
Three Months Ended June 30,
 
2016
 
2015
NET INCOME (LOSS)
$
(2,150
)
 
$
508

OTHER COMPREHENSIVE INCOME:
 
 
 
Change in fair value of cash flow hedge, net of tax
181

 
53

Less: reclassification adjustment for amounts recognized in net income
(119
)
 
(116
)
Total other comprehensive income (loss)
62

 
(63
)
COMPREHENSIVE INCOME (LOSS)
$
(2,088
)
 
$
445


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

5


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts, unaudited)
 
Six Months Ended
June 30,
 
2016
 
2015
PATIENT REVENUES, net
$
193,750

 
$
191,513

EXPENSES:
 
 
 
Operating
157,003

 
153,797

Lease and rent expense
14,106

 
14,331

Professional liability
4,000

 
4,081

General and administrative
13,615

 
12,392

Depreciation and amortization
4,063

 
3,742

Lease termination costs
2,008

 
—

Total expenses
194,795

 
188,343

OPERATING INCOME (LOSS)
(1,045
)
 
3,170

OTHER EXPENSE:
 
 
 
Equity in net income of unconsolidated affiliate
61

 
183

Interest expense, net
(2,228
)
 
(1,999
)
Debt retirement costs
(351
)
 
—

Total other expense
(2,518
)
 
(1,816
)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(3,563
)
 
1,354

BENEFIT (PROVISION) FOR INCOME TAXES
1,339

 
(542
)
INCOME (LOSS) FROM CONTINUING OPERATIONS
(2,224
)
 
812

LOSS FROM DISCONTINUED OPERATIONS:
 
 
 
Operating loss, net of tax benefit of $21 and $392, respectively
(37
)
 
(562
)
NET INCOME (LOSS)
(2,261
)
 
250

NET INCOME (LOSS) PER COMMON SHARE:
 
 
 
Per common share – basic
 
 
 
Continuing operations
$
(0.36
)
 
$
0.13

Discontinued operations
(0.01
)
 
(0.09
)
 
$
(0.37
)
 
$
0.04

Per common share – diluted
 
 
 
Continuing operations
$
(0.36
)
 
$
0.13

Discontinued operations
(0.01
)
 
(0.09
)
 
$
(0.37
)
 
$
0.04

COMMON STOCK DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
$
0.11

 
$
0.11

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
Basic
6,185

 
6,072

Diluted
6,185

 
6,302


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

6


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands and unaudited)
 
 
Six Months Ended
June 30,
 
2016
 
2015
NET INCOME (LOSS)
$
(2,261
)
 
$
250

OTHER COMPREHENSIVE INCOME:
 
 
 
Change in fair value of cash flow hedge, net of tax
492

 
231

Less: reclassification adjustment for amounts recognized in net income
(263
)
 
(236
)
Total other comprehensive income (loss)
229

 
(5
)
COMPREHENSIVE INCOME (LOSS)
$
(2,032
)
 
$
245


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


7


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands and unaudited)
 
 
Six Months Ended June 30,
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
(2,261
)
 
$
250

Discontinued operations
(37
)
 
(562
)
Income (loss) from continuing operations
(2,224
)
 
812

Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
4,063

 
3,742

Provision for doubtful accounts
3,661

 
3,306

Deferred income tax provision (benefit)
(1,689
)
 
112

Provision for self-insured professional liability, net of cash payments
1,595

 
1,706

Stock-based compensation
486

 
702

Equity in net income of unconsolidated affiliate, net of investment
(61
)
 
(183
)
Debt retirement costs
351

 
—

Provision for leases in excess of cash payments
(1,093
)
 
(802
)
Lease termination costs, net of cash payments
1,958

 
—

Other
358

 
189

Changes in assets and liabilities affecting operating activities:
 
 
 
Receivables, net
(710
)
 
(9,693
)
Prepaid expenses and other assets
(384
)
 
(829
)
Trade accounts payable and accrued expenses
1,688

 
1,235

Net cash provided by continuing operations
7,999

 
297

Discontinued operations
(2,879
)
 
(3,591
)
Net cash provided by (used in) operating activities
5,120

 
(3,294
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment
(10,055
)
 
(2,360
)
Acquisition of property and equipment through business combination
—

 
(7,000
)
Change in restricted cash
1,658

 
2,490

Deposits and other deferred balances
—

 
(9
)
Net cash used in continuing operations
(8,397
)
 
(6,879
)
Discontinued operations
—

 
—

Net cash used in investing activities
(8,397
)
 
(6,879
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of debt obligations
(66,422
)
 
(7,672
)
Proceeds from issuance of debt
71,066

 
18,855

Financing costs
(1,795
)
 
(180
)
Issuance and redemption of employee equity awards
(96
)
 
33

Payment of common stock dividends
(683
)
 
(672
)
Payment for preferred stock restructuring
(317
)
 
(307
)
Net cash provided by financing activities
1,753

 
10,057

Discontinued operations
—

 
—

Net cash provided by financing activities
$
1,753

 
$
10,057


8


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands and unaudited)
(continued)
 
 
Six Months Ended June 30,
 
2016
 
2015
NET DECREASE IN CASH AND CASH EQUIVALENTS
$
(1,524
)
 
$
(116
)
CASH AND CASH EQUIVALENTS, beginning of period
4,585

 
3,818

CASH AND CASH EQUIVALENTS, end of period
$
3,061

 
$
3,702

SUPPLEMENTAL INFORMATION:
 
 
 
Cash payments of interest
$
1,904

 
$
1,761

Cash payments of income taxes
$
332

 
$
156

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

9


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2016 AND 2015

1.
BUSINESS
Diversicare Healthcare Services, Inc. (together with its subsidiaries, “Diversicare Healthcare Services” or the “Company”) provides long-term care services to nursing center patients in nine states, primarily in the Southeast, Midwest, and Southwest. The Company’s centers provide a range of health care services to their patients and residents that include nursing, personal care, and social services. Additionally, the Company’s nursing centers also offer a variety of comprehensive rehabilitation services, as well as nutritional support services. The Company's continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Missouri, Ohio, Tennessee, and Texas.
As of June 30, 2016 , the Company’s continuing operations consist of 54 nursing centers with 5,879 licensed nursing beds. The Company owns 17 and leases 37 of its nursing centers. Our nursing centers range in size from 48 to 320 licensed nursing beds. The licensed nursing bed count does not include 496 licensed assisted and residential living beds.

2.
CONSOLIDATION AND BASIS OF PRESENTATION OF FINANCIAL STATEMENTS
The interim consolidated financial statements include the operations and accounts of Diversicare Healthcare Services and its subsidiaries, all wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation. The investment in an unconsolidated affiliate (a 50 percent -owned joint venture partnership) is accounted for using the equity method and is described in Note 8 to the interim consolidated financial statements.
The interim consolidated financial statements for the three and six month periods ended June 30, 2016 and 2015 , included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management of the Company, the accompanying interim consolidated financial statements reflect all normal, recurring adjustments necessary to present fairly the Company’s financial position at June 30, 2016 , and the results of operations for the three and six month periods ended June 30, 2016 and 2015 , and cash flows for the six month periods ended June 30, 2016 and 2015 . The Company’s balance sheet information at December 31, 2015 , was derived from its audited consolidated financial statements as of December 31, 2015 .
The results of operations for the periods ended June 30, 2016 and 2015 are not necessarily indicative of the operating results that may be expected for a full year. These interim consolidated financial statements should be read in connection with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 .

3.
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. We will adopt the requirements of this standard effective January 1, 2018, and are currently evaluating the impact of the adoption on our financial condition and results of operations.
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 must 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 and the Company has complied with the applicable disclosures for a change in accounting principle. The adoption of this guidance has not had a material impact on the Company's consolidated financial statements.

10


In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes , which changes how deferred taxes are classified on our 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, the Company anticipates reclassifying deferred income taxes of approximately $7,426,000 from current to non-current assets.
In February 2016, the FASB issued ASU No. 2016-02, Leases . The new standard requires that a lessee of operating leases recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The lease liability will be equal to the present value of lease payments, with the right-of-use asset based upon the lease liability. The classification criteria for distinguishing between finance (or capital) leases and operating leases are substantially similar to the previous lease guidance. As such, operating leases will result in straight-line rent expense similar to current practice. For short-term leases (term of 12 months or less), a lessee is permitted to make an accounting election not to recognize lease assets and lease liabilities, which would generally result in lease expense being recognized on a straight-line basis over the lease term. The guidance is effective for annual and interim periods beginning after December 15, 2018, and will require application of the new guidance at the beginning of the earliest comparable period presented. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition. The adoption of this standard is expected to have a material impact on the Company’s financial position. The Company is still evaluating the impact on its results of operations and expects no material impact on liquidity.
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, and interim periods within those annual periods. Early adoption is permitted. The Company is currently assessing the impact of this new accounting pronouncement on the Company's results of operations, financial position, and cash flows.

4.
LONG-TERM DEBT AND INTEREST RATE SWAP
The Company has agreements with a syndicate of banks for a mortgage term loan ("Original Mortgage Loan") and the Company’s revolving credit agreement ("Original Revolver"). On 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 a $60,000,000 term loan facility and a $12,500,000 acquisition loan facility. Loan acquisition costs associated with the Amended Mortgage Loan and the Amended Revolver were capitalized in the amount of $1,812,000 and are being amortized over the five -year term of the agreements. Additionally, the Glasgow term loan balance 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 June 30, 2016 , the interest rate related to the Amended Mortgage Loan was 4.46% . The Amended Mortgage Loan is secured by seventeen owned nursing centers, related equipment and a lien on the accounts receivable of these centers. The Amended Mortgage Loan and the Amended Revolver are cross-collateralized. The Company’s Amended Revolver has an interest rate of LIBOR plus 4.0% 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. The Amended Mortgage Loan balance was $59,597,000 as of June 30, 2016 .
As of June 30, 2016 , the Company had $5,500,000 borrowings outstanding under the Amended Revolver compared to $12,900,000 outstanding as of December 31, 2015 . The outstanding borrowings on the revolver primarily compensate for accumulated Medicaid and Medicare receivables at recently acquired facilities as these facilities proceed through the change in ownership process with CMS. Annual fees for letters of credit issued under the Amended Revolver are 3.00% of the amount outstanding. The Company has ten letters of credit with a total value of $7,868,000 outstanding as of June 30, 2016 . Considering the balance of eligible accounts receivable, the letters of credit, the amounts outstanding under the revolving credit facility and the maximum loan amount of $27,500,000 , the balance available for borrowing under the Amended Revolver was $10,824,000 at June 30, 2016 .
The Company’s debt agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. As of June 30, 2016 , the Company was compliant with the amended covenants as described in Note 10 to the interim consolidated financial statements.

11


Interest Rate Swap Transaction
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 designated its interest rate swap as a cash flow hedge and the earnings component of the hedge, net of taxes, is reflected as a component of other comprehensive income. In conjunction with the Amendment to the Credit Agreement, the Company amended the terms of its interest rate swap on February 26, 2016. The interest rate swap agreement requires the Company to make fixed rate payments to the bank calculated on the initial notional amount of $30,000,000 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 amount.
The Company assesses the effectiveness of its interest rate swap on a quarterly basis, and at June 30, 2016 , the Company determined that the interest rate swap was effective. The interest rate swap valuation model indicated a net liability of $1,189,000 at June 30, 2016 . The fair value of the interest rate swap is included in “other noncurrent liabilities” on the Company’s interim consolidated balance sheet. The liability related to the interest rate swap included in accumulated other comprehensive loss at June 30, 2016 is $737,180 , net of the income tax benefit of $451,820 . As the Company’s interest rate swap is not traded on a market exchange, the fair value is determined using a valuation based on a discounted cash flow analysis. This analysis reflects the contractual terms of the interest rate swap agreement and uses observable market-based inputs, including estimated future LIBOR interest rates. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy, in accordance with the FASB guidance set forth in ASC 820, Fair Value Measurement .

5.
COMMITMENTS AND CONTINGENCIES
Professional Liability and Other Liability Insurance
The Company has professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. Effective July 1, 2013, the Company established a wholly-owned, consolidated offshore limited purpose insurance subsidiary, SHC Risk Carriers, Inc. (“SHC”) which has issued a policy insuring claims made against all of the Company's nursing centers in Florida and Tennessee, as well as the Company’s formerly operated Arkansas and West Virginia facilities. Several of the Company’s nursing centers in Alabama, Kentucky, Ohio, and Texas are also covered under this policy. The SHC policy provides coverage limits of either $500,000 or $1,000,000 per medical incident with a sublimit per center of $1,000,000 and total annual aggregate policy limits of $5,000,000 . The remaining nursing centers are covered by one of seven claims made professional liability insurance policies purchased from entities unaffiliated with the Company. These policies provide coverage limits of $1,000,000 per claim and have sublimits of $3,000,000 per center, with varying aggregate policy limits. 
Reserve for Estimated Self-Insured Professional Liability Claims
Because the Company’s actual liability for existing and anticipated professional liability and general liability claims will likely exceed the Company’s limited insurance coverage, the Company has recorded total liabilities for reported and estimated future claims of $20,307,000 as of June 30, 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.
As of June 30, 2016 , the Company is engaged in 55 professional liability lawsuits. Ten lawsuits are currently scheduled for trial or arbitration during the next twelve months, and it is expected that additional cases will be set for trial or hearing. The Company’s

12


cash expenditures for self-insured professional liability costs from continuing operations were $1,542,000 and $1,607,000 for the six months ended June 30, 2016 and 2015 , respectively.
Although the Company adjusts its accrual for professional and general liability claims on a quarterly basis and retains a third-party actuarial firm semi-annually to assist management in estimating the appropriate accrual, professional and general liability claims are inherently uncertain, and the liability associated with anticipated claims is very difficult to estimate. Professional liability cases have a long cycle from the date of an incident to the date a case is resolved, and final determination of the Company’s actual liability for claims incurred in any given period is a process that takes years. As a result, the Company’s actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given period. Each change in the amount of this accrual will directly affect the Company’s reported earnings and financial position for the period in which the change in accrual is made.
Civil Investigative Demand ("CID")
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 facilities 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 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 ("PASSRs") submitted to TennCare. We have responded to those requests and are providing additional information to DOJ. The DOJ’s civil investigation now covers all of the Company’s facilities, but thus far only documents from six of our facilities 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 PASSRs. The Company intends to provide documents responsive to the subpoena. The Company cannot predict the outcome of these investigations or any possible related proceedings, and the outcome could have a materially adverse effect on the Company, including the imposition of 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.
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. From July 1, 2008 through June 30, 2016 , 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 $232,000 at June 30, 2016 . The Company has a non-current receivable for workers’ compensation policies covering previous years of $1,156,000 as of June 30, 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 June 30, 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 $664,000 at June 30, 2016 . The differences between actual settlements and reserves are included in expense in the period finalized.

