NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
AND
2016
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
September 30, 2017
, the Company’s continuing operations consist of
76
nursing centers with
8,457
licensed nursing beds. The Company owns
18
and leases
58
of its nursing centers. Our nursing centers range in size from
48
to
320
licensed nursing beds. The licensed nursing bed count does not include
496
licensed assisted and residential living beds.
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2.
|
CONSOLIDATION AND BASIS OF PRESENTATION OF FINANCIAL STATEMENTS
|
The interim consolidated financial statements include the operations and accounts of Diversicare Healthcare Services and its subsidiaries, all wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company had
one
equity method investee, which was sold during the fourth quarter of 2016. The Company's share of the profits and losses from this investment are reported as equity in earnings of investment in an unconsolidated affiliate and the proceeds received from the sale are reported under the heading "Gain on sale of investment in unconsolidated affiliate" in the accompanying interim consolidated statements of operations. The sale resulted in a
$1,366,000
gain in the fourth quarter of 2016. Subsequently, the Company recognized an additional gain of
$733,000
for the
nine
-month period ended
September 30, 2017
, related to the liquidation of remaining assets affiliated with the partnership.
The interim consolidated financial statements for the three and nine month periods ended
September 30, 2017
and
2016
, included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management of the Company, the accompanying interim consolidated financial statements reflect all normal, recurring adjustments necessary to present fairly the Company’s financial position at
September 30, 2017
, and the results of operations for the three and
nine
month periods ended
September 30, 2017
and
2016
, and cash flows for the
nine
month periods ended
September 30, 2017
and
2016
. The Company’s balance sheet information at
December 31, 2016
, was derived from its audited consolidated financial statements as of
December 31, 2016
.
The results of operations for the periods ended
September 30, 2017
and
2016
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, 2016
.
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3.
|
RECENT ACCOUNTING GUIDANCE
|
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606), which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. Topic 606 will be effective for annual and interim reporting periods beginning after December 15, 2017. The Company will adopt the requirements of this standard effective January 1, 2018. The new standard may be applied retrospectively to each period presented (full retrospective method) or retrospectively with the cumulative effect recognized in beginning retained earnings as of the date of adoption (modified retrospective method). The Company will elect to apply the modified retrospective approach upon adoption. Additionally, the new guidance requires enhanced disclosures about the nature, amount, timing, and uncertainty of revenue and cash flows arising from patient contracts, including revenue recognition policies to identify performance obligations, assets recognized from costs incurred to obtain and fulfill a contract, and significant judgments in measurement and recognition. The Company is determining the impact of adopting Topic 606 on its revenue recognition policies, procedures and control framework and the resulting impact on its consolidated financial position, results of operation and cash flows. The Company is in the process of reviewing revenue sources and evaluating the patient account population to determine the appropriate distribution of patient accounts into portfolios with similar collection experience that, when evaluated for collectability, will result in a materially consistent revenue amount for such portfolios as if each patient account was evaluated on a contract-by-contract basis. We expect to complete this process in 2017. The Company is also in the process of assessing the impact of the new standard on various
reimbursement programs that represent variable consideration, including settlements with government payors, state Medicaid programs and bundled payment of care programs. Due to the many forms of calculation and reimbursement that these programs take that vary from state to state, the application of the new standard could have an impact on the revenue recognized for variable consideration. We expect to complete our assessment on variable considerations in 2017. Industry guidance is continuing to develop, and any conclusions in the final industry guidance that is inconsistent with the Company's application could result in changes to the Company's expectations regarding the impact of the new standard on the Company's financial statements. Additionally, the adoption of the new standard will impact the presentation on the Company's statement of operations. After the adoption, the majority of what is currently classified as bad debt expense will be reflected as an implicit price concession as defined in the standard and therefore an adjustment to net patient revenues.
In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, which changes how deferred taxes are classified on the Company's balance sheets. The Company adopted ASU No. 2015-17 as of January 1, 2017, and the new standard was applied on a retrospective basis. The adoption of this guidance resulted in a
$7,644,000
reclassification between current deferred income taxes and non-current deferred income taxes as of December 31, 2016.
