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, 2019
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 every Interactive Data File required to be submitted 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 such files).    Yes   ý     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
Accelerated filer
 
¨
Non-accelerated filer
 
¨ (do not check if a smaller reporting company)
Smaller reporting company
 
ý
 
 
 
Emerging growth company
 
¨
       If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   ý
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value per share
DVCR
The Nasdaq Capital Market
6,678,926
(Outstanding shares of the issuer’s common stock as of July 31, 2019 )
 



Part I. FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS
DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED BALANCE SHEETS
(in thousands)
 
 
June 30,
2019
 
December 31,
2018
 
(Unaudited)
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
2,986

 
$
2,685

Receivables
67,984

 
66,257

Self-insurance receivables, current portion
2,350

 
4,475

Other receivables
1,336

 
1,191

Prepaid expenses and other current assets
3,861

 
4,728

Income tax refundable
474

 
1,115

Current assets of discontinued operations
—

 
86

Total current assets
78,991

 
80,537

PROPERTY AND EQUIPMENT, at cost
141,156

 
138,460

Less accumulated depreciation and amortization
(90,514
)
 
(85,361
)
Property and equipment, net
50,642

 
53,099

OTHER ASSETS:
 
 
 
Deferred income taxes, net
—

 
15,851

Deferred leasehold costs
—

 
206

Operating lease assets
371,289

 
—

Acquired leasehold interest, net
6,003

 
6,307

Other noncurrent assets
3,342

 
3,244

Total other assets
380,634

 
25,608

 
$
510,267

 
$
159,244

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 per share amounts)
(continued)
 
 
June 30,
2019
 
December 31,
2018
 
(Unaudited)
 
 
CURRENT LIABILITIES:
 
 
 
Current portion of long-term debt and finance lease obligations, net
$
10,369

 
$
12,449

Trade accounts payable
16,112

 
15,659

Current liabilities of discontinued operations
—

 
86

Current portion of operating lease liabilities
23,011

 
—

Accrued expenses:
 
 
 
Payroll and employee benefits
17,444

 
19,471

Self-insurance reserves, current portion
12,590

 
13,158

Provider taxes
2,362

 
2,394

Other current liabilities
7,866

 
7,128

Total current liabilities
89,754

 
70,345

NONCURRENT LIABILITIES:
 
 
 
Long-term debt and finance lease obligations, less current portion and deferred financing costs, net
67,130

 
60,984

Operating lease liabilities, less current portion
356,062

 
—

Self-insurance reserves, noncurrent portion
15,885

 
16,057

Litigation contingency, less current portion
9,000

 
6,400

Other noncurrent liabilities
1,498

 
6,656

Total noncurrent liabilities
449,575

 
90,097

COMMITMENTS AND CONTINGENCIES

 

SHAREHOLDERS’ DEFICIT:
 
 
 
Common stock, authorized 20,000 shares, $.01 par value, 6,911 and 6,751 shares issued, and 6,679 and 6,519 shares outstanding, respectively
69

 
68

Treasury stock at cost, 232 shares of common stock
(2,500
)
 
(2,500
)
Paid-in capital
23,738

 
23,413

Accumulated deficit
(50,958
)
 
(23,016
)
Accumulated other comprehensive income
589

 
837

Total shareholders’ deficit
(29,062
)

(1,198
)
 
$
510,267

 
$
159,244

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,
 
2019
 
2018
PATIENT REVENUES, net
$
135,370

 
$
141,082

EXPENSES:
 
 
 
Operating
108,641

 
111,440

Lease and rent expense
15,802

 
13,725

Professional liability
2,957

 
3,182

Litigation contingency expense (Note 7)
3,100

 
—

General and administrative
7,594

 
9,295

Depreciation and amortization
3,002

 
2,847

Total expenses
141,096

 
140,489

OPERATING INCOME (LOSS)
(5,726
)
 
593

OTHER INCOME (EXPENSE):
 
 
 
Gain on sale of investment in unconsolidated affiliate
—

 
308

Other income
45

 
28

Interest expense, net
(1,556
)
 
(1,661
)
Total other expense
(1,511
)
 
(1,325
)
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(7,237
)
 
(732
)
BENEFIT (PROVISION) FOR INCOME TAXES
(17,351
)
 
425

LOSS FROM CONTINUING OPERATIONS
(24,588
)
 
(307
)
LOSS FROM DISCONTINUED OPERATIONS:
 
 
 
Operating loss, net of tax benefit of $0 and $0, respectively
(8
)
 
(4
)
NET LOSS
$
(24,596
)
 
$
(311
)
NET LOSS PER COMMON SHARE:
 
 
 
Per common share – basic
 
 
 
Continuing operations
$
(3.80
)
 
$
(0.05
)
Discontinued operations
—

 
—

 
$
(3.80
)
 
$
(0.05
)
Per common share – diluted
 
 
 
Continuing operations
$
(3.80
)
 
$
(0.05
)
Discontinued operations
—

 
—

 
$
(3.80
)
 
$
(0.05
)
COMMON STOCK DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
$
—

 
$
0.055

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
Basic
6,472

 
6,370

Diluted
6,472

 
6,370

                              
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,
 
2019
 
2018
NET LOSS
$
(24,596
)
 
$
(311
)
OTHER COMPREHENSIVE INCOME (LOSS):
 
 
 
Change in fair value of cash flow hedge, net of tax
(185
)
 
134

Less: reclassification adjustment for amounts recognized in net loss
—

 
(38
)
Total other comprehensive income (loss)
(185
)
 
96

COMPREHENSIVE LOSS
$
(24,781
)
 
$
(215
)

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,
 
2019
 
2018
PATIENT REVENUES, net
$
269,723

 
$
282,367

EXPENSES:

 
 
Operating
216,754

 
223,718

Lease and rent expense
31,606

 
27,438

Professional liability
6,378

 
5,957

Litigation contingency expense (Note 7)

3,100

 
—

General and administrative
15,107

 
17,434

Depreciation and amortization
5,496

 
5,728

Total expenses
278,441

 
280,275

OPERATING INCOME (LOSS)
(8,718
)
 
2,092

OTHER INCOME (EXPENSE):
 
 
 
Gain on sale of investment in unconsolidated affiliate
—

 
308

Other income
205

 
79

Interest expense, net
(3,016
)
 
(3,330
)
Total other expense
(2,811
)
 
(2,943
)
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(11,529
)
 
(851
)
BENEFIT (PROVISION) FOR INCOME TAXES

(16,396
)
 
463

LOSS FROM CONTINUING OPERATIONS
(27,925
)
 
(388
)
LOSS FROM DISCONTINUED OPERATIONS:
 
 
 
Operating loss, net of tax benefit of $0 and $11, respectively
(17
)
 
(26
)
NET LOSS
$
(27,942
)
 
$
(414
)
NET LOSS PER COMMON SHARE:
 
 
 
Per common share – basic
 
 
 
Continuing operations
$
(4.33
)
 
$
(0.06
)
Discontinued operations
—

 
—

 
$
(4.33
)
 
$
(0.06
)
Per common share – diluted
 
 
 
Continuing operations
$
(4.33
)
 
$
(0.06
)
Discontinued operations
—

 
—

 
$
(4.33
)
 
$
(0.06
)
COMMON STOCK DIVIDENDS DECLARED PER SHARE OF COMMON STOCK
$
—

 
$
0.11

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
Basic
6,448

 
6,342

Diluted
6,448

 
6,342


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,
 
2019
 
2018
NET LOSS
$
(27,942
)
 
$
(414
)
OTHER COMPREHENSIVE INCOME (LOSS):
 
 
 
Change in fair value of cash flow hedge, net of tax
(248
)
 
455

Less: reclassification adjustment for amounts recognized in net income
—

 
(151
)
Total other comprehensive income (loss)
(248
)
 
304

COMPREHENSIVE LOSS
$
(28,190
)
 
$
(110
)

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


7


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(in thousands and unaudited)
 
Common Stock
 
Treasury Stock
 
Paid-in Capital
 
Accumulated Deficit
 
Accumulated
Other
Comprehensive Income (Loss)
 
Total
Shareholders' Equity(Deficit)
 
Shares Issued
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2017
6,687

 
$
67

 
232

 
$
(2,500
)
 
$
22,720

 
$
(14,534
)
 
$
709

 
$
6,462

Net loss
—

 
—

 
—

 
—

 
—

 
(103
)
 
—

 
(103
)
Common stock dividends declared
—

 
—

 
—

 
—

 
13

 
(363
)
 
—

 
(350
)
Issuance/redemption of equity grants, net
86

 
1

 
—

 
—

 
(79
)
 
—

 
—

 
(78
)
Interest rate cash flow hedge
—

 
—

 
—

 
—

 
—

 
—

 
208

 
208

Stock-based compensation
—

 
—

 
—

 
—

 
236

 
—

 
—

 
236

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, MARCH 31, 2018
6,773

 
68

 
232

 
(2,500
)
 
22,890

 
(15,000
)
 
917

 
6,375

Net loss
—

 
—

 
—

 
—

 
—

 
(311
)
 
—

 
(311
)
Common stock dividends declared
—

 
—

 
—

 
—

 
11

 
(362
)
 
—

 
(351
)
Issuance/redemption of equity grants, net
(5
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Interest rate cash flow hedge
—

 
—

 
—

 
—

 
—

 
—

 
96

 
96

Stock-based compensation
—

 
—

 
—

 
—

 
348

 
—

 
—

 
348

BALANCE, JUNE 30, 2018
6,768

 
68

 
232

 
(2,500
)
 
23,249

 
(15,673
)
 
1,013

 
6,157

Net loss
—

 
—

 
—

 
—

 
—

 
(7,397
)
 
—

 
(7,397
)
Common stock dividends declared
—

 
—

 
—

 
—

 
9

 
(362
)
 
—

 
(353
)
Issuance/redemption of equity grants, net
(19
)
 
—

 
—

 
—

 
(140
)
 
—

 
—

 
(140
)
Interest rate cash flow hedge
—

 
—

 
—

 
—

 
—

 
—

 
46

 
46

Stock-based compensation
—

 
—

 
—

 
—

 
149

 
—

 
—

 
149

BALANCE, SEPTEMBER 30, 2018
6,749

 
68

 
232

 
(2,500
)
 
23,267

 
(23,432
)
 
1,059

 
(1,538
)
Net income
—

 
—

 
—

 
—

 
—

 
416

 
—

 
416

Issuance/redemption of equity grants, net
2

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Interest rate cash flow hedge
—

 
—

 
—

 
—

 
—

 
—

 
(222
)
 
(222
)
Stock-based compensation
—

 
—

 
—

 
—

 
146

 
—

 
—

 
146

BALANCE, DECEMBER 31, 2018
6,751

 
68

 
232

 
(2,500
)
 
23,413

 
(23,016
)
 
837

 
(1,198
)
Net loss
—

 
—

 
—

 
—

 
—

 
(3,346
)
 
—

 
(3,346
)
Issuance/redemption of equity grants, net
163

 
1

 
—

 
—

 
41

 
—

 
—

 
42

Interest rate cash flow hedge
—

 
—

 
—

 
—

 
—

 
—

 
(63
)
 
(63
)
Stock-based compensation
—

 
—

 
—

 
—

 
140

 
—

 
—

 
140

BALANCE, MARCH 31, 2019
$
6,914

 
$
69

 
$
232

 
$
(2,500
)
 
$
23,594

 
$
(26,362
)
 
$
774

 
$
(4,425
)
The accompanying notes are an integral part of these interim consolidated financial statements.

8


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(in thousands and unaudited)
(continued)
 
Common Stock
 
Treasury Stock
 
Paid-in Capital
 
Accumulated Deficit
 
Accumulated
Other
Comprehensive Income (Loss)
 
Total
Shareholders' Equity(Deficit)
 
Shares Issued
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, MARCH 31, 2019
6,914

 
$
69

 
232

 
$
(2,500
)
 
$
23,594

 
$
(26,362
)
 
$
774

 
$
(4,425
)
Net loss
—

 
—

 
—

 
—

 
—

 
(24,596
)
 
—

 
(24,596
)
Issuance/redemption of equity grants, net
(3
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Interest rate cash flow hedge
—

 
—

 
—

 
—

 
—

 
—

 
(185
)
 
(185
)
Stock-based compensation
—

 
—

 
—

 
—

 
144

 
—

 
—

 
144

BALANCE, JUNE 30, 2019
6,911

 
$
69

 
232

 
$
(2,500
)
 
$
23,738

 
$
(50,958
)
 
$
589

 
$
(29,062
)

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


9


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands and unaudited)
 
 
Six Months Ended June 30,
 
2019
 
2018
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(27,942
)
 
$
(414
)
Discontinued operations
(17
)
 
(26
)
Loss from continuing operations
(27,925
)
 
(388
)
Adjustments to reconcile loss from continuing operations to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
5,496

 
5,728

Deferred income tax provision (benefit)
16,008

 
(34
)
Provision for self-insured professional liability, net of cash payments
2,559

 
1,722

Litigation contingency expense
3,100

 
—

Stock-based and deferred compensation
284

 
765

Gain on sale of unconsolidated affiliate
—

 
(308
)
Provision (benefit) for leases in excess of cash payments
2,564

 
(916
)
Other
487

 
283

Changes in assets and liabilities affecting operating activities:
 
 
 
Receivables, net
(41
)
 
342

Prepaid expenses and other assets
(1,027
)
 
(2,651
)
Trade accounts payable and accrued expenses
(2,279
)
 
2,072

Net cash provided by (used in) continuing operations
(774
)
 
6,615

Discontinued operations
(17
)
 
(632
)
Net cash provided by (used in) operating activities
(791
)
 
5,983

NET CASH FLOWS USED IN INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment
(2,496
)
 
(3,896
)
Proceeds from sale of unconsolidated affiliate
—

 
308

Net cash used in continuing operations
(2,496
)
 
(3,588
)
Discontinued operations
—

 
—

Net cash used in investing activities
(2,496
)
 
(3,588
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of debt and finance lease obligations
(2,741
)
 
(9,057
)
Proceeds from issuance of debt
6,500

 
8,203

Financing costs
(213
)
 
(137
)
Issuance and redemption of employee equity awards, net
42

 
(78
)
Payment of common stock dividends
—

 
(702
)
Payment for preferred stock restructuring
—

 
(337
)
Net cash provided by (used in) continuing operations
3,588

 
(2,108
)
Discontinued operations
—

 
—

Net cash provided by (used in) financing activities
$
3,588

 
$
(2,108
)
The accompanying notes are an integral part of these interim consolidated financial statements.

