NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
AND
2017
(Dollars and shares in thousands, except per share data)
(Unaudited)
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, 2018
, the Company’s continuing operations consist of
76
nursing centers with
8,456
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
497
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 sale resulted in a
$1,366
gain in the fourth quarter of 2016. Subsequently, the Company recognized additional gains of
$308
and
$733
for the
nine
-month periods ended September, 2018 and 2017, respectively, related to the liquidation of remaining assets affiliated with the partnership. All amounts subject to the liquidation of remaining assets affiliated with the partnership have been settled.
The interim consolidated financial statements for the three and nine month periods ended
September 30, 2018
and
2017
, 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, 2018
, and the results of operations for the three and
nine
month periods ended
September 30, 2018
and
2017
, and cash flows for the
nine
month periods ended
September 30, 2018
and
2017
. The Company’s balance sheet information at
December 31, 2017
, was derived from its audited consolidated financial statements as of
December 31, 2017
.
Effective January 1, 2018, we adopted the requirements of Accounting Standards Update ("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 standard.
The results of operations for the periods ended
September 30, 2018
and
2017
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, 2017
.
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3.
|
RECENT ACCOUNTING GUIDANCE
|
Recent Accounting Standards Adopted by the Company
In May 2014, the Financial Accounting Standards Board ("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. Topic 606 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 impact of the implementation to the consolidated financial statements for periods subsequent to adoption is not material. See Note 4, "Revenue Recognition" for a discussion regarding revenue recognition under the new standard.
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 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 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 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 February 2016, the 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 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. 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 an accounting election by asset class not to recognize lease assets and lease liabilities, which would generally result in lease expense being recognized on a straight-line basis over the lease term. The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. 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 intends to use the optional expedient to reflect adoption in the period of adoption (which is January 1, 2019 for us) rather than the earliest period presented. For periods presented under Topic 842, extensive quantitative and qualitative 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. The Company anticipates this standard will have a material impact on the consolidated financial position, primarily from nursing center operating leases. The Company has organized an implementation group of cross-functional departmental management to ensure the completeness of the lease information (specifically for new contracts entered into after the adoption date), analyze the appropriate classification of leases under the new standard, and develop new processes to execute, approve and classify new leases on an ongoing basis. The Company has also implemented software tools and processes to maintain lease information critical to applying the standard. The Company is in the process of cataloging its existing lease contracts and implementing changes to the systems, related processes and controls. The Company is planning to elect 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 Company is continuing to evaluate the extent of this anticipated impact on the consolidated financial position and results of operations and the quantitative and qualitative factors that will impact the Company as part of the adoption. The Company is additionally evaluating any modifications to its leasing strategy in response to the requirements of this standard.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): 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 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. 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.
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. Early adoption is permitted. The Company is evaluating the effect this guidance will have on our consolidated financial statements and related disclosures.
In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 ("SAB No. 118"), which allowed SEC registrants to record provisional amounts in earnings for the year ended December 31, 2017 due to the complexities involved in accounting for the enactment of the Tax Cuts and Jobs Act. The Company recognized the estimated income tax effects of the Tax Cuts and Jobs Act in its 2017 Consolidated Financial Statements in accordance with SAB No. 118.
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 reported results for 2018 reflect the application of ASC 606 guidance while the reported results for 2017 were prepared under the guidance of ASC 605,
Revenue Recognition
(ASC 605), which is also referred to herein as "legacy GAAP". The adoption of ASC 606 represents a change in accounting principle that will more closely align revenue recognition with the delivery of the Company's services. 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 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.
Financial Statement Impact of Adopting ASC 606
The Company adopted ASC 606 using the modified retrospective method. 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. As a result of applying the modified retrospective method to adopt ASC 606, the following adjustments were made to our operating results:
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|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
|
As Reported
|
|
Increase
(Decrease)
|
|
Balances as if the previous accounting guidance was in effect
|
Patient Revenues, net
|
$141,431
|
|
3,903
|
(a)
|
$145,065
|
|
(269)
|
(b)
|
|
3,634
|
|
Operating Expenses
|
$113,799
|
|
3,903
|
(a)
|
$117,702
|
Total Expenses
|
$147,397
|
|
3,903
|
(a)
|
$151,300
|
(a) Adjusts for the implicit price concession of bad debt expense.