In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Disclosures will be required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for building and equipment operating leases and will result in a significant increase in the assets and liabilities on the consolidated balance sheet.
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU was issued as part of the FASB Simplification Initiative and involves several aspects of accounting for share-based payment transactions, including the income tax consequences and classification on the statement of cash flows. We adopted this standard as of January 1, 2017. The adoption did not have a material impact on our financial position, results of operations or cash flows.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This update is intended to improve financial reporting by requiring timelier recognition of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. This update requires that financial statement assets measured at an amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. This standard is effective for the fiscal year beginning after December 15, 2019 with early adoption permitted. The Company is in the initial stages of evaluating the impact from the adoption of this new standard on the consolidated financial statements and related notes.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). The ASU provides clarification regarding how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The ASU is effective for annual and interim periods beginning after December 15, 2017, which will require the Company to adopt these provisions in the first quarter of fiscal 2018 using a retrospective approach. Early adoption is permitted. The Company is currently evaluating the impact this standard will have on our consolidated financial statements.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that the Statement of Cash Flows explain the changes during the period of cash and cash equivalents inclusive of amounts categorized as Restricted Cash. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The standard is effective for periods beginning after December 15, 2017. The Company plans to adopt this standard on January 1, 2018.
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, with early adoption permitted in certain circumstances. The Company is still evaluating the effect, if any, the standard will have on the Company's consolidated financial condition and results of operations. The Company will evaluate future acquisitions under this guidance, which may result in future acquisitions being 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 conditions of a share-based payment award. The new guidance is effective for all entities after December 15, 2017. Early adoption is permitted. The Company does not presently believe adoption of this new standard will be material to its consolidated financial statements.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging - 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. Early adoption is permitted in any interim period or fiscal year before the effective date. The Company is evaluating the effect this guidance will have on our consolidated financial statements and related disclosures.
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4.
|
LONG-TERM DEBT AND INTEREST RATE SWAP
|
The Company has agreements with a syndicate of banks for a mortgage term loan ("Original Mortgage Loan") and the Company’s revolving credit agreement ("Original Revolver"). On February 26, 2016, the Company executed an Amended and Restated Credit Agreement (the "Credit Agreement") which modified the terms of the Original Mortgage Loan and the Original Revolver Agreements dated April 30, 2013. The Credit Agreement increases the Company's borrowing capacity to
$100,000,000
allocated between a
$72,500,000
Mortgage Loan ("Amended Mortgage Loan") and a
$27,500,000
Revolver ("Amended Revolver"). The Amended Mortgage Loan consists of a
$60,000,000
term loan facility and a
$12,500,000
acquisition loan facility. Loan acquisition costs associated with the Amended Mortgage Loan and the Amended Revolver were capitalized in the amount of
$2,162,000
and are being amortized over the
five
-year term of the agreements.
Under the terms of the amended agreements, the syndicate of banks provided the Amended Mortgage Loan with an original principal balance of
$72,500,000
with a
five
-year maturity through February 26, 2021, and a
$27,500,000
Amended Revolver through February 26, 2021. The Amended Mortgage Loan has a term of
five
years, with principal and interest payable monthly based on a
25
-year amortization. Interest on the term and acquisition loan facilities 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
$30,000,000
. The Amended Mortgage Loan balance was
$67,525,000
as of
September 30, 2017
, consisting of
$65,025,000
on the term loan facility with an interest rate of
5.25%
and
$2,500,000
on the acquisition loan facility with an interest rate of
6.0%
. The Amended Mortgage Loan is secured by
eighteen
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
$27,500,000
in the Amended Revolver to
$52,250,000
; provided that the maximum revolving facility be reduced to
$42,250,000
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
$52,250,000
.
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 Mortgage Loan Agreement by increasing the Company’s letter of credit sublimit from
$10,000,000
to
$15,000,000
.
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
$7,500,000
.
