Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________ 
FORM 10-K
________________________________ 
CHECK ONE:
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             .

Commission file No.: 1-12996
________________________________ 
Diversicare Healthcare Services, Inc.
(exact name of registrant as specified in its charter)
 ________________________________
Delaware
 
62-1559667
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
1621 Galleria Boulevard, Brentwood, TN
37027
(Address of principal executive offices)
(Zip Code)

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

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

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

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

None.

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company þ
Emerging growth company ¨

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
¨

The aggregate market value of Common Stock held by non-affiliates on June 30, 2017 (based on the closing price of such shares on the NASDAQ Capital Market) was approximately $38,398,000. For purposes of the foregoing calculation only, all directors, named executive officers and persons known to the registrant to be holders of 5% or more of the registrant's Common Stock have been deemed affiliates of the registrant.

On February 15, 2018, 6,455,487 shares of the registrant's $0.01 par value Common Stock were outstanding.

Documents Incorporated by Reference

Registrant's definitive proxy materials for its 2018 annual meeting of shareholders are incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

 





Table of Contents
 
 
 
Page
Part I
  
 
 
Item 1.
  
Business
Item 1A.
  
Risk Factors
Item 1B.
  
Unresolved Staff Comments
Item 2.
  
Properties
Item 3.
  
Legal Proceedings
Item 4.
  
Mine Safety Disclosures
 
 
 
Part II
  
 
 
Item 5.
  
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
24
Item 6.
  
Selected Consolidated Financial Data
Item 7.
  
Management's Discussion and Analysis of Financial Condition and Results of Operations
27
Item 7A.
  
Quantitative and Qualitative Disclosures about Market Risk
Item 8.
  
Financial Statements and Supplementary Data
Item 9.
  
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
  
Controls and Procedures
Item 9B.
  
Other Information
 
 
 
Part III
  
 
 
Item 10.
  
Directors, Executive Officers and Corporate Governance
Item 11.
  
Executive Compensation
Item 12.
  
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
  
Certain Relationships and Related Transactions, and Director Independence
Item 14.
  
Principal Accountant Fees and Services
 
 
 
Part IV
  
 
 
Item 15.
  
Exhibits and Financial Statement Schedules
Item 16.
 
Form 10-K Summary





PART 1

ITEM 1. BUSINESS

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

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

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

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

Nursing Centers and Services.
Diversicare provides a broad range of post-acute care services to patients and residents including skilled nursing, ancillary health care services and assisted living. In addition to the nursing and social services usually provided in long-term care centers, we offer a variety of rehabilitative, nutritional, respiratory, and other specialized ancillary services. As of December 31, 2017, our continuing operations consist of 76 nursing centers with 8,456 licensed skilled nursing beds. Our nursing centers range in size from 48 to 320 licensed nursing beds. The licensed nursing bed count does not include 489 licensed assisted living beds. Our continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Mississippi, Missouri, Ohio, Tennessee, and Texas.

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The following table summarizes certain information with respect to the nursing centers we own or lease as of December 31, 2017:

 
Number of
Centers
 
Licensed Nursing
Beds (1)
 
Available Nursing
Beds (1)
Operating Locations:
 
 
 
 
 
Alabama
20

 
2,385

 
2,318

Florida
1

 
79

 
79

Indiana
1

 
158

 
158

Kansas
6

 
464

 
464

Kentucky
13

 
1,127

 
1,123

Mississippi
9

 
1,039

 
1,004

Missouri
3

 
339

 
339

Ohio
5

 
403

 
393

Tennessee
5

 
617

 
551

Texas
13

 
1,845

 
1,662

 
76

 
8,456

 
8,091

Classification:
 
 
 
 
 
Owned
18

 
1,607

 
1,404

Leased
58

 
6,849

 
6,687

Total
76

 
8,456

 
8,091

____________
(1)
The number of Licensed Nursing Beds is based on the regulatory licenses for the nursing center. The Company reports its occupancy based on licensed nursing beds. The number of Available Nursing Beds represents Licensed Nursing Beds reduced by beds removed from service. Available Nursing Beds is subject to change based upon the needs of the centers, including configuration of patient rooms, common usage areas and offices, status of beds (private, semi-private, ward, etc.) and renovations. The number of Licensed and Available Nursing Beds does not include 489 Licensed Assisted Living/Residential Beds, all of which are also available, and the number of centers excludes one stand-alone Assisted Living Facility in Ohio. These beds are excluded from the bed counts as our operating statistics such as occupancy are calculated using Nursing Beds only.
Our nursing centers provide skilled nursing health care services, including nutrition services, recreational therapy, social services, housekeeping and laundry services. Skilled nursing care is provided for post-acute patients and residents with comorbidities. This care includes assessment using evidence based tools; individualized care plan development based on identified areas of risk and care needs; and skilled interventions such as IV services. We also provide for the delivery of ancillary medical services at the nursing centers we operate. These specialty services include rehabilitation therapy services, such as audiology, speech, occupational and physical therapies, which are provided through licensed therapists and registered nurses, and the provision of medical supplies, nutritional support, infusion therapies and related clinical services. The majority of these services are provided using our internal resources and clinicians.
Within the framework of a nursing center, we may provide other specialty care, including:
Transitional Care Unit. Many of our nursing centers have units designated as transitional care units, our designation for patients requiring transitional care following an acute stay in the hospital. These units specialize in short-term nursing and rehabilitation with the goal of returning the patient to their highest potential level of functionality. These units provide enhanced services with emphasis on upgraded amenities. The design and programming of the units generally appeal to the clinical and hospitality needs of individuals as they progress to the next appropriate level of care. Specialized therapeutic treatment regimens include orthopedic rehabilitation, neurological rehabilitation and complex medical rehabilitation. While these patients generally have a shorter length of stay, the intensive level of nursing and rehabilitation required by these patients typically results in higher levels of reimbursement.
Memory Care Unit. Like our transitional care units, many of our nursing centers have memory care units, our designation for advanced care for dementia-related disorders including Alzheimer's disease. The goal of the units is to provide a safe, homelike and supportive environment for cognitively impaired patients, utilizing an interdisciplinary team approach. Family and community involvement complement structured programming in the secure environment instrumental in fostering as much resident independence and purposeful quality of life as long as possible despite diminished capacity.

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



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

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

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

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

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

Acquisitions, Significant Transactions and Divestitures.
Acquisitions
Effective July 1, 2017, the Company acquired a 103-bed skilled nursing center in Selma, Alabama, for an aggregate purchase price of $8,750,000, pursuant to an Asset Purchase Agreement with Park Place Nursing and Rehabilitation Center, LLC, Dunn Nursing Home, Inc., Wood Properties of Selma LLC, and Homewood of Selma, LLC.
On February 26, 2016, the Company exercised its purchase options to acquire the real estate assets for Diversicare of Hutchinson in Hutchinson, Kansas and Clinton Place in Clinton, Kentucky for $4,250,000 and $3,300,000, respectively. The Company has operated these centers since February 2015 and April 2012, respectively. Hutchinson is an 85-bed skilled nursing center and Clinton is an 88-bed skilled nursing center.

Golden Living Transaction
On August 15, 2016, the Company entered into an Operation Transfer Agreement with Golden Living (the "Lessor") to assume the operations of 22 centers in Alabama and Mississippi. On October 1, 2016, the Company entered into a Master Lease Agreement (the "Lease") with Golden Living to directly lease 8 centers located in Mississippi from the Lessor. The Company also assumed

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individual leases of two centers in Mississippi from third parties. On November, 1 2016, the Company amended and restated the Lease ("Amended Lease") with the Lessor to directly lease an additional twelve centers located in Alabama. Refer to the chart below for a complete listing of these centers' locations and number of licensed beds.
Lease Agreements and Assumption of Operations
During 2016, the Company assumed operations at 22 centers comprising a total increase of 2,574 licensed beds. The Company did not enter into any lease agreements to assume operations during 2017. See table below for details of the 2016 operations acquired by the Company:
Center
Location
Effective Date
Licensed Bed Count
Diversicare of Amory
Amory, Mississippi
October 1, 2016
152

Diversicare of Batesville
Batesville, Mississippi
October 1, 2016
130

Diversicare of Brookhaven
Brookhaven, Mississippi
October 1, 2016
58

Diversicare of Carthage
Carthage, Mississippi
October 1, 2016
99

Diversicare of Eupora
Eupora, Mississippi
October 1, 2016
119

Diversicare of Meridian
Meridian, Mississippi
October 1, 2016
120

Diversicare of Ripley
Ripley, Mississippi
October 1, 2016
140

Diversicare of Southaven
Southaven, Mississippi
October 1, 2016
140

Diversicare of Tupelo
Tupelo, Mississippi
October 1, 2016
120

Diversicare of Tylertown
Tylertown, Mississippi
October 1, 2016
60

Diversicare of Arab
Arab, Alabama
November 1, 2016
87

Diversicare of Bessemer
Bessemer, Alabama
November 1, 2016
180

Diversicare of Riverchase
Birmingham, Alabama
November 1, 2016
132

Diversicare of Boaz
Boaz, Alabama
November 1, 2016
100

Diversicare of Foley
Foley, Alabama
November 1, 2016
154

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

Diversicare of Lanett
Lanett, Alabama
November 1, 2016
85

Diversicare of Montgomery
Montgomery, Alabama
November 1, 2016
138

Diversicare of Oneonta
Oneonta, Alabama
November 1, 2016
120

Diversicare of Oxford
Oxford, Alabama
November 1, 2016
173

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

Diversicare of Winfield
Winfield, Alabama
November 1, 2016
123

Lease Terminations
Effective 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.
Effective May 31, 2016, the Company entered into an Agreement with Avon Ohio, LLC to amend the original lease agreement, thus terminating the Company's right of possession of the center. As a result, the Company incurred lease termination costs of $2,008,000 in the second quarter of 2016. Under the amended agreement, the Company is required to pay $300,000 per year through the term of the original lease agreement, July 31, 2024.
Under current accounting guidance, these transactions were not reported as discontinued operations, as the disposals did not represent a strategic shift that has (or will have) a major effect on the Company's operations and financial results.
Pharmacy Partnership
Effective October 28, 2016, the Company and its partners entered into an asset purchase agreement to sell the pharmacy joint venture. The sale resulted in a $1,366,000 gain in the fourth quarter of 2016. Subsequently, we recognized an additional gain of $733,000 in the first quarter of 2017, related to the continuing liquidation of remaining net assets affiliated with the partnership.



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

Competition.
The post-acute care business is highly competitive. We face direct competition for additional centers, and our centers face competition for employees and patients. Some of our present and potential competitors for acquisitions are significantly larger and have or may obtain greater financial and marketing resources. Competing companies may offer new or more modern centers or new or different services that may be more attractive to patients than some of the services we offer.
The nursing centers operated by us compete with other centers in their respective markets, including rehabilitation hospitals and other skilled and personal care residential centers. In the few urban markets in which we operate, some of the long-term care providers with which our centers compete are significantly larger and have or may obtain greater financial and marketing resources than our centers. Some of these providers are not-for-profit organizations with access to sources of funds not available to our centers. Construction of new long-term care centers near our existing centers could adversely affect our business. We believe that the most important competitive factors in the long-term care business are: a nursing center's local reputation with referral sources, such as acute care hospitals, physicians, religious groups, other community organizations, Managed Care organizations, and a patient's family and friends; physical plant condition; the ability to identify and meet particular care needs in the community; the availability of qualified personnel to provide the requisite care; and the rates charged for services. There is limited, if any, price competition with respect to Medicaid and Medicare patients, since revenues for services to such patients are strictly controlled and are based on fixed rates and cost reimbursement principles. Although the degree of success with which our centers compete varies from location to location, we believe that our centers generally compete effectively with respect to these factors.



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Revenue Sources
We classify our revenues earned from patients and residents into four major categories: Medicaid, Medicare, managed care, and private pay and other. Medicaid revenues are those received under the traditional Medicaid program, which provides benefits to those in need of financial assistance in the securing of medical services. Medicare revenues include revenues received under both Part A and Part B. Managed Care revenues are received from insurance entities, including third-party plans that administer Medicare benefits, known as Medicare Advantage plans. The private pay and other revenues are composed primarily of individuals or parties who directly pay for their services. Included in the private pay and other category are patients who are hospice beneficiaries as well as the recipients of Veterans Administration benefits. Veterans Administration payments are made pursuant to renewable contracts negotiated with these payors.
The following table sets forth net patient revenues related to our continuing operations by payor source for the periods presented (dollar amounts in thousands):
 
Year Ended December 31,
 
2017

2016

2015
Medicaid
$
300,926

 
52.4
%
 
$
215,381

 
50.6
%
 
$
188,323

 
48.6
%
Medicare
149,020

 
25.9
%
 
117,143

 
27.5
%
 
112,305

 
29.0
%
Managed Care
42,673

 
7.4
%
 
29,066

 
6.8
%
 
27,856

 
7.2
%
Private Pay and other
82,175

 
14.3
%
 
64,473

 
15.1
%
 
59,111

 
15.2
%
Total
$
574,794

 
100.0
%
 
$
426,063

 
100.0
%
 
$
387,595

 
100.0
%
The following table sets forth average daily skilled nursing census, or average number of patients per day, by payor source for our continuing operations for the periods presented:
 
Year Ended December 31,
 
2017
 
2016
 
2015
Medicaid
4,681

 
69.1
%
 
3,448

 
68.1
%
 
3,104

 
67.1
%
Medicare
760

 
11.2
%
 
591

 
11.7
%
 
577

 
12.5
%
Managed Care
265

 
3.9
%
 
178

 
3.5
%
 
173

 
3.7
%
Private Pay and other
1,072

 
15.8
%
 
844

 
16.7
%
 
772

 
16.7
%
Total
6,778

 
100.0
%
 
5,061

 
100.0
%
 
4,626

 
100.0
%
Consistent with the nursing center industry in general, changes in the mix of a center's patient population among Medicaid, Medicare, Managed Care, and private pay and other can significantly affect the profitability of the center's operations. We will attempt to increase revenues from non-governmental sources to the extent capital is available to do so. However, private payors, including managed care payors, are increasingly demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments, which can result in significant losses to health care providers if patients require expensive treatment not adequately covered by the capitated rate.