10


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands and unaudited)
(continued)
 
 
Six Months Ended June 30,
 
2019
 
2018
NET INCREASE IN CASH AND CASH EQUIVALENTS
$
301

 
$
287

CASH AND CASH EQUIVALENTS, beginning of period
2,685

 
3,524

CASH AND CASH EQUIVALENTS, end of period
$
2,986

 
$
3,811

SUPPLEMENTAL INFORMATION:
 
 
 
Cash payments of interest
$
2,701

 
$
2,920

Cash payments of income taxes
$
254

 
$
321

SUPPLEMENTAL INFORMATION ON NON-CASH INVESTING AND FINANCING TRANSACTIONS:

 
 
 
Acquisition of equipment through finance leases
$
239

 
$
—

Acquisition of operating leases through adoption of ASC 842
$
389,403

 
$
—

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

11


DIVERSICARE HEALTHCARE SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2019 AND 2018
(Dollars and shares in thousands, except per share data)
(Unaudited)

1.
BUSINESS
Diversicare Healthcare Services, Inc. (together with its subsidiaries, “Diversicare” or the “Company”) provides long-term care services to nursing center patients in ten 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, Mississippi, Missouri, Ohio, Tennessee, and Texas.
As of June 30, 2019 , the Company’s continuing operations consist of 72 nursing centers with 8,214 licensed nursing beds. The Company owns 15 and leases 57 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 429 licensed assisted and residential living beds.

2.
CONSOLIDATION AND BASIS OF PRESENTATION OF FINANCIAL STATEMENTS
The interim consolidated financial statements for the three and six month periods ended June 30, 2019 and 2018 , 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 generally accepted accounting principles in the United States of America ("GAAP") 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, 2019 , and the results of operations, and changes in shareholders' equity (deficit) for the three and six month periods ended June 30, 2019 and 2018 , and cash flows for the six month period ended June 30, 2019 and 2018 . The Company’s balance sheet information at December 31, 2018 , was derived from its audited consolidated financial statements as of December 31, 2018 .
Effective January 1, 2019, we adopted the requirements of Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842), as discussed in Notes 3 and 6 to the interim consolidated financial statements. Effective January 1, 2018, we adopted the requirements of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), as discussed in Notes 3 and 4 to the interim consolidated financial statements. All amounts and disclosures set forth in this Form 10-Q have been updated to comply with the new standards.
The results of operations for the periods ended June 30, 2019 and 2018 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, 2018 .

3.
RECENT ACCOUNTING GUIDANCE

Recent Accounting Standards Adopted by the Company
In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-02, Leases (Topic 842). The standard establishes a right-of-use ("ROU") model that requires a lessee to record a ROU asset and a lease liability on the balance sheet. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. For short-term leases (those with a term of 12 months or less and that do not include a lessee purchase option that is reasonably certain to be exercised), a lessee is permitted to make (and the Company chose to utilize) an accounting policy election by asset class not to recognize ROU assets and lease liabilities, which would generally result in lease expense for these short term leases being recognized on a straight-line basis over the lease term. The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company adopted the requirements of this standard effective January 1, 2019. In July 2018, the FASB issued ASU 2018-11, Leases - Targeted Improvements, which allows lessees and lessors to recognize and measure existing leases at the beginning of the period of adoption without modifying the comparative period financial statements (which therefore will remain under prior GAAP, Topic 840, Leases). The Company elected to use the optional expedient to reflect adoption in the period of adoption (January 1, 2019) rather than the earliest period presented. The Company also elected the package of practical expedients upon transition, which includes retaining the lease classification for any leases that exist prior to adoption of the standard. The adoption of the new standard resulted in the recording of net lease assets and lease liabilities of $384,187 and $389,403 , respectively, as of January 1, 2019. The standard did not materially impact our

12


consolidated net earnings and had no impact on cash flows. See Note 6, "Leases" for a discussion regarding leases under the new standard.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which is intended to simplify and amend the application of hedge accounting to more clearly portray the economics of an entity’s risk management strategies in its financial statements. The new guidance will make more financial and nonfinancial hedging strategies eligible for hedge accounting and reduce complexity in fair value hedges of interest rate risk. The new guidance also changes how companies assess effectiveness and amends the presentation and disclosure requirements. The new guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally the entire change in the fair value of a hedging instrument will be required to be presented in the same income statement line as the hedged item. The new guidance also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. The new guidance is effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those years. The Company adopted the requirements of this standard effective January 1, 2019. The adoption did not have a material impact on our consolidated financial statements and related disclosures.
In February 2018, the FASB issued ASU No. 2018-02, Income Statement- Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The new guidance allows entities the option to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act from accumulated other comprehensive income (OCI) to retained earnings. The new guidance allows the option to apply the guidance retrospectively or in the period of adoption. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company adopted the requirements of this standard effective January 1, 2019. The adoption did not have a material impact on our consolidated financial statements and related disclosures.
In June 2018, the FASB issued ASU No. 2018-07, Compensation-Stock Compensation (Topic 718): Improvement to Nonemployee Share-Based Payment Accounting, which modifies the accounting for share-based payment awards issued to nonemployees to largely align it with the accounting for share-based payment awards issued to employees. The standard is effective for fiscal years beginning after December 15, 2018. The Company adopted the requirements of this standard effective January 1, 2019. The adoption did not have a material impact on our consolidated financial statements and related disclosures.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. The new guidance is effective for annual and interim reporting periods beginning after December 15, 2017. The Company adopted the requirements of this standard effective January 1, 2018. The Company elected to apply the modified retrospective approach with the cumulative transition effect recognized in beginning retained earnings as of the date of adoption. The adoption of ASC 606 represents a change in accounting principle that more closely aligns revenue recognition with the delivery of the Company's services. The cumulative effect of applying the new guidance to all contracts with customers as of January 1, 2018 was not material to the interim consolidated financial statements. See Note 4, "Revenue Recognition" for a discussion regarding revenue recognition under the new standard.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). The ASU provides clarification regarding how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The new guidance addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The ASU is effective for annual and interim periods beginning after December 15, 2017, which required the Company to adopt these provisions in the first quarter of fiscal 2018 using a retrospective approach. The adoption did not have a material impact on our financial position, results of operations or cash flows.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that the Statement of Cash Flows explain the changes during the period of cash and cash equivalents inclusive of amounts categorized as Restricted Cash. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The standard is effective for periods beginning after December 15, 2017, which required the Company to adopt these provisions in the first quarter of fiscal 2018. The adoption did not have a material impact on our financial position, results of operations or cash flows.
In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805) - Clarifying the Definition of a Business, which provides guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The adoption is effective for annual and interim periods beginning after December 15, 2017. The Company will evaluate future acquisitions under this guidance, which may result in future acquisitions being accounted for as asset acquisitions.
In May 2017, the FASB issued ASU No. 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. The amended standard specifies the modification accounting applicable to any entity which changes the terms or

13


conditions of a share-based payment award. The new guidance is effective for all entities after December 15, 2017. The adoption did not have a material impact on our financial position, results of operations or cash flows.
Accounting Standards Recently Issued But Not Yet Adopted by the Company
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The new guidance intends to improve financial reporting by requiring timelier recognition of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. This update requires that financial statement assets measured at an amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. This standard is effective for the fiscal year beginning after December 15, 2022 with early adoption permitted. The Company is in the initial stages of evaluating the impact from the adoption of this new standard on the consolidated financial statements and related disclosures.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurements (Topic 820): Disclosure Framework- Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this update modify the disclosure requirements of fair value measurements under Topic 820. The standard is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company is evaluating the effect this guidance will have on our consolidated financial statements and related disclosures.
In October 2018, the FASB issued ASU No. 2018-16, Derivatives and Hedging (Topic 805): Inclusion of the Secured Overnight Financing Rate ("SOFR") Overnight Index Swap ("OIS") Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. The ASU amends ASC 815 to add the OIS rate based on the SOFR as a fifth US benchmark interest rate. The Company is evaluating the effect this guidance will have on our consolidated financial statements and related disclosures.

4. REVENUE RECOGNITION
On January 1, 2018, the Company adopted Accounting Standards Codification ("ASC") 606 using the modified retrospective method for all contracts as of the date of adoption. The adoption of ASC 606 represents a change in accounting principle that more closely aligns revenue recognition with the delivery of the Company's services. The cumulative effect of applying the new guidance to all contracts with customers as of January 1, 2018 was not material to the interim consolidated financial statements. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. ASC 606 requires companies to exercise more judgment and recognize revenue in accordance with the standard's core principle by applying the following five steps:
Step 1: Identify the contract with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
Performance obligations are promises made in a contract to transfer a distinct good or service to the customer. A contract's transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company has concluded that the contracts with patients and residents represent a bundle of distinct services that are substantially the same, with the same pattern of transfer to the customer. Accordingly, the promise to provide quality care is accounted for as a single performance obligation.
The Company performed analyses using the application of the portfolio approach as a practical expedient to group patient contracts with similar characteristics, such that revenue for a given portfolio would not be materially different than if it were evaluated on a contract-by-contract basis. These analyses incorporated consideration of reimbursements at varying rates from Medicaid, Medicare, Managed Care, Private Pay, Assisted Living, Hospice, and Veterans for services provided in each corresponding state. It was determined that the contracts are not materially different for the following groups: Medicaid, Medicare, Managed Care and Private Pay and other (Assisted Living, Hospice and Veterans).
In order to determine the transaction price, the Company estimates the amount of variable consideration at the beginning of the contract using the expected value method. The estimates consider (i) payor type, (ii) historical payment trends, (iii) the maturity of the portfolio, and (iv) geographic payment trends throughout a class of similar payors. The Company typically enters into agreements with third-party payors that provide for payments at amounts different from the established charges. These arrangement terms provide for subsequent settlement and cash flows that may occur well after the service is provided. The Company constrains (reduces) the estimates of variable consideration such that it is probable that a significant reversal of previously recognized revenue will not occur throughout the life of the contract. Changes in the Company's expectation of the amount it will receive from the patient or third-party payors will be recorded in revenue unless there is a specific event that suggests the patient or third-party payor no longer has the ability and intent to pay the amount due and, therefore, the changes in its estimate of variable consideration

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better represent an impairment, or bad debt. These estimates are re-assessed each reporting period, and any amounts allocated to a satisfied performance obligation are recognized as revenue or a reduction of revenue in the period in which the transaction price changes.
The Company satisfies its performance obligation by providing quality of care services to its patients and residents on a daily basis until termination of the contract. The performance obligation is recognized on a time elapsed basis, by day, for which the services are provided. For these contracts, the Company has the right to consideration from the customer in an amount that directly corresponds with the value to the customer of the Company's performance to date. Therefore, the Company recognizes revenue based on the amount billable to the customer in accordance with the practical expedient in ASC 606-10-55-18. Additionally, because the Company applied ASC 606 using certain practical expedients, the Company elected not to disclose the aggregate amount of the transaction price for unsatisfied, or partially unsatisfied, performance obligations for all contracts with an original expected length of one year or less.
The Company incurs costs related to patient/resident contracts, such as legal and advertising expenses. The contract costs are expensed as incurred. They are not expected to be recovered and are not chargeable to the patient/resident regardless of whether the contract is executed.
Disaggregation of Revenue and Accounts Receivable
The following table summarizes revenue from contracts with customers by payor source for the periods presented (dollar amounts in thousands):
 
Three Months Ended June 30,
 
2019
 
2018
Medicaid
$
64,284

47.5
%
 
$
65,603

46.5
%
Medicare
24,291

17.9
%
 
27,863

19.7
%
Managed Care
14,161

10.5
%
 
13,303

9.4
%
Private Pay and other
32,634

24.1
%
 
34,313

24.4
%
Total
$
135,370

100.0
%
 
$
141,082

100.0
%
 
Six Months Ended June 30,
 
2019
 
2018
Medicaid
$
127,815

47.4
%
 
$
129,489

45.9
%
Medicare
49,346

18.3
%
 
57,614

20.4
%
Managed Care
28,336

10.5
%
 
27,515

9.7
%
Private Pay and other
64,226

23.8
%
 
67,749

24.0
%
Total
$
269,723

100.0
%
 
$
282,367

100.0
%

Accounts receivable as of June 30, 2019 and December 31, 2018 are summarized in the following table:
 