As of
September 30, 2017
, the Company had
$20,000,000
borrowings outstanding under the Amended Revolver compared to
$15,000,000
outstanding as of
December 31, 2016
. The outstanding borrowings on the revolver were used primarily to compensate for accumulated Medicaid and Medicare receivables at recently acquired facilities as these facilities proceed through the change in ownership process with Centers for Medicare & Medicaid Services (“CMS”). Annual fees for letters of credit issued under the Amended Revolver are
3.0%
of the amount outstanding. The Company has
eleven
letters of credit with a total value of
$13,408,000
outstanding as of
September 30, 2017
. 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
$38,255,000
, the balance available for borrowing under the Amended Revolver was
$4,847,000
at
September 30, 2017
.
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
September 30, 2017
.
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
$28,775,000
as of
September 30, 2017
. 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
September 30, 2017
, the Company determined that the interest rate swap was highly effective. The interest rate swap valuation model indicated a net liability of
$20,000
at
September 30, 2017
. 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
September 30, 2017
is
$12,000
, net of the income tax benefit of
$8,000
. As the Company’s interest rate swap is not traded on a market exchange, the fair value is determined using a valuation based on a discounted cash flow analysis. This analysis reflects the contractual terms of the interest rate swap agreement and uses observable market-based inputs, including estimated future LIBOR interest rates. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy, in accordance with the FASB guidance set forth in ASC 820,
Fair Value Measurement
.
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5.
|
COMMITMENTS AND CONTINGENCIES
|
Professional Liability and Other Liability Insurance
The Company has professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. Effective July 1, 2013, the Company established a wholly-owned, 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 most of the nursing centers in Alabama, Kentucky, and Texas. The SHC policy provides coverage limits of either
$500,000
or
$1,000,000
per medical incident with a sublimit per center of
$1,000,000
and total annual aggregate policy limits of
$5,000,000
. The remaining nursing centers are covered by one of
seven
claims made professional liability insurance policies purchased from entities unaffiliated with the Company. These policies provide coverage limits of
$1,000,000
per claim and have sublimits of
$3,000,000
per center, with varying self-insured retention levels per claim and varying aggregate policy limits.
Reserve for Estimated Self-Insured Professional Liability Claims
Because the Company’s actual liability for existing and anticipated professional liability and general liability claims will likely exceed the Company’s limited insurance coverage, the Company has recorded total liabilities for reported and estimated future claims of
$19,592,000
as of
September 30, 2017
. This accrual includes estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, actual liabilities related to settlements, including settlements to be paid over time, and estimates of legal costs related to these claims. All losses are projected on an undiscounted basis and are presented without regard to any potential insurance recoveries. Amounts are added to the accrual for estimates of anticipated liability for claims incurred during each period, and amounts are deducted from the accrual for settlements paid on existing claims during each period.
The Company evaluates the adequacy of this liability on a quarterly basis. Semi-annually, the Company retains a third-party actuarial firm to assist in the evaluation of this reserve. Since May 2012, Merlinos & Associates, Inc. (“Merlinos”) has assisted management in the preparation of the appropriate accrual for incurred but not reported general and professional liability claims based on data furnished as of May 31 and November 30 of each year. Merlinos primarily utilizes historical data regarding the frequency and cost of the Company's past claims over a multi-year period, industry data and information regarding the number of occupied beds to develop its estimates of the Company's ultimate professional liability cost for current periods.
On a quarterly basis, the Company obtains reports of asserted claims and lawsuits incurred. These reports, which are provided by the Company’s insurers and a third-party claims administrator, contain information relevant to the actual expense already incurred with each claim as well as the third-party administrator’s estimate of the anticipated total cost of the claim. This information is reviewed by the Company quarterly and provided to the actuary semi-annually. Based on the Company’s evaluation of the actual
claim information obtained, the semi-annual estimates received from the third-party actuary, the amounts paid and committed for settlements of claims and on estimates regarding the number and cost of additional claims anticipated in the future, the reserve estimate for a particular period may be revised upward or downward on a quarterly basis. Any increase in the accrual decreases results of operations in the period and any reduction in the accrual increases results of operations during the period.
As of
September 30, 2017
, the Company is engaged in
71
professional liability lawsuits.