Medicare and Medicaid Reimbursement
A significant portion of our revenues are derived from government-sponsored health insurance programs, primarily Medicare and Medicaid. We employ third-party specialists in reimbursement and also use these services to monitor regulatory developments to comply with reporting requirements and to ensure that proper payments are made to our operated nursing centers.
Medicare
Medicare is a federally-funded and administered health insurance program for the aged and for certain chronically disabled individuals. Part A of the Medicare program covers certain services furnished by skilled nursing centers and other institutional providers and inpatient hospital services. Part B covers physician services, durable medical equipment, various outpatient services and certain ancillary services. Medicare generally covers skilled nursing center services for beneficiaries who require nursing care or rehabilitation services after a qualifying hospital stay. Medicare pays a per diem rate for each beneficiary, adjusted for patient acuity and additional factors such as geographic differences in wage rates. The payment rates are set forth under a prospective payment system that uses nursing and therapy indexes to assign a payment rate to each beneficiary. The Centers for Medicare &

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Medicaid Services (“CMS”) updates the rates annually. The payment rates cover all services to be provided to a beneficiary, including room and board, skilled nursing care, therapy, and medications.
In August 2017, CMS issued its final rule outlining Medicare payment rates and policies for skilled nursing centers for federal fiscal year 2018, which began October 1, 2017. CMS projects that aggregate payments to skilled nursing centers will increase by a net 1.0% for federal fiscal year 2018. This reflects a 1.0% market basket increase, as required by the Medicare Access and CHIP Reauthorization Act of 2015 (“MACRA”). The payment rates for federal fiscal year 2017, which were projected to increase aggregate payments to skilled nursing centers by 2.4%, reflected a 2.7% market basket increase with a 0.3 percentage point productivity reduction required by the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, “Affordable Care Act”).
In addition to the adjustments described above, payment rates are reduced pursuant to ongoing sequestration. The Budget Control Act of 2011 (“BCA”) requires automatic spending reductions to reduce the federal deficit, including Medicare spending reductions of up to 2% per fiscal year, with a uniform percentage reduction across all Medicare programs. CMS began imposing a 2% reduction on Medicare claims in April of 2013. These reductions have been extended through 2027.
CMS has increasingly introduced policies intended to shift Medicare to value-based payment methodologies, tying reimbursement to quality of care rather than quantity. For example, CMS has implemented the Quality Reporting Program, under which skilled nursing centers are required to report quality data. Beginning in federal fiscal year 2018, skilled nursing centers that fail to submit required data will be subject to a 2% reduction to the annual market basket update. Beginning in federal fiscal year 2019, the Skilled Nursing Facility Value-Based Purchasing (“SNF VBP”) Program will make incentive payments available to skilled nursing centers based on their past performance on a specified quality measure related to hospital readmissions. CMS will fund the SNF VPB Program incentive payment pool by withholding 2% of skilled nursing center payments and then redistributing the withheld payments. Data from the calendar year 2017 performance period will be used to calculate incentive payments for federal fiscal year 2019; data from the federal fiscal year 2018 performance period will be used to calculate incentive payments for federal fiscal year 2020. CMS will publish rankings based on performance scores on the Nursing Home Compare website beginning in 2018.
The Nursing Home Compare website is intended to assist the public in finding and comparing skilled care providers. Under the Five-Star Quality Rating System, each nursing home is given a rating between 1 and 5 stars, which is published on the Nursing Home Compare website. An overall star rating is determined based on three components (information from the last three years of health inspections, staffing information, and quality measures), each of which also has its own five-star rating. The ratings are based, in part, on the quality data nursing centers are required to report. For example, nursing centers must report the percentage of short-stay residents who are successfully discharged into the community and the percentage who had an outpatient emergency department visit. We remain diligent in continuing to provide outstanding patient care to achieve high rankings for our centers, as well as assuring that our rankings are correct and appropriately reflect our quality results.
MACRA required the establishment of the Quality Payment Program (“QPP”), a payment methodology intended to reward high-quality patient care. Beginning in 2017, physicians and certain other clinicians are required to participate in one of two QPP tracks. Under both tracks, performance data collected in 2017 will affect Medicare payments in 2019, and performance data collected in 2018 will affect Medicare payments in 2020. The Advanced Alternative Payment Model (“Advanced APM”) track makes incentive payments available for participation in specific innovative payment models approved by CMS. A provider with sufficient participation in an Advanced APM is exempt from the reporting requirements and payment adjustments imposed under the second track, the Merit-Based Incentive Payment System (“MIPS”). Providers electing to participate in MIPS will receive either payment incentives or be subject to payment reductions based on their performance with respect to clinical quality, resource use, clinical improvement activities, and meaningful use of electronic health records. MIPS consolidates components of previously established incentive programs, including the Value-Based Payment Modifier program and the Physician Quality Reporting System.
Therapy Services. Reimbursement for physical therapy, occupational therapy, and speech-language pathology services covered under Medicare Part B is determined according to the Medicare Physician Fee Schedule ("MPFS"), which is updated annually. Under MACRA, the MPFS reimbursement rate increases 0.5% in calendar year 2018. If a beneficiary receives multiple therapy treatments in one day, Medicare Part B pays the full rate for the therapy unit of service that has the highest Practice Expense ("PE") component. A multiple procedure payment reduction is applied to the second and subsequent therapy units, reducing reimbursement to 50% of the applicable PE component.
The Bipartisan Budget Act of 2018 repealed the annual per-beneficiary payment limits on therapy services covered under Medicare Part B for services provided after December 31, 2017. Instead, targeted medical reviews will be performed when expenses for a beneficiary exceed a threshold of $3,000 for physical and speech therapy services combined or $3,000 for occupational therapy services alone. Deductible and coinsurance amounts paid by the beneficiary for therapy services count toward the amount applied to the limit. Claims above the threshold may be subject to post-payment review of medical necessity documentation by Supplemental Medical Review Contractors.

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Medicaid
Medicaid is a medical assistance program for the indigent that is funded jointly by the federal and state governments and administered by the states. Federal law requires states to cover certain nursing center services for Medicaid-eligible individuals when other payment options are unavailable. However, Medicaid eligibility requirements and benefits vary by state, and states may impose limitations on nursing services. States may also establish levels of service or payment methodologies by acuity or specialization of a nursing center.
The Affordable Care Act, as currently structured, requires states to expand Medicaid coverage by adjusting eligibility requirements such as income thresholds. However, the Presidential administration and certain members of Congress continue to attempt to repeal or significantly modify the Affordable Care Act, which may result in changes to Medicaid. Further, states may opt out of the Medicaid expansion. Some states use or have applied to use waivers granted by CMS to implement expansion, impose different eligibility or enrollment restrictions, or otherwise implement programs that vary from federal standards.
For example, effective February 1, 2015, the Company began participating in Indiana's Upper Payment Limit ("UPL") supplemental payment program, which provides supplemental Medicaid payments for skilled nursing centers that are licensed to non-state government entities such as county hospital districts. One skilled nursing center previously operated by the Company entered into a transaction with one such hospital district participating in the UPL program, providing for the transfer of the license from the Company to the hospital district. The Company's operating subsidiary retained the management of the center on behalf of the hospital district. The agreement between the hospital district and the Company is terminable by either party.
We receive the majority of our annual Medicaid rate increases during the third quarter of each year. The rate changes received in 2017 and 2016, along with increased Medicaid acuity in our acuity based states, were the primary contributor to our 3.3% increase in average rate per day for Medicaid patients in 2017 compared to 2016. Based on the rate changes received during the third quarter of 2017, we expect a favorable impact to our rate per day for Medicaid patients as we move into 2018 due to modest rate increases in many of the states within which we operate.
Several states in which we operate face budget shortfalls, which could result in reductions in Medicaid funding for nursing centers. Pressures on state budgets are expected to continue in the future. Certain of the states in which we operate are actively seeking ways to reduce Medicaid spending for nursing center care by such methods as capitated payments and substantial reductions in reimbursement rates. Some states are promoting alternatives such as community and home-based services. CMS administrators have indicated that they intend to increase state flexibility in the administration of Medicaid programs. We are unable to predict what, if any, reform proposals or reimbursement limitations will be implemented in the future, or the effect such changes would have on our operations. For the year ended December 31, 2017, we derived 25.9% and 52.4% of our total patient revenues related to continuing operations from the Medicare and Medicaid programs, respectively.  Any health care reforms that significantly limit rates of reimbursement under these programs could, therefore, have a material adverse effect on our financial position and profitability. 

Employees.
As of February 2, 2018, we employed approximately 8,800 employees, referred to as "team members," in connection with our continuing operations, approximately 6,300 of which are considered full-time team members. We believe that our team member relations are good. Approximately 842 of our team members are represented by a labor union.
Although we believe we are able to employ sufficient nurses and therapists to provide our services, a shortage of health care professional personnel in any of the geographic areas in which we operate could affect our ability to recruit and retain qualified team members and could increase our operating costs. We compete with other health care providers for both professional and non-professional team members and with non-health care providers for non-professional team members. This competition contributed to a significant increase in the salaries that we had to pay to hire and retain these team members. As is common in the health care industry, we expect the salary and wage increases for our skilled healthcare providers will continue to be higher than average salary and wage increases nationally.
Supplies and Equipment.
We purchase drugs, solutions and other materials and lease certain equipment required in connection with our business from many suppliers. We have not experienced, and do not anticipate that we will experience, any significant difficulty in purchasing supplies or leasing equipment from current suppliers. In the event that such suppliers are unable or fail to sell us supplies or lease equipment, we believe that other suppliers are available to adequately meet our needs at comparable prices. National purchasing contracts are in place for all major supplies, such as food, linens and medical supplies. These contracts assist in maintaining quality, consistency and efficient pricing. Based on contract pricing for food and other supplies, we expect cost increases in 2018 to be relatively the same or slightly lower than the increases we experienced in 2017.