June 30,
 
December 31,
 
2019
 
2018
Medicaid
$
27,868

 
$
27,532

Medicare
13,431

 
15,706

Managed Care
9,271

 
8,126

Private Pay and other
17,414

 
14,893

Total accounts receivable
$
67,984

 
$
66,257



5.
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 increased the Company's borrowing capacity to $100,000 allocated between a $72,500 Mortgage Loan ("Amended Mortgage Loan") and a $27,500 Revolver ("Amended Revolver"). The Amended Mortgage Loan consists of a $60,000 term loan facility and a $12,500 acquisition loan facility. Loan acquisition costs associated

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with the Amended Mortgage Loan and the Amended Revolver were capitalized in the amount of $2,162 and are being amortized over the five -year term of the agreements.
Under the terms of the amended agreements, the syndicate of banks provided the Amended Mortgage Loan with an original principal balance of $72,500 with a five -year maturity through February 26, 2021, and a $27,500 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 is 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 . The Amended Mortgage Loan balance was $60,147 as of June 30, 2019 , consisting of $50,747 on the term loan facility with an interest rate of 6.50% and $9,400 on the acquisition loan facility with an interest rate of 7.25% . The Amended Mortgage Loan is secured by fifteen owned nursing centers, related equipment and a lien on the accounts receivable of these centers. The Amended Mortgage Loan and the Amended Revolver are cross-collateralized and cross-defaulted. The Company’s Amended Revolver has an interest rate of LIBOR plus 4.0% and is secured by accounts receivable and is subject to limits on the maximum amount of loans that can be outstanding under the revolver based on borrowing base restrictions.
Effective October 3, 2016, the Company entered into the Second Amendment ("Second Revolver Amendment") to amend the Amended Revolver. The Second Revolver Amendment increased the Amended Revolver capacity from the  $27,500  in the Amended Revolver to  $52,250 ; provided that the maximum revolving facility be reduced to $42,250 on August 1, 2017. Subsequently, on June 30, 2017, the Company executed a Fourth Amendment (the "Fourth Revolver Amendment") to amend the Amended Revolver, which modifies the capacity of the revolver to remain at $52,250 .
On December 29, 2016, the Company executed a Third Amendment ("Third Revolver Amendment") to amend the Amended Revolver. The Third Amendment modified the terms of the Amended Revolving Agreement by increasing the Company’s letter of credit sublimit from  $10,000  to  $15,000 .
Effective June 30, 2017, the Company entered into a Second Amendment ("Second Term Amendment") to amend the Amended Mortgage Loan. The Second Term Amendment amended the terms of the Amended Mortgage Loan Agreement by increasing the Company's term loan facility by $7,500 .
Effective February 27, 2018, the Company executed a Fifth Amendment to the Amended Revolver and a Third Amendment to the Amended Mortgage Loan. Under the terms of the Amendments, the minimum fixed charge coverage ratio shall not be less than 1.01 to 1.00 as of March 31, 2018 and for each quarter thereafter.
Effective December 1, 2018, the Company entered into the Sixth Amendment ("Sixth Revolver Amendment") to amend the Amended Revolver. The Sixth Amendment decreased the Amended Revolver capacity from $52,250 to $42,250 . The Company also applied $4,947 of net proceeds from the sale of the Kentucky centers to the outstanding borrowings under the Amended Revolver.
Effective December 1, 2018, the Company executed a Fourth Amendment (the "Fourth Term Amendment") to amend the Amended Mortgage Loan. The Company applied $11,100 and $2,100 of net proceeds from the sale of the Kentucky centers to the Term Loan and Acquisition Loan, respectively. Additionally, we amended the Acquisition Loan availability to include a reserve of $2,100 , and therefore, our borrowing capacity is $10,400 . For further discussion of the sale of the Kentucky centers, refer to Note 10, "Business Development and Other Significant Transactions."
The Company is participating in the Texas Quality Incentive Payment Program ("QIPP"). Effective May 13, 2019, the Company entered into a Fifth Amendment (the “Fifth Term Amendment”) to amend the Amended Mortgage Loan to release the operators of three of the QIPP centers in Texas from the Amended Mortgage Loan and a Seventh Amendment (the “Seventh Revolver Amendment”) to amend the Amended Revolver to remove the operators of all four of the QIPP centers in Texas from the Amended Revolver and to permanently reduce the amount available under the Amended Revolver by $2,000 . At the same time, the operators of these four facilities entered into a separate revolving loan (the "affiliated revolver")with the same syndicate of banks to provide for the temporary working capital requirements of the four QIPP centers. The affiliated revolver, which is guaranteed by the Company, has an initial capacity of $5,000 , which amount is reduced by $1,000 on each of January 1, 2020, April 1, 2020 and July 1, 2020. The affiliated revolver has the same maturity date as the Amended Revolver and the Amended Mortgage Loan of February 26, 2021. The affiliated revolver is cross-defaulted with the Amended Revolver and the Amended Mortgage Loan. For further discussion of the QIPP centers in Texas, refer to Note 10, "Business Development and Other Significant Transactions." As of June 30, 2019 , the Company had zero borrowings outstanding under the affiliated revolver.
As of June 30, 2019 , the Company had $17,500 borrowings outstanding under the Amended Revolver compared to $15,000 outstanding as of December 31, 2018 . The interest rate related to the Amended Revolver was 6.50% as of June 30, 2019 . The outstanding borrowings on the revolver were used primarily for temporary working capital requirements. Annual fees for letters of credit issued under the Amended Revolver are 3.0% of the amount outstanding. The Company has four letters of credit with a total value of $13,594 outstanding as of June 30, 2019 . Considering the balance of eligible accounts receivable, the letters of credit,

16


the amounts outstanding under the revolving credit facility and the maximum loan amount of $36,739 the balance available for borrowing under the Amended Revolver and affiliated revolver was $5,645 at June 30, 2019 .
The Company’s debt agreements contain various financial covenants, the most restrictive of which relates to debt service coverage ratios. The Company is in compliance with all such covenants at June 30, 2019 .
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 (loss). In conjunction with the February 26, 2016 amendment to the Credit Agreement, the Company amended the terms of its interest rate swap. The interest rate swap agreement has the same effective date and maturity date as the Amended Mortgage Loan, and has an amortizing notional amount that was $27,245 as of June 30, 2019 . The interest rate swap agreement requires the Company to make fixed rate payments to the bank calculated on the applicable notional amount at an annual fixed rate of 5.79% while the bank is obligated to make payments to the Company based on LIBOR on the same notional amount.
The Company assesses the effectiveness of its interest rate swap on a quarterly basis, and at June 30, 2019 , the Company determined that the interest rate swap was highly effective. The interest rate swap valuation model indicated a net liability of $30 at June 30, 2019 . 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 change in the interest rate swap included in accumulated other comprehensive income at June 30, 2019 is $23 net of the income tax provision of $7 . 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 .

6.      LEASES

The Company has operating and finance leases for facilities, corporate offices, and certain equipment. The Company recognizes lease expense for these operating leases on a straight-line basis over the lease term. Leases with an initial term of one year or less are not recorded on the balance sheet. The Company's other leases have original lease terms of one to twelve years, some of which include options to extend the lease for up to twenty years, and some of which include options to terminate the leases within one year. The exercise of lease renewal options is at our sole discretion. The Company's lease agreements do not contain any material residual value guarantees or material restrictive covenants. Upon adoption of Topic 842, the Company elected the practical expedient to not separate lease and non-lease components for all of its leases as the non-lease components are not significant to the overall lease costs.

Leases
 
 
Classification
 
June 30, 2019
Assets
 
 
 
 
   Operating lease assets
 
Operating lease assets
 
$
371,289

   Finance lease assets
 
Property and equipment, net  (a)
 
1,167

Total leased assets
 
 
 
$
372,456

 
 
 
 
 
Liabilities
 
 
 
 
Current
 
 
 
 
   Operating
 
Current portion of operating lease liabilities
 
$
23,011

   Finance
 
Current portion of long-term debt and finance lease obligations, net

 
334

Noncurrent
 
 
 
 
   Operating
 
Operating lease liabilities
 
356,062

   Finance
 
Long-term debt and finance lease obligations, less current portion and deferred financing costs, net

 
575

Total lease liabilities
 
 
 
$
379,982

 
 
 
 
 
(a) Finance lease assets are recorded net of accumulated amortization of $1,421 as of June 30, 2019.


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Lease Cost
 
 
 
 
Three Months Ended
 
Six Months Ended
 
 
Classification
 
June 30, 2019
 
June 30, 2019
Operating lease cost (a)
 
Lease and rent expense
 
$
15,802

 
$
31,606

Finance lease cost:
 
 
 
 
 
 
   Amortization of finance lease assets
 
Depreciation and amortization
 
76

 
143

   Interest on finance lease liabilities
 
Interest expense, net
 
15

 
26

Short term lease cost
 
Operating expense
 
162

 
303

Net lease cost
 
 
 
$
16,055

 
$
32,078

 
 
 
 
 
 
 
(a) Includes variable lease costs, which are immaterial
 
 

Maturity of Lease Liabilities
As of June 30, 2019
 
 
Operating Leases (a)
 
Finance Leases (a)
 
Total
 
 
 
 
 
 
 
2019
 
$
58,853

 
$
375

 
$
59,228

2020
 
59,956

 
247

 
60,203

2021
 
61,158

 
222

 
61,380

2022
 
62,383

 
105

 
62,488

2023
 
63,201

 
39

 
63,240

After 2023
 
289,966

 
—

 
289,966

Total lease payments
 
$
595,517

 
$
988

 
$
596,505

Less: Interest
 
(216,444
)
 
(79
)
 
(216,523
)
Present value of lease liabilities
 
$
379,073

 
$
909

 
$
379,982

 
 
 
 
 
 
 
(a)  Operating and Finance lease payments exclude option to extend lease terms that are not reasonably certain of being exercised.

The Company's future minimum lease commitments as of December 31, 2018, under Accounting Standards Codification Topic 840, predecessor to Topic 842, are as follows:
As of December 31, 2018
 
 
Operating Leases (a)
 
Finance Leases (a)
 
Total
 
 
 
 
 
 
 
2018
 
$
58,291

 
$
454

 
$
58,745

2019
 
59,391

 
174

 
59,565

2020
 
60,575

 
173

 
60,748

2021
 
61,808

 
127

 
61,935

2022
 
63,065

 
—

 
63,065

After 2022
 
321,797

 
—

 
321,797

Total lease payments
 
$
624,927

 
$
928

 
$
625,855

 
 
 
 
 
 
 
(a)  Operating and Finance lease payments exclude option to extend lease terms that are not reasonably certain of being exercised.

The measurement of right-of-use assets and lease liabilities requires the Company to estimate appropriate discount rates. To the extent the rate implicit in the lease is readily determinable, such rate is utilized. However, based on information available at lease commencement for the majority of our leases, the rate implicit in the lease is not known. In these instances, the Company utilizes an incremental borrowing rate, which represents the rate of interest that it would pay to borrow on a collateralized basis over a similar term.

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Lease Term and Discount Rate
 
 
June 30, 2019
 
 
 
Weighted-average remaining lease term (years)
 
 
   Operating leases
 
9.53
   Finance leases
 
2.06
Weighted-average discount rate
 
 
   Operating leases
 
9.9%
   Finance leases
 
5.5%

Other Information
 
 
Six Months Ended
 
 
June 30, 2019
Cash paid for amounts included in the measurement of lease liabilities
 
 
   Operating cash flows for operating leases
 
$
29,033

   Operating cash flows for finance leases
 
$
26

   Financing cash flows for finance leases
 
$
250

Acquisition of operating leases through adoption of ASC 842

 
$
389,403


7.     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, offshore limited purpose insurance subsidiary, SHC Risk Carriers, Inc. (“SHC”), to replace some of the expiring commercial policies. SHC covers losses up to specified limits per occurrence. All of the Company's nursing centers in Florida, and Tennessee are now covered under the captive insurance policies along with many of the nursing centers in Alabama, Kentucky, and Texas. The insurance coverage provided for these centers under the SHC policy provides coverage limits of at least $1,000 per medical incident with a sublimit per center of $3,000 and total annual aggregate policy limits of $5,000 . All other centers within the Company's portfolio are covered through various commercial insurance policies which provide similar coverage limits per medical incident, per location, and on an aggregate basis for covered centers. The deductibles for these policies are covered through the insurance subsidiary.
Reserve for Estimated Self-Insured Professional Liability Claims
Because the Company’s actual liability for existing and anticipated professional liability and general liability claims will likely exceed the Company’s limited insurance coverage, the Company has recorded total liabilities for reported and estimated future claims of $26,107 and $27,201 as of June 30, 2019 and December 31, 2018 , respectively. 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

19


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, 2019 , the Company is engaged in 83 professional liability lawsuits. Twenty-two lawsuits are currently scheduled for trial or arbitration during the next twelve months, and it is expected that additional cases will be set for trial or hearing. The Company’s cash expenditures for self-insured professional liability costs from continuing operations were $3,610 and $2,775 for the six months ended June 30, 2019 and 2018 , respectively.
The Company follows the accounting guidance in ASC Topic 954 that clarifies that a health care entity should not net insurance recoveries against a related professional liability claim and that the amount of the claim liability should be determined without consideration of insurance recoveries. Accordingly, the estimated insurance recovery receivables are included within "Self-insurance receivables" on the Consolidated Balance Sheet. As of June 30, 2019 and December 31, 2018 there are estimated insurance recovery receivables of $2,955 and $5,478 , 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 centers that were subject of the original civil investigative demand ("CID"). In connection with this matter, between July 2013 and early February 2016, the Company received three civil investigative demands (a form of subpoena) for documents. The Company has responded to those demands and also provided voluntarily additional information requested by the DOJ. The DOJ has also taken testimony from current and former employees of the Company. In May 2018, the Company learned that a second FCA complaint had been filed in late 2016 relating to the Company’s practices and policies for rehabilitation therapy at some of its facilities. The government’s investigation relates to the Company’s practices and policies for rehabilitation and other services at all of its facilities, for preadmission evaluation forms ("PAEs") required by TennCare and for Pre-Admission Screening and Resident Reviews ("PASRRs") required by the Medicare program.
In June, 2019, the Company and the U.S. Department of Justice (the “DOJ”) reached an agreement in principle on the financial terms of a settlement regarding this investigation. The Company has agreed to the settlement in principle in order to avoid the uncertainty and expense of litigation.
Based on the agreement in principle and in anticipation of the execution of final agreements and payment of a settlement amount of $9,500 (the “Settlement Amount”) the Company recorded an additional loss contingency expense in the amount of $3,100 in the second quarter of 2019, to increase its previously estimated and recorded liability related to this investigation, of which based on the payment terms of the settlement in principle, $500 has been recorded as a current liability. The Company expects to remit the Settlement Amount to the government over a period of five (5) years, once the settlement has been fully documented and executed, and further expects the settlement to require a contingent payment in the event the Company sells any of its owned facilities during the five year payment period and a payment of attorneys' fees to relator's counsel.
The agreement in principle is subject to negotiation, completion and execution of appropriate implementing agreements, including a settlement agreement and a corporate integrity agreement, which are expected to be finalized in the second half of 2019, and the final approval of the respective parties. There can be no assurance that the Company will enter into a final settlement agreement with the DOJ. The Company denies any wrong doing and is prepared to vigorously defend its actions if a settlement is not reached.