Seven
lawsuits are currently scheduled for trial or arbitration during the next twelve months, and it is expected that additional cases will be set for trial or hearing. The Company’s cash expenditures for self-insured professional liability costs from continuing operations were
$6,077,000
and
$2,779,000
for the
nine
months ended
September 30, 2017
and
2016
, 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
two
of its centers. In response to civil investigative demands (“CIDs”) and informal requests, the Company has provided to the DOJ documents and information relating to the Company’s practices and policies for rehabilitation and other services, relating to the preadmission evaluation forms ("PAEs") required by TennCare, and relating to the Pre-Admission Screening and Resident Reviews ("PASRRs") required by the Medicare program. The DOJ has also obtained testimony from current and former employees of the Company. The DOJ’s civil investigation has been focused on
six
of our centers, but the DOJ has indicated that all of the Company’s centers are the subject of the investigation related to rehabilitation therapy.
In June 2016, the Company received an authorized investigative demand (a form of subpoena) for documents in connection with a criminal investigation by the DOJ related to our practices with respect to PAEs and PASRRs. The Company has responded to this subpoena and provided additional information as requested. The Company cannot predict the outcome of these investigations or the related lawsuits, and the outcome could have a materially adverse effect on the Company, including the imposition of treble damages, criminal charges, fines, penalties and/or a corporate integrity agreement. The Company is committed to provide caring and professional services to its patients and residents in compliance with applicable laws and regulations.
Other Insurance
With respect to workers’ compensation insurance, substantially all of the Company’s employees became covered under either an indemnity insurance plan or state-sponsored programs in May 1997. The Company is completely self-insured for workers’ compensation exposures prior to May 1997. The Company has been and remains a non-subscriber to the Texas workers’ compensation system and is, therefore, completely self-insured for employee injuries with respect to its Texas operations. From June 30, 2003 until June 30, 2007, the Company’s workers’ compensation insurance programs provided coverage for claims incurred with premium adjustments depending on incurred losses. For the period from July 1, 2007 until June 30, 2008, the Company is completely self-insured for workers' compensation exposure. From July 1, 2008 through
September 30, 2017
, the Company is covered by a prefunded deductible policy. Under this policy, the Company is self-insured for the first
$500,000
per claim, subject to an aggregate maximum of
$3,000,000
. The Company funds a loss fund account with the insurer to pay for claims below the deductible. The Company accounts for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred. The liability for workers’ compensation claims is
$871,000
at
September 30, 2017
. The Company has a non-current receivable for workers’ compensation policies covering previous years of
$1,652,000
as of
September 30, 2017
. The non-current receivable is a function of payments paid to the Company’s insurance carrier in excess of the estimated level of claims expected to be incurred.
As of
September 30, 2017
, the Company is self-insured for health insurance benefits for certain employees and dependents for amounts up to
$175,000
per individual annually. The Company provides reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate. The liability for reported claims and estimates for incurred but unreported claims is
$1,293,000
at
September 30, 2017
. The differences between actual settlements and reserves are included in expense in the period finalized.
Hurricanes Harvey and Irma
During the
nine
months ended
September 30, 2017
, Hurricanes Harvey and Irma impacted
four
of our centers in Texas and
one
center in Florida, respectively. We incurred
$0.2 million
of costs which were
recorded as hurricane costs in the accompanying interim consolidated statements of operations for the three and
nine
months ended
September 30, 2017
. The Company continues to evaluate the impact of the hurricanes on the business and intends to file a claim under its insurance program for damages.
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6.
|
STOCK-BASED COMPENSATION
|
Overview of Plans
In December 2005, the Compensation Committee of the Board of Directors adopted the 2005 Long-Term Incentive Plan (“2005 Plan”). The 2005 Plan allows the Company to issue stock options and other share and cash based awards. Under the 2005 Plan,
700,000
shares of the Company's common stock have been reserved for issuance upon exercise of equity awards granted thereunder. This plan has expired and no new grants may be made under the 2005 Plan. All grants under this plan expire
10
years from the date the grants were authorized by the Board of Directors.