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Government Regulation.
The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, quality of patient care and Medicare and Medicaid fraud and abuse. Over the last several years, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of a number of statutes and regulations, including those regulating fraud and abuse, false claims , patient privacy and quality of care issues. Violations of these laws and regulations could result in exclusion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations is subject to ongoing government review and interpretation, as well as regulatory actions in which government agencies seek to impose fines and penalties. The Company is involved in regulatory actions of this type from time to time.
Licensure and Certification.
All our nursing centers must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing centers are subject to Certificate of Need ("CON") laws, which require us to obtain government approval for the construction of new nursing centers or the addition of new licensed beds to existing centers. Our nursing centers must comply with detailed statutory and regulatory requirements on an ongoing basis in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid certification are similar and relate to quality and adequacy of personnel, quality of medical care, record keeping, dietary services, patient rights, and the physical condition of the nursing center and the adequacy of the equipment used therein. Failure to comply with applicable laws and regulations could result in exclusion from the Medicare and Medicaid programs, which could have an adverse impact on our business, financial condition, or results of operations.
In 2016, CMS published a comprehensive update to the health and safety standards applicable to long-term care facilities participating in the Medicare or Medicaid programs. These revisions are aimed at improving quality of life, care and services in long-term care facilities, optimizing resident safety, and reflecting current professional standards. For example, CMS added requirements related to infection prevention and control, compliance and ethics programs, staff training. and QAPI programs. To allow facilities time to achieve compliance, CMS is implementing the requirements in three phases, over a three year period. We are in substantial compliance with the Phase 1 and Phase 2 requirements, and expect to be in substantial compliance with the Phase 3 requirements by the deadline of November 28, 2019. The total costs associated with implementing the requirements is not known at this time.
Each center is subject to periodic inspections, known as “surveys” by health care regulators, to determine compliance with all applicable licensure and certification standards. Such requirements are both subjective and subject to change. If the survey concludes that there are deficiencies in compliance, the center is subject to various sanctions, including but not limited to monetary fines and penalties, suspension of new admissions, non-payment for new admissions and loss of licensure or certification. Generally, however, once a center receives written notice of any compliance deficiencies, it may submit a written plan of correction and is given a reasonable opportunity to correct the deficiencies. There can be no assurance that, in the future, we will be able to maintain such licenses and certifications for our centers or that we will not be required to expend significant sums in order to comply with regulatory requirements.
Health care and health insurance reform.
In recent years, the U.S. Congress and some state legislatures have considered and enacted significant legislation concerning health care and health insurance. The most prominent of these efforts, The Affordable Care Act affects how health care services are covered, delivered and reimbursed. As currently structured, the Affordable Care Act expands coverage through a combination of public program expansion and private sector reforms, provides for reduced growth in Medicare program spending, and promotes initiatives that tie reimbursement to quality and care coordination. Some of the provisions, such as the requirement that large employers provide health insurance benefits to full-time employees, have increased our operating expenses. The Affordable Care Act expands the role of home-based and community services, which may place downward pressure on our sustaining population of Medicaid patients. Reforms that we believe may have a material impact on the long-term care industry and on our business include, among others, possible modifications to the conditions of qualification for payment, bundling of payments to cover both acute and post-acute care and the imposition of enrollment limitations on new providers. However, there is considerable uncertainty regarding the future of the Affordable Care Act. The Presidential administration and certain members of Congress have expressed
their intent to repeal or make significant changes to the law, its implementation or its interpretation. For example, in 2017, Congress eliminated the financial penalty associated with the individual mandate, effective January 1, 2019.
Skilled nursing centers are required to bill Medicare on a consolidated basis for certain items and services that they furnish to patients, regardless of the cost to deliver these services. This consolidated billing requirement essentially makes the skilled nursing center responsible for billing Medicare for all care services delivered to the patient during the length of stay. CMS has instituted a number of test programs designed to extend the reimbursement and financial responsibilities under consolidated billing beyond the traditional discharge date to include a broader set of bundled services. Such examples may include, but are not exclusive to, home health, durable medical equipment, home and community based services, and the cost of re-hospitalizations during a specified bundled period. Currently, these test programs for bundled reimbursement are confined to a small set of clinical conditions, but CMS has indicated that it is developing additional bundled payment models. This bundled form of reimbursement could be extended to a broader range of diagnosis related conditions in the future. The potential impact on skilled nursing center utilization and reimbursement is currently unknown. The process for defining bundled services has not been fully determined by CMS and therefore is subject to change during the rule making process.
Health Insurance Portability and Accountability Act of 1996 Compliance.
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) has mandated an extensive set of regulations to standardize electronic patient health, administrative and financial data transactions and to protect the privacy of individually identifiable health information. We have a HIPAA compliance committee and designated privacy and security officers.
The HIPAA transaction standards are intended to simplify the electronic claims process and other healthcare transactions by encouraging electronic transmission rather than paper submission. These regulations provide for uniform standards for data reporting, formatting and coding that we must use in certain transactions with health plans. The HIPAA security regulations establish requirements for safeguarding protected health information that is electronically transmitted or electronically stored. Some of the security regulations are technical in nature, while others are addressed through policies and procedures.
The HIPAA regulations related to privacy establish comprehensive federal standards relating to the use and disclosure of individually identifiable health information (“protected health information”). The privacy regulations establish limits on the use and disclosure of protected health information, provide for patients' rights, including rights to access, to request amendment of, and to receive an accounting of certain disclosures of protected health information, and require certain safeguards for protected health information. In addition, each covered entity must contractually bind individuals and entities that furnish services to the covered entity or perform a function on its behalf, and to which the covered entity discloses protected health information, to restrictions on the use and disclosure of that protected health information. In general, the HIPAA regulations do not supersede state laws that are more stringent or grant greater privacy rights to individuals. Thus, we must reconcile the HIPAA regulations and other state privacy laws.
Although we believe that we are in material compliance with these HIPAA regulations, inadvertent violations of these regulations may occur in the course of our business. For this and other reasons, the HIPAA regulations are expected to continue to impact us operationally and financially and may pose increased regulatory risk.
Self-Referral and Anti-Kickback Legislation.
The health care industry is subject to state and federal laws that regulate the relationships of providers of health care services, physicians and other clinicians. These self-referral laws impose restrictions on physician referrals to any entity with which they have a financial relationship, which is a broadly defined term. We believe our relationships with physicians are in compliance with the self-referral laws. Failure to comply with self-referral laws could subject us to a range of sanctions, including civil monetary penalties and possible exclusion from government reimbursement programs. There are also federal and state laws making it illegal to offer anyone anything of value in return for referral of patients. These laws, generally known as “anti-kickback” laws, are broad and subject to interpretations that are highly fact dependent. Given the lack of clarity of these laws, there can be no absolute assurance that any health care provider, including us, will not be found in violation of the anti-kickback laws in any given factual situation. Strict sanctions, including fines and penalties, exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for violation of the anti-kickback laws.
Reporting Obligations under Section 111 of the Medicare, Medicaid and SCHIP Extension Act of 2007 (“MMSEA”).
The MMSEA expanded the Medicare Secondary Reporting Act. Since January 1, 2010, we have reported specific information regarding all claimants and claim settlements involving Medicare participants so CMS can recover Medicare funds expended to provide healthcare treatment to the claimant. The requirements are to ensure that CMS is notified so that it may recoup the amounts paid for services from the settlement proceeds. This does not result in us making additional payments to CMS for these services

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provided and does not result in an incremental cost to us. Strict sanctions, including fines and penalties, exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for non-compliance with these reporting obligations.


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

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

ITEM 1A. RISK FACTORS
There have been a number of material developments both within the Company and the long-term care industry. These developments have had and are likely to continue to have a material impact on us. This section summarizes these developments, as well as other risks that should be considered by our shareholders and prospective investors.
Risks Related to our Operations
We are substantially self-insured and have significant potential professional liability exposure.
The provision of health care services entails an inherent risk of liability. Participants in the health care industry are subject to an increasing number of lawsuits alleging malpractice, negligence, product liability or related legal theories, many of which involve large claims and significant defense costs. Like many other companies engaged in the long-term care profession in the United States, we have numerous pending liability claims, disputes and legal actions for professional liability and other related issues. We expect to continue to be subject to such suits as a result of the nature of our business. We have professional liability insurance coverage for our nursing centers that, based on historical claims experience, is likely to be substantially less than the amount required to satisfy claims that are expected to be incurred. See “Item 3. Legal Proceedings” for further descriptions of pending claims and see “Item 7. Management's Discussion and Analysis of Financial Condition - Accounting Policies and Judgments - Professional Liability and Other Self-Insurance Reserves” for discussion of our reserve for self-insured claims and of our ability to meet our anticipated cash needs.
We may have substantial adjustments to our accrual for professional liability claims which could cause significant changes in our net earnings.
Each year, we record adjustments to our accrual for self-insured risks associated with professional liability claims. While these adjustments to the accrual result in changes to reported expenses and income, they are not directly related to changes in cash because the accrual is not funded. These self-insurance reserves are assessed on a quarterly basis, with changes in estimated losses being recorded in the consolidated statements of operations in the period identified. Any increase in the accrual decreases income in the period, and any reduction in the accrual increases income during the period. Our actual professional liabilities may vary significantly from the accrual due to an increase in the number of claims asserted or claim costs in excess of estimates, and the amount of the accrual has and may continue to fluctuate by a material

13



amount in any given quarter. For the years ended December 31, 2017, 2016 and 2015, we recorded professional liability expense of $10.8 million, $8.5 million and $8.1 million, respectively.
Our outstanding indebtedness is subject to various financial covenants and floating rates of interest which could be subject to fluctuations based on changing interest rates.
We have long-term indebtedness of $88.1 million at December 31, 2017. Certain of our debt agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. As of December 31, 2017, we were in compliance with these financial covenants. Our failure to comply with those covenants could result in an event of default, which, if not cured or waived, could result in the acceleration of some or all of our debts. Such non-compliance could result in a material adverse impact to our financial position, results of operations and cash flows. See “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” for additional discussion of our covenants.
In connection with the refinancing transaction in February 2016 discussed in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources,” we entered into an interest rate swap with respect to a portion of the mortgage loan to mitigate the floating interest rate risk of such borrowing. The interest rate swap converted the variable rate on our mortgage indebtedness to a fixed interest rate for the five year term of this indebtedness, decreasing our exposure to risks of variable rates of interest. While limiting our risk to increases in interest rates by utilizing the interest rate swap, we forgo benefits that might result from downward fluctuations in interest rates. We also are exposed to the risk that our counterpart to the swap agreement will default on its obligations.
Our accrual for professional liability claims is not funded, and if a material judgment is entered against us in any lawsuit, we may lack adequate cash to pay the judgment.
As of December 31, 2017, we are engaged in 72 professional liability lawsuits. Although we work diligently to limit the cash required to settle and defend professional liability claims, a significant judgment entered against us in one or more legal actions could have a material adverse impact on our cash flows and could result in our being unable to meet all of our cash needs as they become due.
The U.S. Department of Justice has commenced an investigation of our practices related to the provision of therapy and the completion of certain resident admission forms, which could adversely affect our operations and financial condition.
Our business is currently under investigation for potential civil and criminal violations of the federal False Claims Act ("FCA") and other laws governmental health care benefit programs.  See Legal Proceedings for further information regarding this investigation. Any finding that we are not in compliance with these laws could require us to change our operations or could subject us to treble damages, penalties and/or make us ineligible to participate in certain government funded healthcare programs, any of which could in turn significantly harm our business and financial condition.
Our operational and strategic flexibility is limited due to the number of our centers that are leased from third parties.
A substantial majority of our centers are leased from third parties. The loss or deterioration of our relationship with any of our landlords may adversely affect our business. The terms of such leases generally require us to operate such centers as skilled nursing centers, and generally do not allow us to assign the lease to a third party without the applicable landlord’s consent. Therefore, our ability to divest such leased properties is limited, and we may be forced to continue operating such centers as skilled nursing centers even if doing so becomes unprofitable.
While we expect to renew or extend our leases in the normal course of business, there can be no assurance that these rights will be exercised in the future or that we will be able to satisfy the conditions precedent to exercising any such renewal or extension, to the extent that such provisions exist in our leases. In addition, if we are unable to renew or extend any of our master leases, we may lose all of the facilities subject to that master lease agreement. If we are not able to renew or extend our leases at or prior to the end of the existing lease terms, or if the terms of such options are unfavorable or unacceptable to us, our business, financial condition and results of operation could be adversely affected.

14



Our failure to pay rent or otherwise comply with the provisions of any of our Master Lease Agreements could materially adversely affect our business, financial position, results of operations, and liquidity.
Many of our facilities are under a Master Lease Agreement. Our failure to pay the rent or otherwise comply with the provisions of any of our lease agreements could result in an “event of default” under such lease agreement and also could result in a cross default under other master lease agreements and the agreements for our indebtedness. Upon an event of default, remedies available to our landlords generally include, without limitation, terminating such lease agreement, repossessing and reletting the leased properties and requiring us to remain liable for all obligations under such lease agreement, including the difference between the rent under such lease agreement and the rent payable as a result of reletting the leased properties, or requiring us to pay the net present value of the rent due for the balance of the term of such lease agreement. The exercise of such remedies would have a material adverse effect on our business, financial position, results of operations and liquidity. An event of default under any of our Master Lease Agreements could result in a default under the Credit Facilities and, if repayment of the borrowings under the Credit Facilities were accelerated, the payments under the indentures governing our outstanding notes could also be accelerated. The exercise of remedies by any of our landlords could have a material adverse effect on our business, financial position, results of operations, and liquidity.
We are highly dependent on reimbursement by third-party payors and delays in reimbursement for any reason may cause liquidity problems.
Substantially all of our nursing center revenues are directly or indirectly dependent upon reimbursement from third-party payors, including the Medicare and Medicaid programs and private insurers. For the year ended December 31, 2017, our patient revenues from continuing operations derived from Medicaid, Medicare, Managed Care and private pay (including private insurers) sources were approximately 52.4%, 25.9%, 7.4%, and 14.3%, respectively. Changes in the mix of our patients among Medicare, Medicaid, Managed Care and private pay categories and among different types of private pay sources may affect our net revenues and profitability. Our net revenues and profitability are also affected by the continuing efforts of all payors to contain or reduce the costs of health care. Efforts to impose reduced payments, greater discounts and more stringent cost controls by government and other payors are expected to continue.
The federal government makes frequent changes to the reimbursement provided under the Medicare program. Future changes to payment rates or methodology could significantly reduce the reimbursement we receive. Also, a number of state governments, including several of the states in which we operate, face projected budget shortfalls and/or deficit spending situations. Because Medicaid is typically a substantial part of a state’s budget, many states are considering or have implemented strategies to reduce Medicaid spending or decrease spending growth. Some states are exploring or implementing alternatives to traditional long-term care, including community and home-based nursing services.
Any changes in reimbursement levels or in the timing of payments under Medicare, Medicaid or private pay programs and any changes in applicable government regulations could have a material adverse effect on our net revenues, net income (loss) and cash flows. We are limited in our ability to reduce the direct costs of providing care. We are unable to predict the nature and success of future financial or delivery system reforms or the effect such changes will have on our operations. No assurance can be given that such reforms will not have a material adverse effect on us. See “Item 1. Business - Government Regulation and Reimbursement.”
If we have problems with our information systems that affect payment or if other issues arise with Medicare, Medicaid or other payors that affect the amount or timeliness of reimbursements, we may encounter delays in our payment cycle. Any significant payment timing delay could cause us to experience working capital shortages. Working capital management, including prompt and diligent billing and collection, is an important factor in our consolidated results of operations and liquidity. Our working capital management procedures may not successfully mitigate the effects of any delays in our receipt of payments or reimbursements. Accordingly, such delays could have an adverse effect on our liquidity and financial condition.
We operate in an industry that is highly competitive.
The long-term care industry generally, and the nursing home business particularly, is highly competitive. We face direct competition for the acquisition of centers. In turn, our centers face competition for patients. Our ability to compete is based on several factors including, but not limited to, building age and appearance, reputation, relationships with referral sources, availability of patients, survey history and CMS rankings. Some of our present and potential competitors are significantly larger and have or may obtain greater financial and marketing resources than we can. In addition, some competitors are implementing vertical alignment strategies. For example, some hospitals provide long-term care services and some providers are aligned or are pursuing alignment strategies with payors. Certain of our competitors are operated by not-for-profit, non-taxpaying or governmental agencies that can finance capital expenditures on a tax exempt basis

