10-Q 1 a03312017-documentx10q.htm 10-Q Document

 
 
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
(Mark One) 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2017 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                    to                    

Commission File Number 001-33135
 
AdCare Health Systems, Inc.
(Exact name of registrant as specified in its charter) 
Georgia
 
31-1332119
(State or other jurisdiction
of incorporation)
 
(I.R.S. Employer Identification Number)
 454 Satellite Boulevard NW, Suite 100, Suwanee, GA 30024
(Address of principal executive offices)
(678) 869-5116
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o
 
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 definition of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer  o
 (Do not check if a
smaller reporting company)
 
Smaller reporting company ý
 
Emerging growth company o

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. Yes o    No o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  
Yes o  No ý
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 As of April 30, 2017:  19,805,924 shares of common stock, no par value, were outstanding.



AdCare Health Systems, Inc.
 
Form 10-Q
 
Table of Contents
 
 
 
Page
 Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Forward-Looking Statements
 
This Quarterly Report on Form 10-Q (this “Quarterly Report”) and certain information incorporated herein by reference contain forward-looking statements and information within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. This information includes assumptions made by, and information currently available to management, including statements regarding future economic performance and financial condition, liquidity and capital resources, and management’s plans and objectives. In addition, certain statements included in this Quarterly Report, in the Company’s future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and written statements made by us or with our approval, which are not statements of historical fact, are forward-looking statements. Words such as “may,” “could,” “should,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “seeks,” “plan,” “project,” “continue,” “predict,” “will,” “should,” and other words or expressions of similar meaning are intended by us to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Forward-looking statements are based on the Company’s current expectations about future events or results and information that is currently available to us, involve assumptions, risks, and uncertainties, and speak only as of the date on which such statements are made. 
All forward-looking statements are subject to the risks and uncertainties inherent in predicting the future. The Company’s actual results may differ materially from those projected, stated or implied in these forward-looking statements as a result of many factors, including the Company’s critical accounting policies and risks and uncertainties related to, but not limited to, the operating results of the Company’s tenants, the overall industry environment and the Company’s financial condition. These and other risks and uncertainties are described in more detail in the Company’s most recent Annual Report on Form 10-K, as well as other reports that the Company files with the SEC. 
Forward-looking statements speak only as of the date they are made and should not be relied upon as representing the Company’s views as of any subsequent date. The Company undertakes no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur, except as required by applicable laws, and you are urged to review and consider disclosures that the Company makes in this Quarterly Report and other reports that the Company files with the SEC that discuss factors germane to the Company’s business.

3

Part I.  Financial Information 
Item 1.  Financial Statements 
ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in 000’s)
 
 
March 31, 
 2017
 
December 31, 
 2016
 
 
(Unaudited)
 
 
ASSETS
 
 

 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
4,184

 
$
14,045

Restricted cash
 
1,660

 
1,600

Accounts receivable, net of allowance of $6,678 and $7,529
 
2,263

 
2,429

Prepaid expenses and other
 
2,586

 
2,395

Total current assets
 
10,693

 
20,469

Restricted cash and investments
 
2,155

 
3,864

Property and equipment, net
 
78,526

 
79,168

Intangible assets - bed licenses
 
2,471

 
2,471

Intangible assets - lease rights, net
 
2,587

 
2,754

Goodwill
 
2,105

 
2,105

Lease deposits
 
911

 
1,411

Other assets
 
8,038

 
7,244

Total assets
 
$
107,486

 
$
119,486

LIABILITIES AND DEFICIT
 
 

 
 

Current liabilities:
 
 

 
 

Current portion of notes payable and other debt
 
$
4,390

 
$
4,018

Current portion of convertible debt, net
 
2,478

 
9,136

Accounts payable
 
3,316

 
3,037

Accrued expenses and other
 
8,000

 
9,077

Total current liabilities
 
18,184

 
25,268

Notes payable and other debt, net of current portion:
 