In June 2008, the Company adopted the Advocat Inc. 2008 Stock Purchase Plan for Key Personnel (“Stock Purchase Plan”). The Stock Purchase Plan provides for the granting of rights to purchase shares of the Company's common stock to directors and officers . The Stock Purchase Plan allows participants to elect to utilize a specified portion of base salary, annual cash bonus, or director compensation to purchase restricted shares or restricted share units (“RSU's”) at
85%
of the quoted market price of a share of the Company's common stock on the date of purchase. The restriction period under the Stock Purchase Plan is generally
two
years from the date of purchase and during which the shares will have the rights to receive dividends, however, the restricted share certificates will not be delivered to the shareholder and the shares cannot be sold, assigned or disposed of during the restriction period. In June 2016, our shareholders approved an amendment to the Stock Purchase Plan to increase the number of shares of our common stock authorized under the Plan from
150,000
shares to
350,000
shares. No grants can be made under the Stock Purchase Plan after April 25, 2028.
In April 2010, the Compensation Committee of the Board of Directors adopted the 2010 Long-Term Incentive Plan (“2010 Plan”), followed by approval by the Company's shareholders in June 2010. The 2010 Plan allows the Company to issue stock appreciation rights, stock options and other share and cash based awards. In June 2017, our shareholders approved an amendment to the Long-Term Incentive Plan to increase the number of shares of our common stock authorized under the Plan from
380,000
shares to
680,000
shares. No grants can be made under the 2010 Plan after May 31, 2027.
Equity Grants and Valuations
During the
nine
months ended
September 30, 2017
and
2016
, the Compensation Committee of the Board of Directors approved grants totaling approximately
88,000
and
83,000
shares of restricted common stock to certain employees and members of the Board of Directors, respectively. The fair value of restricted shares are determined as the quoted market price of the underlying common shares at the date of the grant. The restricted shares typically vest
33%
on the first, second and third anniversaries of the grant date. Unvested shares may not be sold or transferred. During the vesting period, dividends accrue on the restricted shares, but are paid in additional shares of common stock upon vesting, subject to the vesting provisions of the underlying restricted shares. The restricted shares are entitled to the same voting rights as other common shares. Upon vesting, all restrictions are removed.
Prior to
2016
, the Compensation Committee of the Board of Directors also approved grants of Stock Only Stock Appreciation Rights (“SOSARs”) and Stock Options at the market price of the Company's common stock on the grant date. The SOSARs and Options vest
33%
on the first, second and third anniversaries of the grant date, and expire
10
years from the grant date.
Summarized activity of the equity compensation plans is presented below:
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
Options/
|
|
Average
|
|
SOSARs
|
|
Exercise Price
|
Outstanding, December 31, 2016
|
231,000
|
|
|
$
|
6.97
|
|
Granted
|
—
|
|
|
—
|
|
Exercised
|
—
|
|
|
—
|
|
Expired or cancelled
|
(17,000
|
)
|
|
11.29
|
|
Outstanding, September 30, 2017
|
214,000
|
|
|
$
|
6.64
|
|
|
|
|
|
Exercisable, September 30, 2017
|
209,000
|
|
|
$
|
6.55
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
Average
|
|
Restricted
|
|
Grant Date
|
|
Shares
|
|
Fair Value
|
Outstanding, December 31, 2016
|
153,000
|
|
|
$
|
9.47
|
|
Granted
|
88,000
|
|
|
9.98
|
|
Dividend Equivalents
|
3,000
|
|
|
10.35
|
|
Vested
|
(74,000
|
)
|
|
9.03
|
|
Cancelled
|
(1,000
|
)
|
|
9.98
|
|
Outstanding, September 30, 2017
|
169,000
|
|
|
$
|
9.94
|
|
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, 2016
|
54,000
|
|
|
$
|
11.10
|
|
Granted
|
26,000
|
|
|
9.98
|
|
Dividend Equivalents
|
1,000
|
|
|
10.35
|
|
Vested
|
(37,000
|
)
|
|
12.11
|
|
Cancelled
|
—
|
|
|
—
|
|
Outstanding, September 30, 2017
|
44,000
|
|
|
$
|
9.59
|
|
The SOSARs and Options were valued and recorded in the same manner, and will be settled with issuance of new stock for the difference between the market price on the date of exercise and the exercise price. The Company estimated the total recognized and unrecognized compensation related to SOSARs and stock options using the Black-Scholes-Merton equity grant valuation model.