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and receive funds and charitable contributions unavailable to us. In addition, we may encounter substantial competition from new market entrants. Consequently, there can be no assurance that we will not encounter increased competition in the future, which could limit our ability to attract patients or expand our business, and could materially and adversely affect our business or decrease our market share.
We may have difficulty attracting and retaining qualified nurses, therapists, healthcare professionals and other key personnel, which, along with a growing number of minimum wage and compensation related regulations, may increase our costs related to these employees.
Our team members are essential to our business. We rely on our ability to attract and retain qualified nurses, therapists and other healthcare professionals. The market for these key personnel is highly competitive, and we could experience significant increases in our operating costs due to shortages in their availability. Like other healthcare providers, we have at times experienced difficulties in attracting and retaining qualified personnel. We may continue to experience increases in our labor costs, primarily due to higher wages and greater benefits required to attract and retain qualified healthcare personnel, and such increases may adversely affect our profitability. Furthermore, while we attempt to manage overall labor costs in the most efficient way, our efforts to manage them through wage freezes and similar means may have limited effectiveness and may lead to increased turnover and other challenges.
Tight labor markets and high demand for such team members can contribute to high turnover among clinical professional staff. A shortage of qualified personnel at a facility could result in significant increases in labor costs and increased reliance on overtime and expensive temporary staffing agencies, and could otherwise adversely affect operations at the affected centers. If we are unable to attract and retain qualified professionals, our ability to adequately provide services to our residents and patients may decline and our ability to grow may be constrained.
Our cost of labor may be influenced by unanticipated factors in certain markets or, with respect to collective bargaining agreements that we are a party to, we may experience above-market increases. A substantial number of our team members are hourly team members whose wage rates are affected by increases in the federal or state minimum wage rate. As collective bargaining agreements are renegotiated or minimum wage rates increase we may need to increase the wages paid to team members. This may be applicable to not only minimum wage team members but also to team members at wage rates which are currently above the minimum wage.
The Department of Labor issued rule changes to the Fair Labor Standards Act that increased the minimum salary threshold for team members exempt from overtime along with an automatic annual increase to this salary threshold. The future of these rule changes, as well as other potential changes, remains uncertain given the recent change in Presidential administrations. However, these rule changes could increase our cost of services provided.
Because we are largely funded by government programs according to predetermined, nonnegotiable rates, we do not have an ability to pass such wage increases through to revenue sources. Any such mandated wage increases could have a material adverse effect on our results of operations, liquidity and financial condition.
Possible changes in the acuity of residents and patients, as well as payor mix and payment methodologies, may significantly affect our profitability.
The sources and amount of our revenues are determined by a number of factors, including the occupancy rates of our facilities, the length of stay, the payor mix of residents and patients, rates of reimbursement, and patient acuity. Changes in patient acuity as well as payor mix among private pay, Medicare, and Medicaid may significantly affect our profitability. In particular, any significant decrease in our population of high-acuity patients or any significant increase in our Medicaid population could have a material adverse effect on our business, financial position, results of operations, and liquidity, especially if state Medicaid programs continue to limit, or more aggressively seek limits on, reimbursement rates or service levels.
Our systems are subject to security breaches and other cybersecurity incidents.
While we maintain information technology security and safeguards, complex medical systems have been and may continue to be targeted for cyber attacks, which may result in unauthorized parties obtaining access to our computer systems and networks. Cyber attacks could result in the misappropriation of our patient information that is protected by law, private employee information, proprietary business information and technology or result in interruptions to our business. The reliability and security of our information technology infrastructure is critical to our business. To the extent that any disruptions or security breaches result in significant loss or damage to our data, or inappropriate use or disclosure of patient, employee or proprietary information, we could be required to notify affected individuals, state and federal agencies and the media of the breach, could experience damage to our reputation and patient relationships and be subject to civil

16



and/or criminal fines and penalties or related class action litigation, any of which could have a material adverse effect on our business, results of operations and financial condition.
The success of previous and future acquisitions cannot be guaranteed and such acquisitions may consume substantial capital and other resources and could expose us to unforeseen liabilities and integration risks.
We have in the past and plan to in the future make investments in additional centers, whether by opening new centers or acquiring existing centers. Such acquisitions may involve significant cash expenditures, debt incurrence, operating losses and additional expenses that could have a material adverse effect on our financial position, results of operations and liquidity. Acquisitions involve numerous risks, including:
difficulties integrating acquired operations, personnel and accounting and information systems, or in realizing projected efficiencies and cost savings;
diversion of management's attention from other business concerns;
potential loss of key team members or customers of acquired companies;
entry into markets in which we may have limited or no experience;
increased indebtedness and reduced ability to access additional capital when needed;
assumption of unknown liabilities or regulatory issues of acquired companies, including failure to comply with healthcare regulations or to establish internal financial controls; and
straining of our resources, including internal controls relating to information and accounting systems, regulatory compliance, logistics and others.
Furthermore, certain of the foregoing risks could be exacerbated when combined with other growth measures that we may pursue.
Investing in our business initiatives and development could adversely impact our results of operations and financial condition.
We plan to invest in business initiatives and development that will increase our operating expenses. These initiatives may or may not be successful in growing our census or revenues. There is typically a time delay between incurring such expenses and the attaining of revenues and cash flows expected from these initiatives and development. As a result, our revenue and operating cash flow may not increase enough during a reporting period to cover these increased expenses. Such additional revenues may not materialize to the level we anticipate, if at all.
Disasters and similar events may seriously harm our business.
Natural and man-made disasters and similar events, including terrorist attacks and acts of nature such as hurricanes, tornados, earthquakes and wildfires, may cause damage or disruption to us, our employees and our centers, which could have an adverse impact on our patients and our business.  In order to provide care for our patients, we are dependent on consistent and reliable delivery of food, pharmaceuticals, utilities and other goods to our centers, and the availability of employees to provide services at our centers.  If the delivery of goods or the ability of employees to reach our centers were interrupted in any material respect due to a natural disaster or other reasons, it would have a significant impact on our centers and our business.  Furthermore, the impact, or impending threat, of a natural disaster has in the past and may in the future require that we evacuate one or more centers, which would be costly and would involve risks, including potentially fatal risks, for the patients.  The impact of disasters and similar events is inherently uncertain.  Such events could harm our patients and employees, severely damage or destroy one or more of our centers, harm our business, reputation and financial performance, or otherwise cause our business to suffer in ways that we currently cannot predict.
Failure to maintain effective internal control over our financial reporting could have an adverse effect on our ability to report our financial results on a timely and accurate basis.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (the “Exchange Act”), and is required to evaluate the effectiveness of these controls and procedures on a periodic basis and publicly disclose the results of these evaluations and related matters in accordance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002.  Effective internal control over financial reporting is necessary for us to provide reliable financial reports, to help mitigate the risk of fraud and to operate successfully. However, testing and maintaining our internal control over financial reporting can be expensive and divert our management's attention from other business matters. Any failure to implement and maintain effective internal controls could result in material weaknesses or material misstatements in our consolidated financial statements. 

17



If we fail to maintain effective internal control over financial reporting, we may be required to take corrective measures or restate the affected historical financial statements. In addition, we may be subjected to investigations and/or sanctions by federal and state securities regulators, and/or civil lawsuits by security holders. Any of the foregoing could also cause investors to lose confidence in our reported financial information and in our company and would likely result in a decline in the market price of our stock and in our ability to raise additional financing if needed in the future.
New accounting pronouncements or new interpretations of existing standards could require us to make adjustments in our accounting policies that could affect our financial statements.
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Financial Accounting Standards Board, the SEC, or other accounting organizations or governmental entities frequently issue new pronouncements or new interpretations of existing accounting standards. Changes in accounting standards, how the accounting standards are interpreted, or the adoption of new accounting standards can have a significant effect on our reported results, and could even retroactively affect previously reported transactions, and may require that we make significant changes to our systems, processes and controls.
Changes resulting from these new standards may result in materially different financial results and may require that we change how we process, analyze and report financial information and that we change financial reporting controls. Such changes in accounting standards may have an adverse effect on our business, financial position, and income, which may negatively impact our financial results.
Risks Related to Government Regulations
We are subject to significant government regulation.
The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, protection of patient health information, reimbursement for patient services, quality of patient care, Medicare and Medicaid fraud and abuse, debt collection and communications with consumers. Various federal and state laws regulate relationships among providers of services, including employment or service contracts and investment relationships. The operation of long-term care centers and the provision of services are also subject to extensive federal, state, and local laws relating to, among other things, the adequacy of medical care, distribution of pharmaceuticals, equipment, personnel, operating policies, environmental compliance, compliance with the Americans with Disabilities Act, fire prevention and compliance with building codes.
Long-term care facilities are subject to periodic inspection to assure continued compliance with various standards and licensing requirements under state law, as well as with Medicare and Medicaid conditions of participation. The failure to obtain or renew any required regulatory approvals or licenses could prevent us from offering our existing or additional services, subject us to penalties, and adversely affect our growth. In addition, health care is an area of extensive and frequent regulatory change. Changes in the laws or new interpretations of existing laws can have a significant effect on methods and costs of doing business and amounts of payments received from governmental and other payors. Our operations could be adversely affected by, among other things, regulatory developments such as mandatory increases in the scope and quality of care to be afforded patients and revisions in licensing and certification standards. We attempt at all times to comply with all applicable laws; however, there can be no assurance that we will remain in compliance at all times with all applicable laws and regulations or that new legislation or administrative or judicial interpretation of existing laws or regulations will not have a material adverse effect on our operations or financial condition. Federal or state proceedings seeking to impose fines and penalties for violations of applicable laws and regulations, as well as federal and state changes in these laws and regulations, may negatively impact us. See “Item 1. Business - Government Regulation.” See also “Item 3. Legal Proceedings.”
We are the subject of governmental audits, investigations, claims and litigation, which could have an adverse effect on our business or financial position.
Healthcare companies are subject to high levels of regulatory scrutiny. Various government agencies and their agents may conduct audits of our operations, including the Department of Health and Human Services (“HHS”) Office of Inspector General (“OIG”), which is tasked with combating fraud, waste and abuse within the Medicare and Medicaid programs. The OIG’s enforcement priorities are outlined in a work plan that is updated monthly. Recent additions to the work plan include life safety reviews and compliant billing practices. The OIG has also focused on quality of care, assessment and monitoring, poorly performing nursing facilities, hospitalizations, criminal background checks, Medicare part B services, accuracy of nursing facilities Minimum Data, transparency of ownership, and civil monetary penalty funds. We cannot predict the likelihood, scope or outcome of any OIG investigations of our centers.

18



The costs associated with potential litigation or the public announcement that we are being investigated, even if a dispute is resolved in our favor, or any determination that we have violated laws or regulations could have an adverse effect on our business, financial position or results of operations. In particular, government investigations, as well as qui tam lawsuits, may lead to significant penalties, including fines, damages payments or exclusion from government healthcare programs. Settlements of lawsuits involving Medicare and Medicaid issues routinely involve both financial penalties and corporate integrity agreements, either of which could have an adverse effect on our business, financial position or results of operations.
Payments we receive from Medicare and Medicaid are subject to audits. Such audits could result in an obligation to refund amounts previously paid to us.
Payments we receive from Medicare and Medicaid can be retroactively adjusted after examination during the claims settlement process or as a result of post-payment audits. Private pay sources also reserve the right to conduct audits. Payors may disallow our requests for reimbursement, or recoup amounts previously reimbursed, based on determinations by the payors or their third-party audit contractors that certain costs are not reimbursable because either adequate or additional documentation was not provided or because certain services were not covered or deemed to not be medically necessary. We believe that billing and reimbursement errors and disagreements are common in our industry. Significant adjustments, recoupments or repayments of our Medicare or Medicaid revenue could adversely affect our business, financial condition or results of operations.
We are subject to claims under the false claims, self-referral and anti-kickback legislation.
We are subject to numerous federal and state laws intended to prevent fraud, waste and abuse within the healthcare industry. Violations of these laws may result in substantial damage awards, civil or criminal penalties for individuals or entities, including large civil monetary penalties and exclusion from participation in the Medicare or Medicaid programs. Such awards, exclusion or penalties, if applied to us, could have a material adverse effect on our financial position and profitability.
In the United States, various state and federal laws regulate the relationships between providers of health care services, physicians, and other clinicians. These laws impose restrictions on physician referrals for designated health services to entities with which they have financial relationships. These laws also prohibit the offering, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare or state health care program patients or patient care opportunities for the purchase, lease or order of any item or service that is covered by the Medicare and Medicaid programs. To the extent that we, any of our centers through which we do business, or any of the owners or directors have a financial relationship with each other or with other health care entities providing services to long-term care patients, such relationships could be subject to increased scrutiny.
Federal and state laws prohibit the submission of false claims for reimbursement and prohibit the making of false claims or statements. Under the FCA, actions against a provider can be initiated by the federal government or by a private party on behalf of the federal government. These private parties, who are often referred to as “qui tam relators” or “relators,” are entitled to share in any amounts recovered by the government. Both direct enforcement activity by the government and qui tam relator actions have increased significantly in recent years.
A FCA violation occurs when a provider knowingly submits a claim for items or services not provided. Liability also arises for the knowing failure to report and refund an overpayment received from the government. The submission of false claims or the failure to timely repay overpayments may lead to the imposition of significant civil monetary penalties, significant criminal fines and imprisonment, and/or exclusion from participation in state and federally-funded healthcare programs, including the Medicare and Medicaid programs. Some courts have held that providers who allegedly have violated other statutes, such as self-referral or kickback laws, have thereby submitted false claims under the FCA. Allegations of poor quality of care can also lead to FCA actions under a theory of worthless services, which contends that care provided was so deficient that it was tantamount to no service at all.
The implied certification theory expands of the scope of the FCA. Under the implied certification theory, a violation of the FCA occurs when a provider’s request for payment implies a certification of compliance with the applicable statutes, regulations or contract provisions that are preconditions to payment. The recognition of this theory has increased the risk that a healthcare company will have to defend a false claims action, pay fines and treble damages or settlement amounts or be excluded from the federal and state healthcare programs as a result of an investigation arising out of the FCA. Many states have enacted similar laws providing for imposition of civil and criminal penalties for the filing of fraudulent claims.
Because we submit thousands of claims to Medicare each year and there is a relatively long statute of limitations under the FCA, there is a risk that intentional, or even negligent or recklessly submitted claims that prove to be incorrect, or