Other Insurance
With respect to workers’ compensation insurance, substantially all of the Company’s employees became covered under either a prefunded deductible policy or state-sponsored programs. 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. From the period from July 1, 2008 through June 30, 2019 , the Company is covered by a prefunded deductible policy. Under this policy, the Company is self-insured for the first $500 per claim,

20


subject to an aggregate maximum of $3,000 . 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 $698 and $618 at June 30, 2019 and December 31, 2018 , respectively. The Company has a non-current receivable for workers’ compensation policies covering previous years of $1,467 and $1,258 as of June 30, 2019 and December 31, 2018 , respectively. 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, 2019 , the Company is self-insured for health insurance benefits for certain employees and dependents for amounts up to $200 per individual annually. The Company provides reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate. The liability for reported claims and estimates for incurred but unreported claims is $1,671 at June 30, 2019 . The differences between actual settlements and reserves are included in expense in the period finalized.

8.
STOCK-BASED COMPENSATION

Overview of Plans
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. 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 shares to 350 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. In June 2017, our shareholders approved an amendment to the 2010 Plan to increase the number of shares of our common stock authorized under the 2010 Plan from 380 shares to 680 shares. No grants can be made under the 2010 Plan after May 31, 2027.
Equity Grants and Valuations
During the six months ended June 30, 2019 and 2018 , the Compensation Committee of the Board of Directors approved grants totaling approximately 151 and 90 shares of restricted common stock to certain employees and members of the Board of Directors, respectively. The fair value of restricted shares is determined as the quoted market price of the underlying common shares at the date of the grant. The restricted shares typically vest one-third on the first, second and third anniversaries of the grant date. Unvested shares may not be sold or transferred. During the vesting period, dividends accrue on the restricted shares, but are paid in additional shares of common stock upon vesting, subject to the vesting provisions of the underlying restricted shares. The restricted shares are entitled to the same voting rights as other common shares. Upon vesting, all restrictions are removed. Our policy is to account for forfeitures of share-based compensation awards as they occur.
In computing the fair value estimates using the Black-Scholes-Merton valuation method, 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.

21


Summarized activity of the equity compensation plans is presented below:
 
 
 
Weighted
 
Options/
 
Average
 
SOSARs
 
Exercise Price
Outstanding, December 31, 2018
122

 
$
7.29

Granted
—

 
—

Exercised
(2
)
 
2.37

Expired or cancelled
(21
)
 
8.36

Outstanding, June 30, 2019
99

 
$
7.16

 
 
 
 
Exercisable, June 30, 2019
89

 
$
7.05


 
 
 
Weighted
 
 
 
Average
 
Restricted
 
Grant Date
 
Shares
 
Fair Value
Outstanding, December 31, 2018
120

 
$
8.77

Granted
151

 
3.93

Dividend Equivalents
—

 
—

Vested
(58
)
 
8.91

Cancelled
(3
)
 
5.62

Outstanding, June 30, 2019
210

 
$
5.30


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, 2018
43

 
$
9.26

Granted
36

 
3.93

Dividend Equivalents
—

 
—

Vested
(30
)
 
9.76

Outstanding, June 30, 2019
49

 
$
5.05


The SOSARs and Options were valued and recorded in the same manner, and, other than amounts that may be settled pursuant to employment agreements with certain members of management, 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.

The following table summarizes information regarding stock options and SOSAR grants outstanding as of June 30, 2019 :
 
 
Weighted
 
 
 
 
 
 
 
 
 
 
Average
 
 
 
Intrinsic
 
 
 
Intrinsic
Range of
 
Exercise
 
Grants
 
Value-Grants
 
Grants
 
Value-Grants
Exercise Prices
 
Prices
 
Outstanding
 
Outstanding
 
Exercisable
 
Exercisable
$8.14 to $10.21
 
$
8.83

 
45

 
$
—

 
35

 
$
—

$5.45 to $5.86
 
$
5.76

 
54

 
$
—

 
54

 
$
—

 
 
 
 
99

 
 
 
89

 
 

22


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 $284 and $236 in the six month periods ended June 30, 2019 and 2018 , respectively.
9. INCOME TAXES
The Company recorded an income tax provision of  $16,396  during the six months ended June 30, 2019 and a benefit of $463  during the  six months ended June 30, 2018 .
When assessing the recoverability of the Company’s recorded deferred tax assets, the accounting guidance, ASC 740, Income Taxes , requires that all available positive and negative evidence be considered in evaluating the likelihood that the Company will be able to realize the benefit of its deferred tax assets in the future, which is highly judgmental. Such evidence includes, but may not be limited to, scheduled reversals of deferred tax assets and liabilities, projected future taxable income, tax-planning strategies, and the results of recent operations.
When assessing all available evidence, the Company recognized that governmental and regulatory changes have put downward revenue pressure on the long-term care industry as a piece of negative evidence in its analysis. In 2019 and 2018 combined, the Company has recognized a contingent liability expense of $9.5 million related to the CID settlement in principle. Additionally, in 2017 it recorded an additional $5.5 million of income tax expense related to the revaluation of deferred tax assets in accordance with the Tax Cuts and Jobs Act. Because of these items and other financial results, the Company entered a cumulative loss for the 36 preceding months and performed a thorough assessment of the available positive and negative evidence in order to ascertain whether it is more likely than not that in future periods the Company will generate sufficient pre-tax income to utilize all of its federal deferred tax assets and its net operating loss and other carryforwards and credits.
The Company also identified several pieces of positive evidence that were considered and weighed in the analysis performed regarding the valuation of deferred tax assets. The evidence included the planned termination of operations for 10 nursing facilities in Kentucky expected to be completed in the third quarter of 2019, the related corporate and regional restructuring and other cost saving initiatives already in process. The evidence also included consideration of participation in revenue incentive programs that are expected to generate additional revenue, the long-term expiration dates of a majority of the net operating losses and credits, and the Company’s history of not having carryforwards or credits expire unutilized.
In performing the analysis, the Company contemplated utilization of the recorded deferred tax assets under multiple scenarios. After consideration of these factors, the Company determined that a full valuation allowance is necessary. At June 30, 2019, the Company has established a valuation allowance in the amount of  $20.0 million .  The Company will continue to periodically assess the realizability of its future deferred tax assets.
The Company is not currently under examination by any major income tax jurisdiction. During 2019, the statutes of limitations will lapse on the Company's 2015 Federal tax year and certain 2014 and 2015 state tax years. The Company does not believe the Federal or state statute lapses or any other event will significantly impact the balance of unrecognized tax benefits in the next twelve months. The net balance of unrecognized tax benefits was not material to the Interim Financial Statements for the  six months ended June 30, 2019 and 2018 .



23



10.
EARNINGS PER COMMON SHARE
Information with respect to basic and diluted net loss per common share is presented below in thousands, except per share:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Net loss
 
 
 
 
 
 
 
Loss from continuing operations
$
(24,588
)
 
$
(307
)
 
$
(27,925
)
 
$
(388
)
Loss from discontinued operations, net of income taxes
(8
)
 
(4
)
 
(17
)
 
(26
)
Net loss
$
(24,596
)
 
$
(311
)
 
$
(27,942
)
 
$
(414
)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Net loss per common share:
 
 
 
 
 
 
 
Per common share – basic
 
 
 
 
 
 
 
Loss from continuing operations
$
(3.80
)
 
$
(0.05
)
 
$
(4.33
)
 
$
(0.06
)
Loss from discontinued operations
—

 
—

 
—

 
—

Net loss per common share – basic
$
(3.80
)
 
$
(0.05
)
 
$
(4.33
)
 
$
(0.06
)
Per common share – diluted
 
 
 
 
 
 
 
Loss from continuing operations
$
(3.80
)
 
$
(0.05
)
 
$
(4.33
)
 
$
(0.06
)
Loss from discontinued operations
—

 
—

 
—

 
—

Net loss per common share – diluted
$
(3.80
)
 
$
(0.05
)
 
$
(4.33
)
 
$
(0.06
)
Weighted Average Common Shares Outstanding:
 
 
 
 
 
 
 
Basic
6,472

 
6,370

 
6,448

 
6,342

Diluted
6,472

 
6,370

 
6,448

 
6,342

The effects of 98 and 226 SOSARs and options outstanding were excluded from the computation of diluted earnings per common share in the six months ended June 30, 2019 and 2018 , respectively, because these securities would have been anti-dilutive.

11.
BUSINESS DEVELOPMENTS AND OTHER SIGNIFICANT TRANSACTIONS
2019 Divestiture
On May 22, 2019, the Company announced that it entered into an agreement with Omega Healthcare Investors ("Omega") to amend its master lease to terminate operations of ten nursing facilities, totaling approximately 885 skilled nursing beds, located in Kentucky and to concurrently transfer operations to an operator selected by Omega. The transaction is subject to closing conditions, including but not limited to, state licensure and regulatory approval, due diligence and successful sale of the real estate by Omega. Upon the completion of the transaction, Diversicare will no longer operate any skilled nursing centers in the State of Kentucky. The transaction is expected to become effective in the third quarter of 2019. In accordance with ASC 205, these centers will meet the accounting criteria to be reported as discontinued operations during the third quarter of 2019. In accordance with ASC 250, the remaining assets that are expected to be abandoned are being depreciated at an accelerated rate, and will be fully depreciated when the transaction becomes effected.
Quality Incentive Payment Program
The Company recently expanded its participation in QIPP as administered by the Texas Health and Human Services Commission. QIPP provides supplemental Medicaid payments for skilled nursing centers that achieve certain quality measures. The Company previously had one of its Texas skilled nursing centers participating in the QIPP. During April 2019, the Company enrolled an additional eleven of its Texas skilled nursing centers in the program, such that twelve of the Company’s centers will participate in the QIPP effective September 1, 2019. To allow four of these centers to meet the QIPP participation requirements, the Company entered into a transaction with a Texas medical district already participating in the QIPP, providing for the transfer of the provider

24


license from the Company to the medical district. The Company’s operating subsidiary retained the management of the centers on behalf of the medical district.
2018 Assets Sold
On October 30, 2018 the Company entered into an Asset Purchase Agreement (the "Agreement") with Fulton Nursing and Rehabilitation, LLC, Holiday Fulton Propco LLC, Birchwood Nursing and Rehabilitation LLC, Padgett Clinton Propco LLC, Westwood Nursing and Rehabilitation LLC, and Westwood Glasgow Propco (the "Buyers") to sell the assets and transfer the operation of Diversicare of Fulton, LLC, Diversicare of Clinton, LLC and Diversicare of Glasgow, LLC (the "Kentucky Properties"). On December 1, 2018, the Company completed the sale of the Kentucky Properties with the Buyers for a purchase price of $18,700 . This transaction did not meet the accounting criteria to be reported as a discontinued operation. The carrying value of these centers' assets was $13,331 , resulting in a gain of $4,825 , with remaining proceeds for miscellaneous closing costs. The proceeds were used to relieve debt, which is required under the terms of the Company's Amended Mortgage Loan and Amended Revolver. Refer to Note 5, "Long-term Debt, Interest Rate Swap" for more information on this transaction.
2018 New Master Lease Agreement
On October 1, 2018, the Company entered into a New Master Lease Agreement (the "Lease") with Omega Healthcare Investors (the "Lessor") to lease 34 centers currently owned by the Lessor and operated by Diversicare. The old Master Lease with the Lessor provided for its operation of 23 skilled nursing centers in Texas, Kentucky, Alabama, Tennessee, Florida, and Ohio. Additionally, Diversicare operated 11 centers owned by the Lessor under separate leases in Missouri, Kentucky, Indiana, and Ohio. The Lease entered into by Diversicare and the Lessor consolidates the leases for all 34 centers under one New Master Lease. The Lease has an initial term of twelve years with two optional 10 -year extensions. The Lease has a common date of annual lease fixed escalators of 2.15% beginning on October 1, 2019.