In computing the fair value estimates using the Black-Scholes-Merton valuation model, the Company took into consideration the exercise price of the equity grants and the market price of the Company's stock on the date of grant. The Company used an expected volatility that equals the historical volatility over the most recent period equal to the expected life of the equity grants. The risk free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. The Company used the expected dividend yield at the date of grant, reflecting the level of annual cash dividends currently being paid on its common stock.
While
no
SOSARs or Options were granted during
2017
and
2016
, previously granted SOSARs and Options remain outstanding as of
September 30, 2017
. The following table summarizes information regarding stock options and SOSAR grants outstanding as of
September 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
Intrinsic
|
|
|
|
Intrinsic
|
Range of
|
|
Exercise
|
|
Grants
|
|
Value-Grants
|
|
Grants
|
|
Value-Grants
|
Exercise Prices
|
|
Prices
|
|
Outstanding
|
|
Outstanding
|
|
Exercisable
|
|
Exercisable
|
$10.21 to $10.88
|
|
$
|
10.63
|
|
|
46,000
|
|
|
$
|
40,000
|
|
|
41,000
|
|
|
$
|
33,000
|
|
$2.37 to $6.21
|
|
$
|
5.55
|
|
|
168,000
|
|
|
$
|
1,000,000
|
|
|
168,000
|
|
|
$
|
1,000,000
|
|
|
|
|
|
214,000
|
|
|
|
|
209,000
|
|
|
|
Stock-based compensation expense is non-cash and is included as a component of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. The Company recorded total stock-based compensation expense of
$766,000
and
$721,000
in the
nine
month periods ended
September 30, 2017
and
2016
, respectively.
|
|
7.
|
EARNINGS (LOSS) PER COMMON SHARE
|
Information with respect to basic and diluted net income (loss) per common share is presented below in thousands, except per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net income (loss)
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
(581
|
)
|
|
$
|
(958
|
)
|
|
1,148
|
|
|
(3,182
|
)
|
Income (loss) from discontinued operations, net of income taxes
|
1
|
|
|
(17
|
)
|
|
(42
|
)
|
|
(54
|
)
|
Net income (loss)
|
$
|
(580
|
)
|
|
$
|
(975
|
)
|
|
$
|
1,106
|
|
|
$
|
(3,236
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net income (loss) per common share:
|
|
|
|
|
|
|
|
Per common share – basic
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
(0.09
|
)
|
|
$
|
(0.16
|
)
|
|
$
|
0.18
|
|
|
$
|
(0.51
|
)
|
Loss from discontinued operations
|
—
|
|
|
—
|
|
|
(0.01
|
)
|
|
(0.01
|
)
|
Net income (loss) per common share – basic
|
$
|
(0.09
|
)
|
|
$
|
(0.16
|
)
|
|
$
|
0.17
|
|
|
$
|
(0.52
|
)
|
Per common share – diluted
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
(0.09
|
)
|
|
$
|
(0.16
|
)
|
|
$
|
0.18
|
|
|
$
|
(0.51
|
)
|
Loss from discontinued operations
|
—
|
|
|
—
|
|
|
(0.01
|
)
|
|
(0.01
|
)
|
Net income (loss) per common share – diluted
|
$
|
(0.09
|
)
|
|
$
|
(0.16
|
)
|
|
$
|
0.17
|
|
|
$
|
(0.52
|
)
|
Weighted Average Common Shares Outstanding:
|
|
|
|
|
|
|
|
Basic
|
6,294
|
|
|
6,212
|
|
|
6,274
|
|
|
6,195
|
|
Diluted
|
6,294
|
|
|
6,212
|
|
|
6,465
|
|
|
6,195
|
|
The effects of
46,000
and
231,000
SOSARs and options outstanding were excluded from the computation of diluted earnings per common share in the
nine
months ended
September 30, 2017
and
2016
, respectively, because these securities would have been anti-dilutive.