19



even billing errors, cost reporting errors or lapses in statutory or regulatory compliance with regard to the provision of healthcare services (including, without limitation the Anti-Kickback Statue and the self-referral laws discussed above), could result in significant civil or criminal penalties against us. At least one false claims act case is pending against us, and there can be no assurance that our operations will not be subject to review, scrutiny, penalties or enforcement actions under these laws, or that these laws will not change in the future. Any penalties or allegations involving false claims, whether valid or not, could have a significant impact on our business.
We are subject to laws governing the confidentiality of patient health information.
Both federal and state laws impose certain requirements regarding maintaining the confidentiality of patient health information. In particular, HIPAA rules and regulations require us to protect the medical records and other personal health information of our patients, limit our use of and ability to disclose such information, and give patients a right to access and amend their personal health information. A violation of HIPAA or any other federal or state laws regarding the confidentiality or use of such information could subject us to civil or criminal penalties, and could in turn damage our reputation, affect our ability to attract or retain patients, and thereby have a material adverse effect on our revenues, financial position, results of operations and cash flows.
We cannot predict the effects that healthcare reform initiatives, including possible repeal of or changes to the Affordable Care Act, and other changes in government programs may have on our business, financial condition or results of operations.
In recent years, there have been initiatives on the federal and state levels for comprehensive reforms affecting the availability, payment and reimbursement of healthcare services in the United States. The most prominent of these efforts is the Affordable Care Act, which affects how healthcare services are covered, delivered and reimbursed. However, there is significant uncertainty regarding the future of the Affordable Care Act. The Presidential administration and certain members of Congress have expressed their intent to repeal or make significant changes to the law, its implementation or interpretation. It is difficult to predict the impact of the Affordable Care Act and related regulations or the impact of its modification on our operations in light of the uncertainty regarding whether, when or how the law will be changed and what alternative reforms, if any, may be enacted. Significant changes to, or repeal of, the Affordable Care Act or other healthcare legislation or regulations could materially and adversely our business.
State efforts to regulate or deregulate the healthcare services industry or the construction or expansion of healthcare facilities could impair our ability to expand our operations, or could result in increased competition.
Some states require healthcare providers to obtain prior approval, known as a certificate of need, for:
the purchase, construction or expansion of healthcare facilities;
capital expenditures exceeding a prescribed amount; or
changes in services or bed capacity.
In addition, other states that do not require certificates of need have effectively barred the expansion of existing facilities and the development of new ones by placing partial or complete moratoria on the number of new Medicaid beds they will certify in certain areas or in the entire state. Other states have established such stringent development standards and approval procedures for constructing new healthcare facilities that the construction of new facilities, or the expansion or renovation of existing facilities, may become cost prohibitive or extremely time-consuming. In addition, some states the acquisition of a facility being operated by a non-profit organization requires the approval of the state Attorney General.
Our ability to acquire or construct new facilities or expand or provide new services at existing facilities would be adversely affected if we are unable to obtain the necessary approvals, if there are changes in the standards applicable to those approvals, or if we experience delays and increased expenses associated with obtaining those approvals. We may not be able to obtain licensure, certificate of need approval, Medicaid certification, Attorney General approval or other necessary approvals for future expansion projects. Conversely, the elimination or reduction of state regulations that limit the construction, expansion or renovation of new or existing facilities could result in increased competition to us or result in overbuilding of facilities in some of our markets. If overbuilding in the healthcare industry in the markets in which we operate were to occur, it could reduce the occupancy rates of existing facilities and, in some cases, might reduce the private rates that we charge for our services.

20



Changes to federal and state income tax laws and regulations could adversely affect our position on income taxes and estimated income liabilities.
We are subject to both state and federal income taxes in the U.S. and our operations, plans and results are affected by tax and other initiatives. On December 22, 2017, a law commonly known as the Tax Cuts and Jobs Act (“Tax Act") was enacted in the United States. As a result, our 2017 results include a non-cash increase in the provisions for income taxes of $5.5 million related to the estimated impact of the Tax Act on our deferred tax assets and liabilities.
The Company considers the accounting for the deferred tax re-measurements and other items to be complete, but ongoing accounting guidance and interpretation could result in adjustments to the consolidated financial statements. Among other things, the Tax Act reduces the U.S. corporate income tax rate to 21 percent, which could result in changes in the valuation of our deferred tax asset and liabilities. Any such change in valuation could have a material impact on our income tax expense and deferred tax balances.
We are also subject to regular reviews, examinations, and audits by the Internal Revenue Service and other taxing authorities with respect to our taxes. There are uncertainties and ambiguities in the application of the Tax Act and it is possible that the IRS could issue subsequent guidance or take positions on audit that differ from our interpretations and assumptions. Although we believe our tax estimates are reasonable, if a taxing authority disagrees with the positions we have taken, we could face additional tax liability, including interest and penalties. Our effective tax rate could be adversely affected by changes in the mix of earnings in states with different statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws and regulations, changes in our interpretations of tax laws, including the Tax Act. Unanticipated changes in our tax rates or exposure to additional income tax liabilities could affect our profitability. There can be no assurance that payment of such additional amounts upon final adjudication of any disputes will not have a material impact on our results of operations and financial position.
Risks Related to our Common Stock
Our ability and intent to pay cash dividends in the future may be limited.
We currently pay a $0.055 quarterly dividend on our common shares, and while the Board of Directors intends to pay quarterly dividends, the Board will make the determination of the amount of future cash dividends, if any, to be declared and paid based on, among other things, our financial condition, funds from operations, the level of our capital expenditures and future business prospects. The Company is restricted by its debt agreements in its ability to pay dividends.
Our securities are now and have historically been thinly traded. An active trading market in our equity securities may cease to exist, which would adversely affect the market price and liquidity of our common stock, in addition our stock price has been subject to fluctuating prices.
Shares of our common stock are now and have been thinly traded, meaning that the number of persons interested in purchasing our common stock at or near ask prices at any given time may be relatively small or non-existent. As a consequence, our stock price may not reflect an actual or perceived value of the business. Also, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, as compared to an issuer that has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. We cannot predict the actions of market makers, investors or other market participants, and can offer no assurances that the market for our securities will be stable. If there is no active trading market in our equity securities, the market price and liquidity of the securities will be adversely affected. The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market or the perception that these sales could occur. Due to these conditions, you may not be able to sell your shares at or near ask prices or at all if you need money or otherwise desire to liquidate your shares. These conditions also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
We have a number of policies in place that could be considered anti-takeover protections.
Our Certificate of Incorporation (the “Certificate”) requires the approval of the holders of two-thirds of the outstanding shares to amend certain provisions of the Certificate. Section 203 of the Delaware General Corporate Law restricts the ability of a Delaware corporation to engage in any business combination with an interested shareholder. We are also authorized to issue up to 795,000 shares of preferred stock, the rights of which may be fixed by our Board without shareholder approval. Provisions in certain of our executive officers' employment agreements provide for post-termination compensation, including payment of amounts up to two times their annual salary, following certain changes in control (as defined in such agreements). Our stock incentive plans provide for the acceleration of the vesting of options in the event of certain changes in control (as defined in such plans). Certain changes in control also constitute an event of default

21



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



22



ITEM 2. PROPERTIES
We own 18 and lease 58 long-term care centers as discussed in “Item 1 Business - Nursing Centers and Services.” See further details below.

Our current operations include 58 nursing centers subject to operating leases, including 35 owned by Omega Health Investors ("Omega"), 20 owned by Golden Living and three owned by other parties. In our role as lessee, we are responsible for the day-to-day operations of all operated centers. These responsibilities include recruiting, hiring and training all nursing and other personnel, and providing patient care, nutrition services, marketing, quality improvement, accounting, and data processing services for each center. The lease agreements pertaining to our 58 leased centers are “triple net” leases, requiring us to maintain the premises, provide insurance, pay taxes and pay for all utilities. The average remaining term of our lease agreements, including renewal options, is approximately 16 years. See the table below for a summary of owned and leased beds operated by the Company.
State
 
Centers
 
Leased Beds
 
Owned Beds
 
Total Operational Beds (1)
Alabama
 
20

 
2,079

 
306

 
2,385

Florida
 
1

 
79

 

 
79

Indiana
 
1

 
172

 

 
172

Kansas
 
6

 

 
483

 
483

Kentucky
 
13

 
917

 
252

 
1,169

Mississippi
 
9

 
1,039

 

 
1,039

Missouri
 
3

 
455

 

 
455

Ohio
 
5

 
701

 

 
701

Tennessee
 
5

 
497

 
120

 
617

Texas
 
13

 
1,370

 
475

 
1,845

Total
 
76

 
7,309

 
1,636

 
8,945

____________
(1)
The number of Operational Beds includes 489 Licensed Assisted Living/Residential Beds.
Brentwood Support Center and Regional Offices
We lease approximately 29,000 square feet of office space in Brentwood, Tennessee that houses our executive offices, and centralized management support functions. Lease periods on these centers range up to three years. Regional executives for Kansas work from an office of approximately 922 square feet. We believe that our leased properties are adequate for our present needs and that suitable additional or replacement space will be available as required.

ITEM 3. LEGAL PROCEEDINGS
The provision of health care services entails an inherent risk of liability. Participants in the health care industry are subject to lawsuits alleging malpractice, negligence, violations of false claims acts, product liability, or related legal theories, many of which involve large claims and significant defense costs. Like many other companies engaged in the long-term care profession in the United States, we have numerous pending liability claims, disputes and legal actions for professional liability and other related issues. It is expected that we will continue to be subject to such suits as a result of the nature of our business. Further, as with all health care providers, we are periodically subject to regulatory actions seeking fines and penalties for alleged violations of health care laws and are potentially subject to the increased scrutiny of regulators for issues related to compliance with health care fraud and abuse laws and with respect to the quality of care provided to residents of our center. Like other health care providers, in the ordinary course of our business, we are also subject to claims made by employees and other disputes and litigation arising from the conduct of our business.
As of December 31, 2017, we are engaged in 72 professional liability lawsuits. Five lawsuits are currently scheduled for trial or arbitration during the next twelve months, and it is expected that additional cases will be set for trial or hearing. The ultimate results of any of our professional liability claims and disputes cannot be predicted. We have limited, and sometimes no, professional liability insurance with regard to most of these claims. A significant judgment entered against us in one or more of these legal actions could have a material adverse impact on our financial position and cash flows.
In July 2013, the Company learned that the United States Attorney for the Middle District of Tennessee ("DOJ") had commenced a civil investigation of potential violations of the False Claims Act ("FCA").

23



In October 2014, the Company learned that the investigation was started by the filing under seal of a false claims action against the two centers that were the subject of the original civil investigative demand ("CID"). In connection with this matter, between July 2013 and early February 2016, the Company has received three civil investigative demands (a form of subpoena) for documents and information relating to our practices and policies for rehabilitation, and other services, our preadmission evaluation forms ("PAEs") required by TennCare and our Pre-Admission Screening and Resident Reviews ("PASRRs"). We have responded to those requests. The DOJ has also issued CID’s for testimony from current and former employees of the Company. The DOJ’s civil investigation of the Company’s practices and policies for rehabilitation now covers all of the Company’s centers, but thus far only documents from six of our centers have been requested.
In June 2016, the Company received an authorized investigative demand (a form of subpoena) for documents in connection with a criminal investigation by the DOJ related to our practices with respect to PAEs and PASRRs, and the Company has provided documents responsive to this subpoena and continues to provide additional information as requested. The Company cannot predict the outcome of these investigations or the related lawsuits, and the outcome could have a materially adverse effect on the Company, including the imposition of treble damages, criminal charges, fines, penalties and/or a corporate integrity agreement. Additionally, the uncertainty regarding the outcome of this investigation makes it more difficult for the Company to pursue strategic possibilities, longer term initiatives or to make significant financial commitments outside of the normal course of its business. The Company is committed to provide caring and professional services to its patients and residents in compliance with applicable laws and regulations.
In January 2009, a purported class action complaint was filed in the Circuit Court of Garland County, Arkansas against the Company and certain of its subsidiaries and Garland Nursing & Rehabilitation Center (the “Center”). The complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Center over the five-year period prior to the filing of the complaints. The Court has not yet ruled on the motion to dismiss, so lawsuit remains in its early stages and has not yet been certified by the court as a class action. The Company intends to defend the lawsuit vigorously.
We cannot currently predict with certainty the ultimate impact of any of the above cases on our financial condition, cash flows or results of operations. Our reserve for professional liability expenses does not include any amounts for the pending DOJ investigation or the purported class action against the Arkansas centers. An unfavorable outcome in any of these lawsuits or any of our professional liability actions, any regulatory action, any investigation or lawsuit alleging violations of fraud and abuse laws or of elderly abuse laws or any state or Federal False Claims Act case could subject us to fines, penalties and damages, including exclusion from the Medicare or Medicaid programs, and could have a material adverse impact on our financial condition, cash flows or results of operations.

ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.



24



PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information. Our common stock is traded on the NASDAQ Capital Market and began trading there on September 12, 2006 under the symbol “AVCA.” Effective March 15, 2013, the Company changed its name from Advocat Inc. to Diversicare Healthcare Services, Inc. as a result of a merger of the Company and a wholly-owned subsidiary. In connection with the name change, the Company changed its NASDAQ ticker symbol from “AVCA” to “DVCR” effective with the market open on
Monday, March 18, 2013. The following table sets forth the high and low bid prices of our common stock, as reported by NASDAQ.com, for each quarter in 2017 and 2016:

Period
High
Low
Dividends
2016
1st  
Quarter
$
9.95

$
6.75

$
0.055

2016
2nd  
Quarter
$
8.90

$
7.00

$
0.055

2016
3rd  
Quarter
$
10.07

$
6.41

$
0.055

2016
4th   
Quarter
$
12.82

$
9.98

$
0.055

2017
1st  
Quarter
$
11.91

$
8.40

$
0.055

2017
2nd  
Quarter
$
11.20

$
8.70

$
0.055

2017
3rd  
Quarter
$
11.60

$
8.50

$
0.055

2017
4th   
Quarter
$
12.25

$
9.40

$
0.055


Our common stock has been traded since May 10, 1994. On February 15, 2018, the closing price for our common stock was $7.76, as reported by NASDAQ.com.
Holders. On February 15, 2018, there were approximately 261 holders of record. Most of our shareholders have their holdings in the street name of their broker/dealer.
Dividends. For each of the two most recent fiscal years, we have paid a quarterly dividend of $0.055 per common share. While the Board of Directors intends to continue to pay quarterly dividends, the Board will make the determination of the amount of future cash dividends, if any, to be declared and paid based on, among other things, the Company's financial condition, funds from operations, the level of its capital expenditures and its future business prospects. The Company is restricted by its debt agreements in its ability to pay dividends.

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

25



 
 
Year Ended December 31,
 
 
2017
 
2016
 
2015
 
2014
 
2013
Statement of Operations Data
 
 
 
(in thousands, except per share amounts)
 
 
REVENUES:
 
 
 
 
 
 
 
 
 
 
Patient revenues, net
 
$
574,794

 
$
426,063

 
$
387,595

 
$
344,192

 
$
260,221

EXPENSES:
 
 
 
 
 
 
 
 
 
 
Operating
 
458,122

 
342,932

 
311,035

 
275,605

 
213,064

Lease and rent expense
 
54,988

 
33,364

 
28,690

 
26,151

 
20,396

Professional liability
 
10,764

 
8,456

 
8,122

 
7,216

 
5,666

General and administrative
 
33,311

 
30,271

 
24,793

 
22,133

 
20,940

Depreciation and amortization
 
10,902

 
8,292

 
7,524

 
7,078

 
6,363

Lease termination costs (receipts)
 
(180
)
 
2,008

 

 

 

Restructuring
 

 

 

 

 
1,446

 
 
567,907

 
425,323

 
380,164

 
338,183

 
267,875

OPERATING INCOME (LOSS)
 
6,887

 
740

 
7,431

 
6,009

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

 
273

 
339

 
(5
)
 
(183
)
Gain on bargain purchase
 
925

 

 

 

 

Gain on sale of investment in unconsolidated affiliate
 
733

 
1,366

 

 
 
 
 
Hurricane costs
 
(232
)


 

 

 

Interest expense, net
 
(6,369
)
 
(4,802
)
 
(4,102
)
 
(3,697
)
 
(3,032
)
Debt retirement costs
 

 
(351
)
 

 

 
(320
)
 
 
(4,943
)
 
(3,514
)
 
(3,763
)
 
(3,702
)
 
(3,535
)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
 
1,944

 
(2,774
)
 
3,668

 
2,307

 
(11,189
)
BENEFIT (PROVISION) FOR INCOME TAXES
 
(6,743
)
 
1,030

 
(916
)
 
(857
)
 
4,196

INCOME (LOSS) FROM CONTINUING OPERATIONS
 
(4,799
)
 
(1,744
)
 
2,752

 
1,450

 
(6,993
)
DISCONTINUED OPERATIONS, net of taxes
 
(28
)
 
(67
)
 
(1,128
)
 
3,258

 
(1,469
)
NET INCOME (LOSS)
 
$
(4,827
)
 
$
(1,811
)
 
$
1,624

 
$
4,708

 
$
(8,462
)
INCOME (LOSS) PER COMMON SHARE:
 
 
 
 
 
 
 
 
 
 
Basic
 
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
(0.76
)
 
$
(0.28
)
 
$
0.45

 
$
0.21

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

 
(0.25
)
Net income (loss) per common share
 
$
(0.77
)
 
$
(0.29
)
 
$
0.27

 
$
0.75

 
$
(1.51
)
Diluted
 
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
(0.76
)
 
$
(0.28
)
 
$
0.44

 
0.20

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

 
(0.25
)
Net income (loss) per common share
 
$
(0.77
)
 
$
(0.29
)
 
$
0.26

 
$
0.72

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

 
$
0.22

 
$
0.22

 
$
0.22

 
$
0.22

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
 
 
 
 
 
 
 
Basic
 
6,279

 
6,199

 
6,100

 
6,011

 
5,899

Diluted
 
6,279

 
6,199

 
6,315

 
6,197

 
5,899



26



 
 
December 31,
 
 
2017
 
2016
 
2015
 
2014
 
2013
Balance Sheet Data
 
(in thousands)
Working capital
 
$
8,391

 
$
13,521

 
$
13,052

 
$
8,797

 
$
8,044

Total assets
 
$
167,569

 
$
163,051

 
$
137,084

 
$
129,089

 
$
137,744

Long-term debt and capitalized lease obligations, less current portion and deferred financing costs, net
 
$
89,552

 
$
82,133

 
$
60,867

 
$
48,265

 
$
53,577

Preferred Stock - Series C
 
$

 
$

 
$

 
$

 
$
4,918

Total Shareholders' Equity of Diversicare Healthcare Services, Inc.
 
$
6,462

 
$
11,420

 
$
13,267

 
$
11,754

 
$
8,129

Total Equity
 
$
6,462

 
$
11,420

 
$
13,267

 
$
11,754

 
$
9,566




27



ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview
Diversicare Healthcare Services, Inc. provides long-term care services to nursing center patients in ten states, primarily in the Southeast, Midwest and Southwest. Our centers provide a range of health care services to their patients and residents. In addition to the nursing, personal care and social services usually provided in long-term care centers, we offer a variety of comprehensive rehabilitation services as well as nutritional support services. As of December 31, 2017, our continuing operations consist of 76 nursing centers with 8,456 licensed skilled nursing beds and 489 assisted-living and other residential beds. We own 18 and lease 58 of our nursing centers included in continuing operations. The Company's continuing operations include centers in Alabama, Florida, Indiana, Kansas, Kentucky, Mississippi, Missouri, Ohio, Tennessee, and Texas.
Key Performance Metrics
Skilled mix. Skilled mix represents the number of days our Medicare and Managed Care patients are receiving services at the skilled nursing facilities divided by the total number of days patients (less days from assisted living services) from all payor sources are receiving services at the skilled nursing facilities for any given period.
Average rate per day. Average rate per day is the revenue by payor source for a period at the skilled nursing facility divided by actual patient days for the revenue source for a given period.
Average daily skilled nursing census. Average daily skilled nursing census is the average number of patients who are receiving skilled nursing care as a percentage of total number of patient days.
Strategic Operating Initiatives
We identified several key strategic objectives to increase shareholder value through improved operations and business development. These strategic operating initiatives include: improving our facilities’ quality metrics, improving skilled mix in our nursing centers, improving our average Medicare rate, implementing and maintaining Electronic Medical Records (“EMR”) to improve Medicaid capture, and completing strategic acquisitions and divestitures. We have experienced success in these initiatives and expect to continue to build on these improvements. In light of challenges facing the industry and the Company specifically, including the unresolved governmental investigation. we believe that now is not the time to attempt to engage in a company-wide strategic transaction.
Improving skilled mix and average Medicare rate:
One of our key performance indicators is skilled mix. Our strategic operating initiatives of improving our skilled mix and our average Medicare rate required investing in nursing and clinical care to treat more acute patients along with nursing center-based marketing representatives to attract these patients. These initiatives developed referral and Managed Care relationships that have attracted and are expected to continue to attract payor sources for patients covered by Medicare and Managed Care. The Company's skilled mix for the years ended December 31, 2017, 2016 and 2015 was 15.1%, 15.2% and 16.2%, respectively. The graph below illustrates our average Medicare rate per day: 
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12099032&doc=16

28



Utilizing Electronic Medical Records to improve Medicaid acuity capture:
As another part of our strategic operating initiatives, we successfully completed a full implemented of EMR in our nursing centers to improve Medicaid acuity capture, primarily in our states where the Medicaid payments are acuity based. We completed the implementation on time and under budget, and since implementation, have increased our average Medicaid rate despite rate cuts in certain acuity based states by accurate and timely capture of care delivery. The graph below illustrates our success with increasing our average Medicaid rate per day since implementation:
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12099032&doc=15
Completing strategic transactions:
Our strategic operating initiatives include a renewed focus on completing strategic acquisitions. We continue to pursue and investigate opportunities to acquire, lease or develop new centers, focusing primarily on opportunities within our existing geographic areas of operation. We expect to announce additional development projects in the near future.
Effective July 1, 2017, the Company acquired a 103-bed skilled nursing center in Selma, Alabama, for an aggregate purchase price of $8,750,000, pursuant to an Asset Purchase Agreement with Park Place Nursing and Rehabilitation Center, LLC, Dunn Nursing Home, Inc., Wood Properties of Selma LLC, and Homewood of Selma, LLC. Additionally, on October 1, 2016 and November 1, 2016, we assumed the operations of ten centers in Mississippi and 12 centers in Alabama, respectively. These transactions are further discussed in Note 2 "Business Development and Other Significant Transactions" to the consolidated financial statements.

Divestitures
As part of our strategic efforts, we have also performed thorough analysis on our existing centers in order to determine whether continuing operations within certain markets or regions was in line with the short-term and long-term strategy of the business. As a result, in September 2017, we ceased operations at our Carthage, Mississippi, facility, thus terminating our lease with Trend Health and Rehab of Carthage, LLC. Additionally, in May 2016, we ceased operations at our Avon, Ohio, facility, thus terminating our lease with Avon Ohio, LLC. These transactions were not reported as discontinued operations as described in Note 2 "Business Development and Other Significant Transactions" to the consolidated financial statements.
Basis of Financial Statements.
Our patient revenues consist of the fees charged for the care of patients in the nursing centers we own and lease. Our operating expenses include the costs, other than lease, depreciation and amortization expenses, incurred in the operation of the nursing centers we own and lease. Our general and administrative expenses consist of the costs of the corporate office and regional support functions. Our interest, depreciation and amortization expenses include all such expenses across the range of our operations.