6.
STOCK-BASED COMPENSATION

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

13


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. 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 the six months ended June 30, 2016 and 2015 , the Compensation Committee of the Board of Directors approved grants totaling approximately 83,000 and 74,000 shares of restricted common stock to certain employees and members of the Board of Directors, respectively. The fair value of restricted shares are determined as the quoted market price of the underlying common shares at the date of the grant. The restricted shares typically vest 33% on the first, second and third anniversaries of the grant date. Unvested shares may not be sold or transferred. During the vesting period, dividends accrue on the restricted shares, but are paid in additional shares of common stock upon vesting, subject to the vesting provisions of the underlying restricted shares. The restricted shares are entitled to the same voting rights as other common shares. Upon vesting, all restrictions are removed. Summarized activity of the equity compensation plans is presented below:
 
 
 
Weighted
 
Options/
 
Average
 
SOSARs
 
Exercise Price
Outstanding, December 31, 2015
232,000

 
$
6.97

Granted
—

 
—

Exercised
(1,000
)
 
3.91

Expired or cancelled
—

 
—

Outstanding, June 30, 2016
231,000

 
$
6.98

 
 
 
 
Exercisable, June 30, 2016
222,000

 
$
6.83


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

 
$
9.07

Granted
83,000

 
8.87

Dividend Equivalents
2,000

 
8.40

Vested
(68,000
)
 
7.85

Cancelled
(4,000
)
 
9.66

Outstanding, June 30, 2016
154,000

 
$
9.48



14


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
1,000

 
8.35

Vested
(24,000
)
 
5.69

Cancelled
—

 
—

Outstanding, June 30, 2016
56,000

 
$
11.04



Prior to 2015 , the Compensation Committee of the Board of Directors also approved grants of Stock Only Stock Appreciation Rights (“SOSARs”) and Stock Options at the market price of the Company's common stock on the grant date. The SOSARs and Options vest 33% on the first, second and third anniversaries of the grant date, and expire 10 years from the grant date. The SOSARs and Options were valued and recorded in the same manner, and will be settled with issuance of new stock for the difference between the market price on the date of exercise and the exercise price. The Company estimated the total recognized and unrecognized compensation related to SOSARs and stock options using the Black-Scholes-Merton equity grant valuation model.

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

While no SOSARs or Options were granted during 2016 and 2015 , previously granted SOSARs and Options remain outstanding as of June 30, 2016 . The following table summarizes information regarding stock options and SOSAR grants outstanding as of June 30, 2016 :
 
 
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

 
$
—

 
52,000

 
$
—

$2.37 to $6.21
 
$
5.55

 
170,000

 
$
440,000

 
170,000

 
$
441,000

 
 
 
 
232,000

 
 
 
222,000

 
 
Stock-based compensation expense is non-cash and is included as a component of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. The Company recorded total stock-based compensation expense of $486,000 and $702,000 in the six month periods ended June 30, 2016 and 2015 , respectively.


15


7.
EARNINGS (LOSS) PER COMMON SHARE
Information with respect to basic and diluted net income (loss) per common share is presented below in thousands, except per share:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss)
 
 
 
 
 
 
 
Income (loss) from continuing operations
$
(2,150
)
 
$
807

 
(2,224
)
 
812

Loss from discontinued operations, net of income taxes
—

 
(299
)
 
(37
)
 
(562
)
Net income (loss)
$
(2,150
)
 
$
508

 
$
(2,261
)
 
$
250

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss) per common share:
 
 
 
 
 
 
 
Per common share – basic
 
 
 
 
 
 
 
Income (loss) from continuing operations
$
(0.35
)
 
$
0.13

 
$
(0.36
)
 
$
0.13

Loss from discontinued operations
—

 
(0.05
)
 
(0.01
)
 
(0.09
)
Net income (loss) per common share – basic
$
(0.35
)
 
$
0.08

 
$
(0.37
)
 
$
0.04

Per common share – diluted
 
 
 
 
 
 
 
Income (loss) from continuing operations
$
(0.35
)
 
$
0.13

 
$
(0.36
)
 
$
0.13

Loss from discontinued operations
—

 
(0.05
)
 
(0.01
)
 
(0.09
)
Net income (loss) per common share – diluted
$
(0.35
)
 
$
0.08

 
$
(0.37
)
 
$
0.04

Weighted Average Common Shares Outstanding:
 
 
 
 
 
 
 
Basic
6,211

 
6,098

 
6,185

 
6,072

Diluted
6,211

 
6,327

 
6,185

 
6,302

The effects of 62,000 SOSARs and options outstanding were excluded from the computation of diluted earnings per common share in the six months ended June 30, 2016 , because these securities would have been anti-dilutive. For the six months ended June 30, 2015 , none of the securities were excluded from the computation.

8. EQUITY METHOD INVESTMENT
The investment in unconsolidated affiliate reflected on the interim consolidated balance sheet relates to a pharmacy joint venture partnership in which the Company owns 50% . This investment in unconsolidated affiliate is accounted for using the equity method as the Company exerts significant influence, but does not control or otherwise consolidate the entity. The investment in unconsolidated affiliate balance at June 30, 2016 , was $859,000 as compared to $798,000 at December 31, 2015 . Additionally, the Company's share of the net profits and losses of the unconsolidated affiliate are reported in equity in net earnings or losses of unconsolidated affiliate in our statement of operations. The Company's equity in the net income of unconsolidated affiliate for the quarter ended June 30, 2016 , was $28,000 as compared to $75,000 for the quarter ended June 30, 2015 . For the six -month period ended June 30, 2016 , the equity in the net income of unconsolidated affiliate was $61,000 compared to $183,000 for the six -month period ended June 30, 2015 .


16


9.
BUSINESS DEVELOPMENTS AND OTHER SIGNIFICANT TRANSACTIONS
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. Diversicare has operated these facilities since February 2015 and April 2012, respectively. Hutchinson is an 85 -bed skilled nursing facility, and Clinton is an 88 -bed skilled nursing facility. As a result of the consummation of the Agreements, the Company allocated the purchase price and acquisition costs between the assets acquired. 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 assets acquired is as follows:
 

 
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 certain land, improvements, furniture, fixtures and equipment, personal property and intangible property, together comprising a 94 -bed skilled nursing center in Glasgow, Kentucky, for an aggregate purchase price of $7,000,000 .

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



17


On November 1, 2015, the Company entered into an Asset Purchase Agreement with Haws Fulton Investors, LLC to acquire certain land, improvements, furniture, fixtures and equipment, personal property and intangible property, together comprising 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


2016 Lease Termination
On May 31, 2016, the Company entered into an Agreement with Avon Ohio, LLC to amend the original lease agreement, thus terminating Diversicare's right of possession of the facility. As a result, the Company incurred lease termination costs of $2.0 million in the second quarter of 2016 . Under the amended agreement, we are required to pay $0.3 million 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.


10.
SUBSEQUENT EVENT

On August 3, 2016, the Company executed a First Amendment to the Amended Revolver and a First Amendment to the Amended Mortgage Loan, effective June 30, 2016. Under the terms of the Amendments, the minimum fixed charge coverage ratio shall not be less than 1.00 to 1.00 for the quarters ending June 30, 2016, September 30, 2016 and December 31, 2016 and 1.05 to 1.00 for the quarter ending March 31, 2017 and for each quarter thereafter. Further, the minimum Adjusted EBITDA shall not be less than $9,500,000 for the quarter ending June 30, 2016, $8,500,000 for the quarter ending September 30, 2016, $9,500,000 for the quarter ending December 31, 2016, and $10,000,000 for the quarter ending March 31, 2017, and for each quarter thereafter.


18



ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Diversicare Healthcare Services, Inc. (together with its subsidiaries, “Diversicare” or the “Company”) provides long-term care services to nursing center patients in nine states, primarily in the Southeast, Midwest, and Southwest. The Company’s centers provide a range of health care services to their patients and residents that include nursing, personal care, and social services. Additionally, the Company’s nursing centers also offer a variety of comprehensive rehabilitation services, as well as nutritional support services. The Company's continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Missouri, Ohio, Tennessee, and Texas.
As of June 30, 2016 , the Company’s continuing operations consist of 54 nursing centers with 5,879 licensed nursing beds. The Company owns 17 and leases 37 of its nursing centers. 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 and residential beds.
Strategic Operating Initiatives
During the third quarter of 2010, we identified several key strategic objectives to increase shareholder value through improved operations and business development. These strategic operating initiatives included: improving skilled mix in our nursing centers, improving our average Medicare rate, implementing Electronic Medical Records (“EMR”) to improve Medicaid capture, accelerating center renovations and completing strategic acquisitions. We have experienced success in these initiatives and expect to continue to build on these improvements. We describe each of these below as well as provide metrics for our most recent quarter versus the third quarter of 2010, the quarter before we embarked on our strategic operating initiatives.
Improving skilled mix and average Medicare rate:
Our strategic operating initiatives of improving our skilled mix and our average Medicare rate by accurately capturing the delivery of care required investing in nursing and clinical care to treat more acute patients along with nursing center based sales representatives to attract these patients. These initiatives developed referral and Managed Care relationships that have attracted and are expected to continue to attract patients whose stay in the centers is covered by Medicare and Managed Care. A comparison of our most recent quarter versus the third quarter of 2010, the quarter before we embarked on our strategic operating initiatives, reflects our success with these strategic operating initiatives:  
 
Three Months Ended
 
June 30, 2016
 
September 30,
2010
As a percent of total census:
 
 
 
Medicare census
11.7
%
 
12.3
%
Managed Care census
3.5
%
 
1.3
%
Total skilled mix census
15.2
%
 
13.6
%
As a percent of total revenues:
 
 
 
Medicare revenues
27.6
%
 
29.3
%
Managed Care revenues
6.8
%
 
2.8
%
Total skilled mix revenues
34.4
%
 
32.1
%
Medicare average rate per day:
$
456.91

 
$
394.23

The initiatives have developed positive results in growing our skilled patient population, increasing the Managed Care census to 3.5% of total census in the second quarter of 2016 , as compared to 1.3% in the third quarter of 2010, and total skilled mix census to 15.2% from 13.6% over the same period.

19


Implementing Electronic Medical Records to improve Medicaid capture:
As another part of our strategic operating initiative, we implemented EMR to improve documentation of the delivery of care. We completed the implementation of EMR in all our nursing centers in December 2011, on time and under budget. A comparison of our most recent quarter versus the third quarter of 2010 reflects the increase in our average Medicaid rate per day:
 
Three Months Ended
 
June 30, 2016
 
September 30,
2010
Medicaid average rate per day:
$
168.36

 
$
147.93


Completing strategic acquisitions and dispositions:
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.
As part of our strategic efforts, we have also performed thorough analyses on our existing centers in order to determine whether continuing operations within certain markets or regions was in line with the short-term and long-term strategy of the business. As a result, we disposed of an owned building in Arkansas in 2012, and reached an agreement to terminate our lease for eleven other facilities in Arkansas in 2013. In addition in 2014, the Company disposed of an owned building and two leased facilities in West Virginia. As a result of these transactions, we no longer operate within the states of Arkansas or West Virginia. 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 9 to the interim consolidated financial statements.
Basis of Financial Statements
Our patient revenues consist of the fees charged for the care of patients in the nursing centers we own and lease. Our operating expenses include the costs, other than lease, professional liability, depreciation and amortization expenses, incurred in the operation of the nursing centers we own and lease. Our general and administrative expenses consist of the costs of the corporate office and regional support functions. Our interest, depreciation and amortization expenses include all such expenses across the range of our operations.

Critical Accounting Policies and Judgments
A “critical accounting policy” is one which is both important to the understanding of our financial condition and results of operations and requires management’s most difficult, subjective or complex judgments often involving estimates of the effect of matters that are inherently uncertain. Actual results could differ from those estimates and cause our reported net income or loss to vary significantly from period to period. Our critical accounting policies are more fully described in our 2015 Annual Report on Form 10-K.
Revenue Sources
We classify our revenues from patients and residents into four major categories: Medicaid, Medicare, Managed Care, and Private Pay and other. Medicaid revenues are composed of the traditional Medicaid program established to provide benefits to those in need of financial assistance in the securing of medical services. Medicare revenues include revenues received under both Part A and Part B of the Medicare program. Managed Care revenues include payments for patients who are insured by a third-party entity, typically called a Health Maintenance Organization, often referred to as an HMO plan, or are Medicare beneficiaries who assign their Medicare benefits to a Managed Care replacement plan often referred to as Medicare replacement products. The Private Pay and other revenues are composed primarily of individuals or parties who directly pay for their services. Included in the Private Pay and other payors 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.

20


The following table sets forth net patient and resident revenues related to our continuing operations by payor source for the periods presented (dollar amounts in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Medicaid
$
48,339

 
50.5
%
 
$
46,291

 
48.1
%
 
$
95,545

 
49.3
%
 
$
91,050

 
47.5
%
Medicare
26,397

 
27.6

 
28,059

 
29.1

 
54,418

 
28.1

 
57,574

 
30.1

Managed Care
6,531

 
6.8

 
6,727

 
7.0

 
13,933

 
7.2

 
13,577

 
7.1

Private Pay and other
14,538

 
15.1

 
15,211

 
15.8

 
29,854

 
15.4

 
29,312

 
15.3

Total
$
95,805

 
100.0
%
 
$
96,288

 
100.0
%
 
$
193,750

 
100.0
%
 
$
191,513

 
100.0
%

The following table sets forth average daily skilled nursing census by payor source for our continuing operations for the periods presented:  
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
2015
 
2016
 
2015
Medicaid
3,138

 
68.3
%
 
3,078

 
66.8
%
 
3,113

 
67.4
%
 
3,059

 
66.6
%
Medicare
538

 
11.7

 
574

 
12.5

 
556

 
12.0

 
599

 
13.0

Managed Care
161

 
3.5

 
167

 
3.6

 
170

 
3.7

 
175

 
3.8

Private Pay and other
758

 
16.5

 
791

 
17.1

 
781

 
16.9

 
762

 
16.6

Total
4,595

 
100.0
%
 
4,610

 
100.0
%
 
4,620

 
100.0
%
 
4,595

 
100.0
%
Consistent with the nursing home industry in general, changes in the mix of a facility’s patient population among Medicaid, Medicare, Managed Care, and Private Pay and other can significantly affect the profitability of the facility’s operations.