8.
EQUITY METHOD INVESTMENT
The Company had
one
equity method investee, which was sold during the fourth quarter of 2016. The Company's share of the net profits and losses of the unconsolidated affiliate are reported as equity in net earnings or losses of unconsolidated affiliate in our statement of operations. For the
nine
-month period ended
September 30, 2017
, the equity in the net income of an unconsolidated affiliate was
zero
compared to
$191,000
for the
nine
-month period ended
September 30, 2016
. The proceeds received from the sale are considered in the calculation of the gain on sale of investment in unconsolidated affiliate in our statement of operations. For the
nine
-month period ended
September 30, 2017
, the gain on the sale of investment in unconsolidated affiliate was
$733,000
, related to the liquidation of remaining assets affiliated with the partnership.
|
|
9.
|
BUSINESS DEVELOPMENTS AND OTHER SIGNIFICANT TRANSACTIONS
|
2017 Acquisition
On June 8, 2017, the Company entered into an Asset Purchase Agreement (the "Purchase Agreement") with Park Place Nursing and Rehabilitation Center, LLC, Dunn Nursing Home, Inc., Wood Properties of Selma LLC, and Homewood of Selma, LLC to acquire a
103
-bed skilled nursing center in Selma, Alabama, for an aggregate purchase price of
$8,750,000
. In connection with the funding of the acquisition, on June 30, 2017, the Company amended the terms of its Second Amended and Restated Term Loan Agreement to increase the facility by
$7,500,000
, which is described in Note 4 to the interim consolidated financial statements herein. The acquisition transaction closed on July 1, 2017. As a result of this business combination transaction, the Company preliminarily allocated the purchase price of
$8,750,000
based on the fair value of the acquired net assets. The preliminary allocation for the building, land and furniture, fixtures and equipment were
$7,332,000
,
$715,000
, and
$703,000
, respectively.
2017 Lease Termination
On September 30, 2017, the Company entered into an Agreement with Trend Health and Rehab of Carthage, LLC ("Trend Health") to terminate the lease and the Company's right of possession of the center in Carthage, Mississippi. In consideration of the early termination of the lease, Trend Health provided the Company with a
$250,000
cash termination payment which is included in lease termination receipts in the accompanying interim consolidated statements of operations for the three and
nine
months ended
September 30, 2017
. For accounting purposes, this transaction was not reported as a discontinued operation, which is in accordance with the modified authoritative guidance for reporting discontinued operations, effective January 1, 2015. A disposal is now required to be reported in discontinued operations only if the disposal represents a strategic shift that has (or will have) a major effect on the Company's operations and financial results.
Golden Living Transaction
On August 15, 2016, the Company entered into an Operation Transfer Agreement with Golden Living (the "Lessor") to assume the operations of
22
centers in Alabama and Mississippi.
On October 1, 2016, the Company entered into a Master Lease Agreement (the "Lease") with Golden Living to directly lease
eight
centers located in Mississippi from the Lessor, which include: (i) a
152
-bed skilled nursing center known as Golden Living Center - Amory; (ii) a
130
-bed skilled nursing center known as Golden Living Center - Batesville; (iii) a
58
-bed skilled nursing center known as Golden Living Center - Brook Manor; (iv) a
119
-bed skilled nursing center known as Golden Living Center - Eupora; (v) a
140
-bed skilled nursing center known as Golden Living Center - Ripley; (vi) a
140
-bed skilled nursing center known as Golden Living Center - Southaven; (vii) a
120
-bed skilled nursing center known as Golden Living Center - Eason Blvd; (viii) a
60
-bed skilled nursing center known as Golden Living Center - Tylertown. The Lease is triple net and has an initial term of
ten years
with two separate five year options to extend the term. The Company also assumed the individual leases of a
120
-bed center known as Broadmoor Nursing Home, with an initial lease term of
ten years
with first year rent of
$540,000
, escalating to
$780,000
in the second year, and
2%
annually thereafter, and a
99
-bed skilled nursing center known as Leake County Nursing Home, with a lease term of
two years
with annual rent of
$300,000
.