25


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 ten 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, Mississippi, Missouri, Ohio, Tennessee, and Texas.
As of June 30, 2019 , the Company’s continuing operations consist of 72 nursing centers with 8,214 licensed nursing beds. The Company owns 15 and leases 57 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 429 licensed assisted living and residential beds.
Key Performance Metrics
Skilled Mix . Skilled mix represents the number of days our Medicare or Managed Care patients are receiving services at the skilled nursing facilities divided by the total number of days (less days from assisted living patients).
Average rate per day. Average rate per day is the revenue by payor source for a period at the skilled nursing facility divided by actual patient days for the revenue source for a given period.
Average daily skilled nursing census . Average daily skilled nursing census is the average number of patients who are receiving skilled nursing care.
Strategic Operating Initiatives
We identified several key strategic objectives to increase shareholder value through improved operations and business development. These strategic operating initiatives include: improving our facilities' quality metrics, improving skilled mix in our nursing centers, improving our average Medicare rate, implementing and maintaining Electronic Medical Records (“EMR”) to improve Medicaid capture, and completing strategic acquisitions and divestitures. We have experienced success in some of these initiatives and expect to continue to build on these improvements. In light of challenges facing the industry and the Company specifically, including the unresolved governmental investigation, we believe that now is not the time to attempt to engage in a company-wide strategic transaction.
Improving skilled mix and average Medicare rate:
One of our key performance indicators is skilled mix. Our strategic operating initiatives of improving our skilled mix and our average Medicare rate required investing in nursing and clinical care to treat more acute patients along with nursing center-based marketing representatives to attract these patients. These initiatives developed referral and Managed Care relationships

26


that have attracted and are expected to continue to attract payor sources for patients covered by Medicare and Managed Care. The Company's skilled mix for the three months ended  June 30, 2019 and 2018  was  14.3% and 14.8% , respectively.
Utilizing Electronic Medical Records to improve Medicaid acuity capture:
As another part of our strategic operating initiatives, all of our nursing centers utilize EMR to improve Medicaid acuity capture, primarily in our states where the Medicaid payments are acuity based. By using EMR, we have increased our average Medicaid rate despite rate cuts in certain acuity based states by accurate and timely capture of care delivery.
Completing strategic transactions:
Our strategic operating initiatives include a renewed focus on completing strategic acquisitions and divestitures. We continue to pursue and investigate opportunities to acquire or lease new centers, focusing primarily on opportunities within our existing geographic areas of operation. As part of our strategic efforts, we have also performed thorough analysis on our existing centers in order to determine whether continuing operations within certain markets or regions is in line with the short-term and long-term strategy of the business.
On May 22, 2019, the Company announced that it entered into an agreement with Omega Healthcare Investors to amend its master lease to terminate operations of ten nursing facilities, totaling approximately 885 skilled nursing beds, located in Kentucky and to concurrently transfer operations to an operator selected by Omega. The transaction is subject to closing conditions, including but not limited to, state licensure and regulatory approval, due diligence and successful sale of the real estate by Omega. Upon the completion of the transaction, Diversicare will no longer operate any skilled nursing centers in the State of Kentucky. The transaction is expected to become effective in the third quarter of 2019.
The Company recently expanded its participation in QIPP as administered by the Texas Health and Human Services Commission. QIPP provides supplemental Medicaid payments for skilled nursing centers that achieve certain quality measures. The Company previously had one of its Texas skilled nursing centers participating in the QIPP. During April 2019, the Company enrolled an additional eleven of its Texas skilled nursing centers in the program, such that twelve of the Company’s centers will participate in the QIPP effective September 1, 2019. To allow four of these centers to meet the QIPP participation requirements, the Company entered into a transaction with a Texas medical district already participating in the QIPP, providing for the transfer of the provider license from the Company to the medical district. The Company’s operating subsidiary retained the management of the centers on behalf of the medical district.
On October 30, 2018, the Company entered into an Asset Purchase Agreement (the "Agreement") with Fulton Nursing and Rehabilitation LLC, Holiday Fulton Propco LLC, Birchwood Nursing and Rehabilitation LLC, Padgett Clinton Propco LLC, Westwood Nursing and Rehabilitation LLC, and Westwood Glasgow Propco (the "Buyers") to sell the assets and transfer the operations of Diversicare of Fulton, Diversicare of Clinton and Diversicare of Glasgow (the "Properties"). The purchase price of the Properties was $18.7 million and the sale was effective on December 1, 2018.
On October 1, 2018, the Company entered into a New Master Lease Agreement (the "Lease") with Omega Healthcare Investors (the "Lessor") to lease 34 centers currently owned by the Lessor and operated by Diversicare. The old Master Lease with the Lessor provided for its operation of 23 skilled nursing centers in Texas, Kentucky, Alabama, Tennessee, Florida, and Ohio. Additionally, Diversicare operates 11 centers owned by the Lessor under separate leases in Missouri, Kentucky, Indiana, and Ohio. The Lease entered into by Diversicare and the Lessor consolidates the leases for all 34 centers under one New Master Lease. The Lease has an initial term of twelve years with two optional 10 year extensions. The Lease has a common date of annual lease fixed escalators of 2.15% beginning on October 1, 2019.
On July 8, 2018, the Company entered into a membership interest purchase agreement with ALS Ontario Operating, Inc. to transfer all of the issued and outstanding membership units of Ontario Pointe, a stand-alone 50 bed assisted living facility. The termination of this lease was effective on October 1, 2018.
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 2018 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.
The following table sets forth net patient and resident revenues related to our continuing operations by primary payor source for the periods presented (dollar amounts in thousands). The balances below reflect the adoption of ASC 606 in January 2018. Refer to Note 4 "Revenue Recognition" to the interim consolidated financial statements.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Medicaid
$
64,284

47.5
%
 
$
65,603

46.5
%
 
$
127,815

47.4
%
 
$
129,489

45.9
%
Medicare
24,291

17.9
%
 
27,863

19.7
%
 
49,346

18.3
%
 
57,614

20.4
%
Managed Care
14,161

10.5
%
 
13,303

9.4
%
 
28,336

10.5
%
 
27,515

9.7
%
Private Pay and other
32,634

24.1
%
 
34,313

24.4
%
 
64,226

23.8
%
 
67,749

24.0
%
Total
$
135,370

100.0
%
 
$
141,082

100.0
%
 
$
269,723

100.0
%
 
$
282,367

100.0
%

The following table sets forth average daily skilled nursing census by primary payor source for our continuing operations for the periods presented:  
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Medicaid
4,462

 
69.2
%
 
4,645

 
68.9
%
 
4,443

68.9
%
 
4,617

68.4
%
Medicare
625

 
9.7
%
 
715

 
10.6
%
 
638

9.9
%
 
749

11.1
%
Managed Care
296

 
4.6
%
 
281

 
4.2
%
 
302

4.7
%
 
292

4.3
%
Private Pay and other
1,068

 
16.5
%
 
1,105

 
16.3
%
 
1,065

16.5
%
 
1,093

16.2
%
Total
6,451

 
100.0
%
 
6,746

 
100.0
%
 
6,448

100.0
%
 
6,751

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 regulation by numerous federal, state, and local governments. These laws and regulations include, but are not limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, quality of patient care and Medicare and Medicaid fraud and abuse. Over the last several years, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of a number of statutes and regulations, including those regulating fraud and abuse, false claims, patient privacy and quality of care issues. Violations of these laws and regulations could result in exclusion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations is subject to ongoing government review and interpretation, as well as regulatory actions in which government agencies seek to impose fines and penalties. The Company is involved in regulatory actions of this type from time to time.
In recent years, the U.S. Congress and some state legislatures have considered and enacted significant legislation concerning health care and health insurance. The most prominent of these efforts, the Affordable Care Act, affects how health care services are covered, delivered and reimbursed. As currently structured, the Affordable Care Act expands coverage through a combination of public program expansion and private sector reforms, provides for reduced growth in Medicare program spending, and promotes initiatives that tie reimbursement to quality and care coordination. Some of the provisions, such as the requirement that large employers provide health insurance benefits to full-time employees, have increased our operating expenses. The Affordable Care Act expands the role of home-based and community services, which may place downward pressure on our sustaining population

27


of Medicaid patients. Reforms that we believe may have a material impact on the long-term care industry and on our business include, among others, possible modifications to the conditions of qualification for payment, bundling of payments to cover both acute and post-acute care and the imposition of enrollment limitations on new providers. However, there is considerable uncertainty regarding the future of the Affordable Care Act. The Presidential administration and certain members of Congress have made and expressed their intent to repeal or make additional significant changes to the law, its implementation or its interpretation. For example, effective January 1, 2019, Congress eliminated the financial penalty associated with the individual mandate. Because the penalty associated with the individual mandate was eliminated, a federal judge in Texas ruled in December 2018 that the entire law was unconstitutional. However, the law remains in place pending appeal.
Skilled nursing centers are required to bill Medicare on a consolidated basis for certain items and services that they furnish to patients, regardless of the cost to deliver these services. This consolidated billing requirement essentially makes the skilled nursing center responsible for billing Medicare for all care services delivered to the patient during the length of stay. CMS has instituted a number of test programs designed to extend the reimbursement and financial responsibilities under consolidating billing beyond the traditional discharge date to include a broader set of bundled services. Such examples may include, but are not exclusive to, home health, durable medical equipment, home and community based services, and the cost of re-hospitalizations during a specified bundled period. Currently, these test programs for bundled reimbursement are confined to a small set of clinical conditions, but CMS has indicated that it is developing additional bundled payment models. This bundled form of reimbursement could be extended to a broader range of diagnosis related conditions in the future. The potential impact on skilled nursing center utilization and reimbursement is currently unknown.
On July 31, 2018, CMS issued a final rule outlining Medicare payment rates for skilled nursing facilities that became effective October 1, 2018. In addition, CMS updated the SNF market basket percentage to 2.4%, as required by the Bipartisan Budget Act of 2018. CMS finalized a payment system called the Patient-Driven Payment Model ("PDPM") to replace the Resource Utilization Group ("RUG-IV") model. The PDPM is an updated version of the 2017 Advanced Notice of Proposed Rulemaking Resident Classification System Version 1 ("RCS-1"). CMS notes RCS-1 was revised based on stakeholder input. The implementation date for the final system is October 1, 2019. CMS will use a budget neutrality factor to satisfy the requirement that PDPM be budget neutral relative to RUG-IV. CMS stated that it intends for the new model not to change the aggregate amount of Medicare payments to SNFs, but to more accurately reflect resource utilization.
CMS publishes rankings based on performance scores on the Nursing Home Compare website, which is intended to assist the public in finding and comparing skilled care providers. The Nursing Home Compare website also publishes for each nursing home a rating between 1 and 5 stars as part of CMS’s Five-Star Quality Rating System. An overall star rating is determined based on three components (information from the last three years of health inspections, staffing information, and quality measures), each of which also has its own five-star rating. The ratings are based, in part, on the quality data nursing centers are required to report. For example, nursing centers must report the percentage of short-stay residents who are successfully discharged into the community and the percentage who had an outpatient emergency department visit.
In March 2019, CMS announced changes to the Five-Star Quality Rating System, effective April 2019. These changes include revisions to the inspection process, adjustment of staffing rating thresholds, including increased emphasis on registered nurse staffing, implementation of new quality measures, and changes in the scoring of various quality measures. CMS added two new quality measures: Long-stay emergency department transfers and long-stay hospitalizations.  CMS also established separate quality ratings for short-stay and long-stay residents, and will now provide separate short-stay and long-stay ratings in addition to the overall quality measure rating. Ratings for the quality measures are based on 17 of the quality measures posted on the Nursing Home Compare website.
The impact of the most recent five star rating methodology is expected to be significant across the industry.  The change in star ratings may be confusing to consumers.  A center could lose stars as a result of these changes despite not changing its operations.  These changes will also make comparisons to prior reporting periods not relevant. We remain diligent in continuing to provide outstanding patient care to achieve high rankings for our centers, as well as assuring that our rankings are correct and appropriately reflect our quality results. Our focus has been and continues to be on the delivery of quality care to our patients and residents.

Contractual Obligations and Commercial Commitments
We have certain contractual obligations of continuing operations as of June 30, 2019 , 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)
$
84,384

 
$
15,412

 
$
68,829

 
$
143

 
$
—

Settlement obligations (2)
2,010

 
2,010

 
—

 
—

 
—

Operating leases (3)
595,517

 
58,853

 
121,114

 
125,584

 
289,966

Required capital expenditures under operating leases (4)
24,319

 
2,516

 
5,032

 
5,032

 
11,739

Total
$
706,230

 
$
78,791

 
$
194,975

 
$
130,759

 
$
301,705

 
(1)
Long-term debt obligations include scheduled future payments of principal and interest of long-term debt and amounts outstanding on our finance lease obligations. Our long-term debt obligations decreased $0.5 million between December 31, 2018 and June 30, 2019 . See Note 5, "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.