(b) Adjusts for the implementation of ASC 606.
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2018
|
|
As Reported
|
|
Increase
(Decrease)
|
|
Balances as if the previous accounting guidance was in effect
|
Patient Revenues, net
|
$423,798
|
|
11,155
|
(a)
|
$434,066
|
|
(887)
|
(b)
|
|
10,268
|
|
Operating Expenses
|
$337,517
|
|
11,155
|
(a)
|
$348,672
|
Total Expenses
|
$427,672
|
|
11,155
|
(a)
|
$438,827
|
(a) Adjusts for the implicit price concession of bad debt expense.
(b) Adjusts for the implementation of ASC 606.
|
|
|
|
|
|
|
|
As of September 30, 2018
|
|
As Reported
|
|
Increase
(Decrease)
|
|
Balances as if the previous accounting guidance was in effect
|
Accounts Receivable
|
$65,927
|
|
(887)
|
(a)
|
$81,275
|
|
16,235
|
(b)
|
|
15,348
|
|
Accumulated Deficit
|
$(23,432)
|
|
887
|
(a)
|
$(22,829)
|
|
(284)
|
(c)
|
|
603
|
|
(a) Adjusts for the implementation of ASC 606.
(b) Adjusts for a direct reduction of accounts receivable that would have been reflected as allowance for doubtful accounts in the consolidated balance sheet prior to the adoption of ASC 606.
(c) Reflects the tax impact for the ASC 606 adjustment of
$887
.
Disaggregation of Revenue
The following table summarizes revenue from contracts with customers by payor source for the periods presented (dollar amounts in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
2018
|
|
2018
|
|
2017(1)
|
|
As reported
|
|
As Adjusted to Legacy GAAP
|
|
As reported
|
Medicaid
|
$
|
68,929
|
|
48.7
|
%
|
|
$
|
78,200
|
|
53.9
|
%
|
|
$
|
77,027
|
|
52.6
|
%
|
Medicare
|
26,997
|
|
19.1
|
%
|
|
34,933
|
|
24.1
|
%
|
|
36,449
|
|
24.9
|
%
|
Managed Care
|
12,404
|
|
8.8
|
%
|
|
10,874
|
|
7.5
|
%
|
|
10,992
|
|
7.5
|
%
|
Private Pay and other
|
33,101
|
|
23.4
|
%
|
|
21,058
|
|
14.5
|
%
|
|
21,909
|
|
15.0
|
%
|
Total
|
$
|
141,431
|
|
100.0
|
%
|
|
$
|
145,065
|
|
100.0
|
%
|
|
$
|
146,377
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2018
|
|
2017(1)
|
|
As reported
|
|
As Adjusted to Legacy GAAP
|
|
As reported
|
Medicaid
|
$
|
198,418
|
|
46.8
|
%
|
|
$
|
226,631
|
|
52.2
|
%
|
|
$
|
223,410
|
|
51.9
|
%
|
Medicare
|
84,611
|
|
20.0
|
%
|
|
109,150
|
|
25.1
|
%
|
|
113,360
|
|
26.3
|
%
|
Managed Care
|
39,919
|
|
9.4
|
%
|
|
34,854
|
|
8.0
|
%
|
|
31,756
|
|
7.4
|
%
|
Private Pay and other
|
100,850
|
|
23.8
|
%
|
|
63,431
|
|
14.7
|
%
|
|
61,901
|
|
14.4
|
%
|
Total
|
$
|
423,798
|
|
100.0
|
%
|
|
$
|
434,066
|
|
100.0
|
%
|
|
$
|
430,427
|
|
100.0
|
%
|
(1) As noted above, prior period amounts have not been adjusted under the application of the modified retrospective method.