 

 
 

Senior debt, net
 
58,179

 
60,189

Bonds, net
 
6,605

 
6,586

Other debt, net
 
181

 
41

Other liabilities
 
3,395

 
3,677

Deferred tax liability
 
226

 
226

Total liabilities
 
86,770

 
95,987

Commitments and contingencies (Note 15)
 

 

Preferred stock, no par value; 5,000 shares authorized; 2,762 and 2,762 shares issued and outstanding, redemption amount $69,038 and $69,038 at March 31, 2017 and December 31, 2016, respectively
 
61,446

 
61,446

Stockholders’ deficit:
 
 

 
 

Common stock and additional paid-in capital, no par value; 55,000 shares authorized; 19,806 and 19,927 issued and outstanding at March 31, 2017 and December 31, 2016, respectively
 
61,690

 
61,643

Accumulated deficit
 
(102,420
)
 
(99,590
)
Total stockholders’ deficit
 
(40,730
)
 
(37,947
)
Total liabilities and stockholders’ deficit
 
$
107,486

 
$
119,486

 
See accompanying notes to unaudited consolidated financial statements

4

ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in 000’s, except per share data)
(Unaudited)
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Revenues:
 
 

 
 

Rental revenues
 
$
5,775

 
$
6,849

Management fee and other revenues
 
360

 
233

Total revenues
 
6,135

 
7,082

 
 
 
 
 
Expenses:
 
 

 
 

Facility rent expense
 
2,171

 
2,179

Depreciation and amortization
 
1,135

 
1,713

General and administrative expense
 
1,622


2,542

Other operating expenses
 
555

 
203

Total expenses
 
5,483

 
6,637

 
 
 
 
 
Income from operations
 
652

 
445

 
 
 
 
 
Other expense:
 
 

 
 

Interest expense, net
 
1,032

 
1,825

Loss on extinguishment of debt
 
63

 
—

Other expense
 
95

 
42

Total other expense, net
 
1,190

 
1,867

 
 
 
 
 
Loss from continuing operations before income taxes
 
(538
)
 
(1,422
)
Income tax expense
 
1

 
—

Loss from continuing operations
 
(539
)
 
(1,422
)
 
 
 
 
 
Loss from discontinued operations, net of tax
 
(413
)
 
(528
)
Net loss
 
(952
)
 
(1,950
)
 
 
 
 
 
Preferred stock dividends
 
(1,878
)
 
(1,777
)
Net loss attributable to AdCare Health Systems, Inc. common stockholders
 
$
(2,830
)
 
$
(3,727
)
 
 
 
 
 
Net loss per share of common stock attributable to AdCare Health Systems, Inc.
 
 

 
 

Basic and diluted:
 
 

 
 

Continuing operations
 
$
(0.12
)
 
$
(0.16
)
Discontinued operations
 
(0.02
)
 
(0.03
)
 
 
$
(0.14
)
 
$
(0.19
)
 
 
 
 
 
Weighted average shares of common stock outstanding:
 
 

 
 

Basic and diluted
 
19,825

 
19,885


 See accompanying notes to unaudited consolidated financial statements

5

ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT
(Amounts in 000’s)
(Unaudited)

 
 
Shares of Common Stock
 
Common Stock and Additional
Paid-in
Capital
 
Accumulated
Deficit
 
Total
Balances, December 31, 2016
 
19,927

 
$
61,643

 
$
(99,590
)
 
$
(37,947
)
 
 
 
 
 
 
 
 
 
Stock-based compensation
 
—

 
234

 
—

 
234

 
 
 
 
 
 
 
 
 
Common stock repurchase program
 
(118
)
 
(187
)
 
—

 
(187
)
 
 
 
 
 
 
 
 
 
Issuance of restricted stock, net of forfeitures
 
(3
)
 
—

 
—

 
—

 
 
 
 
 
 
 
 