28


(3)
Represents minimum annual lease payments (exclusive of taxes, insurance, and maintenance costs) under our operating lease agreements, which does not include renewals. Our operating lease obligations decreased $29.4 million between December 31, 2018 and June 30, 2019 . See Note 6, "Leases," to the interim consolidated financial statements included in this report for additional information.
(4)
Includes annual expenditure requirements under operating leases. Our required capital expenditures decreased $2.2 million between December 31, 2018 and June 30, 2019 .
Employment Agreements
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 $1.7 million as of June 30, 2019 . The terms of such agreements are for one year and automatically renew for one year if not terminated by us or the employee.
Civil Investigative Demand
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 FCA.
In October 2014, the Company learned that the investigation was started by the filing under seal of a false claims action against the two centers that were subject of the original CID. In connection with this matter, between July 2013 and early February 2016, the Company received three civil investigative demands (a form of subpoena) for documents. The Company has responded to those demands and also provided voluntarily additional information requested by the DOJ. The DOJ has also taken testimony from current and former employees of the Company. In May 2018, the Company learned that a second FCA complaint had been filed in late 2016 relating to the Company’s practices and policies for rehabilitation therapy at some of its facilities. The government’s investigation relates to the Company’s practices and policies for rehabilitation and other services at all of its facilities, for PAEs required by TennCare and for PASRRs required by the Medicare program.
In June, 2019, the Company and the U.S. DOJ reached an agreement in principle on the financial terms of a settlement regarding this investigation in the amount of $9.5 million. The Company has agreed to the settlement in principle in order to avoid the uncertainty and expense of litigation.
See additional description of our contingencies in Note 7 "Commitments and Contingencies" to the interim consolidated financial statements.


29


Results of Operations
The following tables present the unaudited interim consolidated statements of operations and related data for the three and six month periods ended June 30, 2019 and 2018 :
 
(in thousands)
Three Months Ended June 30,
 
2019
 
2018
 
Change
 
%
PATIENT REVENUES, net
$
135,370

 
$
141,082

 
$
(5,712
)
 
(4.0
)%
EXPENSES:
 
 
 
 
 
 
 
Operating
108,641

 
111,440

 
(2,799
)
 
(2.5
)%
Lease and rent expense
15,802

 
13,725

 
2,077

 
15.1
 %
Professional liability
2,957

 
3,182

 
(225
)
 
(7.1
)%
Litigation contingency expense
3,100

 
—

 
3,100

 
100.0
 %
General and administrative
7,594

 
9,295

 
(1,701
)
 
(18.3
)%
Depreciation and amortization
3,002

 
2,847

 
155

 
5.4
 %
Total expenses
141,096

 
140,489

 
607

 
0.4
 %
OPERATING INCOME (LOSS)
(5,726
)
 
593

 
(6,319
)
 
N/M
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Gain on sale of investment in unconsolidated affiliate

—

 
308

 
(308
)
 
(100.0
)%
Other income
45

 
28

 
17

 
60.7
 %
Interest expense, net
(1,556
)
 
(1,661
)
 
105

 
6.3
 %
Total other expenses
(1,511
)
 
(1,325
)
 
(186
)
 
(14.0
)%
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(7,237
)
 
(732
)
 
(6,505
)
 
N/M
BENEFIT (PROVISION)FOR INCOME TAXES
(17,351
)
 
425

 
(17,776
)
 
N/M
LOSS FROM CONTINUING OPERATIONS
$
(24,588
)
 
$
(307
)
 
$
(24,281
)
 
N/M
(in thousands)
Six Months Ended June 30,
 
2019
 
2018
 
Change
 
%
PATIENT REVENUES, net
$
269,723

 
$
282,367

 
$
(12,644
)
 
(4.5
)%
EXPENSES:
 
 
 
 
 
 
 
Operating
216,754

 
223,718

 
(6,964
)
 
(3.1
)%
Lease and rent expense
31,606

 
27,438

 
4,168

 
15.2
 %
Professional liability
6,378

 
5,957

 
421

 
7.1
 %
Litigation contingency expense
3,100

 
—

 
3,100

 
100.0
 %
General and administrative
15,107

 
17,434

 
(2,327
)
 
(13.3
)%
Depreciation and amortization
5,496

 
5,728

 
(232
)
 
(4.1
)%
Total expenses
278,441

 
280,275

 
(1,834
)
 
(0.7
)%
OPERATING INCOME (LOSS)
(8,718
)
 
2,092

 
(10,810
)
 
N/M
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Gain on sale of investment in unconsolidated affiliate

—

 
308

 
(308
)
 
(100.0
)%
Other income
205

 
79

 
126

 
100.0
 %
Interest expense, net
(3,016
)
 
(3,330
)
 
314

 
9.4
 %
Total other expenses
(2,811
)
 
(2,943
)
 
132

 
4.5
 %
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(11,529
)
 
(851
)
 
(10,678
)
 
N/M
BENEFIT (PROVISION) FOR INCOME TAXES
(16,396
)
 
463

 
(16,859
)
 
N/M
LOSS FROM CONTINUING OPERATIONS
$
(27,925
)
 
$
(388
)
 
$
(27,537
)
 
N/M
N/M = Not Meaningful

30



Percentage of Net Revenues
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
PATIENT REVENUES, net
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
EXPENSES:
 
 
 
 
 
 
 
Operating
80.3

 
79.0

 
80.4

 
79.2

Lease and rent expense
11.7

 
9.7

 
11.7

 
9.7

Professional liability
2.2

 
2.3

 
2.4

 
2.1

Litigation contingency expense
2.3

 
—

 
1.1

 
—

General and administrative
5.6

 
6.6

 
5.6

 
6.2

Depreciation and amortization
2.2

 
2.0

 
2.0

 
2.0

Total expenses
104.3

 
99.6

 
103.2

 
99.2

OPERATING INCOME (LOSS)
(4.3
)
 
0.4

 
(3.2
)
 
0.8

OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Gain on sale of investment in unconsolidated affiliate

—

 
0.2

 
—

 
0.1

Other income
—

 
—

 
0.1

 
—

Interest expense, net
(1.0
)
 
(1.1
)
 
(1.1
)
 
(1.2
)
Total other expenses
(1.0
)
 
(0.9
)
 
(1.0
)
 
(1.1
)
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
(5.3
)
 
(0.5
)
 
(4.3
)
 
(0.3
)
BENEFIT (PROVISION) FOR INCOME TAXES
(12.8
)
 
0.3

 
(6.1
)
 
0.2

LOSS FROM CONTINUING OPERATIONS
(18.1
)%
 
(0.2
)%
 
(10.4
)%
 
(0.1
)%

31


Three Months Ended June 30, 2019 Compared To Three Months Ended June 30, 2018
Patient Revenues
Patient revenues were $135.4 million   and $141.1 million for the three months ended June 30, 2019 and 2018 , respectively, a decrease of $ 5.7 million . The following summarizes the revenue fluctuations attributable to changes in our portfolio (in thousands):
 
Three Months Ended June 30,
 
2019
 
2018
 
Change
Same-store revenue
$
135,370

 
$
136,544

 
$
(1,174
)
2018 disposition revenue
—

 
4,538

 
(4,538
)
Total revenue
$
135,370

 
$
141,082

 
$
(5,712
)
The three Kentucky centers we sold in December 2018 contributed $4.5 million of the $5.7 million decreases in patient revenues. Our same-store patient revenues decreased by $1.2 million . Our average Medicaid rate per patient day for the second  quarter of  2019 increased compared to the  second  quarter of  2018 , resulting in an increase in revenue of $1.6 million , or 2.1% . Our Hospice and Managed Care average daily census for the  second  quarter of  2019 increased 14.2% and 7.6% , respectively, resulting in $1.0 million and $0.8 million in additional revenue, respectively. Conversely, our Medicare, Medicaid and Private average daily census for the  second  quarter of  2019 decreased 9.6% , 0.6% and 13.3% , respectively, resulting in revenue losses of $2.7 million , $0.4 million and $1.4 million , respectively.
The following table summarizes key revenue and census statistics for continuing operations for each period:
 
 
Three Months Ended June 30,
 
2019
 
2018
Skilled nursing occupancy
78.5
%
 
79.8
%
As a percent of total census:
 
 
 
Medicare census
9.7
%
 
10.6
%
Medicaid census
69.2
%
 
68.9
%
Managed Care census
4.6
%
 
4.2
%
As a percent of total revenues:
 
 
 
Medicare revenues
17.9
%
 
19.7
%
Medicaid revenues
47.5
%
 
46.5
%
Managed Care revenues
10.5
%
 
9.4
%
Average rate per day:
 
 
 
Medicare
$
458.33

  
$
455.29

Medicaid
$
181.42

  
$
177.58

Managed Care
$
393.81

  
$
397.49


32


Operating Expense
Operating expense decreased in the second quarter of 2019 to $108.6 million from $111.4 million in the second quarter of 2018 , a decrease of $2.8 million . Operating expense increased as a percentage of revenue at 80.3% for the second quarter of 2019 as compared to 79.0% for the second quarter of 2018 . The following table summarizes the expense increases attributable to changes in our portfolio (in thousands):
 
Three Months Ended June 30,
 
2019
2018
 
Change
Same-store operating expense
$
108,447

 
$
107,850

 
$
597

2018 disposition operating expenses

194

 
3,590

 
(3,396
)
Total expense
$
108,641

 
$
111,440

 
$
(2,799
)
The three Kentucky centers we sold in December 2018 reduced operating expenses by $3.4 million . Our same-store operating expenses increased by $0.6 million , which is mostly attributable to increases in health insurance costs of $1.5 million in the second quarter of 2019 compared to the second quarter of 2018 . This was partially offset by decreases in nursing and ancillary expenses and maintenance and utility costs of $0.8 million and $0.2 million, respectively, in the second quarter of 2019 compared to the second quarter of 2018 .
One of the largest components of operating expenses is wages, which decreased from $67.8 million in the second quarter of 2018 , to $65.2 million during the second quarter of 2019 .
Lease Expense
Lease expense in the second quarter of 2019 increased to $15.8 million as compared to $13.7 million in the second quarter of 2018 . The increase in lease expense was due to rent increases resulting from the new master lease agreement with Omega Healthcare Investors and the impact of non-cash straight-line rent expense.
Professional Liability
Professional liability expense was $3.0 million and $3.2 million in the second quarters of 2019 and 2018 , respectively. Our cash expenditures for professional liability costs of continuing operations were $1.7 million for the second quarters of 2019 and 2018 . Professional liability expense fluctuates based on the results of our third-party professional liability actuarial studies and cash expenditures are incurred to defend and settle existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.
Litigation contingency expense
In June, 2019, the Company and the U.S. Department of Justice reached an agreement in principle on the financial terms of a settlement regarding a civil investigative demand. In anticipation of the execution of final agreements and payment of a settlement amount of $9.5 million , we recorded an additional loss contingency expense of $3.1 million in the second quarter of 2019 to increase our previously estimated and recorded liability related to this investigation. The Company denies any wrong doing and is prepared to vigorously defend its actions. Refer to Note 7 to the interim consolidated financial statements for further discussion.
General and Administrative Expense
General and administrative expense was $7.6 million in the second quarter of 2019 as compared to $9.3 million in the second quarter of 2018 . General and administrative expense decreased as a percentage of revenue to 5.6% in the second quarter of 2019 from 6.6% in the second quarter of 2018 . The decrease in general and administrative expense is mainly attributable to $1.2 million of executive severance expense in the second quarter of 2018 . The remaining change is due to a decrease in salaries and related taxes of $0.7 million in the second  quarter of  2019 as compared to the  second  quarter of  2018 .
Depreciation and Amortization
Depreciation and amortization expense was $3.0 million in the second quarter of 2019 as compared to $2.8 million in the second quarter of 2018 . The increase in depreciation expense relates to the acceleration of depreciation for the leasehold improvements in Kentucky, which are expected to be abandoned in the third quarter of 2019. See Note 10, "Business Developments and Other Significant Transactions" to the interim consolidated financial statements.
Interest Expense, Net
Interest expense was $1.6 million in the second quarter of 2019 and $1.7 million in the second quarter of 2018 . The decrease of $0.1 million is due to a decrease in the outstanding borrowings on our loan facilities.

33


Income Tax Benefit (Provision)
The Company recorded an income tax provision of  $17.4 million  during the second quarter of 2019 and an income tax benefit of $0.4 million  during the second quarter of 2018 . The increase in income tax expense is attributable to a non-cash charge for a valuation allowance recognized against our deferred tax assets in the amount of  $20.0 million in the second quarter of 2019.
Loss from Continuing Operations before Income Taxes; Loss from Continuing Operations per Common Share
As a result of the above, continuing operations reported a loss of $7.2 million before income taxes for the second quarter of 2019 as compared to a loss of $0.7 million for the second quarter of 2018 . Both basic and diluted loss per common share from continuing operations were $3.80 for the second quarter of 2019 as compared to both basic and diluted loss per common share from continuing operations of $0.05 in the second quarter of 2018 .