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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 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
$72,150
as of
September 30, 2018
, consisting of
$63,150
on the term loan facility with an interest rate of
6.00%
and
$9,000
on the acquisition loan facility with an interest rate of
6.8%
. 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
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.
As of
September 30, 2018
, the Company had
$18,500
borrowings outstanding under the Amended Revolver compared to
$16,000
outstanding as of
December 31, 2017
. The interest rate related to the Amended Revolver was
6.00%
as of
September 30, 2018
. 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”). Also, borrowings on the revolver relate to the timing of cash flows and our operating activities. 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
$13,714
outstanding as of
September 30, 2018
. 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
$37,710
the balance available for borrowing under the Amended Revolver was
$5,496
at
September 30, 2018
.
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, 2018
.
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
$27,915
as of
September 30, 2018
. 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, 2018
, the Company determined that the interest rate swap was highly effective. The interest rate swap valuation model indicated a net asset of
$661
at
September 30, 2018
. The fair value of the interest rate swap is included in “other noncurrent assets” on the Company’s interim consolidated balance sheet. The asset related to the change in the interest rate swap included in accumulated other comprehensive income at
September 30, 2018
is
$403
net of the income tax provision of
$258
. 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.
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
$500
per medical incident with a sublimit per center of
$1,000
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
$27,070
as of
September 30, 2018
. 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, 2018
, the Company is engaged in
83
professional liability lawsuits.
Twenty
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
$4,452
and
$6,077
for the
nine
months ended
September 30, 2018
and
2017
, respectively.
The Company follows the FASB ASU No. 2010-24, "Presentation of Insurance Claims and Related Insurance Recoveries," that clarifies that a health care entity should not net insurance recoveries against a related professional liability claim and that the amount of the claim liability should be determined without consideration of insurance recoveries. Accordingly, the estimated insurance recovery receivables are included within "Other Current Assets" and "Other Noncurrent Assets" on the Consolidated Balance Sheet. As of
September 30, 2018
there are estimated insurance recovery receivables of
$5,425
.
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.
The Company is engaged in preliminary discussions with the DOJ regarding settlement of this investigation. The Company denies any wrong doing and is prepared to vigorously defend its actions. However, based upon preliminary settlement discussions, the Company believes that it is probable a loss will result from this contingency and has accrued
$6,400
as a contingent liability in connection with this matter during the three months ended September 30, 2018. The Company cannot predict whether a settlement can be achieved, the outcome of the litigation if there is no settlement or the length of time necessary to conclude. Accordingly, the contingent liability has been classified as a noncurrent liability in the accompanying interim consolidated balance sheets.
The Company’s ultimate ability to settle this investigation will depend on several factors, including whether the amount and terms of an acceptable settlement can be reached with the DOJ, the Company’s assessment of the risks of litigating this case and the effect of protracted litigation or settlement terms on the Company’s business plans. Because the outcome of this investigation and related settlement discussions remain uncertain, there is a reasonable possibility that the amount ultimately incurred in connection with the resolution of this matter could differ materially from the current accrual, as the Company cannot, at this time, estimate the possible range of loss that may result from either a settlement or litigation of this matter. The ultimate outcome of this litigation 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.
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 the practices of some of its employees with respect to PAEs and PASRRs, and the Company provided documents responsive to this subpoena and coordinated examinations of certain employees of the Company. The Company understands that this criminal investigation has been closed, subject to re-opening at the discretion of the government.