 
Preferred stock dividends
 
—

 
—

 
(1,878
)
 
(1,878
)
 
 
 
 
 
 
 
 
 
Net loss
 
—

 
—

 
(952
)
 
(952
)
Balances, March 31, 2017
 
19,806

 
$
61,690

 
$
(102,420
)
 
$
(40,730
)
 
See accompanying notes to unaudited consolidated financial statements

6
ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Amounts in 000’s)
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 

Net loss
 
$
(952
)
 
$
(1,950
)
Loss from discontinued operations, net of tax
 
413

 
528

Loss from continuing operations
 
(539
)
 
(1,422
)
Adjustments to reconcile net loss from continuing operations to net cash provided by (used in) operating activities:
 
 

 
 

Depreciation and amortization
 
1,135

 
1,713

Stock-based compensation expense
 
234

 
480

Rent expense in excess of cash paid
 
158

 
203

Rent revenue in excess of cash received
 
(768
)
 
(718
)
Amortization of deferred financing costs
 
95

 
216

Amortization of debt discounts and premiums
 
4

 
4

Bad debt expense
 
466

 
—

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
163

 
(1,219
)
Prepaid expenses and other
 
(201
)
 
(242
)
Other assets
 
(294
)
 
17

Accounts payable and accrued expenses
 
236

 
(590
)
Other liabilities
 
60

 
617

Net cash provided by (used in) by operating activities - continuing operations
 
749

 
(941
)
Net cash used in operating activities - discontinued operations
 
(1,051
)
 
(639
)
Net cash used in operating activities
 
(302
)
 
(1,580
)
 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

Change in restricted cash
 
1,649

 
3,839

Purchase of property and equipment
 
(329
)

(19
)
Proceeds from the sale of property and equipment
 
—

 
325

Net cash provided by investing activities - continuing operations
 
1,320

 
4,145

Net cash used in investing activities - discontinued operations
 
—

 
(1
)
Net cash provided by investing activities
 
1,320

 
4,144

 
 
 
 
 
Cash flows from financing activities:
 
 

 
 

Proceeds from debt
 
—

 
203

Repayment of notes payable
 
(1,974
)
 
(4,518
)
Repayment on convertible debt
 
(6,700
)
 
—

Debt issuance costs
 
—

 
(25
)
Proceeds from preferred stock issuances, net
 
—

 
3,677

Repurchase of common stock
 
(187
)
 
(312
)
Dividends paid on preferred stock
 
(1,878
)
 
(1,777
)
Net cash used in financing activities - continuing operations
 
(10,739
)
 
(2,752
)
Net cash used in financing activities - discontinued operations
 
(140
)
 
(268
)
Net cash used in financing activities
 
(10,879
)
 
(3,020
)
Net change in cash and cash equivalents
 
(9,861
)
 
(456
)
Cash and cash equivalents, beginning
 
14,045

 
2,720

Cash and cash equivalents, ending
 
$
4,184

 
$
2,264

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Interest paid
 
$
682


$
1,630

Income taxes paid
 
$
—


$
—

Supplemental disclosure of non-cash activities:
 
 
 
 
Surrender of security deposit
 
$
500

 
$
—

Non-cash proceeds from vendor-financed insurance
 
$
193

 
$
—

Non-cash proceeds from financing of South Carolina Medicaid audit repayment
 
$
385

 
$
—

 See accompanying notes to unaudited consolidated financial statements

7

ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
March 31, 2017
 
NOTE 1.                          ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES 

See Part II, Item 8, Notes to Consolidated Financial Statements, Note 1 - Organization and Significant Accounting Policies included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission (the “SEC”) on April 17, 2017 (the “Annual Report”), for a description of all significant accounting policies. 
Description of Business
 
AdCare Health Systems, Inc. (“AdCare”), through its subsidiaries (together, the “Company” or “we”), is a self-managed real estate investment company that invests primarily in real estate purposed for long-term care and senior living. The Company’s business primarily consists of leasing and subleasing healthcare facilities to third-party tenants, which operate such facilities. The operators of the Company’s facilities provide a range of healthcare services, including skilled nursing and assisted living services, social services, various therapy services, and other rehabilitative and healthcare services for both long-term and short-stay patients and residents.