On November, 1 2016, the Company amended and restated the Lease ("Amended Lease") with the Lessor to directly lease an additional
twelve
centers located in Alabama from the Lessor, which include: (i) a
87
-bed skilled nursing center known as Golden Living Center - Arab; (ii) a
180
-bed skilled nursing center known as Golden Living Center - Meadowood; (iii) a
132
-bed skilled nursing center known as Golden Living Center - Riverchase; (iv) a
100
-bed skilled nursing center known as Golden Living Center - Boaz; (v) a
154
-bed skilled nursing center known as Golden Living Center - Foley; (vi) a
50
-bed skilled nursing center known as Golden Living Center - Hueytown; (vii) a
85
-bed skilled nursing center known as Golden Living Center - Lanett; (viii) a
138
-bed skilled nursing center known as Golden Living Center - Montgomery; (ix) a
120
-bed skilled nursing center known as Golden Living Center - Oneonta; (x) a
173
-bed skilled nursing center known as Golden Living Center - Oxford; (xi) a
94
-bed skilled nursing center known as Golden Living Center - Pell City; (xii) a
123
-bed skilled nursing center known as Golden Living Center - Winfield. The Amended Lease is triple net and has an initial term of
ten years
with
two
separate
five years
options to extend the term. Base rent for the amended lease is
$24,675,000
for the first year and escalates
2%
annually thereafter.
2016 Acquisitions
On February 26, 2016, the Company exercised its purchase options to acquire the real estate assets for Diversicare of Hutchinson in Hutchinson, Kansas and Clinton Place in Clinton, Kentucky for
$4,250,000
and
$3,300,000
, respectively. The Company has operated these facilities since February 2015 and April 2012, respectively. Hutchinson is an
85
-bed skilled nursing facility, and Clinton is an
88
-bed skilled nursing facility. As a result of the consummation of the Agreements, the Company allocated the purchase price and acquisition costs among the assets acquired based on their relative fair value at the acquisition date. The allocation of the purchase price was determined with the assistance of a third-party real estate valuation firm. The allocation for the assets acquired is as follows:
|
|
|
|
|
|
|
|
|
Hutchinson
|
Clinton Place
|
Purchase Price
|
$
|
4,250,000
|
|
$
|
3,300,000
|
|
Acquisition Costs
|
43,000
|
|
34,000
|
|
|
$
|
4,293,000
|
|
$
|
3,334,000
|
|
|
|
|
Allocation:
|
|
|
Buildings
|
3,443,000
|
|
2,898,000
|
|
Land
|
365,000
|
|
267,000
|
|
Furniture, Fixtures and Equipment
|
485,000
|
|
169,000
|
|
|
$
|
4,293,000
|
|
$
|
3,334,000
|
|
2016 Lease Termination
On May 31, 2016, the Company entered into an Agreement with Avon Ohio, LLC to amend the original lease agreement, thus terminating the Company's right of possession of the facility in Avon, Ohio. As a result, the Company incurred lease termination costs of
$2,008,000
in the second quarter of 2016. Under the amended agreement, the Company is required to pay
$300,000
per year through the term of the original lease agreement, July 31, 2024. For accounting purposes, this transaction was not reported as a discontinued operation, which is in accordance with the modified authoritative guidance for reporting discontinued operations, effective January 1, 2015. A disposal is now required to be reported in discontinued operations only if the disposal represents a strategic shift that has (or will have) a major effect on the Company's operations and financial results.
2016 Sale of Investment in Unconsolidated Affiliate
On October 28, 2016, the Company and its partners entered into an asset purchase agreement to sell the pharmacy joint venture. The sale resulted in a
$1,366,000
gain in the fourth quarter of 2016. Subsequently, we recognized an additional gain of
$733,000
for the
nine
-month period ended
September 30, 2017
, related to the final liquidation of remaining net assets affiliated with the partnership.