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
September 30, 2018
, the Company is covered by a prefunded deductible policy. Under this policy, the Company is self-insured for the first
$500
per claim, 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
$620
at
September 30, 2018
. The Company has a non-current receivable for workers’ compensation policies covering previous years of
$1,074
as of
September 30, 2018
. 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, 2018
, 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
$1,662
at
September 30, 2018
. The differences between actual settlements and reserves are included in expense in the period finalized.
|
|
7.
|
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
nine
months ended
September 30, 2018
and
2017
, the Compensation Committee of the Board of Directors approved grants totaling approximately
90
and
88
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
33%
on the first, second and third anniversaries of the grant date. Generally, unvested shares may not be sold or transferred. During the vesting period, dividends accrue on the restricted shares, but are paid in additional shares of common stock upon vesting, subject to the vesting provisions of the underlying restricted shares. The restricted shares are entitled to the same voting rights as other common shares. Upon vesting, all restrictions are removed. In addition, during the nine months ended September 30, 2018, the Company granted stock options to purchase a total of
30
shares of common stock at an exercise price equal to the market price of the Company’s common stock on the date of grant to
two
new directors. These stock options vest one third on the date of grant and one third on the first and second anniversary of the date of grant.
Prior to
2017
, 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.
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.
Summarized activity of the equity compensation plans is presented below:
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
Options/
|
|
Average
|
|
SOSARs
|
|
Exercise Price
|
Outstanding, December 31, 2017
|
211
|
|
|
$
|
6.64
|
|
Granted
|
30
|
|
|
8.14
|
|
Exercised
|
(100
|
)
|
|
5.79
|
|
Expired or cancelled
|
(17
|
)
|
|
9.76
|
|
Outstanding, September 30, 2018
|
124
|
|
|
$
|
7.24
|
|
|
|
|
|
Exercisable, September 30, 2018
|
104
|
|
|
$
|
7.06
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
Average
|
|
Restricted
|
|
Grant Date
|
|
Shares
|
|
Fair Value
|
Outstanding, December 31, 2017
|
164
|
|
|
$
|
9.95
|
|
Granted
|
90
|
|
|
8.14
|
|
Dividend Equivalents
|
4
|
|
|
6.95
|
|
Vested
|
(131
|
)
|
|
9.71
|
|
Cancelled
|
(7
|
)
|
|
9.62
|
|
Outstanding, September 30, 2018
|
120
|
|
|
$
|
8.77
|
|
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, 2017
|
44
|
|
|
$
|
9.59
|
|
Granted
|
16
|
|
|
8.14
|
|
Dividend Equivalents
|
1
|
|
|
6.89
|
|
Vested
|
(17
|
)
|
|
8.91
|
|
Outstanding, September 30, 2018
|
44
|
|
|
$
|
9.25
|
|
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
September 30, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
Intrinsic
|
|
|
|
Intrinsic
|
Range of
|
|
Exercise
|
|
Grants
|
|
Value-Grants
|
|
Grants
|
|
Value-Grants
|
Exercise Prices
|
|
Prices
|
|
Outstanding
|
|
Outstanding
|
|
Exercisable
|
|
Exercisable
|
$8.14 to $10.80
|
|
$
|
9.32
|
|
|
60
|
|
|
$
|
—
|
|
|
40
|
|
|
$
|
—
|
|
$2.37 to $5.86
|
|
$
|
5.28
|
|
|
64
|
|
|
$
|
75
|
|
|
64
|
|
|
$
|
75
|
|
|
|
|
|
124
|
|
|
|
|
104
|
|
|
|
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
$947
and
$766
in the
nine
month periods ended
September 30, 2018
and
2017
, respectively. The stock-based compensation expense balance for the nine month period ended September 30, 2018 is inclusive of
$259
related to the vesting of executive equity awards.
|
|
8.