Health Care Industry
The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, quality of resident care and Medicare and Medicaid fraud and abuse. Over the last several years, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse laws and regulations as well as laws and regulations governing quality of care issues in the skilled nursing profession in general. Violations of these laws and regulations could result in exclusion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations is subject to ongoing government review and interpretation, as well as regulatory actions in which government agencies seek to impose fines and penalties. From time to time, the Company, like others in the healthcare industry, may be involved in regulatory actions of this type.
On April 16, 2015, the President signed into law MACRA. This bill includes a number of provisions, including the replacement of the Sustainable Growth Rate formula used by Medicare to pay physicians with new systems for establishing annual payment rate updates for physicians' services, an extension of the outpatient therapy cap exception process until December 31, 2017; and payment updates for post-acute providers. In addition, it increases premiums for Part B and Part D of Medicare for beneficiaries with income above certain levels and makes numerous other changes to Medicare and Medicaid. On October 30, 2015, CMS released a final rule addressing the implementation of certain provisions of MACRA, including the implementation of the new Merit-Based Incentive Payment System ("MIPS"). The current Value-Based Payment Modifier program is set to expire in 2018, with MIPS to begin in 2019. The October 30, 2015 final rule added measures where gaps exist in the current Physician Quality Reporting System, which is used by CMS to track the quality of care provided to Medicare beneficiaries. The final rule also excludes services furnished in SNFs from the definition of primary care services for purposes of the Shared Savings Program. The final rule could impact our revenue in the future.
On February 20, 2015, CMS modified the Five Star Quality Rating System for nursing homes to include the use of antipsychotics in calculating the star ratings, modified calculations for staffing levels and reflect higher standards for nursing homes to achieve a high rating on the quality measure dimension. Since the standards for performance are more difficult to achieve, the number of our 4 and 5 star facilities could be reduced.
In March 2010, significant legislation concerning health care and health insurance was passed, including the “Patient Protection and Affordable Care Act,” (“Affordable Care Act”) along with the “Health Care and Education Reconciliation Act of 2010” (“Reconciliation Act”) collectively defined as the “Legislation.” We expect this Legislation to impact our Company, our employees and our patients in a variety of ways. Some aspects of these new laws have been implemented while others will be

21


phased in over the next several years. This Legislation significantly changes the future responsibility of employers with respect to providing health care coverage to employees in the United States.
We also expect for this Legislation to continue to impact our Medicare and Medicaid reimbursement as well, though the exact timing and level of that impact is currently unknown. For example, the Legislation expands the role of home-based and community services, which may place downward pressure on our ability to maintain our population of Medicaid residents. Additional provisions under the Legislation for skilled nursing facilities participating in Medicare and/or Medicaid, including but not limited to, new transparency, reporting, and certification requirements, will likely lead to an increase in the Company's administrative and other costs.
The provisions of the Affordable Care Act discussed above are only examples of federal health reform provisions that we believe may have a material impact on the long-term care industry and on our business. We anticipate that many of the changes and reforms resulting from the Legislation, as well as other similar health care reforms, may be subject to further clarification and modification through promulgation of regulations, executive orders, and judicial review and could have a material adverse impact on our business, financial condition, and results of operations.
Medicare and Medicaid Reimbursement
A significant portion of our revenues are derived from government-sponsored health insurance programs. Our nursing centers derive revenues under Medicare, Medicaid, 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 and other changes to applicable coverage criteria to comply with reporting requirements and to ensure that proper payments are made to our operated nursing centers. It is generally recognized that all government-funded programs have been and will continue to be under cost containment pressures, but the extent to which these pressures will affect our future reimbursement is unknown.
Medicare
Effective October 1, 2011, Medicare rates were reduced by a nationwide average of 11.1%, the net effect of a reduction to restore overall payments to their intended levels on a prospective basis and the application of a 2.7% market basket increase and a negative 1.0% productivity adjustment required by the Affordable Care Act. The final Centers for Medicare and Medicaid Services (“CMS”) rule also adjusts the method by which group therapy is counted for reimbursement purposes and, for patients receiving therapy, changes the timing of reassessment for purposes of determining patient RUG categories. These October 2011 Medicare reimbursement changes decreased our Medicare revenue and our Medicare rate per patient day. The new regulations also resulted in an increase in costs to provide therapy services to our patients.
The Budget Control Act of 2011 (“BCA”), enacted on August 2, 2011, increased the United States debt ceiling and linked the debt ceiling increase to corresponding deficit reductions through 2021. The BCA also established a 12 member joint committee of Congress known as the Joint Select Committee on Deficit Reduction (“Super Committee”). The Super Committee’s objective was to create proposed legislation to reduce the United States federal budget deficit by $1.5 trillion for fiscal years 2012 through 2021. Part of the BCA required this legislation to be enacted by December 23, 2011, or approximately $1.2 trillion in spending reductions would automatically begin through sequestration on January 1, 2013, split between domestic and defense spending. As no legislation was passed that would achieve the targeted savings outlined in the BCA, payments to Medicare providers have been reduced by 2% from planned levels effective April 1, 2013. In April 2015, congressional committees began deliberations on proposed legislation that would extend sequestration and increase the amount cut by $700 million. If the bill were to become law, it would result in a net effect of increasing the sequester in 2024 beyond the 2% in the BCA.
In July 2016, CMS issued its final rule outlining fiscal year 2017 Medicare payment rates and quality programs for skilled nursing facilities. The policies in the proposed rule continue to shift Medicare payments from volume to value. CMS projects that aggregate payments to skilled nursing facilities will increase by a net 2.4% for fiscal year 2017. This estimate increase reflected a 2.7% market basket increase, reduced by a 0.3% multi-factor productivity (MFP) adjustment required by the Patient Protection and Affordable Care Act (PPACA). This final rule also further defines the skilled nursing facilities Quality Reporting Program and clarifies the Value-Based Purchasing Program to establish performance standards, baseline and performance periods, performance scoring methodology and feedback reports. The Value-Based Purchasing Program final rule specifies the skilled nursing facility 30-day potentially preventable readmission measure, which assesses the facility-level risk standardized rate of unplanned, potentially preventable hospital readmissions for skilled nursing facility patients within 30 days of discharge from a prior admission to a hospital paid under the Inpatient Prospective Payment System, a critical access hospital, or a psychiatric hospital. There is also finalized additional policies related to the Value-Based Purchasing Program including: establishing performance standards; establishing baseline and performance periods; adopting a performance scoring methodology; and providing confidential feedback reports to the skilled nursing facilities.

22


Therapy Services . There are annual Medicare Part B reimbursement limits on therapy services that can be provided to an individual. The limits impose a $1,940 per patient annual ceiling on physical and speech therapy services, and a separate $1,940 per patient annual ceiling on occupational therapy services. CMS established an exception process to permit therapy services in certain situations and we provide services that are reimbursed under the exceptions process. The exceptions process has been extended several times, most recently in April 2015 by the Medicare Access and CHIP Reauthorization Act, which extended this exception process through December 31, 2017. This allows Part B providers to continue delivering therapy services above the current $1,940 threshold for therapy services, provided the services were medically necessary. In addition, the legislation replaced the mandatory medical manual review of therapy claims exceeding the cap with a review process targeting providers with high denial rates and outlier billing patterns, new providers and certain medical conditions within group practices.
Related to the exceptions process discussed above, for services provided with dates of service, providers are required to submit a request for an exception for therapy services above the threshold of $3,700 which will then be manually medically reviewed, consistent with the treatment of these services historically. Similar to the therapy cap exceptions process, the threshold process will have a $3,700 per patient threshold on physical and speech therapy services, and a separate $3,700 per patient threshold on occupational therapy services. The exception reviews were conducted by Medicare Administrative Contractors during this period.
On November 2, 2010, CMS released a final proposed rule as part of the Medicare Physician Fee Schedule (“MPFS”) that was effective January 1, 2011. The policy impacts the reimbursement we receive for Medicare Part B therapy services in our facilities. The policy provides that Medicare Part B pay the full rate for the therapy unit of service that has the highest Practice Expense ("PE") component for each patient on each day they receive multiple therapy treatments. Reimbursement for the second and subsequent therapy units for each patient each day they receive multiple therapy treatments is reimbursed at a rate equal to 75% of the applicable PE component through March 31, 2013. Effective April 1, 2013, the rate at which these services are reimbursed was reduced to 50% of the applicable PE component.
Medicare Part B therapy services in our centers are determined according to MPFS. Annually since 1997, the MPFS has been subject to a Sustainable Growth Rate Adjustment (“SGR”) intended to keep spending growth in line with allowable spending. Each year since the SGR was enacted, this adjustment produced a scheduled negative update to payment for physicians, therapists and other healthcare providers paid under the MPFS. In April 2015, as part of the Medicare Access and CHIP Reauthorization Act, Congress passed and the President signed into law the "permanent SGR fix" or "doc fix." Under this legislation, the Medicare formula for establishing physician payment rates was permanently replaced. The permanent fix is expected to remove a substantial annual risk of future payment reductions.
The Medicare Access and CHIP Reauthorization Act also extended several other elements of the Middle Class Tax Relief and Job Creation Act of 2012, including the reduction of bad debt treated as an allowable cost. Prior to this act, Medicare reimbursed providers for beneficiaries’ unpaid coinsurance and deductible amounts after reasonable collection efforts at a rate between 70 and 100% of beneficiary bad debt. This provision reduced bad debt reimbursement exposure for all providers to 65%. In addition to the provisions above, the legislation sets that for fiscal year 2018 (October 1, 2017 through September 30, 2018), all Medicare Part B providers will receive inflationary market basket increases no greater than 1%. This provision is expected to reduce Medicare payments to all post-acute providers by approximately $15.4 billion over the 2018-2025 period.
Medicaid
Several states in which we operate face budget shortfalls, which could result in reductions in Medicaid funding for nursing centers. The federal government made an effort to address the financial challenges state Medicaid programs are facing by increasing the amount of Medicaid funding available to states. Pressures on state budgets are expected to continue in the future and are expected to result in Medicaid rate reductions.
We receive the majority of our annual Medicaid rate increases during the third quarter of each year. The rate changes received in 2015, along with increased Medicaid acuity in our acuity based states, were the primary contributor to our 1.8% increase in average rate per day for Medicaid patients in 2016 compared to 2015. Based on the rate changes received during the third quarter of 2015, we have experienced a favorable impact to our rate per day for Medicaid patients due to modest rate increases in many of the states within which we operate.
Effective February 1, 2015, the Company began participating in the Upper Payment Limit ("UPL") supplemental payment program in the state of Indiana that provides supplemental Medicaid payments for skilled nursing facilities that are licensed to non-state government entities such as county hospital districts. One skilled nursing facility previously operated by the Company entered into a transaction with one such hospital providing for the transfer of the license from the Company to the hospital district, and providing further for the Company's operating subsidiaries to retain the management of the facility on behalf of the hospital district, which is participating in the UPL program. The affected operating subsidiary therefore retains operations of its skilled nursing facility and the agreement between the hospital district and the Company is terminable by either party to fully restore the prior license status.

23


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 six months ended June 30, 2016 , we derived 27.6% and 50.5% of our total patient revenues related to continuing operations from the Medicare and Medicaid programs, respectively. Any health care reforms that significantly limit rates of reimbursement under these programs could, therefore, have a material adverse effect on our profitability.
We will attempt to increase revenues from non-governmental sources to the extent capital is available to do so. However, private payors, including Managed Care payors, are increasingly demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments, which can result in significant losses to health care providers if patients require expensive treatment not adequately covered by the capitated rate.
Licensure and Other Health Care Laws
All of our nursing centers must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing centers are subject to certificate of need laws, which require us to obtain government approval for the construction of new nursing centers or the addition of new licensed beds to existing centers. Our nursing centers must comply with detailed statutory and regulatory requirements on an ongoing basis in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid certification are similar and relate to quality and adequacy of personnel, quality of medical care, record keeping, dietary services, patient rights, and the physical condition of the center and the adequacy of the equipment used therein. Each center is subject to periodic inspections, known as “surveys” by health care regulators, to determine compliance with all applicable licensure and certification standards. Such requirements are both subjective and subject to change. If the survey concludes that there are deficiencies in compliance, the center is subject to various sanctions, including, but not limited to, monetary fines and penalties, suspension of new admissions, non-payment for new admissions and loss of licensure or certification. Generally, however, once a center receives written notice of any compliance deficiencies, it may submit a written plan of correction and is given a reasonable opportunity to correct the deficiencies. There can be no assurance that, in the future, we will be able to maintain such licenses and certifications for our facilities or that we will not be required to expend significant sums in order to comply with regulatory requirements.


24


Contractual Obligations and Commercial Commitments
We have certain contractual obligations of continuing operations as of June 30, 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)
$
74,851

 
$
9,646

 
$
7,660

 
$
57,545

 
$
—

Settlement obligations (2)
3,432

 
3,432

 
—

 
—

 
—

Elimination of Preferred Stock Conversion feature (3)
1,546

 
687

 
859

 
—

 
—

Operating leases (4)
537,275

 
30,839

 
62,986

 
65,527

 
377,923

Required capital expenditures under operating leases (5)
2,335

 
201

 
403

 
403

 
1,328

Total
$
619,439

 
$
44,805

 
$
71,908

 
$
123,475

 
$
379,251

 
(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 $0.2 million between December 31, 2015 and June 30, 2016 , which is related to our Amended and Restated Credit agreements. See Note 4, "Long-Term Debt and Interest Rate Swap," to the interim 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 which 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 renewal periods are enacted. Our operating lease obligations decreased $35.6 million between December 31, 2015 and June 30, 2016 , which is related to our purchase of the Clinton and Hutchinson facilities.
(5)
Includes annual expenditure requirements under operating leases.
We have employment agreements with certain members of management that provide for the payment to these members of amounts up to two times their annual salary in the event of a termination without cause, a constructive discharge (as defined therein), or upon a change of control of the Company (as defined therein). The maximum contingent liability under these agreements is approximately $1,789,000 as of June 30, 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 our common stock on June 30, 2016 , the potential contingent liability for the repurchase of the equity grants is $251,000 .


25


Results of Operations
The following tables present the unaudited interim statements of operations and related data for the three and six month periods ended June 30, 2016 and 2015 :
 
(in thousands)
Three Months Ended June 30,
 
2016
 
2015
 
Change
 
%
PATIENT REVENUES, net
$
95,805

 
$
96,288

 
$
(483
)
 
(0.5
)%
EXPENSES:
 
 
 
 
 
 
 
Operating
78,385

 
76,652

 
1,733

 
2.3
 %
Lease and rent expense
6,854

 
7,186

 
(332
)
 
(4.6
)%
Professional liability
1,934

 
1,926

 
8

 
0.4
 %
General and administrative
6,881

 
6,341

 
540

 
8.5
 %
Depreciation and amortization
2,060

 
1,863

 
197

 
10.6
 %
Lease termination costs
2,008

 
—

 
2,008

 
100.0
 %
Total expenses
98,122

 
93,968

 
4,154

 
4.4
 %
OPERATING INCOME (LOSS)
(2,317
)
 
2,320

 
(4,637
)
 
(199.9
)%
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Equity in net income of unconsolidated affiliate
28

 
75

 
(47
)
 
(62.7
)%
Interest expense, net
(1,158
)
 
(1,049
)
 
(109
)
 
(10.4
)%
 
(1,130
)
 
(974
)
 
(156
)
 
(16.0
)%
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(3,447
)
 
1,346

 
(4,793
)
 
(356.1
)%
BENEFIT (PROVISION) FOR INCOME TAXES
1,297

 
(539
)
 
1,836

 
340.6
 %
INCOME (LOSS) FROM CONTINUING OPERATIONS
$
(2,150
)
 
$
807

 
$
(2,957
)
 
(366.4
)%
 
(in thousands)
Six Months Ended
June 30,
 
2016
 
2015
 
Change
 
%
PATIENT REVENUES, net
$
193,750

 
$
191,513

 
$
2,237

 
1.2
 %
EXPENSES:
 
 
 
 
 
 

Operating
157,003

 
153,797

 
3,206

 
2.1
 %
Lease and rent expense
14,106

 
14,331

 
(225
)
 
(1.6
)%
Professional liability
4,000

 
4,081

 
(81
)
 
(2.0
)%
General and administrative
13,615

 
12,392

 
1,223

 
9.9
 %
Depreciation and amortization
4,063

 
3,742

 
321

 
8.6
 %
Lease termination costs
2,008

 
—

 
2,008

 
100.0
 %
Total expenses
194,795

 
188,343

 
6,452

 
3.4
 %
OPERATING INCOME (LOSS)
(1,045
)
 
3,170

 
(4,215
)
 
(133.0
)%
OTHER INCOME (EXPENSE):
 
 
 
 
 
 

Equity in net income of unconsolidated affiliate
61

 
183

 
(122
)
 
66.7
 %
Interest expense, net
(2,228
)
 
(1,999
)
 
(229
)
 
(11.5
)%
Debt retirement costs
(351
)
 