The Company was incorporated in Ohio on August 14, 1991, under the name Passport Retirement, Inc. In 1995, the Company acquired substantially all of the assets and liabilities of AdCare Health Systems, Inc. and changed its name to AdCare Health Systems, Inc. AdCare completed its initial public offering in November 2006. Initially based in Ohio, the Company expanded its portfolio through a series of strategic acquisitions to include properties in a number of other states, primarily in the Southeast. In 2012, the Company relocated its executive offices and accounting operations to Georgia, and AdCare changed its state of incorporation from Ohio to Georgia on December 12, 2013.

The Company leases its currently-owned healthcare properties, and subleases its currently-leased healthcare properties, on a triple-net basis, meaning that the lessee (i.e., the third-party operator of the property) is obligated under the lease or sublease, as applicable, for all costs of operating the property including insurance, taxes and facility maintenance, as well as the lease or sublease payments, as applicable. These leases are generally long-term in nature with renewal options and annual rent escalation clauses. The Company has many of the characteristics of a real estate investment trust (“REIT”) and is focused on the ownership, acquisition and leasing of healthcare properties. AdCare’s Board of Directors (the “Board”) continues to analyze and consider: (i) whether and, if so, when, the Company could satisfy the requirements to qualify as a REIT under the Internal Revenue Code of 1986, as amended; (ii) the structural and operational complexities which would need to be addressed before the Company could qualify as a REIT, including the disposition of certain assets or the termination of certain operations which may not be REIT compliant; and (iii) if the Company were to qualify as a REIT, whether electing REIT status would be in the best interests of the Company and its shareholders in light of various factors, including our significant consolidated federal net operating loss carryforwards. There is no assurance that the Company will qualify as a REIT in future taxable years or, if it were to so qualify, that the Board would determine that electing REIT status would be in the best interests of the Company and its shareholders.

As of March 31, 2017, the Company owns, leases, or manages 29 facilities primarily in the Southeast (see Note 17 - Subsequent Events). Of the 29 facilities, the Company: (i) leased 14 owned and 11 leased skilled nursing facilities to third-party tenants; (ii) leased one owned assisted living facility to a third-party tenant; and (iii) managed on behalf of third-party owners two skilled nursing facilities and one independent living facility (see Note 7 - Leases below and Part II, Item 8, Notes to Consolidated Financial Statements, Note 7 - Leases in the Annual Report for a more detailed description of the Company’s leases).

Basis of Presentation
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Article 8 of Regulations S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results of operations for the periods presented have been included.  Operating results for the three months ended March 31, 2017 and 2016 are not necessarily indicative of the results that may be expected for the fiscal year. The balance sheet at December 31, 2016 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. 

8

You should read the accompanying unaudited consolidated financial statements together with the historical consolidated financial audited statements of the Company for the year ended December 31, 2016, included in the Annual Report. 
Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported results of operations during the reporting period. Examples of significant estimates include allowance for doubtful accounts, self-insurance reserves, deferred tax valuation allowance, fair value of employee and nonemployee stock based awards, valuation of goodwill and other long-lived assets, and cash flow projections. Actual results could differ materially from those estimates.

Revenue Recognition and Allowances
Triple-Net Leased Properties. The Company's triple-net leases provide for periodic and determinable increases in rent. The Company recognizes rental revenues under these leases on a straight-line basis over the applicable lease term when collectibility is reasonably assured. Recognizing rental income on a straight-line basis generally results in recognized revenues during the first half of a lease term exceeding the cash amounts contractually due from our tenants, creating a straight-line rent receivable that is included in other assets on our consolidated balance sheets. In the event the Company cannot reasonably estimate the future collection of rent from one or more tenant(s) of the Company’s facilities, rental income for the affected facilities will be recognized only upon cash collection, and any accumulated straight-line rent receivable will be reversed in the period in which the Company first deems rent collection no longer reasonably assured.