34


Six Months Ended June 30, 2019 Compared To Six Months Ended June 30, 2018
Patient Revenues
Patient revenues were $269.7 million  and $282.4 million for the six months ended June 30, 2019 and 2018 , respectively, a decrease of $12.6 million . The following summarizes the revenue fluctuations attributable to changes in our portfolio (in thousands):
 
Six Months Ended June 30,
 
2019
 
2018
 
Change
Same-store revenue
$
269,723

 
$
273,115

 
$
(3,392
)
2018 disposition revenue
—

 
9,252

 
$
(9,252
)
Total revenue
$
269,723

 
$
282,367

 
$
(12,644
)
The three Kentucky centers we sold in December 2018 contributed $9.3 million of the $12.6 million patient revenues decrease. Our same-store patient revenues decreased by $3.4 million . Our average Medicaid and Medicare rates per patient day for the for the six months ended June 30, 2019 increased compared to the  six months ended June 30, 2018 , resulting in increases in revenue of $3.3 million and $0.3 million , respectively, or 2.3% and 0.4% , respectively. Our Hospice and Managed Care average daily census for the  six months ended June 30, 2019 increased 15.0% and 4.9% , respectively, resulting in $2.1 million and $1.0 million in additional revenue, respectively. Conversely, our Medicare, Medicaid and Private average daily census for the  six months ended June 30, 2019 decreased 11.6% , 0.4% and 11.9% , respectively, resulting in revenue losses of $6.9 million , $0.5 million and $2.6 million , respectively.
The following table summarizes key revenue and census statistics for continuing operations for each period:
 
 
Six Months Ended June 30,
 
2019
 
2018
Skilled nursing occupancy
78.5
%
 
79.8
%
As a percent of total census:
 
 
 
Medicare census
9.9
%
 
11.1
%
Medicaid census
68.9
%
 
68.4
%
Managed Care census
4.7
%
 
4.3
%
As a percent of total revenues:
 
 
 
Medicare revenues
18.3
%
 
20.4
%
Medicaid revenues
47.4
%
 
45.9
%
Managed Care revenues
10.5
%
 
9.7
%
Average rate per day:
 
 
 
Medicare
$
457.70

  
$
455.51

Medicaid
$
181.28

  
$
177.19

Managed Care
$
394.19

  
$
394.64


35


Operating Expense
Operating expense decreased for the six months ended June 30, 2019 to $216.8 million from $223.7 million for the six months ended June 30, 2018 , a decrease of $7.0 million . Operating expense increased as a percentage of revenue at 80.4% for the six months ended June 30, 2019 as compared to 79.2% for the six months ended June 30, 2018 . The following table summarizes the expense increases attributable to changes in our portfolio (in thousands):
 
Six Months Ended June 30,
 
2019
2018
 
Change
Same-store operating expense
$
216,511

 
$
216,903

 
$
(392
)
2018 disposition operating expenses
243

 
6,815

 
(6,572
)
Total expense
$
216,754

 
$
223,718

 
$
(6,964
)
The three Kentucky centers we sold in December 2018 contributed $6.6 million of the $7.0 million operating expense decrease. Our same-store operating expenses decreased by $0.4 million , which is mostly attributable to decreases in nursing and ancillary costs, salaries and related taxes and maintenance and utility expense of $1.3 million, $0.6 million and $0.4 million, respectively, for the six months ended June 30, 2019 compared to the six months ended June 30, 2018 . This was offset by increases in health insurance costs of $2.0 million for the six months ended June 30, 2019 compared to the six months ended June 30, 2018 .
One of the largest components of operating expenses is wages, which decreased from $134.9 million for the six months ended June 30, 2018 to $130.3 million for the six months ended June 30, 2019 .
Lease Expense
Lease expense for the six months ended June 30, 2019 increased to $31.6 million as compared to $27.4 million for the six months ended June 30, 2018 . The increase in lease expense was due to rent increases resulting from the new master lease agreement with Omega Healthcare Investors and the impact of non-cash straight-line rent expense.
Professional Liability
Professional liability expense was $6.4 million and $6.0 million for the six months ended June 30, 2019 and 2018 , respectively. Our cash expenditures for professional liability costs of continuing operations were $3.6 million and $2.8 million for the six months ended June 30, 2019 and 2018 , respectively. Professional liability expense fluctuates based on the results of our third-party professional liability actuarial studies, and cash expenditures are incurred to defend and settle existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.
Litigation contingency expense
In June, 2019, the Company and the U.S. Department of Justice reached an agreement in principle on the financial terms of a settlement regarding a civil investigative demand. In anticipation of the execution of final agreements and payment of a settlement amount of $9.5 million , we recorded a contingent liability related to the DOJ investigation of $3.1 million during the six months ended June 30, 2019 to increase our previously estimated and recorded liability related to this investigation. The Company denies any wrong doing and is prepared to vigorously defend its actions. Refer to Note 7 to the interim consolidated financial statements for further discussion.
General and Administrative Expense
General and administrative expense was $15.1 million for the six months ended June 30, 2019 as compared to $17.4 million for the second quarter of 2018 . General and administrative expense decreased as a percentage of revenue to 5.6% for the six months ended June 30, 2019 from 6.2% for the six months ended June 30, 2018 . The decrease in general and administrative expense is mainly attributable $1.2 million of executive severance expense for the six months ended June 30, 2018 . The remaining change is due to a decrease in salaries and related taxes of $1.4 million for the six months ended June 30, 2019 as compared to the  six months ended June 30, 2018 .
Depreciation and Amortization
Depreciation and amortization expense was $5.5 million for the six months ended June 30, 2019 as compared to $5.7 million for the six months ended June 30, 2018 . The decrease in depreciation expense relates to the dispositions of Fulton, Clinton and Glasgow in the fourth quarter of 2018. See Note 10, "Business Developments and Other Significant Transactions" to the interim consolidated financial statements.
Interest Expense, Net
Interest expense was $3.0 million for the six months ended June 30, 2019 and $3.3 million for the six months ended June 30, 2018 . The decrease of $0.3 million is due to a decrease in the outstanding borrowings on our loan facilities.

36


Income Tax Benefit (Provision)
The Company recorded an income tax provision of  $16.4 million  during the six months ended June 30, 2019 and an income tax benefit of $0.5 million  during the  six months ended June 30, 2018 . The increase in income tax expense is attributable to a non-cash valuation allowance recognized against our deferred tax assets in the amount of  $20.0 million during the six months ended June 30, 2019 .
Loss from Continuing Operations before Income Taxes; Loss from Continuing Operations per Common Share
As a result of the above, continuing operations reported a loss of $11.5 million before income taxes for the six months ended June 30, 2019 as compared to a loss of $0.9 million for the six months ended June 30, 2018 . Both basic and diluted loss per common share from continuing operations were $4.33 for the six months ended June 30, 2019 as compared to both basic and diluted loss per common share from continuing operations of $0.06 for the six months ended June 30, 2018 .
Liquidity and Capital Resources
Liquidity
Our primary sources of liquidity are the net cash flow provided by the operating activities of our centers and draws on our revolving credit facility. We believe that these internally generated cash flows will be adequate to service existing debt obligations and fund required capital expenditures. 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 use of cash include, but are not limited to, capital improvements, purchase of additional shares of our common stock, acquisitions, payment of existing debt obligations as well as initiatives to improve nursing center performance. We review these potential uses and align them to our cash flows with a goal of achieving long-term success.
Net cash used in operating activities of continuing operations totaled $0.8 million for the six months ended June 30, 2019 , compared to net cash provided by operating activities of continuing operations of $6.6 million in the same period of 2018 . The primary driver of the decrease in cash provided by operating activities from continuing operations is due to our net loss of $27.9 million for the six months ended June 30, 2019, compared to net loss of $0.4 million in the same period of 2018. The net loss includes a $20.0 million non-cash charge to record a valuation allowance against our deferred tax assets, additional loss contingency expense of $3.1 million, and $3.5 million of additional rent expense from the straight-line impact of the new Omega master lease, which commenced in the fourth quarter 2018.
Our cash expenditures related to professional liability claims of continuing operations were $3.6 million and $2.8 million for the six months ended June 30, 2019 and 2018 , 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 inability to meet all of our cash needs as they become due.
Investing activities of continuing operations used cash of $2.5 million and $3.6 million for the three months ended in 2019 and 2018 , respectively. The cash used for investing activities relates to the purchase of property and equipment at the centers we operate.
Financing activities of continuing operations provided cash of $3.6 million and used cash of $2.1 million for the six months ended June 30, 2019 and 2018 , respectively. The increase is primarily due to the additional draws on the Company's revolving credit facility, which was partially offset by the dividend and preferred stock payments in 2018.
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, which has issued a policy insuring claims made against all of the Company's nursing centers in Florida and Tennessee, and several of the Company's nursing centers in Alabama, Kentucky, Ohio, and Texas. The insurance coverage provided for these centers under the SHC policy provides coverage limits of at least $1,000 per medical incident with a sublimit per center of $3,000 and total annual aggregate policy limits of $5,000. All other centers within the Company's portfolio are covered through various commercial insurance policies which provide similar coverage limits per medical incident, per location, and on an aggregate basis for covered centers. The deductibles for these policies are covered through the insurance subsidiary.
As of June 30, 2019 , we have recorded total liabilities for reported and settled professional liability claims and estimates for incurred, but unreported claims of $26.1 million . Our calculation of this estimated liability is based on the Company's best estimate

37


of the likelihood of adverse judgments with respect to any asserted claim; however, a significant judgment could be entered against us in one or more of these legal actions, and such a judgment could have a material adverse impact on our financial position and cash flows.
Capital Resources
As of June 30, 2019 , we had $78.6 million of outstanding long-term debt and finance lease obligations. The $78.6 million total includes $0.9 million in finance lease obligations and $17.5 million currently outstanding on the revolving credit facility. The balance of the long-term debt is comprised of $60.1 million owed on our mortgage loan, which includes $50.7 million on the term loan facility and $9.4 million on the acquisition loan facility.
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 $2.2 million and are being amortized over the five -year term of the agreements.
Under the terms of the amended agreements, the syndicate of banks provided the Amended Mortgage Loan with an original balance of $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 is 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, 2019 , the interest rate related to the Amended Mortgage Loan was 6.50% . The Amended Mortgage Loan is secured by fifteen owned nursing centers, related equipment and a lien on the accounts receivable of these centers. The Amended Mortgage Loan and the Amended Revolver are cross-collateralized and cross-defaulted. The Company’s Amended Revolver has an interest rate of LIBOR plus 4.0% and is secured by accounts receivable and is subject to limits on the maximum amount of loans that can be outstanding under the revolver based on borrowing base restrictions.
Effective October 3, 2016, the Company entered into the Second Amendment ("Second Revolver Amendment") to amend the Amended Revolver. The Second Revolver Amendment increased the Amended Revolver capacity from the  $27.5 million  in the Amended Revolver to  $52.3 million ; provided that the maximum revolving facility be reduced to $42.3 million on August 1, 2017. Subsequently, on June 30, 2017, the Company executed a Fourth Amendment (the "Fourth Revolver Amendment") to amend the Amended Revolver, which modifies the capacity of the revolver to remain at $52.3 million .
On December 29, 2016, the Company executed a Third Amendment ("Third Revolver Amendment") to amend the Amended Revolver. The Third Amendment modifies the terms of the Amended Revolving Agreement by increasing the Company’s letter of credit sublimit from  $10.0 million  to  $15.0 million .
Effective June 30, 2017, the Company entered into a Second Amendment (the "Second Term Amendment") to amend the Amended Mortgage Loan. The Second Term Amendment amends the terms of the Amended Mortgage Loan Agreement by increasing the Company's term loan facility by $7.5 million .
Effective February 27, 2018, the Company executed a Fifth Amendment to the Amended Revolver and a Third Amendment to the Amended Mortgage Loan. Under the terms of the Amendments, the minimum fixed charge coverage ratio shall not be less than 1.01 to 1.00 as of March 31, 2018 and for each quarter thereafter.
Effective December 1, 2018, the Company entered into the Sixth Amendment ("Sixth Revolver Amendment") to amend the Amended Revolver. The Sixth Amendment decreased the Amended Revolver capacity from $52.3 million to $42.3 million . The Company also applied $4.9 million of net proceeds from the sale of the Kentucky centers to the outstanding borrowing under the Amended Revolver.
Effective December 1, 2018, the Company executed a Fourth Amendment (the "Fourth Term Amendment") to amend the Amended Mortgage Loan. The Company applied $11.1 million and $2.1 million of net proceeds from the sale of the Kentucky centers to the Term Loan and Acquisition Loan, respectively. Additionally, we amended the Acquisition Loan availability to include a reserve of $2.1 million , and therefore, our borrowing capacity is $10.4 million . For further discussion of the sale of the Kentucky centers, refer to Note 10, "Business Development and Other Significant Transactions."
Effective May 13, 2019, the Company entered into a Fifth Amendment (the “Fifth Term Amendment”) to amend the Amended Mortgage Loan to release the operators of three of the QIPP centers in Texas from the Amended Mortgage Loan and a Seventh Amendment (the “Seventh Revolver Amendment”) to amend the Amended Revolver to remove the operators of all four of the QIPP centers in Texas from the Amended Revolver and to permanently reduce the amount available under the Amended Revolver by $2.0 million . At the same time, the operators of these four facilities entered into a separate revolving loan with the same syndicate

38


of banks to provide for the temporary working capital requirements of the four QIPP centers. The affiliated revolver, which is guaranteed by the Company, has an initial capacity of $5.0 million , which amount is reduced by $1.0 million on each of January 1, 2020, April 1, 2020 and July 1, 2020. The affiliated revolver has the same maturity date as the Amended Revolver and the Amended Mortgage Loan of February 26, 2021. The affiliated revolver is cross-defaulted with the Amended Revolver and the Amended Mortgage Loan. For further discussion of the QIPP centers in Texas, refer to Note 10, "Business Development and Other Significant Transactions." As of June 30, 2019 , the Company had zero borrowings outstanding under the affiliated revolver.
As of June 30, 2019 , the Company had $17.5 million borrowings outstanding under the Amended Revolver compared to $15.0 million outstanding as of December 31, 2018 . The interest rate related to the Amended Revolver was 6.50% as of June 30, 2019 . The outstanding borrowings on the revolver were used primarily for temporary working capital requirements. Annual fees for letters of credit issued under the Amended Revolver are 3.00% of the amount outstanding. The Company has four letters of credit with a total value of $13.6 million outstanding as of June 30, 2019 . 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 $36.7 million , the balance available for borrowing under the Amended Revolver and affiliated revolver was $5.6 million at June 30, 2019 .
Our lending agreements contain various financial covenants, the most restrictive of which relates to debt service coverage ratios. We are in compliance with all such covenants at June 30, 2019 .
Our calculated compliance with financial covenants is presented below:
 