—

 
(351
)
 
100.0
 %
 
(2,518
)
 
(1,816
)
 
(702
)
 
(38.7
)%
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(3,563
)
 
1,354

 
(4,917
)
 
(363.1
)%
BENEFIT (PROVISION) FOR INCOME TAXES
1,339

 
(542
)
 
1,881

 
347.0
 %
INCOME (LOSS) FROM CONTINUING OPERATIONS
$
(2,224
)
 
$
812

 
$
(3,036
)
 
(373.9
)%

26


Percentage of Net Revenues
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
PATIENT REVENUES, net
100.0
 %
 
100.0
%
 
100.0
 %
 
100.0
 %
EXPENSES:
 
 
 
 
 
 
 
Operating
81.8

 
79.6

 
81.0

 
80.3

Lease and rent expense
7.2

 
7.5

 
7.3

 
7.5

Professional liability
2.0

 
2.0

 
2.1

 
2.1

General and administrative
7.2

 
6.6

 
7.0

 
6.5

Depreciation and amortization
2.2

 
1.9

 
2.1

 
2.0

Lease termination costs
2.1

 
—

 
1.0

 
—

Total expenses
102.5

 
97.6

 
100.5

 
98.4

OPERATING INCOME (LOSS)
(2.5
)
 
2.4

 
(0.5
)
 
1.6

OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Equity in net losses of unconsolidated affiliate
—

 
0.1

 
—

 
0.1

Interest expense, net
(1.2
)
 
(1.1
)
 
(1.1
)
 
(1.0
)
Debt retirement costs
—

 
—

 
(0.2
)
 
—

 
(1.2
)
 
(1.0
)
 
(1.3
)
 
(0.9
)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(3.7
)
 
1.4

 
(1.8
)
 
0.7

BENEFIT (PROVISION) FOR INCOME TAXES
1.4

 
(0.6
)
 
0.7

 
(0.3
)
INCOME (LOSS) FROM CONTINUING OPERATIONS
(2.3
)%
 
0.8
%
 
(1.1
)%
 
0.4
 %

27


Three Months Ended June 30, 2016 Compared With Three Months Ended June 30, 2015
Patient Revenues
Patient revenues were $95.8 million  and $96.3 million for the three months ended June 30, 2016 and 2015 , respectively, a decrease of $0.5 million . The following table summarizes the revenue fluctuations attributable to our portfolio growth (in thousands):
 
Three Months Ended June 30,
 
2016
 
2015
 
Change
Same-store revenue
$
91,873

 
$
93,227

 
$
(1,354
)
2015 acquisition revenue
3,932

 
3,061

 
871

Total revenue
$
95,805

 
$
96,288

 
$
(483
)
The overall decrease in revenue of $0.5 million is primarily driven by a decrease in census related to our same-store Medicare and Private payors of $1.9 million and $0.7 million , respectively. This was partially offset by the Medicaid rate and census increase of $0.8 million and $0.5 million , respectively. Incremental revenue contributions from acquisition activity in 2015 of $0.9 million offset our decrease in same-store revenue for the quarter.
The following table summarizes key revenue and census statistics for continuing operations for each period:
 
 
Three Months Ended June 30,
 
 
 
2016
 
 
 
2015
 
 
Skilled nursing occupancy
76.7
%
 
 
 
76.8
%
 
 
As a percent of total census:
 
 
 
 
 
 
 
Medicare census
11.7
%
 
 
 
12.5
%
 
 
Medicaid census
68.3
%
 
 
 
66.8
%
 
 
Managed Care census
3.5
%
 
 
 
3.6
%
 
 
As a percent of total revenues:
 
 
 
 
 
 
 
Medicare revenues
27.6
%
 
 
 
29.1
%
 
 
Medicaid revenues
50.5
%
 
 
 
48.1
%
 
 
Managed Care revenues
6.8
%
 
 
 
7.0
%
 
 
Average rate per day:
 
 
 
 
 
 
 
Medicare
$
456.91

 
  
 
$
457.46

 
 
Medicaid
$
168.36

 
  
 
$
165.30

 
 
Managed Care
$
388.45

 
  
 
$
384.64

 
 

28


Operating Expense
Operating expense increased in the second quarter of 2016 to $78.4 million as compared to $76.7 million in the second quarter of 2015 . The following table summarizes the expense increases attributable to our portfolio growth (in thousands):
 
Three Months Ended June 30,
 
2016
 
2015
 
Change
Same-store operating expense
$
75,276

 
$
74,320

 
$
956

2015 acquisition expense
3,109

 
2,332

 
777

Total expense
$
78,385

 
$
76,652

 
$
1,733

Operating expense increased as a percentage of revenue at 81.8% for the second quarter of 2016 as compared to 79.6% for the second quarter of 2015 . The increase is driven partially by the $0.8 million increase in operating costs attributable to the nursing center operations acquired in 2015 . Considering the aforementioned addition of the new centers, we experienced an increase of $0.7 million in health insurance premiums in  2016  compared to the prior year. Additionally, bad debt expense increased by $0.2 million in the second quarter of  2016  compared to the second quarter of  2015 .
Lease Expense
Lease expense decreased in the second quarter of 2016 to $6.9 million as compared to $7.2 million in the second quarter of 2015 . The decrease in lease expense was primarily attributable to the purchase of Clinton and Hutchinson in February 2016.
Professional Liability
Professional liability expense was $1.9 million in the second quarter of 2016 and 2015 . Our cash expenditures for professional liability costs of continuing operations were $0.9 million and $0.8 million for the second quarters of 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 and on the costs incurred in defending and settling existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.

General and Administrative Expense
General and administrative expense was $6.9 million in the second quarter of 2016 as compared to $6.3 million in the second quarter of 2015 , an increase of $0.6 million, and increased slightly as a percentage of revenue from 6.6% in 2015 to 7.2% in 2016 . The increase in general and administrative expense is primarily attributable to an increase in salaries of $0.2 million in the second quarter of 2016 compared to the second quarter of 2015 . Additionally, legal fees increased by $0.4 million in the second quarter of 2016 compared to the second quarter of 2015, related to regulatory expenses.
Depreciation and Amortization
Depreciation and amortization expense was approximately $2.1 million in the second quarter of 2016 as compared to $1.9 million in 2015 . The increase in depreciation expense relates to fixed assets at the newly leased and acquired centers.
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.
Interest Expense, Net
Interest expense was $1.2 million in the second quarter of 2016 and $1.0 million in the second quarter of 2015 , an increase of $0.2 million. The increase was primarily attributable to higher debt balances in 2016 as a result of higher outstanding borrowings on the revolving credit facility as a result of the purchase of Hutchinson and Clinton in the first quarter of 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 loss of $3.4 million before income taxes for the second quarter of 2016 as compared to income of $1.3 million for the second quarter of 2015 . The benefit for income taxes was  $1.3 million  for the  second quarter of 2016 , as compared to a provision of  $0.5 million  for the  second quarter of 2015 . The basic and diluted loss per common share from continuing operations were both $0.35 for the second quarter of 2016 as compared to both basic and diluted income per common share from continuing operations of $0.13 in the second quarter of 2015 .

29


Six Months Ended June 30, 2016 Compared With Six Months Ended June 30, 2015
Patient Revenues
Patient revenues were $193.8 million  and $191.5 million for the six months ended June 30, 2016 and 2015 , respectively, an increase of $2.3 million. The following table summarizes the revenue increases attributable to our portfolio growth (in thousands):
 
Six Months Ended June 30,
 
2016
 
2015
 
Change
Same-store revenue
$
185,876

 
$
186,697

 
$
(821
)
2015 acquisition revenue
7,874

 
4,816

 
3,058

Total revenue
$
193,750

 
$
191,513

 
$
2,237

The overall increase in revenue of $2.3 million is attributable to increased revenue contributions from acquisition activity in 2015 of $3.1 million . The same-store revenues decreased by $0.8 million in 2016 compared to the same period in 2015 , primarily driven by a 9.2% decline in Medicare census, resulting in a decrease in revenue of $4.5 million . This was offset by an increase in Medicaid and Hospice census of $0.8 million and $0.9 million , respectively, as well as an increase in Medicaid and Private payor rates of $1.6 million and $0.5 million , respectively.
The following table summarizes key revenue and census statistics for continuing operations for each period:
 
 
Six Months Ended June 30,
 
 
 
2016
 
 
 
2015
 
 
Skilled nursing occupancy
76.7
%
 
 
 
76.9
%
 
 
As a percent of total census:
 
 
 
 
 
 
 
Medicare census
12.0
%
 
 
 
13.0
%
 
 
Medicaid census
67.4
%
 
 
 
66.6
%
 
 
Managed Care census
3.7
%
 
 
 
3.8
%
 
 
As a percent of total revenues:
 
 
 
 
 
 
 
Medicare revenues
28.1
%
 
 
 
30.1
%
 
 
Medicaid revenues
49.3
%
 
 
 
47.5
%
 
 
Managed Care revenues
7.2
%
 
 
 
7.1
%
 
 
Average rate per day:
 
 
 
 
 
 
 
Medicare
$
455.15

 
  
 
$
455.59

 
 
Medicaid
$
167.86

 
  
 
$
164.85

 
 
Managed Care
$
391.86

 
  
 
$
388.67

 
 

30


Operating Expense
Operating expense increased in 2016 to $157.0 million as compared to $153.8 million in 2015 . The following table summarizes the expense increases attributable to our portfolio growth (in thousands):
 
Six Months Ended June 30,
 
2016
 
2015
 
Change
Same-store operating expense
$
150,715

 
$
149,858

 
$
857

2015 acquisition expense
6,288

 
3,939

 
2,349

Total expense
$
157,003

 
$
153,797

 
$
3,206

Operating expense increased as a percentage of revenue at 81.0% for 2016 as compared to 80.3% for 2015 . The majority of the $3.2 million increase in operating expenses is attributable to the nursing center operations assumed in 2015 , amounting to $2.3 million . Additionally, our same-store centers bad debt expense and bad debt crossovers increased by $0.3 million and $0.3 million , respectively. Health insurance premiums and provider taxes increased by $0.5 million and $0.3 million , respectively, which was partially offset by a $0.3 million decrease in nursing and ancillary expenses. Wages and related payroll taxes decreased by $0.4 million year over year.
Lease Expense
Lease expense decreased in 2016 to $14.1 million as compared to $14.3 million in 2015 . The decrease in lease expense was primarily attributable to the purchase of Clinton and Hutchinson in February 2016.
Professional Liability
Professional liability expense was $4.0 million in 2016 compared to $4.1 million in 2015 , a decrease of $0.1 million . Our cash expenditures for professional liability costs of continuing operations were $1.5 million and $1.6 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 and on the costs incurred in defending and settling existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.

General and Administrative Expense
General and administrative expense was $13.6 million in 2016 as compared to $12.4 million in 2015 , an increase of $1.2 million , and increased slightly as a percentage of revenue from 6.5% in 2015 to 7.0% in 2016 . The increase in general and administrative expense is partially attributable to an increase in salaries of $0.4 million in 2016 compared to 2015 . Additionally, legal and consulting fees increased by $0.2 million and $0.2 million, respectively, in 2016 compared to 2015 , related to regulatory expenses.
Depreciation and Amortization
Depreciation and amortization expense was approximately $4.1 million in 2016 as compared to $3.7 million in 2015 . The increase in depreciation expense relates to fixed assets at the newly leased and acquired centers.
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.
Interest Expense, Net
Interest expense was $2.2 million in 2016 and $2.0 million in 2015 , an increase of $0.2 million . The increase was primarily attributable to higher debt balances in 2016 as a result of higher outstanding borrowings on the revolving credit facility as a result of the purchase of Hutchinson and Clinton during the first quarter of 2016.
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 .

31


Income (loss) from Continuing Operations before Income Taxes; Income (loss) from Continuing Operations per Common Share
As a result of the above, continuing operations loss of $3.6 million before income taxes for 2016 as compared to income of $1.4 million in 2015 . The benefit for income taxes was  $1.3 million  for the six months ended June 30, 2016 , as compared to a provision of  $0.5 million  for the six months ended June 30, 2015 . The basic and diluted loss per common share from continuing operations were both $0.36 for 2016 as compared to both basic and diluted income per common share from continuing operations of $0.13 in 2015 .
Liquidity and Capital Resources
Liquidity
Our primary source of liquidity is the net cash flow provided by the operating activities of our centers. We believe that these internally generated cash flows will be adequate to service existing debt obligations, fund required capital expenditures as well as provide cash flows for investing opportunities. In determining priorities for our cash flow, we evaluate alternatives available to us and select the ones that we believe will most benefit us over the long-term. Options for our cash include, but are not limited to, capital improvements, dividends, purchase of additional shares of our common stock, acquisitions, payment of existing debt obligations, preferred stock redemptions as well as initiatives to improve nursing center performance. We review these potential uses and align them to our cash flows with a goal of achieving long-term success.
Net cash provided by operating activities of continuing operations totaled $8.0 million in the six months ended June 30, 2016 , compared to $0.3 million in the same period of 2015 .
Our cash expenditures related to professional liability claims of continuing operations were $1.5 million and $1.6 million for six months ended June 30, 2016 and 2015 , respectively. 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 $8.4 million and $6.9 million in 2016 and 2015 , respectively. The increase is primarily attributable to the asset purchases of Hutchinson and Clinton in February 2016.
Financing activities of continuing operations provided cash of $1.8 million in 2016 primarily due to the new debt associated with the Company's refinance and repayments of debt obligations. In 2015 , financing activities of continuing operations provided cash of $10.1 million primarily the acquisition of the Glasgow nursing center.

Dividends
On August 2, 2016 , the Board of Directors declared a quarterly dividend of $0.055 per common share payable to shareholders of record as of September 30, 2016 , to be paid on October 14, 2016 . 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.
Professional Liability
The Company has professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. Effective July 1, 2013, the Company established a wholly-owned, offshore limited purpose insurance subsidiary, SHC Risk Carriers, Inc. (“SHC”), to replace some of the expiring commercial policies. SHC covers losses up to specified limits per occurrence. On a per claim basis, coverage for losses in excess of those covered by SHC are maintained through unaffiliated commercial reinsurance carriers. All of the Company's nursing centers in Florida and Tennessee, as well as the Company’s formerly operated Arkansas and West Virginia facilities, are now covered under the captive insurance policies along with most of the nursing centers in Alabama, Kentucky, Ohio, and Texas. The insurance coverage provided for these centers under the SHC policy include coverage limits of $0.5 million or $1.0 million per medical incident with a sublimit per center of $1.0 million and total annual aggregate policy limits of $5.0 million . All other centers within the Company’s portfolio are covered through various commercial insurance policies which provide coverage limits of $1.0 million per claim and have sublimits of $3.0 million per center, with varying aggregate policy limits and deductibles. 
As of June 30, 2016 , we have recorded total liabilities for reported and settled professional liability claims and estimates for incurred, but unreported claims of $20.3 million . Our calculation of this estimated liability is based on an assumption that the Company will not incur a severely adverse judgment with respect to any asserted claim; however, a significant judgment could be entered against us in one or more of these legal actions, and such a judgment could have a material adverse impact on our financial position and cash flows.