29



Selected Financial and Operating Data
The following table summarizes the Diversicare statements of continuing operations for the years ended December 31, 2017, 2016 and 2015, and sets forth this data as a percentage of revenues for the same year:

 
 
Year Ended December 31,
 
 
(Dollars in thousands)
 
 
2017
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
Patient revenues, net
 
$
574,794

 
100.0
 %
 
$
426,063

 
100.0
 %
 
$
387,595

 
100.0
 %
Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Operating
 
458,122

 
79.7
 %
 
342,932

 
80.5
 %
 
311,035

 
80.2
 %
Lease and rent expense
 
54,988

 
9.6
 %
 
33,364

 
7.8
 %
 
28,690

 
7.4
 %
Professional liability
 
10,764

 
1.9
 %
 
8,456

 
2.0
 %
 
8,122

 
2.1
 %
General & administrative
 
33,311

 
5.8
 %
 
30,271

 
7.1
 %
 
24,793

 
6.4
 %
Depreciation and amortization
 
10,902

 
1.9
 %
 
8,292

 
1.9
 %
 
7,524

 
1.9
 %
Lease termination costs (receipts)
 
(180
)
 
 %
 
2,008

 
0.5
 %
 

 
 %
 
 
567,907

 
98.9
 %
 
425,323

 
99.8
 %
 
380,164

 
98.0
 %
Operating income
 
6,887

 
1.1
 %
 
740

 
0.2
 %
 
7,431

 
2.0
 %
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
Equity in net income of unconsolidated affiliate
 

 
 %
 
273

 
0.1
 %
 
339

 
0.1
 %
Gain on bargain purchase
 
925

 
0.2
 %
 

 
 %
 

 
 %
Gain on sale of investment in unconsolidated affiliate
 
733

 
0.1
 %
 
1,366

 
0.3
 %
 

 
 %
Hurricane costs
 
(232
)
 
 %
 

 
 %
 

 
 %
Interest expense, net
 
(6,369
)
 
(1.1
)%
 
(4,802
)
 
(1.1
)%
 
(4,102
)
 
(1.1
)%
Debt retirement costs
 

 
 %
 
(351
)
 
(0.1
)%
 

 
 %
 
 
(4,943
)
 
(0.8
)%
 
(3,514
)
 
(0.8
)%
 
(3,763
)
 
(1.0
)%
Income (loss) from continuing operations before income taxes
 
1,944

 
0.3
 %
 
(2,774
)
 
(0.6
)%
 
3,668

 
1.0
 %
Benefit (provision) for income taxes
 
(6,743
)
 
(1.2
)%
 
1,030

 
0.2
 %
 
(916
)
 
(0.2
)%
Income (loss) from continuing operations
 
$
(4,799
)
 
(0.9
)%
 
$
(1,744
)
 
(0.4
)%
 
$
2,752

 
0.8
 %


The following table presents data about the centers we operated as part of our continuing operations as of the dates:
 
 
December 31,
 
 
2017
 
2016
 
2015
Licensed Nursing Center Beds:
 
 
 
 
 
 
Owned
 
1,607

 
1,504

 
1,370

Leased
 
6,849

 
6,949

 
4,690

Total
 
8,456

 
8,453

 
6,060

Facilities:
 
 
 
 
 
 
Owned
 
18

 
17

 
15

Leased
 
58

 
59

 
40

Total
 
76

 
76

 
55




30



Critical Accounting Policies and Judgments
A “critical accounting policy” is one which is both important to the understanding of our financial condition and results of operations and requires management's most difficult, subjective or complex judgments, often of the need to make estimates about the effect of matters that are inherently uncertain. Actual results could differ from those estimates and cause our reported net income (loss) to vary significantly from period to period. Our accounting policies that fit this definition include the following:
Revenues
Patient Revenues, Net
The fees we charge patients in our nursing centers are recorded on an accrual basis. These rates are contractually adjusted with respect to individuals receiving benefits under federal and state-funded programs and other third-party payors. Our net revenues are derived substantially from Medicare, Medicaid and other government programs (approximately 78.3%, 78.1% and 77.6% for 2017, 2016, and 2015, respectively). Medicare intermediaries make retroactive adjustments based on changes in allowed claims. In addition, certain of the states in which we operate require complicated detailed cost reports which are subject to review and adjustments. In the opinion of management, adequate provision has been made for adjustments that may result from such reviews. Retroactive adjustments, if any, are recorded when objectively determinable, generally within three years of the close of a reimbursement year depending upon the timing of appeals and third-party settlement reviews or audits.
Allowance for Doubtful Accounts
We evaluate the collectability of our accounts receivable by reviewing current aging summaries of accounts receivable, historical collections data and other factors. As a percentage of revenue, our provision for doubtful accounts was approximately 1.6%, 1.7%, and 1.9% for 2017, 2016, and 2015, respectively. Historical bad debts have generally resulted from uncollectible private pay balances, some uncollectible coinsurance and deductibles and other factors. Receivables that are deemed to be uncollectible are written off.

Professional Liability and Other Self-Insurance Reserves
Accrual for Professional and General Liability Claims
The Company has professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. Effective July 1, 2013, the Company established a wholly-owned, consolidated offshore limited purpose insurance subsidiary, SHC Risk Carriers, Inc. (“SHC”), which has issued a policy insuring claims made against all of the Company's nursing centers in Florida and Tennessee, the Company’s formerly operated Arkansas and West Virginia centers, and several of the Company’s nursing centers in Alabama, Kentucky, Ohio, and Texas. The insurance coverage provided for these centers under the SHC policy include coverage limits of $500,000 or $1,000,000 per medical incident with a sublimit per center of $1,000,000 and total annual aggregate policy limits of $5,000,000. All other centers within the Company’s portfolio are covered through various commercial insurance policies which provide coverage limits of $1,000,000 per claim and have sublimits of $3,000,000 per center, with varying aggregate policy limits and deductibles.  The deductibles for these policies are covered through the insurance subsidiary.
Because our actual liability for existing and anticipated professional liability and general liability claims will exceed our limited insurance coverage, we have recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $20.1 million as of December 31, 2017, including $1.4 million for settlements that are expected to be paid in 2018, estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, and estimates of related legal costs incurred and expected to be incurred. All losses are projected on an undiscounted basis.
The Company evaluates the adequacy of this liability on a quarterly basis. Semi-annually, the Company retains a third-party actuarial firm to assist in the evaluation of this reserve. Since May 2012, Merlinos & Associates, Inc. (“Merlinos”) has assisted management in the preparation of the appropriate accrual for incurred but not reported general and professional liability claims based on data furnished as of May 31 and November 30 of each year. Merlinos primarily utilizes historical data regarding the frequency and cost of the Company's past claims over a multi-year period, industry data and information regarding the number of occupied beds to develop its estimates of the Company's ultimate professional liability cost for current periods.
On a quarterly basis, we obtain reports of asserted claims and lawsuits from our insurers and a third party claims administrator. These reports contain information relevant to the liability actually incurred to date with that claim as well as the third-party administrator's estimate of the anticipated total cost of the claim. This information is reviewed by us quarterly and provided to the actuary semi-annually. We use this information to determine the timing of claims reporting and the development of reserves and compare the information obtained to our previously recorded estimates of liability. Based on the actual claim information obtained, on the semi-annual estimates received from the actuary and on estimates regarding the number and cost of additional claims

31



anticipated in the future, the reserve estimate for a particular period may be revised upward or downward on a quarterly basis. Final determination of our actual liability for claims incurred in any given period is a process that takes years.
The Company's cash expenditures for self-insured professional liability costs from continuing operations were $6.6 million, $4.5 million and $3.3 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Although we retain a third-party actuarial firm to assist us, professional and general liability claims are inherently uncertain, and the liability associated with anticipated claims is very difficult to estimate. Professional liability cases have a long cycle from the date of an incident to the date a case is resolved, and final determination of our actual liability for claims incurred in any given period is a process that takes years. As a result, our actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given quarter due to the significance of judgments and estimates.
Professional liability costs are material to our financial position, and changes in estimates, as well as differences between estimates and the ultimate amount of loss, may cause a material fluctuation in our reported results of operations. Our professional liability expense was $10.8 million, $8.5 million and $8.1 million for the years ended December 31, 2017, 2016 and 2015, respectively. These amounts are material in relation to our reported income (loss) from continuing operations for the related periods of $(4.8) million, $(1.7) million and $2.8 million, respectively. The total liability recorded at December 31, 2017 was $20.1 million, compared to current assets of $72.7 million and total assets of $167.6 million.
Accrual for Other Self-Insured Claims
With respect to workers' compensation insurance, substantially all of our employees became covered under either a prefunded deductible policy or state-sponsored programs. We have been and remain a non-subscriber to the Texas workers' compensation system and are, therefore, completely self-insured for employee injuries with respect to our Texas operations. From June 30, 2003 until June 30, 2007, our workers' compensation insurance programs provided coverage for claims incurred with premium adjustments depending on incurred losses. For the period from July 1, 2007 until June 30, 2008, the Company is completely insured for workers' compensation exposure. For the period from July 1, 2008 through December 31, 2017, we are covered by a prefunded deductible policy. Under this policy, we are self-insured for the first $500,000 per claim, subject to an aggregate maximum of $3,000,000. We fund a loss fund account with the insurer to pay for claims below the deductible. We account for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred.
We are self-insured for health insurance benefits for certain employees and dependents for amounts up to $200,000 per individual annually. We provide reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate, based on known claims and estimates of unknown claims based on historical information. The differences between actual settlements and reserves are included in expense in the period finalized. Our reserves for health insurance benefits can fluctuate materially from one year to the next depending on the number of significant health issues of our covered employees and their dependents.

Asset Impairment
We evaluate our property, equipment and other long-lived assets on a quarterly basis to determine if facts and circumstances suggest that the assets may be impaired or that the estimated depreciable life of the asset may need to be changed for significant physical changes in the property, or significant adverse changes in general economic conditions, and significant deteriorations of the underlying cash flows or fair values of the property if impairment indicators exist. The need to recognize impairment is based on estimated undiscounted future cash flows from a property compared to the carrying value of that property. If recognition of impairment is necessary, it is measured as the amount by which the carrying amount of the property exceeds the fair value of the property.
No impairment of long lived assets was recognized during 2017, 2016, or 2015. If our estimates or assumptions with respect to a property change in the future, we may be required to record additional impairment charges for our assets.

Business Combinations
For business combination transactions, we recognize and measure the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, as well as the goodwill acquired or gain recognized in a bargain purchase, and we make certain valuations to determine the acquisition date fair value of assets acquired and the liabilities assumed. These valuations are subject to adjustments during the measurement period, generally not to exceed twelve-months from the acquisition date. Such valuations require us to make significant estimates, judgments and assumptions, including projections of future events and operating performance.

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

32



using the Black-Scholes-Merton option valuation method, which requires us to use certain key assumptions to develop the fair value estimates. These key assumptions include expected volatility, risk-free interest rate, expected dividends and expected term. For restricted shares, we utilize the market price at the grant date in order to calculate the stock-based compensation expense to be recognized during the vesting period. During the years ended December 31, 2017, 2016, and 2015, we recorded charges of approximately $1.0 million, $1.0 million and $1.2 million in stock-based compensation, respectively. Stock-based compensation expense is a non-cash expense and such amounts are included as a component of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees.

Income Taxes
Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities at tax rates in effect when such temporary differences are expected to reverse. We generally expect to fully utilize our deferred tax assets; however, when necessary, we record a valuation allowance to reduce our net deferred tax assets to the amount that is more likely than not to be realized.
In determining the need for a valuation allowance or the need for and magnitude of liabilities for uncertain tax positions, we make certain estimates and assumptions. These estimates and assumptions are based on, among other things, knowledge of operations, markets, historical trends and likely future changes and, when appropriate, the opinions of advisors with knowledge and expertise in certain fields. Due to certain risks associated with our estimates and assumptions, actual results could differ.
As a result of the Tax Act, we revaluated our net deferred tax assets, which led to an increase in our income tax expense by $5.5 million for the year ended December 31, 2017. The Company considers the accounting for the deferred tax re-measurements and other items to be complete, but ongoing accounting guidance and interpretation could result in adjustments to the consolidated financial statements. The Tax Act will decrease the corporate income tax rate from 35.0% to 21.0% beginning on January 1, 2018.

Contractual Obligations and Commercial Commitments
We have certain contractual obligations of continuing operations as of December 31, 2017, summarized by the period in which payment is due, as follows (dollar amounts in thousands):
Contractual Obligations
 
Total
 
Less than
1  year
 
1 to 3
Years
 
3 to 5
Years
 
After
5 Years
Long-term debt obligations (1)
 
$
103,464

 
$
17,906

 
$
25,982

 
$
59,576

 
$

Settlement obligations (2)
 
1,369

 
1,369

 

 

 

Elimination of Preferred Stock Conversion feature (3)
 
515

 
515

 

 

 

Operating leases (4)
 
1,065,640

 
58,046

 
119,988

 
123,475

 
764,131

Required capital expenditures under operating leases (5)
 
11,911

 
1,216

 
2,433

 
2,433

 
5,829

Total
 
$
1,182,899

 
$
79,052

 
$
148,403

 
$
185,484

 
$
769,960

 
(1)
Long-term debt obligations include scheduled future payments of principal and interest of long-term debt and amounts outstanding on our capital lease obligations. Our long-term debt obligations increased $8.2 million between December 31, 2016 and December 31, 2017, which is related to assumption of operations for the Golden Living centers and purchase of the center in Selma, Alabama. See Note 5, "Long-Term Debt and Interest Rate Swap," to the consolidated financial statements included in this report for additional information.
(2)
Settlement obligations relate to professional liability cases that are expected to be paid within the next twelve months. The professional liabilities are included in our current portion of self-insurance reserves.
(3)
Payments to Omega, from whom we lease 35 nursing centers, for the elimination of the preferred stock conversion feature in connection with restructuring the preferred stock and master lease agreements. Monthly payments of approximately $0.1 million will be made through the end of the initial lease period that ends in September 2018.
(4)
Represents lease payments under our operating lease agreements. Assumes all renewals periods are enacted. Our operating lease obligations decreased $66.2 million between December 31, 2016 and December 31, 2017.
(5)
Includes annual expenditure requirements under operating leases. Our required capital expenditures decreased $1.3 million between December 31, 2016 and December 31, 2017.
We have employment agreements with certain members of management that provide for the payment to these members of amounts up to two times their annual salary in the event of a termination without cause, a constructive discharge (as defined), or upon a change of control of the Company (as defined). The maximum contingent liability under these agreements is approximately $1.8 million as of December 31, 2017. The terms of such agreements are for one year and automatically renew for one year if not

33



terminated by us or the employee. In addition, upon the occurrence of any triggering event, those certain members of management may elect to require that we purchase equity awards granted to them for a purchase price equal to the difference in the fair market value of our common stock at the date of termination versus the stated equity award exercise price. Based on the closing price of our common stock on December 31, 2017, there is $0.4 million in contingent liabilities for the repurchase of the equity grants. No amounts have been accrued for these contingent liabilities.