 
Requirement
  
Level at
June 30, 2019
Credit Facility:
 
 
 
Minimum fixed charge coverage ratio
1.01:1.00
 
1.02:1.00
Minimum adjusted EBITDA
$13.0 million
 
$15.2 million
Current ratio (as defined in agreement)
1.00:1.00
 
1.28:1.00
Affiliated Revolver:
 
 
 
Minimum fixed charge coverage ratio
1.00:1.00
 
1.20:1.00
Minimum adjusted EBITDA
$0.825 million
 
$0.853 million
Mortgaged Centers:
 
 
 
EBITDAR
$10.0 million
 
$14.5 million
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.
Off-Balance Sheet Arrangements
We have four letters of credit outstanding with an aggregate value of approximately $13.6 million as of June 30, 2019 . The letters of credit serve as a security deposits for certain center leases. 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 interim consolidated financial statements included herein. Certain statements made by or on behalf of us, including those contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those contemplated by the forward-looking statements made herein. Forward-looking statements are predictive in nature and are frequently identified by the use of terms such as "may," "will," "should," "expect," "believe," "estimate," "intend," and similar words indicating possible future expectations, events or actions. In addition to any assumptions and other factors referred to specifically in connection with such statements, other factors, many of which are beyond our ability to control or predict, could cause our actual results to differ materially from the results expressed or implied in any forward-looking statements including, but not limited to:
•
our ability to successfully integrate the operations of new nursing centers, as well as successfully operate all of our centers,
•
our ability to increase census at our centers and occupancy rates at our centers,
•
changes in governmental reimbursement, including the new Patient-Driven Payment Model to be implemented in the fall of 2019
•
government regulation,
•
the impact of the Affordable Care Act, efforts to repeal or further modify the Affordable Care Act, and other health care reform initiatives,
•
any increases in the cost of borrowing under our credit agreements,
•
our ability to comply with covenants contained in those credit agreements,
•
our ability to comply with the terms of our master lease agreements,
•
our ability to renew or extend our leases at or prior to the end of the existing lease terms,
•
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,
•
the costs of investing in our business initiatives and development,

39


•
our ability to control costs,
•
our ability to attract and retain qualified healthcare professionals,
•
changes to our valuation of deferred tax assets,
•
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, 2018 , for a discussion of various risk factors of the Company and that are inherent in the health care industry. Given these risks and uncertainties, we can give no assurances that these forward-looking statements will, in fact, transpire and, therefore, caution investors not to place undue reliance on them. These assumptions may not materialize to the extent assumed, and risks and uncertainties may cause actual results to be different from anticipated results. These risks and uncertainties also may result in changes to the Company’s business plans and prospects. Such cautionary statements identify important factors that could cause our actual results to materially differ from those projected in forward-looking statements. In addition, we disclaim any intent or obligation to update these forward-looking statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The chief market risk factor affecting our financial condition and operating results is interest rate risk. As of June 30, 2019 , we had outstanding borrowings of approximately $77.6 million , $50.4 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 $0.5 million annually, representing the impact of increased or decreased interest expense on variable rate debt.

ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure 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, 2019 . 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, 2019 , 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.
Changes in Internal Control Over Financial Reporting
We completed certain changes to our accounting processes related to our implementation of Topic 842, which was adopted on January 1, 2019. We updated our control activities for the adoption of the new accounting standard and the new accounting processes and methodologies established to evaluate leases and service agreements under Topic 842.
Other than the items described above, there have been no changes to our internal control over financial reporting during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


40


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 facilities. 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, 2019 , we are engaged in 83 professional liability lawsuits. Twenty-two 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 centers that were subject of the original CID. In connection with this matter, between July 2013 and early February 2016, the Company received three civil investigative demands (a form of subpoena) for documents. The Company has responded to those demands and also provided voluntarily additional information requested by the DOJ. The DOJ has also taken testimony from current and former employees of the Company. In May 2018, the Company learned that a second FCA complaint had been filed in late 2016 relating to the Company’s practices and policies for rehabilitation therapy at some of its facilities. The government’s investigation relates to the Company’s practices and policies for rehabilitation and other services at all of its facilities, for PAEs required by TennCare and for PASRRs required by the Medicare program.
In June, 2019, the Company and the U.S. Department of Justice reached an agreement in principle on the financial terms of a settlement regarding this investigation. The Company has agreed to the settlement in principle in order to avoid the uncertainty and expense of litigation.
Based on the agreement in principle and in anticipation of the execution of final agreements and payment of a settlement amount of $9.5 million (the “Settlement Amount”) the Company recorded an additional loss contingency expense in the amount of $3.1 million in the second quarter of 2019, to increase its previously estimated and recorded liability related to this investigation, of which $500,000 has been recorded as a current liability. The Company expects to remit the Settlement Amount to the government over a period of five (5) years, once the settlement has been fully documented and executed, and further expects the settlement to require a contingent payment in the event the Company sells any of its owned facilities during the five year payment period and a payment of attorneys' fees to relator's counsel.
The agreement in principle is subject to negotiation, completion and execution of appropriate implementing agreements, including a settlement agreement and a corporate integrity agreement, which are expected to be finalized in the second half of 2019, and the final approval of the respective parties. There can be no assurance that the Company will enter into a final settlement agreement with the DOJ. The Company denies any wrong doing and is prepared to vigorously defend its actions if a settlement is not reached.
In January 2009, a purported class action complaint was filed in the Circuit Court of Garland County, Arkansas against the Company and certain of its subsidiaries and Garland Nursing & Rehabilitation Center (the “Center”). The Company answered the original complaint in 2009, and there was no other activity in the case until May 2017. At that time, plaintiff filed an amended complaint asserting new causes of action. The amended complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Center over a multi-year period by failing to meet minimum staffing requirements, failing to otherwise adequately staff the Center and failing to provide a clean and safe living environment in the Center. The Company filed an answer to the amended complaint denying plaintiffs’ allegations and asked the Court to dismiss the new causes of action asserted in the amended complaint because the Company was prejudiced by plaintiff’s long delay in filing the amended complaint. The Court has not yet ruled on the motion to dismiss, so the lawsuit remains in its early stages and has not yet been certified by the court as a class action. The Company intends to defend the lawsuit vigorously.
We cannot currently predict with certainty the ultimate impact of any of the above cases on our financial condition, cash flows or results of operations. An unfavorable outcome in any of these lawsuits, any of our professional liability actions, any regulatory action, or any investigation or lawsuit alleging violations of fraud and abuse laws or of elderly abuse laws or any state or Federal

41


False Claims Act law could subject us to fines, penalties and damages, including exclusion from the Medicare or Medicaid programs, and could have a material adverse impact on our financial condition, cash flows or results of operations.

ITEM 1A. RISK FACTORS.
In addition to the other information set forth in this report, you should carefully consider the risks and uncertainties discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2018, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be not material also may materially and adversely affect our business, financial condition and/or operating results. We are including the following revised risk factors, which update and supersede the corresponding risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018, and which should be read in conjunction with our description of risk factors in Part I, Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the year ended December31, 2018:
Changes to federal and state income tax laws and regulations as well as accounting guidance could adversely affect our position on income taxes, estimated income liabilities and deferred tax assets.
We are subject to both state and federal income taxes in the U.S. and our operations, plans and results are affected by tax and other initiatives. On December 22, 2017, a law commonly known as the Tax Cuts and Jobs Act ("Tax Act") was enacted in the United States. Among other things, the Tax Act reduces the U.S. corporate income tax rate to 21 percent, which could result in changes in the valuation of our deferred tax asset and liabilities.
Accounting guidance requires that deferred tax assets be reduced by a valuation allowance, when it is more likely than not that a tax benefit will not be realized. As of June 30, 2019, we had net deferred tax assets of approximately $20.0 million, against which we have applied a full valuation allowance. We continually assess the realizability of our deferred tax assets. Any such change in valuation could have a material impact on our income tax expense and net deferred tax assets.

We are also subject to regular reviews, examinations, and audits by the Internal Revenue Service and other taxing authorities with respect to our taxes. There are uncertainties and ambiguities in the application of the Tax Act and it is possible that the IRS could issue subsequent guidance or take positions on audit that differ from our interpretations and assumptions. Although we believe our tax estimates are reasonable, if a taxing authority disagrees with the positions we have taken, we could face additional tax liability, including interest and penalties. Our effective tax rate could be adversely affected by changes in the mix of earnings in states with different statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws and regulations, changes in our interpretations of tax laws, including the Tax Act. Unanticipated changes in our tax rates or exposure to additional income tax liabilities could affect our profitability. There can be no assurance that payment of such additional amounts upon final adjudication of any disputes will not have a material impact on our results of operations and financial position.
Our common stock may be delisted from the Nasdaq Capital Market, which may make it more difficult for you to sell your shares.
We are required to meet certain financial criteria in order to maintain our listing on the Nasdaq Capital Market (“Nasdaq”). One such requirement is that we maintain a Market Value of Listed Securities (“MVLS”) of at least $35 million. On December 19, 2018, we received a notification letter from the Nasdaq Listing Qualifications Department indicating that the MVLS of our common stock had been below $35 million for the last 30 consecutive business days. In accordance with Nasdaq Listing Rules 5810(c)(3)(C), the Company was provided a period of 180 calendar days, or until June 17, 2019, in which to regain compliance with the requirement. In order to have regained compliance with the MVLS requirement, the Company must have maintained a MVLS of at least $35 million for a minimum of ten consecutive business days during this 180-day period. However, we were unable to regain compliance with this requirement by June 17, 2019. On June 18, 2019, we received written notification from Nasdaq that our common stock would be delisted from Nasdaq effective June 28, 2019. We requested a hearing before the Nasdaq Hearings Panel (the “Panel”), which is scheduled for August 22, 2019.
There can be no assurance that the Panel will grant the Company’s request for continued listing. Under Nasdaq rules, the delisting of the Company’s common stock will be stayed during the pendency of the appeal and during such time, the Company’s common stock will continue to be listed on Nasdaq. There can be no assurance that the Company will be successful in maintaining its listing of the Common Stock on Nasdaq.
Delisting from Nasdaq may adversely affect our ability to raise additional financing through the public or private sale of equity securities, may affect the ability of investors to trade our securities and may negatively affect the value and liquidity of our common stock. Delisting also could have other negative results, including the potential loss of employee confidence, the loss of institutional investor interest business development opportunities.
If we are delisted from Nasdaq, the trading of our common stock would most likely take place on an over-the-counter market established for unlisted securities, such as the OTCQX or the Pink Market maintained by OTC Markets Group Inc. An investor would likely find it less convenient to sell, or to obtain accurate quotations in seeking to buy, our common stock on an over-the-

42


counter market, and many investors would likely not buy or sell our common stock due to difficulty in accessing over-the-counter markets, policies preventing them from trading in securities not listed on a national exchange or other reasons. In addition, as a delisted security, our common stock would be subject to SEC rules as a “penny stock,” which impose additional disclosure requirements on broker-dealers. The regulations relating to penny stocks, coupled with the typically higher cost per trade to the investor of penny stocks due to factors such as broker commissions generally representing a higher percentage of the price of a penny stock than of a higher-priced stock, would further limit the ability of investors to trade in our common stock. For these reasons and others, delisting could adversely affect the liquidity, trading volume and price of our common stock, causing the value of an investment in us to decrease and having an adverse effect on our business, financial condition and results of operations, including our ability to attract and retain qualified employees, to raise capital, and execute on a strategic alternative.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. MINE SAFETY DISCLOSURE.
Not applicable.
ITEM 5. OTHER INFORMATION.
None.

ITEM 6. EXHIBITS
The following exhibits are filed as part of this report on Form 10-Q.

43


 
 
 
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 filed in paper - hyperlink is not required pursuant to Rule 105 of Regulation S-T).
 
 

  
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 filed in paper - hyperlink is not required pursuant to Rule 105 of Regulation S-T).
 
 

  
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 filed in paper - hyperlink is not required pursuant to Rule 105 of Regulation S-T).
 
 

  
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).
 
 

 
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).
 
 
 

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

 
Bylaw Second Amendment adopted April 14, 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 filed in paper - hyperlink is not required pursuant to Rule 105 of Regulation S-T).
 
 
 

 
Seventh Amendment to Third Amended and Restated Revolving Loan and Security Agreement dated May 13, 2019.

 
 
 

 
Fifth Amendment to Second Amended and Restated Term Loan and Security Agreement dated May 13, 2019.

 
 
 

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

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

  
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


44


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 5, 2019
 
 
 
 
 
 
 
By:
 
/s/ James R. McKnight, Jr.
 
 
 
James R. McKnight, Jr.
 
 
 
President and Chief Executive Officer, Principal Executive Officer and
 
 
 
An Officer Duly Authorized to Sign on Behalf of the Registrant
 
 
 
 
By:
 
/s/ Kerry D. Massey
 
 
 
Kerry D. Massey
 
 
 
Executive Vice President and Chief Financial Officer and
 
 
 
An Officer Duly Authorized to Sign on Behalf of the Registrant

45
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