32


Capital Resources
As of June 30, 2016 , we had $65.6 million of outstanding long-term debt and capital lease obligations. The $65.6 million total includes $0.5 million in capital lease obligations and $5.5 million currently outstanding on the revolving credit facility. The balance of the long-term debt is comprised of $59.6 million owed on our mortgage loan.
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 $100.0 million allocated between a $72.5 million Mortgage Loan ("Amended Mortgage Loan") and a $27.5 million Revolver ("Amended Revolver"). The Amended Mortgage Loan consists of a $60 million term loan facility and a $12.5 million acquisition loan facility. Loan acquisition costs associated with the Amended Mortgage Loan and the Amended Revolver were capitalized in the amount of $1.8 million and are being amortized over the five -year term of the agreements. Additionally, the Glasgow term loan balance 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 $72.5 million with a five -year maturity through February 26, 2021, and a $27.5 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 June 30, 2016 , the interest rate related to the Amended Mortgage Loan was 4.46% . The Amended Mortgage Loan is secured by seventeen owned nursing centers, related equipment and a lien on the accounts receivable of these centers. The Amended Mortgage Loan and the Amended Revolver are cross-collateralized. The Company’s Amended Revolver has an interest rate of LIBOR plus 4.0% 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.
As of June 30, 2016 , the Company had $5.5 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 facilities as these facilities proceed through the change in ownership process with CMS. Annual fees for letters of credit issued under the Amended Revolver are 3.00% of the amount outstanding. The Company has ten letters of credit with a total value of $7.9 million outstanding as of June 30, 2016 . Considering the balance of eligible accounts receivable, the letters of credit, the amounts outstanding under the revolving credit facility and the maximum loan amount of $27.5 million , the balance available for borrowing under the Amended Revolver is $10.8 million at June 30, 2016 .
Our lending agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. As of June 30, 2016 , the Company was compliant with the amended covenants as described in Note 10 to the interim consolidated financial statements.
Our calculated compliance with financial covenants is presented below:
 
 
Requirement
  
Level at
June 30, 2016
Minimum fixed charge coverage ratio
1.00:1.00
 
1.03:1.00
Minimum adjusted EBITDA
$9.5 million
 
$9.8 million
EBITDAR (mortgaged centers)
$10.0 million
 
$13.7 million
Current ratio (as defined in agreement)
1.00:1.00
 
1.33:1.00
As part of the debt agreements entered into in February 2016, we amended our 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 us 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.

33


Receivables
Our operations could be adversely affected if we experience significant delays in reimbursement from Medicare, Medicaid or other third-party revenue sources. Our future liquidity will continue to be dependent upon the relative amounts of current assets (principally cash, accounts receivable and inventories) and current liabilities (principally accounts payable and accrued expenses). In that regard, accounts receivable can have a significant impact on our liquidity. Continued efforts by governmental and third-party payors to contain or reduce the acceleration of costs by monitoring reimbursement rates, by increasing medical review of bills for services, or by negotiating reduced contract rates, as well as any delay by us in the processing of our invoices, could adversely affect our liquidity and results of operations.
Accounts receivable attributable to patient services of continuing operations totaled $49.3 million at June 30, 2016 compared to $52.0 million at December 31, 2015 , representing approximately 46 days and 45 days revenue in accounts receivable, respectively. The decrease in accounts receivable is due to an increase in Medicaid collections from the centers undergoing the change in ownership process.
The allowance for bad debt was $9.2 million at June 30, 2016 as compared to $8.2 million at December 31, 2015 . We continually evaluate the adequacy of our bad debt reserves based on patient mix trends, aging of older balances, payment terms and delays with regard to third-party payors, collateral and deposit resources, as well as other factors. We continue to evaluate and implement additional procedures to strengthen our collection efforts and reduce the incidence of uncollectible accounts.
Off-Balance Sheet Arrangements
We have ten letters of credit outstanding with an aggregate value of approximately $7.9 million as of June 30, 2016 , the first of which serves as a security deposit for our facility lease with Omega in the amount of $4.6 million . The second letter of credit serves our initial funding of insurance policies with a captive insurance company in the amount of $1.0 million . The balance of the outstanding letters of credit relate to deposits at various leased facilities where the Company opted to issue letters of credit as a deposit in lieu of cash. These letters of credit were issued under our revolving credit facility. Our accounts receivable serve as the collateral for this revolving credit facility.

Forward-Looking Statements
The foregoing discussion and analysis provides information deemed by management to be relevant to an assessment and understanding of our consolidated results of operations and financial condition. This discussion and analysis should be read in conjunction with our consolidated financial statements included herein. Certain statements made by or on behalf of us, including those contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those contemplated by the forward-looking statements made herein. 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 operate the nursing centers in Alabama, Kansas, Kentucky, Missouri, Ohio, and Indiana, our ability to increase census at our renovated centers, changes in governmental reimbursement, including the impact of the CMS final rule that has resulted in a reduction in Medicare reimbursement 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” in our annual report on Form 10-K for the year ended December 31, 2015 , 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

34


important factors that could cause our actual results to materially differ from those projected in forward-looking statements. In addition, we disclaim any intent or obligation to update these forward-looking statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The chief market risk factor affecting our financial condition and operating results is interest rate risk. As of June 30, 2016 , we had outstanding borrowings of approximately $65.1 million , $35.5 million of which was subject to variable interest rates. In connection with our February 2016 financing agreement, we entered into an interest rate swap with an initial notional amount of $30.0 million to mitigate the floating interest rate risk of a portion of such borrowing. In the event that interest rates were to change 1%, the impact on future pre-tax cash flows would be approximately $0.4 million annually, representing the impact of increased or decreased interest expense on variable rate debt.

ITEM 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the Exchange Act), our management, including our chief executive officer and chief financial officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of June 30, 2016 . Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act, such as this Quarterly Report on Form 10-Q, is properly recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission’s rules and forms. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can provide only reasonable assurance regarding management’s control objectives. Management does not expect that its disclosure controls and procedures will prevent all errors and fraud. A control system, irrespective of how well it is designed and operated, can only provide reasonable assurance, and cannot guarantee that it will succeed in its stated objectives.
Based on an evaluation of the effectiveness of the design and operation of disclosure controls and procedures, our chief executive officer and chief financial officer concluded that, as of June 30, 2016 , our disclosure controls and procedures were effective in reaching a reasonable level of assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms.

PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The provision of health care services entails an inherent risk of liability. Participants in the health care industry are subject to lawsuits alleging malpractice, 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 facility. 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 June 30, 2016 , we are engaged in 55 professional liability lawsuits. Ten 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 had commenced a civil investigation of potential violations of the 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 facilities 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 to our practices and policies for rehabilitation, and other services, our PAEs required by TennCare and our PASSRs submitted to TennCare. We have responded to those requests and are providing additional information to DOJ. The DOJ’s civil investigation now covers all of the Company’s facilities, but thus far only documents from
six of our facilities 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 PASSRs. The Company intends to provide documents responsive to the subpoena. The Company cannot predict the outcome of these investigations or any possible related proceedings, and the outcome could have a materially adverse effect on the Company, including the imposition of 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 “Facility”). The complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Facility over the five-year period prior to the filing of the complaints. On June 4, 2015, the Supreme Court of Arkansas issued a ruling in a lawsuit against another provider that may impact this action. In that case, the Court ruled that a lawsuit against several facilities formerly operated by Golden Living could proceed as a class action. The lawsuit against the Company 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 facilities. 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 6. EXHIBITS
The exhibits filed as part of this report on Form 10-Q are listed in the Exhibit Index immediately following the signature page.

35


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
Diversicare Healthcare Services, Inc.
 
 
 
August 4, 2016
 
 
 
 
 
 
 
By:
 
/s/ Kelly J. Gill
 
 
 
Kelly J. Gill
 
 
 
President and Chief Executive Officer, Principal Executive Officer and
 
 
 
An Officer Duly Authorized to Sign on Behalf of the Registrant
 
 
 
 
By:
 
/s/ James R. McKnight, Jr.
 
 
 
James R. McKnight, Jr.
 
 
 
Executive Vice President and Chief Financial Officer and
 
 
 
An Officer Duly Authorized to Sign on Behalf of the Registrant

36


 
 
 
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.
 
 
 
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

 
Amendment to Diversicare Healthcare Services, Inc. 2008 Employee Stock Purchase Plan for Key Personnel
 
 
 
10.2

 
First Amendment to Third Amended and Restated Revolving Loan and Security Agreement dated August 3, 2016.
 
 
 
10.3

 
First Amendment to Second Amended and Restated Term Loan and Security Agreement dated August 3, 2016.
 
 
 
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.


37


CERTIFICATE OF AMENDMENT
OF CERTIFICATE OF INCORPORATION
OF
DIVERSICARE HEALTHCARE SERVICES, INC.
Diversicare Healthcare Services, Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, (the “DGCL”), acting pursuant to Section 242 of the DGCL, does hereby certify that:
1.    The Certificate of Incorporation of the Corporation is hereby amended by deleting in its entirety Item 3. of Article NINTH thereof and inserting the following in lieu thereof:
“3.    Beginning with 2016 annual meeting of stockholders and at each annual meeting thereafter, the term of office of each director elected at the annual meeting of stockholders, or elected or appointed at any time in the period between annual meetings of stockholders, shall expire at the next annual meeting of stockholders following such election or appointment. Nothing in this Item 3 of ARTICLE NINTH shall shorten the term of any director elected before the 2016 annual meeting of stockholders. Each director elected or appointed shall serve until his or her successor is elected and qualified, or until his or her earlier death, resignation, removal, or disqualification.”
2.    The foregoing amendment to the Certificate of Incorporation of the Corporation has been duly adopted in accordance with Sections 242, 141(f) (by the directors of the Corporation), and 211 (at the annual meeting of the stockholders of the Corporation) of the DGCL.
IN WITNESS WHEREOF, this Certificate of Amendment has been executed by a duly authorized officer of the Corporation on this 9th day of June, 2016.

DIVERSICARE HEALTHCARE SERVICES, INC.

By:     /s/ Kelly J. Gill            
Name:    Kelly J. Gill
Title:    President and Chief Executive Officer


16723746.1




AMENDMENT 2 TO
DIVERSICARE HEALTHCARE SERVICES, INC.
2008 EMPLOYEE STOCK PURCHASE PLAN FOR KEY PERSONNEL
1.    Section 4.1(a) of the Plan is hereby deleted in its entirety and replaced with the following:
4.    Stock Subject to Plan
(a)
The maximum number of Shares that may be collectively distributed as Restricted Shares, Restricted Share Units, and any Dividend Equivalent paid upon any Restricted Share Units under the Plan is 350,000 Shares, which number will be subject to adjustment as provided in Section 9 hereof. Such Shares may be either authorized but unissued Shares or Shares that have been or may be reacquired by the Company.
2.    Section 14 of the Plan is hereby deleted in its entirety and replaced with the following:
14.    Term of the Plan.
The Plan shall terminate April 25, 2028. No other purchases may be made after such termination, but termination of the Plan shall not, without the consent of any Participant who then holds Restricted Shares and/or Restricted Share Units, alter or impair any rights or obligations in respect of such Restricted Shares or Restricted Share Units.