|
EARNINGS 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,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net loss
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
(7,389
|
)
|
|
$
|
(581
|
)
|
|
$
|
(7,777
|
)
|
|
$
|
1,148
|
|
Income (loss) from discontinued operations, net of income taxes
|
(8
|
)
|
|
1
|
|
|
(34
|
)
|
|
(42
|
)
|
Net loss
|
$
|
(7,397
|
)
|
|
$
|
(580
|
)
|
|
$
|
(7,811
|
)
|
|
$
|
1,106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net income (loss) per common share:
|
|
|
|
|
|
|
|
Per common share – basic
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
(1.15
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(1.22
|
)
|
|
$
|
0.18
|
|
Loss from discontinued operations
|
—
|
|
|
—
|
|
|
(0.01
|
)
|
|
(0.01
|
)
|
Net income (loss) per common share – basic
|
$
|
(1.15
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(1.23
|
)
|
|
$
|
0.17
|
|
Per common share – diluted
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
(1.15
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(1.22
|
)
|
|
$
|
0.18
|
|
Loss from discontinued operations
|
—
|
|
|
—
|
|
|
(0.01
|
)
|
|
(0.01
|
)
|
Net income (loss) per common share – diluted
|
$
|
(1.15
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(1.23
|
)
|
|
$
|
0.17
|
|
Weighted Average Common Shares Outstanding:
|
|
|
|
|
|
|
|
Basic
|
6,400
|
|
|
6,294
|
|
|
6,362
|
|
|
6,274
|
|
Diluted
|
6,400
|
|
|
6,294
|
|
|
6,362
|
|
|
6,465
|
|
The effects of
124
and
46
SOSARs and options outstanding were excluded from the computation of diluted earnings per common share in the
nine
months ended
September 30, 2018
and
2017
, respectively, because these securities would have been anti-dilutive.
|
|
9.
|
BUSINESS DEVELOPMENTS AND OTHER SIGNIFICANT TRANSACTIONS
|
2017 Acquisition
During the year ended December 31, 2017, the Company expanded its operations to acquire a center that complements its current portfolio. 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
. The acquisition transaction closed on July 1, 2017. In accordance with ASC 805, this transaction was accounted for as a business combination, which resulted in the expensing of $
140
of acquisition costs and a $
925
recorded gain on bargain purchase for the Company for the year ended December 31, 2017. The operating results of the acquired center have been included in the Company's consolidated statement of operations since the acquisition date. Supplemental pro forma information regarding the acquisition is not material to the consolidated financial statements. The final allocation of the purchase price to the net assets acquired is as follows:
|
|
|
|
|
|
|
|
Park Place
|
Purchase Price
|
|
$
|
8,750
|
|
Gain on bargain purchase
|
|
925
|
|
|
|
$
|
9,675
|
|
|
|
|
Allocation:
|
|
|
Building
|
|
$
|
8,435
|
|
Land
|
|
760
|
|
Land Improvements
|
|
145
|
|
Furniture, Fixtures and Equipment
|
|
335
|
|
|
|
$
|
9,675
|
|
2018 Assets Held for Sale
During the first quarter of 2018,
three
of the Company's skilled nursing facilities met the accounting criteria to be classified as held for sale, but did not meet the accounting criteria to be reported as discontinued operations. The Company is selling the property and equipment affiliated with these centers. The carrying value of these centers' assets are $
13,299
. The centers' assets are classified as held for sale in the accompanying interim consolidated balance sheets. Refer to Note 10 for further discussion.
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
cash termination payment which is included in lease termination receipts in the accompanying interim consolidated statements of operations for the year ended December 31, 2017. For accounting purposes, this transaction was not reported as a discontinued operation as this disposal did not represent 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
gain in the fourth quarter of 2016. Subsequently, the Company recognized additional gains of
$308
and
$733
for the
nine
-month periods ended September 30, 2018 and 2017, respectively, related to the liquidation of remaining assets affiliated with the partnership.
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.
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 Omega and operated by Diversicare. The old Master Lease with Omega provided for its operation of
23
skilled nursing centers in Texas, Kentucky, Alabama, Tennessee, Florida, and Ohio. Additionally, Diversicare operates
11
centers owned by Omega under separate leases in Missouri, Kentucky, Indiana, and Ohio. The Lease entered into by Diversicare and Omega consolidates the leases for all
34
centers under one New Master Lease. The Lease has an initial term of
twelve
years with
two
10
year extensions. The Lease has a common date of annual lease fixed escalators of
2.15%
beginning on October 1, 2019.
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 is
$18,700
and the sale is expected to be completed in the fourth quarter of 2018.