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

(in thousands)
 
Year Ended December 31,
 
 
2017
 
2016
 
Change
 
%
PATIENT REVENUES, net
 
$
574,794

 
$
426,063

 
$
148,731

 
34.9
 %
EXPENSES:
 
 
 
 
 
 
 
 
Operating
 
458,122

 
342,932

 
115,190

 
33.6
 %
Lease and rent expense
 
54,988

 
33,364

 
21,624

 
64.8
 %
Professional liability
 
10,764

 
8,456

 
2,308

 
27.3
 %
General and administrative
 
33,311

 
30,271

 
3,040

 
10.0
 %
Depreciation and amortization
 
10,902

 
8,292

 
2,610

 
31.5
 %
Lease termination costs (receipts)
 
(180
)
 
2,008

 
(2,188
)
 
(109.0
)%
Total expenses
 
567,907

 
425,323

 
142,584

 
33.5
 %
OPERATING INCOME
 
6,887

 
740

 
6,147

 
830.7
 %
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
 
Equity in net income of investment in unconsolidated affiliate
 

 
273

 
(273
)
 
(100.0
)%
Gain on bargain purchase
 
925

 

 
925

 
100.0
 %
Gain on sale of investment in unconsolidated affiliate
 
733

 
1,366

 
(633
)
 
(46.3
)%
Hurricane costs
 
(232
)
 

 
(232
)
 
(100.0
)%
Interest expense, net
 
(6,369
)
 
(4,802
)
 
(1,567
)
 
(32.6
)%
Debt retirement costs
 

 
(351
)
 
351

 
100.0
 %
 
 
(4,943
)
 
(3,514
)
 
(1,429
)
 
(40.7
)%
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
 
1,944

 
(2,774
)
 
4,718

 
170.1
 %
BENEFIT (PROVISION) FOR INCOME TAXES
 
(6,743
)
 
1,030

 
(7,773
)
 
(754.7
)%
LOSS FROM CONTINUING OPERATIONS
 
$
(4,799
)
 
$
(1,744
)
 
$
(3,055
)
 
(175.2
)%



34



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

 
$
387,595

 
$
38,468

 
9.9
 %
EXPENSES:
 
 
 
 
 
 
 
 
Operating
 
342,932

 
311,035

 
31,897

 
10.3
 %
Lease and rent expense
 
33,364

 
28,690

 
4,674

 
16.3
 %
Professional liability
 
8,456

 
8,122

 
334

 
4.1
 %
General and administrative
 
30,271

 
24,793

 
5,478

 
22.1
 %
Depreciation and amortization
 
8,292

 
7,524

 
768

 
10.2
 %
Lease termination costs
 
2,008

 

 
2,008

 
100.0
 %
Total expenses
 
425,323

 
380,164

 
45,159

 
11.9
 %
OPERATING INCOME
 
740

 
7,431

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

 
273

 
339

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

 

 
1,366

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

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

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

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

 
(916
)
 
1,946

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

 
$
(4,496
)
 
(163.4
)%

Year Ended December 31, 2017 Compared With Year Ended December 31, 2016
Patient Revenues
Patient revenues were $574.8 million in 2017 and $426.1 million in 2016, an increase of $148.7 million or 34.9%. This increase is primarily attributable to the acquisition of Golden Living operations in Alabama and Mississippi during the fourth quarter of 2016. The following table summarizes the revenue increases attributable to our portfolio growth (in thousands):
 
Year Ended
December 31,
 
2017

2016

Change
Same-store revenue
$
386,576


$
388,890


$
(2,314
)
2016 acquisition revenue
183,665

 
37,173


146,492

2017 acquisition revenue
4,553




4,553

Total revenue
$
574,794


$
426,063


148,731


The overall increase in revenue of $148.7 million is primarily attributable to revenue contributions from the acquisition of Golden Living operations in Alabama and Mississippi during the fourth quarter of 2016 of $146.5 million and Park Place during the third quarter of 2017 of $4.6 million. The increase from the acquisition activity was partially offset by a decrease in same-store revenue of $2.3 million which is explained in more detail below.

35



The following table summarizes key revenue and census statistics for continuing operations for each period:
 
 
Year Ended
December 31,
 
2017
 
 
 
2016
Skilled nursing occupancy
79.7
%
 

 
78.1
%
As a percent of total census:
 
 
 
 
 
Medicaid census
69.1
%
 
 
 
68.1
%
Medicare census
11.2
%
 
 
 
11.7
%
Managed Care census
3.9
%
 
 
 
3.5
%
As a percent of total revenues:
 
 
 
 
 
Medicaid revenues
52.4
%
 
 
 
50.6
%
Medicare revenues
25.9
%
 
 
 
27.5
%
Managed Care revenues
7.4
%
 
 
 
6.8
%
Average rate per day:
 
 
 
 
 
Medicare
$
454.22

 
  
 
$
456.30

Medicaid
$
175.58

 
  
 
$
169.91

Managed Care
$
381.46

 
  
 
$
385.71


The average Medicaid rate per patient day for same-store nursing centers in 2017 increased 1.7% compared to 2016, resulting in an increase in revenue of $3.3 million. This average rate per day for Medicaid patients is the result of rate increases in certain states and increasing patient acuity levels. The average Medicare rate per patient day for same-store nursing centers in 2017 increased 1.6% compared to 2016, resulting in an increase in revenue of $1.5 million also related to our ability to attract and provide care for patients with increased acuity levels.
Our total average daily census increased by approximately 33.9% for the full portfolio compared to 2016 on a consolidated basis, but was primarily attributable to the aforementioned acquisition activity. On a same-store basis, our Medicare, Medicaid and Private average daily census for 2017 decreased compared to 2016, resulting in decreases in revenue of $5.0 million, $1.4 million and $2.2 million, respectively. Conversely, our Managed Care average daily census increased in 2017 compared to 2016 by $2.0 million.
Our same-store centers for 2017 experienced one less day of operations compared to 2016, resulting in a decrease in revenue of $1.0 million or 2.7%.
Operating Expense
Operating expense increased to $458.1 million in 2017 from $342.9 million in 2016, driven primarily by the $115.9 million in operating costs from the Golden Living nursing centers added in 2016, and $3.6 million from the center acquired in 2017. Operating expense decreased to 79.7% of revenue in 2017, compared to 80.5% of revenue in 2016.
 
Year Ended
December 31,
 
2017
 
2016
 
Change
Same-store operating expenses
$
310,571

 
$
314,944

 
$
(4,373
)
2016 acquisition operating expenses
143,911

 
27,988

 
115,923

2017 acquisition operating expenses
3,640

 

 
3,640

Total operating expenses
$
458,122

 
$
342,932

 
115,190

The largest component of operating expenses is wages, which increased to $268.4 million in 2017 from $199.6 million in 2016, an increase of $68.8 million, or 34.4%.
On a same-store center basis, operating expenses decreased $4.4 million, which is primarily attributable to a decrease in our bad debt expense by $1.1 million and a provider tax refund of $2.8 million from the state of Kentucky. Our same-store nursing and ancillary and dietary expenses decreased by $0.1 million and $0.3 million, respectively. Conversely, these positive variances were

36



slightly offset by an increase in salaries and related taxes of $1.0 million in 2017. However, due to one less day of operations in 2017, we experienced $0.5 million less in salaries and related taxes.
Lease Expense
Lease expense increased to $55.0 million in 2017 from $33.4 million in 2016, an increase of $21.6 million, or 64.8%. The increase in lease expense was driven by $22.1 million from the assumption of the Golden Living centers in the fourth quarter of 2016. This was slightly offset from the termination of the Carthage, Mississippi lease in September 2017.
Professional Liability
Professional liability expense was $10.8 million in 2017 compared to $8.5 million in 2016, an increase of $2.3 million, or 27.3%. As centers have been acquired in 2016 and 2017, the Company has accessed commercial insurance markets, which accounts for a significant portion of the growth in professional liability expense in the current year. We were engaged in 72 professional liability lawsuits as of December 31, 2017, compared to 67 as of December 31, 2016. Our cash expenditures for professional liability costs of continuing operations were $6.6 million and $4.5 million for 2017 and 2016, respectively. Professional liability expense and cash expenditures fluctuate from year to year based respectively on the results of our third-party professional liability actuarial studies, the premium costs of purchased insurance, and on the costs incurred in defending and settling existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.
General and Administrative Expense
General and administrative expenses were approximately $33.3 million in 2017 compared to $30.3 million in 2016, an increase of $3.0 million, or 10.0%. The overall increase in general and administrative expenses were attributable to a $3.7 million increase in salaries and related expenses associated with continued growth at the regional level, as well as additional corporate infrastructure to support the on-going growth of the portfolio. Legal expenses decreased by $0.7 million in 2017 compared to 2016, which is attributable to the 2016 acquisitions.
Depreciation and Amortization
Depreciation and amortization expense was approximately $10.9 million in 2017 and $8.3 million in 2016. The Company incurred an increase of $2.1 million in depreciation and amortization expenses related to capital expenditures for the assumed Golden Living operations in the fourth quarter of 2016.
Lease termination costs (receipts)
The Company ceased operations at our Carthage, Mississippi, center in September 2017, which resulted in a $0.2 million cash termination receipt, net of legal costs. Lease termination costs were $2.0 million in 2016 due to the termination of the Avon, Ohio operating lease in May 2016.
Gain on bargain purchase
The Company acquired the operations and assets of a center in Selma, Alabama in July 2017. In connection with the business combination, we recognized a $0.9 million gain on bargain purchase.
Gain on sale of investment in unconsolidated affiliate
The sale of the pharmacy joint venture resulted in a $1.4 million gain in the fourth quarter of 2016. Subsequently, we recognized an additional gain of $0.7 million in the first quarter of 2017, related to the continuing liquidation of remaining net assets affiliated with the partnership.
Interest Expense, Net
Interest expense has increased to $6.4 million in 2017 compared to $4.8 million in 2016, an increase of $1.6 million. The increase was primarily attributable to higher debt balances in 2017 as a result of additional borrowings made during the change in ownership processes for the newly acquired centers in Alabama and Mississippi, and the amendment of the term loan facility that occurred in June 2017.
Debt retirement costs
Debt retirement costs were $0.4 million in 2016, which relates to the write off of our term loan deferred financing costs, as a result of our debt refinance that took place in February 2016.
Income (loss) from Continuing Operations before Income Taxes; Income (loss) from Continuing Operations per Common Share

37



As a result of the above, continuing operations reported income before taxes of $1.9 million in 2017, as compared to loss before taxes of $2.8 million in 2016. The provision for income taxes was $6.7 million in 2017, an effective rate of 346.9% and the provision for income taxes was $1.0 million in 2016, an effective rate of 37.1%. The higher effective tax rate reflects the impact of our revaluation of our net deferred tax assets of $5.5 million as a result of the Tax Act. The basic and diluted loss per common share from continuing operations were $0.76 and $0.76 in 2017, respectively, compared to a basic and diluted loss per common share from continuing operations of $0.28 and $0.28 in 2016, respectively.

38



Year Ended December 31, 2016 Compared With Year Ended December 31, 2015
Patient Revenues
Patient revenues were $426.1 million in 2016 and $387.6 million in 2015, an increase of $38.5 million or 9.9%. This increase is primarily attributable to the acquisition of Golden Living operations in Alabama and Mississippi during the fourth quarter of 2016. The following table summarizes the revenue increases attributable to our portfolio growth (in thousands):
 
Year Ended
December 31,
 
2016
 
2015
 
Change
Same-store revenue
$
372,452

 
$
376,497

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

 
11,098

 
5,340

2016 acquisition revenue
37,173

 

 
37,173

Total revenue
$
426,063

 
$
387,595

 
38,468


The overall increase in revenue of $38.5 million is primarily attributable to revenue contributions from the acquisition of Golden Living operations in Alabama and Mississippi during the fourth quarter of 2016 of $37.2 million. Additionally, the 2015 acquisitions experienced an incremental increase in revenues of $5.3 million as a result of having a full year in operations during 2016. The increase from the acquisition activity was partially offset by a decrease in same-store revenue of $4.0 million which is explained in more detail below.
The following table summarizes key revenue and census statistics for continuing operations for each period:
 
 
Year Ended
December 31,
 
2016
 
 
 
2015
Skilled nursing occupancy
78.1
%
 
 
 
77.1
%
As a percent of total census:
 
 
 
 
 
Medicaid census
68.1
%
 
 
 
67.1
%
Medicare census
11.7
%
 
 
 
12.5
%
Managed Care census
3.5
%
 
 
 
3.7
%
As a percent of total revenues:
 
 
 
 
 
Medicaid revenues
50.6
%
 
 
 
48.6
%
Medicare revenues
27.5
%
 
 
 
29.0
%
Managed Care revenues
6.8
%
 
 
 
7.2
%
Average rate per day:
 
 
 
 
 
Medicare
$
456.30

 
  
 
$
455.24

Medicaid
$
169.91