0

FIRST AMENDMENT TO THIRD
AMENDED AND RESTATED REVOLVING LOAN AND SECURITY AGREEMENT

THIS FIRST AMENDMENT TO THIRD AMENDED AND RESTATED REVOLVING LOAN AND SECURITY AGREEMENT (this “ Amendment ”) dated as of August 3, 2016, is by and among THE PRIVATEBANK AND TRUST COMPANY , an Illinois banking corporation (together with its successors and assigns, “ Administrative Agent ”) in its capacity as administrative agent for the Lenders (as defined below), the Lenders, DIVERSICARE MANAGEMENT SERVICES CO. , a Tennessee corporation, and certain of its affiliates parties hereto identified on the signature pages as “Borrower” (individually and collectively, “ Borrower ”).
RECITALS :
WHEREAS , Borrower, Administrative Agent, and the financial institutions signatories thereto (the “ Lenders ”) are parties to that certain Third Amended and Restated Revolving Loan and Security Agreement dated as of February 26, 2016 (as amended, restated, supplemented or otherwise modified from time to time, the “ Loan Agreement ”; all capitalized terms used but not defined herein shall have the meanings ascribed thereto in the Loan Agreement as amended by this Amendment); and
WHEREAS , Borrower, Administrative Agent and Lenders desire to amend the Loan Agreement as provided in and subject to the terms and conditions of this Amendment.
NOW, THEREFORE , for and in consideration of the mutual covenants and agreements contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto (intending to be legally bound) hereby agree as follows:
1. Amendments to Loan Agreement . Subject to the satisfaction of the conditions set forth in Section 4 below and in reliance upon the representations and warranties set forth in Section 3 below, Borrower, Administrative Agent and Lenders hereby amend the Loan Agreement as follows:
(a)
     Effective as of the date first written above, the definition of “Libor Base Rate” contained in Section 1.1 of the Loan Agreement is hereby amended by adding the following sentence at the end of such definition: “Notwithstanding anything contained herein to the contrary, at no time shall the Libor Base Rate be less than zero percent (0.0%).”
(b)
     Effective as of June 30, 2016, Section 9.12(a) of the Loan Agreement is hereby amended and restated in its entirety as follows:
(a)     Minimum Fixed Charge Coverage Ratio . The Parent and Borrowers, taken as a whole, shall not permit their Fixed Charge Coverage Ratio to be less than (i) 1.00 to 1.00, for the Fiscal Quarters ending June 30, 2016, September 30, 2016 and December 31, 2016, and (ii) 1.05 to 1.00, for the Fiscal Quarter ending March 31, 2017, and for each Fiscal Quarter thereafter, each measured on the last day of the applicable Fiscal Quarter on a trailing twelve (12) month basis.
(c)
     Effective as of June 30, 2016, Section 9.12(b) of the Loan Agreement is hereby amended and restated in its entirety as follows:
(b)     Minimum Adjusted EBITDA . The Parent and Borrowers, taken as a whole, shall not permit their Adjusted EBITDA to be less than (i) $9,500,000 for the Fiscal Quarter ending June 30, 2016, (ii) $8,500,000 for the Fiscal Quarter ending September 30, 2016, (iii) $9,500,000 for the Fiscal Quarter ending December 31, 2016, and (iv) $10,000,000 for the Fiscal Quarter ending March 31, 2017, and for each Fiscal Quarter thereafter, each measured on the last day of the applicable Fiscal Quarter on a trailing twelve (12) month basis.
2.
     No Other Amendments . Borrower acknowledges and expressly agrees that this Amendment is limited to the extent expressly set forth herein and shall not constitute a modification or amendment of the Loan Agreement or any other Financing Agreements or a course of dealing at variance with the terms or conditions of the Loan Agreement or any other Financing Agreements (other than as expressly set forth in this Amendment).
3.
     Representations and Warranties . In order to induce Administrative Agent and Lenders to enter into this Amendment, Borrower hereby represents and warrants to Administrative Agent and Lenders (which representations and warranties shall survive the execution and delivery hereof), both before and after giving effect to this Amendment that:
(a)
     Each of the representations and warranties of each Borrower contained in the Loan Agreement and the other Financing Agreements to which Borrower is a party are true and correct in all material respects (without duplication of any materiality carve out already provided therein) on and as of the date hereof, in each case as if made on and as of such date, other than representations and warranties that expressly relate solely to an earlier date (in which case such representations and warranties were true and correct on and as of such earlier date);
(b)
     Borrower has the corporate or limited liability company (as applicable) power and authority (i) to enter into the Loan Agreement as amended by this Amendment and (ii) to do all acts and things as are required or contemplated hereunder to be done, observed and performed by Borrower;
(c)
     This Amendment has been duly authorized, validly executed and delivered by one or more Duly Authorized Officers of Borrower, and each of this Amendment, the Loan Agreement as amended hereby, and each of the other Financing Agreements to which Borrower is a party, constitutes the legal, valid and binding obligations of Borrower, enforceable against Borrower in accordance with their respective terms, subject to bankruptcy, insolvency or other similar laws affecting the enforcement of creditor’s rights and remedies generally;
(d)
     The execution and delivery of this Amendment and performance by Borrower under this Amendment, the Loan Agreement and each of the other Financing Agreements to which Borrower is a party do not and will not require the consent or approval of any regulatory authority or governmental authority or agency having jurisdiction over Borrower that has not already been obtained, nor be in contravention of or in conflict with the organizational documents of Borrower, or any provision of any statute, judgment, order, indenture, instrument, agreement, or undertaking, to which Borrower is party or by which Borrower’s respective assets or properties are bound; and
(e)
     No Default or Event of Default will result after giving effect to this Amendment, and no event has occurred that has had or could reasonably be expected to have a Material Adverse Effect after giving effect to this Amendment.
4.
     Conditions Precedent to Effectiveness of this Amendment . The amendments contained in Section 1 hereof shall become effective as long as each of the following conditions precedent is satisfied as determined by Administrative Agent:
(a)
     all of the representations and warranties of Borrower under Section 3 hereof, which are made as of the date hereof, are true and correct;
(b)
     the payment by Borrower to Administrative Agent for the ratable benefit of Lenders of a covenant modification fee in the amount of Seventy-Five Thousand and No/100 Dollars ($75,000.00), which fee shall be non-refundable and deemed fully earned on the date of payment;
(c)
     receipt by Administrative Agent of duly executed signature pages to this Amendment from Borrower and Lenders;
(d)
     Administrative Agent shall have received a duly executed Reaffirmation of Second Amended and Restated Guaranty in the form attached hereto; and
(e)
     receipt by Administrative Agent of such other certificates, schedules, exhibits, documents, opinions, instruments, reaffirmations, amendments or consents Administrative Agent may reasonably require, if any.
5.
     Reaffirmation; References to Loan Agreement; Etc.
(a)    Borrower acknowledges and agrees that all of Borrower’s obligations and Liabilities under the Loan Agreement and the other Financing Agreements, as amended hereby, are and shall be valid and enforceable and shall not be impaired or limited by the execution or effectiveness of this Amendment. The first priority perfected security interests and Liens and rights in the Collateral securing payment of the Liabilities are hereby ratified and confirmed by Borrower in all respects.
(b)    Upon the effectiveness of this Amendment, each reference in the Loan Agreement to “this Agreement,” “hereunder,” “hereof,” “herein” or words of like import shall mean and be a reference to the Loan Agreement, as amended by this Amendment.
(c)    The failure by Administrative Agent, at any time or times hereafter, to require strict performance by any Borrower of any provision or term of the Loan Agreement, this Amendment or any of the Financing Agreements shall not waive, affect or diminish any right of Administrative Agent hereafter to demand strict compliance and performance herewith or therewith. Any suspension or waiver by Administrative Agent of a breach of this Amendment or any Event of Default under or pursuant to the Loan Agreement shall not, except as expressly set forth in a writing signed by Administrative Agent, suspend, waive or affect any other breach of this Amendment or any Event of Default under or pursuant to the Loan Agreement, whether the same is prior or subsequent thereto and whether of the same or of a different kind or character. None of the undertakings, agreements, warranties, covenants and representations of any Borrower contained in this Amendment, shall be deemed to have been suspended or waived by Administrative Agent unless such suspension or waiver is (i) in writing and signed by Administrative Agent (and, if applicable, the Required Lenders) and (ii) delivered to Borrower by Administrative Agent or its counsel.
(d)    In no event shall Administrative Agent’s execution and delivery of this Amendment establish a course of dealing among Administrative Agent, any Borrower, pledgor or Guarantor or any other obligor, or in any other way obligate Administrative Agent to hereafter provide any amendments or modifications or, if at any time applicable, consents or waivers with respect to the Loan Agreement or any other Financing Agreement. The terms and provisions of this Amendment shall be limited precisely as written and shall not be deemed (x) to be a consent to any amendment or modification of any other term or condition of the Loan Agreement or of any of the Financing Agreements (except as expressly provided herein); or (y) to prejudice any right or remedy which Administrative Agent may now have under or in connection with the Loan Agreement or any of the other Financing Agreements. In the event an ambiguity or question of intent or interpretation arises, this Amendment shall be construed as if drafted jointly by the parties hereto, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any of the provisions of this Amendment.
(e)    Except as expressly provided herein, the Loan Agreement and all of the other Financing Agreements shall remain unaltered, and the Loan Agreement and all of the other Financing Agreements shall remain in full force and effect and are hereby ratified and confirmed in all respects.
6.
     Release
(a)    In consideration of, among other things, the consent and amendments provided for herein, and for other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, Borrower and Guarantor (on behalf of themselves and their respective subsidiaries, Affiliates, successors and assigns), and, to the extent permitted by applicable law and the same is claimed by right of, through or under the above, for their past, present and future employees, directors, members, managers, partners, agents, representatives, officers, directors, and equity holders (all collectively, with Borrower and Guarantor, the “ Releasing Parties ”), do hereby unconditionally, irrevocably, fully, and forever remise, satisfy, acquit, release and discharge Administrative Agent, Issuing Lender, and Lenders and each of Administrative Agent’s, Issuing Lender’s and Lender’s past, present and future officers, directors, agents, employees, attorneys, parent, shareholders, successors, assigns, subsidiaries and Affiliates and all other persons and entities to whom Administrative Agent or Lenders would be liable if such persons or entities were found in any way to be liable to any of the Releasing Parties (collectively, the “ Lender Parties ”), of and from any and all manner of action and actions, cause and causes of action, claims, cross-claims, charges, demands, counterclaims, suits, proceedings, disputes, debts, dues, sums of money, accounts, bonds, covenants, contracts, controversies, damages, judgments, liabilities, damages, costs, expenses, executions, liens, claims of liens, claims of costs, penalties, attorneys’ fees, or any other compensation, recovery or relief on account of any liability, obligation, demand, proceedings or cause of action of whatever nature, whether in law, equity or otherwise (including, without limitation, those arising under 11 U.S.C. §§ 541-550 and interest or other carrying costs, penalties, legal, accounting and other professional fees and expenses, and incidental, consequential and punitive damages payable to third parties), whether known or unknown, fixed or contingent, joint and/or several, secured or unsecured, due or not due, primary or secondary, liquidated or unliquidated, contractual or tortious, direct, indirect, or derivative, asserted or unasserted, foreseen or unforeseen, suspected or unsuspected, now existing, heretofore existing or which may have heretofore accrued against any or all of Lender Parties, whether held in a personal or representative capacity, that the Releasing Parties (or any of them) have or may have against the Lender Parties or any of them (whether directly or indirectly) and which are based on any act, fact, event, action or omission or any other matter, condition, cause or thing occurring at or from any time prior to and including the date hereof in any way, directly or indirectly arising out of, connected with or relating to this Amendment, the Loan Agreement or any other Financing Agreement and the transactions contemplated hereby and thereby, the Collateral or the Liabilities, and all other agreements, certificates, instruments and other documents and statements (whether written or oral) related to any of the foregoing, other than any applicable good faith claim as to which a final determination is made in a judicial proceeding (in which Administrative Agent and any of the Released Parties have had an opportunity to be heard) which determination includes a specific finding that Administrative Agent acted in a grossly negligent manner or with actual willful misconduct or illegal activity. Borrower and Guarantor each acknowledges that Administrative Agent and Lenders are specifically relying upon the representations, warranties and agreements contained herein and that such representations, warranties and agreements constitute a material inducement to Administrative Agent and Lenders in entering into this Amendment.
(b)    Borrower and Guarantor each understands, acknowledges and agrees that the release set forth above may be pleaded as a full and complete defense and may be used as a basis for an injunction against any action, suit or other proceeding which may be instituted, prosecuted or attempted in breach of the provisions of such release.
(c)    To the furthest extent permitted by law, Borrower and Guarantor each hereby knowingly, voluntarily, intentionally and expressly waives and relinquishes any and all rights and benefits that it respectively may have as against Lender Parties under any law, rule or regulation of any jurisdiction that would or could have the effect of limiting the extent to which a general release extends to claims which a Lender Party or Releasing Party does not know or suspect to exist as of the date hereof. Borrower and Guarantor each hereby acknowledges that the waiver set forth in the prior sentence was separately bargained for and that such waiver is an essential term and condition of this Amendment.
7.
     Costs and Expenses . Without limiting the obligation of Borrower to reimburse Administrative Agent for all costs, fees, disbursements and expenses incurred by Administrative Agent as specified in the Loan Agreement, Borrower agrees to and shall pay on demand all reasonable costs, fees, disbursements and expenses of Administrative Agent in connection with the preparation, negotiation, revision, execution and delivery of this Amendment and the other agreements, amendments, modifications, reaffirmations, instruments and documents contemplated hereby, including, without limitation, reasonable attorneys’ fees and out-of-pocket expenses. All obligations provided herein shall survive any termination of this Amendment and the Loan Agreement as amended hereby.
8.
     Financing Agreement . This Amendment shall constitute a Financing Agreement.
9.
     Titles. Titles and section headings herein shall be without substantive meaning and are provided solely for the convenience of the parties.
10.
     Severability; Etc. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Amendment shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provisions or the remaining provisions of this Amendment. The parties hereto have participated jointly in the negotiation and drafting of this Amendment. In the event an ambiguity or question of intent or interpretation arises, this Amendment shall be construed as if drafted jointly by the parties hereto, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any of the provisions of this Amendment.
11.
     Successors and Assigns . This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns; provided , however , no Borrower may assign any of its respective rights or obligations under this Amendment without the prior written consent of Administrative Agent.
12.
     Further Assurances . Borrower shall, at its own cost and expense, cause to be promptly and duly taken, executed, acknowledged and delivered all such further acts, certificates, instruments, reaffirmations, amendments, documents and assurances as may from time to time be necessary or as Administrative Agent may from time to time reasonably request in order to more fully carry out the intent and purposes of this Amendment.
13.
     Counterparts; Faxes . This Amendment may be executed in multiple counterparts, each of which shall be deemed to be an original and all of which when taken together shall constitute one and the same agreement. A signature hereto sent or delivered by facsimile or other electronic transmission shall be as legally binding and enforceable as a signed original for all purposes.
14.
     Governing Law . This Amendment shall be governed by and construed and enforced in accordance with the internal laws of the State of Illinois, without regard to conflict of law principles that would require the application of any other laws.
[Signature Page Follows]

IN WITNESS WHEREOF , the parties hereto have duly executed this First Amendment to Third Amended and Restated Revolving Loan and Security Agreement as of the day and year first above written.

BORROWER :
ADVOCAT FINANCE, INC.
DIVERSICARE MANAGEMENT SERVICES CO.
DIVERSICARE LEASING CORP.
STERLING HEALTH CARE MANAGEMENT, INC.

By:
/s/ James R. McKnight, Jr.
Name:
James R. McKnight, Jr.
Its:
Executive Vice President & Chief Financial Officer
SENIOR CARE CEDAR HILLS, LLC
SENIOR CARE GOLFCREST, LLC
SENIOR CARE GOLFVIEW, LLC
SENIOR CARE SOUTHERN PINES, LLC
BY:
SENIOR CARE FLORIDA LEASING, LLC , its sole member
 
BY:
DIVERSICARE LEASING CORP. , its sole member
 
By:
/s/ James R. McKnight, Jr.
 
Name:
James R. McKnight, Jr.
 
Its:
Executive Vice President & Chief Financial Officer



SENIOR CARE FLORIDA LEASING, LLC
DIVERSICARE AFTON OAKS, LLC
DIVERSICARE BRIARCLIFF, LLC
DIVERSICARE CHISOLM, LLC
DIVERSICARE HARTFORD, LLC
DIVERSICARE HILLCREST, LLC
DIVERSICARE LAMPASAS, LLC
DIVERSICARE PINEDALE, LLC
DIVERSICARE WINDSOR HOUSE, LLC
DIVERSICARE YORKTOWN, LLC
DIVERSICARE ROSE TERRACE, LLC
DIVERSICARE THERAPY SERVICES, LLC
DIVERSICARE CLINTON, LLC
DIVERSICARE HIGHLANDS, LLC

BY:
DIVERSICARE LEASING CORP. , its sole member
 
By:
/s/ James R. McKnight, Jr.
 
Name:
James R. McKnight, Jr.
 
Its:
Executive Vice President & Chief Financial Officer
 


DIVERSICARE BALLINGER, LLC
DIVERSICARE DOCTORS, LLC
DIVERSICARE ESTATES, LLC
DIVERSICARE HUMBLE, LLC
DIVERSICARE KATY, LLC
DIVERSICARE TREEMONT, LLC
DIVERSICARE PARIS, LLC  
BY:
DIVERSICARE TEXAS I, LLC , its sole member
 
By:
/s/ James R. McKnight, Jr.
 
Name:
James R. McKnight, Jr.
 
Its:
Executive Vice President & Chief Financial Officer

DIVERSICARE TEXAS I, LLC
By:
/s/ James R. McKnight, Jr.
Name:
James R. McKnight, Jr.
Its:
Executive Vice President & Chief Financial Officer
DIVERSICARE OF CHANUTE, LLC
DIVERSICARE OF COUNCIL GROVE, LLC
DIVERSICARE OF HAYSVILLE, LLC
DIVERSICARE OF SEDGWICK, LLC
DIVERSICARE OF HUTCHINSON, LLC
DIVERSICARE OF LARNED, LLC
BY:
DIVERSICARE KANSAS, LLC
its sole member
 
 
 
By:
/s/ James R. McKnight, Jr.
 
Name:
James R. McKnight, Jr.
 
Its:
Executive Vice President & Chief Financial Officer


DIVERSICARE HOLDING COMPANY, LLC

By:___ /s/ James R. McKnight, Jr. ______
Name:
James R. McKnight, Jr.
Its:
Executive Vice President & Chief Financial Officer


DIVERSICARE KANSAS, LLC

By:___ /s/ James R. McKnight, Jr. ______
Name:
James R. McKnight, Jr.
Its:
Executive Vice President & Chief Financial Officer

DIVERSICARE LEASING COMPANY II, LLC
 
By:___ /s/ James R. McKnight, Jr. ______
Name:
James R. McKnight, Jr.
Its:
Executive Vice President & Chief Financial Officer


DIVERSICARE OF SENECA PLACE, LLC
DIVERSICARE OF BRADFORD PLACE, LLC
DIVERSICARE OF PROVIDENCE, LLC
DIVERSICARE OF SIENA WOODS, LLC
DIVERSICARE OF ST. THERESA, LLC
DIVERSICARE OF BIG SPRINGS, LLC
DIVERSICARE OF NICHOLASVILLE, LLC
DIVERSICARE OF AVON, LLC
DIVERSICARE OF MANSFIELD, LLC
DIVERSICARE OF RIVERSIDE, LLC
DIVERSICARE OF CHATEAU, LLC
DIVERSICARE OF ST. JOSEPH, LLC
DIVERSICARE OF GREENVILLE, LLC


By:
DIVERSICARE LEASING COMPANY II, LLC, its sole member

By:___ /s/ James R. McKnight, Jr. ______
Name:
James R. McKnight, Jr.
Its:
Executive Vice President & Chief Financial Officer




DIVERSICARE OF GLASGOW, LLC
DIVERSICARE OF FULTON, LLC

By:    DIVERSICARE HOLDING COMPANY, LLC, its sole member


By:___ /s/ James R. McKnight, Jr. ______    
Name: James R. McKnight, Jr.
Its:
Executive Vice President & Chief
Financial Officer

DIVERSICARE PROPERTY CO., LLC


By:___ /s/ James R. McKnight, Jr. ______
Name: James R. McKnight, Jr.
Its:    Executive Vice President & Chief Financial Officer
DIVERSICARE AFTON OAKS PROPERTY, LLC
DIVERSICARE BRIARCLIFF PROPERTY, LLC
DIVERSICARE CHANUTE PROPERTY, LLC
DIVERSICARE CHISOLM PROPERTY, LLC
DIVERSICARE COUNCIL GROVE PROPERTY, LLC
DIVERSICARE HAYSVILLE PROPERTY, LLC
DIVERSICARE HARTFORD PROPERTY, LLC
DIVERSICARE HILLCREST PROPERTY, LLC

By:    DIVERSICARE PROPERTY CO., LLC, its sole member


By:___ /s/ James R. McKnight, Jr. ______    
Name: James R. McKnight, Jr.
Its:
Executive Vice President & Chief
Financial Officer


DIVERSICARE HUTCHINSON PROPERTY, LLC
DIVERSICARE LAMPASAS PROPERTY, LLC
DIVERSICARE LARNED PROPERTY, LLC
DIVERSICARE SEDGWICK PROPERTY, LLC
DIVERSICARE WINDSOR HOUSE PROPERTY, LLC
DIVERSICARE YORKTOWN PROPERTY, LLC
DIVERSICARE GLASGOW PROPERTY, LLC
DIVERSICARE CLINTON PROPERTY, LLC
DIVERSICARE FULTON PROPERTY, LLC

By:    DIVERSICARE PROPERTY CO., LLC, its sole member


By:___ /s/ James R. McKnight, Jr. ______    
Name: James R. McKnight, Jr.
Its:
Executive Vice President & Chief
Financial Officer


DIVERSICARE NORMANDY TERRACE, LLC

BY:    DIVERSICARE TEXAS I, LLC , its sole
member

By:___ /s/ James R. McKnight, Jr. ____    
Name: James R. McKnight, Jr.
Its:    Executive Vice President & Chief
    Financial Officer



Acknowledged and Agreed :
DIVERSICARE HEALTHCARE SERVICES, INC.
/s/ Kelly J. Gill
 
Name:
Kelly J. Gill
 
Its:
President and Chief Executive Officer
 


ADMINISTRATIVE AGENT :

THE PRIVATEBANK AND TRUST COMPANY , in its capacity as administrative agent

By:__ /s/ Adam D. Panos ___________________
Name: Adam D. Panos
Its: Managing Director


LENDER :

THE PRIVATEBANK AND TRUST COMPANY

By:__ /s/ Adam D. Panos __________________
Name: Adam D. Panos
Its: Managing Director


LENDER :
BANKERS TRUST COMPANY
By: __ /s/ Jon M. Doll _______________
 
Name:
Jon M. Doll
 
Its:
Vice President
 


LENDER :
BOKF, NA D/B/A BANK OF OKLAHOMA
By: __ /s/ Ryan Kirk _________________
 
Name:
Ryan Kirk
 
Its:
Vice President
 


LENDER :
CIT BANK N.A.
By: _ /s/ Edward Shuster _______________
 
Name:
Edward Shuster
 
Its:
Director
 


LENDER :
OPUS BANK ,  
a California commercial bank

By: _ /s/ Bryan Nance ________________
 
Name:
Bryan Nance
 
Its:
VP, Portfolio Manager Healthcare Banking
 


LENDER :
FRANKLIN SYNERGY BANK

By: _ /s/ Lisa Fletcher _____________
 
Name:
Lisa Fletcher
 
Its:
Senior Vice President
 



REAFFIRMATION OF SECOND AMENDED AND RESTATED GUARANTY

Dated as of: August 3, 2016
The undersigned (“ Guarantor ”) hereby (i) confirms and agrees with The PrivateBank and Trust Company, an Illinois banking corporation in its capacity as administrative agent (together with its successors and assigns, “ Administrative Agent ”) that Guarantor’s Second Amended and Restated Guaranty dated as of February 26, 2016 made in favor of Administrative Agent (as amended or modified, “ Guaranty ”), remains in full force and effect and is hereby ratified and confirmed in all respects, including with regard to the Third Amended and Restated Revolving Loan and Security Agreement dated as of February 26, 2016, as amended by the foregoing First Amendment to Third Amended and Restated Revolving Loan and Security Agreement (“ Amendment ”), and each reference to the “Loan Agreement” shall refer to the Loan Agreement as amended by the Amendment; (ii) represents and warrants to Administrative Agent, which representations and warranties shall survive the execution and delivery hereof, that Guarantor’s representations and warranties contained in the Guaranty are true and correct as of the date hereof, with the same effect as though made on the date hereof, except to the extent that such representations expressly related solely to an earlier date, in which case such representations were true and correct on and as of such earlier date (and except for the representations in Section 10(b) thereof which were true and correct on and as of the date when made); (iii) agrees and acknowledges that such ratification and confirmation is not a condition to the continued effectiveness of the Amendment or the Guaranty; and (iv) agrees that neither such ratification and confirmation, nor Administrative Agent’s solicitation of such ratification and confirmation, constitutes a course of dealing giving rise to any obligation or condition requiring a similar or any other ratification or confirmation from the undersigned with respect to subsequent amendments or modifications, if any, to the Loan Agreement, as amended by the Amendment or any other Financing Agreement (as defined in the Loan Agreement, as amended by the Amendment). The execution, delivery and effectiveness of this instrument shall not operate as a waiver of any right, power or remedy of Administrative Agent under or pursuant to the Guaranty. Guarantor acknowledges and agrees that Guarantor has received and reviewed a fully-executed copy of the Amendment (and any other instrument, document or agreement executed or delivered in connection therewith) and understands the contents thereof. A signature hereto sent or delivered by facsimile or other electronic transmission shall be as legally binding and enforceable as a signed original for all purposes. This instrument shall be governed by and construed and enforced in accordance with the internal laws of the State of Illinois, without regard to conflict of law principles that would require the application of any other laws.
[Signature Page Follows]

DIVERSICARE HEALTHCARE SERVICES, INC. (F/K/A ADVOCAT INC.)

By:     /s/ Kelly J. Gill                
Name:     Kelly J. Gill
Its:    President and Chief Executive Officer



DM3\4159170.4

FIRST AMENDMENT TO
SECOND AMENDED AND RESTATED TERM LOAN AND SECURITY AGREEMENT
THIS FIRST AMENDMENT TO SECOND AMENDED AND RESTATED TERM LOAN AND SECURITY AGREEMENT (this “ Amendment ”) is entered into as of August 3, 2016, by and among THE PRIVATEBANK AND TRUST COMPANY , an Illinois banking corporation (“ Administrative Agent ”) in its capacity as administrative agent for the Lenders (as defined below), the Lenders and the Affiliates of Diversicare Healthcare Services, Inc., identified as “Borrowers” on the signature pages hereto, each a Delaware limited liability company, each a Delaware limited liability company (individually and collectively, “ Borrower ”).
WHEREAS, Borrower, Administrative Agent, and the financial institutions thereto (the “ Lenders ”) are parties to that certain Second Amended and Restated Term Loan and Security Agreement dated as of February 26, 2016 (as amended, restated, supplemented or otherwise modified from time to time, the “ Loan Agreement ”); and
WHEREAS, Borrower, Administrative Agent and Lenders desire to amend the Loan Agreement as provided in and subject to the terms and conditions of this Amendment.
NOW, THEREFORE, for and in consideration of the mutual covenants and agreements contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto (intending to be legally bound) hereby agree as follows:
1. Defined Terms . Unless otherwise defined herein, capitalized terms used herein shall have the meanings assigned to such terms in the Loan Agreement.
2.
     Amendments to Loan Agreement . Subject to the satisfaction of the conditions set forth in Section 5 below and in reliance upon the representations and warranties set forth in Section 4 below, Borrower, Administrative Agent and Lenders hereby amend the Loan Agreement as follows:
(a)
     The definition of “Libor Base Rate” contained in Section 1.1 of the Loan Agreement is hereby amended by adding the following sentence at the end of such definition: “Notwithstanding anything contained herein to the contrary, at no time shall the Libor Base Rate be less than zero percent (0.0%).”
(b)
     Section 5.2(b) of the Loan Agreement is hereby amended and restated in its entirety as follows:
(b)     Invoices . With respect to any Acquisition Loan being requested to finance Capital Expenditures in connection with any (i) Property or Facility owned by a Propco Borrower or (ii) Property (as defined in the Revolving Loan Agreement) or Facility (as defined in the Revolving Loan Agreement) operated by any Affiliated Revolving Borrower, the Administrative Agent shall have received true, complete and correct copies of invoices, purchase orders, or such other documentation in form and substance reasonably acceptable to Administrative Agent; provided , however , that Acquisition Loans used to finance Capital Expenditures pursuant to Section 5.2(b)(ii) hereof shall not exceed Six Million Dollars ($6,000,000) in the aggregate.
(c)
     Section 9.7(y) of the Loan Agreement is hereby amended and restated in its entirety as follows:
(y) the payment of capital expenditures relating solely to (A) the Properties and/or Facilities in the ordinary course of Borrower’s business or (B) any Property (as defined in the Revolving Loan Agreement) and/or any Facility (as defined in the Revolving Loan Agreement) in the ordinary course of Affiliated Revolving Borrowers’ business in an aggregate amount not to exceed Six Million Dollars ($6,000,000);
3.
     No Other Amendments . Borrower acknowledges and expressly agrees that this Amendment is limited to the extent expressly set forth herein and shall not constitute a modification or amendment of the Loan Agreement or any other Financing Agreements or a course of dealing at variance with the terms or conditions of the Loan Agreement or any other Financing Agreements.
4.
     Representations and Warranties . In order to induce Administrative Agent and Lenders to enter into this Amendment, Borrower hereby represents and warrants to Administrative Agent and Lenders (which representations and warranties shall survive the execution and delivery hereof), both before and after giving effect to this Amendment that:
(a)
     This Amendment has been duly authorized, validly executed and delivered by one or more Duly Authorized Officers of Borrower, and each of this Amendment, the Loan Agreement as amended hereby, and each of the other Financing Agreements to which Borrower is a party, constitutes the legal, valid and binding obligations of Borrower, enforceable against Borrower in accordance with their respective terms, subject to bankruptcy, insolvency or other similar laws affecting the enforcement of creditor’s rights and remedies generally;
(b)
     The execution and delivery of this Amendment and performance by Borrower under this Amendment, the Loan Agreement and each of the other Financing Agreements to which Borrower is a party do not and will not require the consent or approval of any regulatory authority or governmental authority or agency having jurisdiction over Borrower that has not already been obtained, nor be in contravention of or in conflict with the organizational documents of Borrower or any provision of any statute, judgment, order, indenture, instrument, agreement, or undertaking, to which Borrower is party or by which Borrower’s respective assets or properties are bound;
(c)
     Each of the representations and warranties of each Borrower contained in the Loan Agreement and the other Financing Agreements to which Borrower is a party are true and correct in all material respects (without duplication of any materiality carve out already provided therein) on and as of the date hereof, in each case as if made on and as of such date, other than representations and warranties that expressly relate solely to an earlier date (in which case such representations and warranties were true and correct on and as of such earlier date);
(d)
     No Default or Event of Default will result after giving effect to this Amendment, and no event has occurred that has had or could reasonably be expected to have a Material Adverse Effect after giving effect to this Amendment; and
(e)
     Borrower has the corporate or limited liability company (as applicable) power and authority (i) to enter into the Loan Agreement as amended by this Amendment and (ii) to do all acts and things as are required or contemplated hereunder to be done, observed and performed by Borrower.
5.
     Conditions Precedent to Effectiveness . The amendments contained in Section 2 hereof shall become effective as of the date first written above upon the satisfaction of the following conditions precedent:
(a)
     each party hereto shall have executed and delivered this Amendment to Administrative Agent;
(b)
     all of the representations and warranties of Borrower under Section 4 hereof, which are made as of the date hereof, are true and correct;
(c)
     Administrative Agent shall have received a duly executed Reaffirmation of Second Amended and Restated Guaranty in the form attached hereto;
(d)
     Borrower shall have delivered (or caused its Affiliates to deliver) to Administrative Agent the fully executed First Amendment to Third Amended and Restated Revolving Loan Agreement contemplated to be delivered in connection with this Amendment, and such First Amendment to Third Amended and Restated Revolving Loan Agreement shall be effective in accordance with its terms; and
(e)
     receipt by Administrative Agent of such other certificates, schedules, exhibits, documents, opinions, instruments, reaffirmations, amendments or consents Administrative Agent may reasonably require, if any.
8.     Reaffirmation; References to Loan Agreement; Etc.
(a)    Borrower acknowledges and agrees that all of Borrower’s obligations and Liabilities under the Loan Agreement and the other Financing Agreements, as amended hereby, are and shall be valid and enforceable and shall not be impaired or limited by the execution or effectiveness of this Amendment. The first priority perfected security interests and Liens and rights in the Collateral securing payment of the Liabilities are hereby ratified and confirmed by Borrower in all respects.
(b)    Upon the effectiveness of this Amendment, each reference in the Loan Agreement to “this Agreement,” “hereunder,” “hereof,” “herein” or words of like import shall mean and be a reference to the Loan Agreement, as amended by this Amendment.
(c)    The failure by Administrative Agent, at any time or times hereafter, to require strict performance by any Borrower of any provision or term of the Loan Agreement, this Amendment or any of the Financing Agreements shall not waive, affect or diminish any right of Administrative Agent hereafter to demand strict compliance and performance herewith or therewith. Any suspension or waiver by Administrative Agent of a breach of this Amendment or any Event of Default under or pursuant to the Loan Agreement shall not, except as expressly set forth in a writing signed by Administrative Agent, suspend, waive or affect any other breach of this Amendment or any Event of Default under or pursuant to the Loan Agreement, whether the same is prior or subsequent thereto and whether of the same or of a different kind or character. None of the undertakings, agreements, warranties, covenants and representations of any Borrower contained in this Amendment, shall be deemed to have been suspended or waived by Administrative Agent unless such suspension or waiver is (i) in writing and signed by Administrative Agent (and, if applicable, the Required Lenders) and (ii) delivered to Borrower by Administrative Agent or its counsel.
(d)    In no event shall Administrative Agent’s execution and delivery of this Amendment establish a course of dealing among Administrative Agent, any Borrower, pledgor or Guarantor or any other obligor, or in any other way obligate Administrative Agent to hereafter provide any amendments or modifications or, if at any time applicable, consents or waivers with respect to the Loan Agreement or any other Financing Agreement. The terms and provisions of this Amendment shall be limited precisely as written and shall not be deemed (x) to be a consent to any amendment or modification of any other term or condition of the Loan Agreement or of any of the Financing Agreements (except as expressly provided herein or in the other documents entered into in connection herewith); or (y) to prejudice any right or remedy which Administrative Agent may now have under or in connection with the Loan Agreement or any of the other Financing Agreements. In the event an ambiguity or question of intent or interpretation arises, this Amendment shall be construed as if drafted jointly by the parties hereto, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any of the provisions of this Amendment.
(e)    Except as expressly provided herein (or in the other documents entered into in connection herewith), the Loan Agreement and all of the other Financing Agreements shall remain unaltered, and the Loan Agreement and all of the other Financing Agreements shall remain in full force and effect and are hereby ratified and confirmed in all respects.
6.
     Release .
(a)
     In consideration of, among other things, the consent and amendments provided for herein, and for other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, Borrower and Guarantor (on behalf of themselves and their respective subsidiaries, Affiliates, successors and assigns), and, to the extent permitted by applicable law, and the same is claimed by right of, through or under the above, for their past, present and future employees, directors, members, managers, partners, agents, representatives, officers, directors, and equity holders (all collectively, with Borrower and Guarantor, the “ Releasing Parties ”), do hereby unconditionally, irrevocably, fully, and forever remise, satisfy, acquit, release and discharge Administrative Agent and Lenders and each of Administrative Agent’s and Lender’s past, present and future officers, directors, agents, employees, attorneys, parent, shareholders, successors, assigns, subsidiaries and Affiliates and all other persons and entities to whom Administrative Agent or Lenders would be liable if such persons or entities were found in any way to be liable to any of the Releasing Parties (collectively, the “ Lender Parties ”), of and from any and all manner of action and actions, cause and causes of action, claims, cross-claims, charges, demands, counterclaims, suits, proceedings, disputes, debts, dues, sums of money, accounts, bonds, covenants, contracts, controversies, damages, judgments, liabilities, damages, costs, expenses, executions, liens, claims of liens, claims of costs, penalties, attorneys’ fees, or any other compensation, recovery or relief on account of any liability, obligation, demand, proceedings or cause of action of whatever nature, whether in law, equity or otherwise (including, without limitation, those arising under 11 U.S.C. §§ 541-550 and interest or other carrying costs, penalties, legal, accounting and other professional fees and expenses, and incidental, consequential and punitive damages payable to third parties), whether known or unknown, fixed or contingent, joint and/or several, secured or unsecured, due or not due, primary or secondary, liquidated or unliquidated, contractual or tortious, direct, indirect, or derivative, asserted or unasserted, foreseen or unforeseen, suspected or unsuspected, now existing, heretofore existing or which may have heretofore accrued against any or all of Lender Parties, whether held in a personal or representative capacity, that the Releasing Parties (or any of them) have or may have against the Lender Parties or any of them (whether directly or indirectly) and which are based on any act, fact, event, action or omission or any other matter, condition, cause or thing occurring at or from any time prior to and including the date hereof in any way, directly or indirectly arising out of, connected with or relating to this Amendment, the Loan Agreement or any other Financing Agreement and the transactions contemplated hereby and thereby, the Collateral or the Liabilities, and all other agreements, certificates, instruments and other documents and statements (whether written or oral) related to any of the foregoing, other than any applicable good faith claim as to which a final determination is made in a judicial proceeding (in which Administrative Agent and any of the Released Parties have had an opportunity to be heard) which determination includes a specific finding that Administrative Agent acted in a grossly negligent manner or with actual willful misconduct or illegal activity. Borrower and Guarantor each acknowledges that Administrative Agent and Lenders are specifically relying upon the representations, warranties and agreements contained herein and that such representations, warranties and agreements constitute a material inducement to Administrative Agent and Lenders in entering into this Amendment.
(b)
     Borrower and Guarantor each understands, acknowledges and agrees that the release set forth above may be pleaded as a full and complete defense and may be used as a basis for an injunction against any action, suit or other proceeding which may be instituted, prosecuted or attempted in breach of the provisions of such release.
(c)
     To the furthest extent permitted by law, Borrower and Guarantor each hereby knowingly, voluntarily, intentionally and expressly waives and relinquishes any and all rights and benefits that it respectively may have as against Lender Parties under any law, rule or regulation of any jurisdiction that would or could have the effect of limiting the extent to which a general release extends to claims which a Lender Party or Releasing Party does not know or suspect to exist as of the date hereof. Borrower and Guarantor each hereby acknowledges that the waiver set forth in the prior sentence was separately bargained for and that such waiver is an essential term and condition of this Amendment.
7.
     Miscellaneous .
(a)
     Costs and Expenses . Without limiting the obligation of Borrower to reimburse Administrative Agent for all costs, fees, disbursements and expenses incurred by Administrative Agent as specified in the Loan Agreement, Borrower agrees to and shall pay on demand all reasonable costs, fees, disbursements and expenses of Administrative Agent in connection with the preparation, negotiation, revision, execution and delivery of this Amendment and the other agreements, amendments, modifications, reaffirmations, instruments and documents contemplated hereby, including, without limitation, reasonable attorneys’ fees and out-of-pocket expenses. All obligations provided herein shall survive any termination of this Amendment and the Loan Agreement as amended hereby.
(b)
     Financing Agreement . This Amendment shall constitute a Financing Agreement.
(c)
     Titles. Titles and section headings herein shall be without substantive meaning and are provided solely for the convenience of the parties.
(d)
     Severability; Etc. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Amendment shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provisions or the remaining provisions of this Amendment. The parties hereto have participated jointly in the negotiation and drafting of this Amendment. In the event an ambiguity or question of intent or interpretation arises, this Amendment shall be construed as if drafted jointly by the parties hereto, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any of the provisions of this Amendment.
(e)
     Successors and Assigns . This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns; provided , however , no Borrower may assign any of its respective rights or obligations under this Amendment without the prior written consent of Administrative Agent.
8.
     Further Assurances . Borrower shall, at its own cost and expense, cause to be promptly and duly taken, executed, acknowledged and delivered all such further acts, certificates, instruments, reaffirmations, amendments, documents and assurances as may from time to time be necessary or as Administrative Agent may from time to time reasonably request in order to more fully carry out the intent and purposes of this Amendment and the other documents entered into in connection herewith.
9.
     Governing Law . This Amendment shall be a contract made under and governed by, and construed and enforced in accordance with, the internal laws of the State of Illinois without regard to conflicts of law principles that would require the application of any other laws.
10.
     Counterparts; Fax Signatures . This Amendment may be executed in any number of counterparts, and by the parties hereto on the same or separate counterparts, and each such counterpart, when executed and delivered, shall be deemed to be an original, but all such counterparts shall together constitute but one and the same Amendment. A signature hereto sent or delivered by facsimile or other electronic transmission shall be as legally valid, effective and enforceable as a signed original for all purposes.
[Signature Pages Follow]

IN WITNESS WHEREOF, the parties hereto have duly executed this First Amendment to Second Amended and Restated Term Loan and Security Agreement as of the day and year first above written.
BORROWER :
DIVERSICARE AFTON OAKS, LLC
DIVERSICARE BRIARCLIFF, LLC
DIVERSICARE CHISOLM, LLC
DIVERSICARE HARTFORD, LLC
DIVERSICARE WINDSOR HOUSE, LLC
DIVERSICARE HILLCREST, LLC
DIVERSICARE LAMPASAS, LLC
DIVERSICARE YORKTOWN, LLC
DIVERSICARE CLINTON, LLC
 
BY:
Diversicare Leasing Corp., its sole member
 
By:
/s/ James R. McKnight, Jr.
 
Name: James R. McKnight, Jr.
 
Its: Executive Vice President &
Chief Financial Officer
DIVERSICARE OF CHANUTE, LLC
DIVERSICARE OF COUNCIL GROVE, LLC
DIVERSICARE OF HAYSVILLE, LLC
DIVERSICARE OF SEDGWICK, LLC
DIVERSICARE OF HUTCHINSON, LLC
DIVERSICARE OF LARNED, LLC
BY:

Diversicare Kansas, LLC,
its sole member

 
By:
/s/ James R. McKnight, Jr.
 
Name: James R. McKnight, Jr.
 
Its: Executive Vice President &
Chief Financial Officer



DIVERSICARE PROPERTY CO., LLC
 
 
 
By:
/s/ James R. McKnight, Jr.
 
Name: James R. McKnight, Jr.
 
Its: Executive Vice President &
Chief Financial Officer

DIVERSICARE AFTON OAKS PROPERTY, LLC
DIVERSICARE BRIARCLIFF PROPERTY, LLC
DIVERSICARE CHANUTE PROPERTY, LLC
DIVERSICARE CHISOLM PROPERTY, LLC
DIVERSICARE COUNCIL GROVE PROPERTY, LLC
DIVERSICARE HAYSVILLE PROPERTY, LLC
DIVERSICARE HARTFORD PROPERTY, LLC
DIVERSICARE HILLCREST PROPERTY, LLC
DIVERSICARE LAMPASAS PROPERTY, LLC
DIVERSICARE LARNED PROPERTY, LLC
DIVERSICARE SEDGWICK PROPERTY, LLC
DIVERSICARE WINDSOR HOUSE PROPERTY, LLC
DIVERSICARE YORKTOWN PROPERTY, LLC
DIVERSICARE GLASGOW PROPERTY, LLC
DIVERSICARE HUTCHINSON PROPERTY, LLC
DIVERSICARE CLINTON PROPERTY, LLC
DIVERSICARE FULTON PROPERTY, LLC
BY:
Diversicare Property Co., LLC, its sole member
 
By:
/s/ James R. McKnight, Jr.
 
Name: James R. McKnight, Jr.
 
Its: Executive Vice President &
Chief Financial Officer


DIVERSICARE OF GLASGOW, LLC
DIVERSICARE OF FULTON, LLC
BY:
Diversicare Holding Company, LLC, its sole member
 
By:
/s/ James R. McKnight, Jr.
 
Name: James R. McKnight, Jr.
 
Its: Executive Vice President &
Chief Financial Officer





Acknowledged and Agreed :
DIVERSICARE HEALTHCARE SERVICES, INC.
/s/ Kelly J. Gill
 
Name:
Kelly J. Gill
 
Its:
President and Chief Executive Officer
 

ADMINISTRATIVE AGENT :

THE PRIVATEBANK AND TRUST COMPANY , in its capacity as administrative agent

By:_ /s/ Adam D. Panos __________________
Name: Adam D. Panos
Its: Managing Director

LENDER :

THE PRIVATEBANK AND TRUST COMPANY

By:__ /s/ Adam D. Panos _________________
Name: Adam D. Panos
Its: Managing Director

LENDER :

BANKERS TRUST COMPANY

By:__ /s/ Jon M. Doll _________________
Name: Jon M. Doll
Its: Vice President


LENDER :

BOKF, NA D/B/A BANK OF OKLAHOMA

By:_ /s/ Ryan Kirk ____________________
Name: Ryan Kirk
Its: Vice President


LENDER :

CIT BANK N.A.


By:_ /s/ Edward Shuster ______________
Name: Edward Shuster
Its: Director



LENDER :
OPUS BANK ,    
a California commercial bank
By:
/s/ Bryan Nance
 
Name: Bryan Nance
 
Its: VP, Portfolio Manager Healthcare Banking


LENDER :
FRANKLIN SYNERGY BANK
By:
/s/ Lisa Fletcher
 
Name: Lisa Fletcher
 
Its: Senior Vice President

REAFFIRMATION OF SECOND AMENDED AND RESTATED GUARANTY

Dated as of: August 3, 2016
The undersigned (“ Guarantor ”) hereby (i) confirms and agrees with The PrivateBank and Trust Company, an Illinois banking corporation in its capacity as administrative agent (together with its successors and assigns, “ Administrative Agent ”) that Guarantor’s Second Amended and Restated Guaranty dated as of February 26, 2016 made in favor of Administrative Agent (as amended or modified, “ Guaranty ”), remains in full force and effect and is hereby ratified and confirmed in all respects, including with regard to the Second Amended and Restated Term Loan and Security Agreement dated as of February 26, 2016, as amended by the foregoing First Amendment to Second Amended and Restated Term Loan and Security Agreement (“ Amendment ”), and each reference to the “Loan Agreement” shall refer to the Loan Agreement as amended by the Amendment; (ii) represents and warrants to Administrative Agent, which representations and warranties shall survive the execution and delivery hereof, that Guarantor’s representations and warranties contained in the Guaranty are true and correct as of the date hereof, with the same effect as though made on the date hereof, except to the extent that such representations expressly related solely to an earlier date, in which case such representations were true and correct on and as of such earlier date (and except for the representations in Section 10(b) thereof which were true and correct on and as of the date when made); (iii) agrees and acknowledges that such ratification and confirmation is not a condition to the continued effectiveness of the Amendment or the Guaranty; and (iv) agrees that neither such ratification and confirmation, nor Administrative Agent’s solicitation of such ratification and confirmation, constitutes a course of dealing giving rise to any obligation or condition requiring a similar or any other ratification or confirmation from the undersigned with respect to subsequent amendments or modifications, if any, to the Loan Agreement, as amended by the Amendment or any other Financing Agreement (as defined in the Loan Agreement, as amended by the Amendment). The execution, delivery and effectiveness of this instrument shall not operate as a waiver of any right, power or remedy of Administrative Agent under or pursuant to the Guaranty. Guarantor acknowledges and agrees that Guarantor has received and reviewed a fully-executed copy of the Amendment (and any other instrument, document or agreement executed or delivered in connection therewith) and understands the contents thereof. A signature hereto sent or delivered by facsimile or other electronic transmission shall be as legally binding and enforceable as a signed original for all purposes. This instrument shall be governed by and construed and enforced in accordance with the internal laws of the State of Illinois, without regard to conflict of law principles that would require the application of any other laws.
[Signature Page Follows]


DIVERSICARE HEALTHCARE SERVICES, INC. (F/K/A ADVOCAT INC.)

By:     /s/ Kelly J. Gill            
Name:     Kelly J. Gill
Its:    President and Chief Executive Officer




Exhibit 31.1
CERTIFICATIONS PURSUANT TO SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
(i) CERTIFICATION
I, Kelly J. Gill, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Diversicare Healthcare Services, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: August 4, 2016
 
 
/s/ Kelly J. Gill

Kelly J. Gill
Chief Executive Officer





Exhibit 31.2
CERTIFICATIONS PURSUANT TO SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
(ii) CERTIFICATION
I, James R. McKnight, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Diversicare Healthcare Services, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date:   August 4, 2016
 
/s/ James R. McKnight, Jr.

James R. McKnight, Jr.
Executive Vice President and Chief Financial Officer





Exhibit 32
CERTIFICATION OF QUARTERLY REPORT ON FORM 10-Q
OF DIVERSICARE HEALTHCARE SERVICES, INC.
FOR THE QUARTER ENDED MARCH 31, 2016
The undersigned hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the undersigned’s best knowledge and belief, the Quarterly Report on Form 10-Q for Diversicare Healthcare Services, Inc. (the “Company”) for the period ending June 30, 2016 as filed with the Securities and Exchange Commission on the date hereof (the “Report”):
(a)
fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(b)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
This Certification is executed as of August 4, 2016 .

 
 
/s/ Kelly J. Gill

Kelly J. Gill
Chief Executive Officer
 
/s/ James R. McKnight, Jr.

James R. McKnight, Jr.
Executive Vice President and Chief Financial Officer
A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.