Management Fee Revenue and Other. The Company recognizes management fee revenues as services are provided. Further, the Company recognizes income from lease inducements receivables and interest income from loans and investments, using the effective interest method when collectibility is reasonably assured. We apply the effective interest method on a loan-by-loan basis.

Allowances. The Company assesses the collectibility of our rent receivables, including straight-line rent receivables and working capital loans to tenants. The Company bases its assessment of the collectibility of rent receivables and working capital loans to tenants on several factors, including, payment history, the financial strength of the tenant and any guarantors, the value of the underlying collateral, and current economic conditions. If the Company's evaluation of these factors indicates it is probable that the Company will be unable to receive the rent payments or payments on a working capital loan, the Company provides a reserve against the recognized straight-line rent receivable asset or working capital loan for the portion that we estimate may not be recovered. If the Company changes its assumptions or estimates regarding the collectibility of future rent payments required by a lease or required from a working capital loan to a tenant, the Company may adjust its reserve to increase or reduce the rental revenue or interest revenue from working capital loans to tenants recognized in the period the Company makes such change in its assumptions or estimates. 

As of March 31, 2017 and December 31, 2016, the Company allowed for approximately $6.7 million and $7.5 million, respectively, of gross patient care related receivables arising from our legacy operations. Allowance for patient care receivables are estimated based on an aged bucket method as well as additional analyses of remaining balances incorporating different payor types. Any changes in patient care receivable allowances are recognized as a component of discontinued operations. All patient care receivables exceeding 365 days are fully allowed at March 31, 2017 and December 31, 2016. Accounts receivable, net totaled $2.3 million at March 31, 2017 and $2.4 million at December 31, 2016 of which $0.9 million and $0.9 million, respectively related to patient care receivables from our legacy operations.
Self-Insurance
The Company has self-insured against professional and general liability claims since it discontinued its healthcare operations during 2014 and 2015 (see Part II, Item 8, Notes to Consolidated Financial Statements, Note 7 - Leases in the Annual Report for a more detailed description of the Company’s leases). The Company evaluates quarterly the adequacy of its self-insurance reserve based on a number of factors, including: (i) the number of actions pending and the relief sought; (ii) analyses provided by defense counsel, medical experts or other information which comes to light during discovery; (iii) the legal fees and other expenses anticipated to be incurred in defending the actions; (v) the status and likely success of any mediation or settlement discussions; and (vi) the venues in which the actions have been filed or will be adjudicated. The Company currently believes that most of the professional and general liability actions, and particularly many of the most recently filed actions, are defensible and intends to defend them through final judgment. Accordingly, the self-insurance reserve primarily reflects the Company's estimated legal costs of litigating the pending actions accordingly. Because the self-insurance reserve is based on estimates, the amount of the

9

self-insurance reserve may not be sufficient to cover the legal costs actually incurred in litigating the pending actions. Since these reserves are based on estimates, the actual expenses we incur may differ from the amount reserved (see Note 8 - Accrued Expenses).
Fair Value Measurements and Financial Instruments 
Accounting guidance establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The categorization of a measurement within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are defined as follows:
Level 1—     Quoted market prices in active markets for identical assets or liabilities
Level 2—     Other observable market-based inputs or unobservable inputs that are corroborated by market data
Level 3—     Significant unobservable inputs
The respective carrying value of certain financial instruments of the Company approximates their fair value. These instruments include cash and cash equivalents, restricted cash and investments, accounts receivable, notes receivable, and accounts payable. Fair values were assumed to approximate carrying values for these financial instruments since they are short-term in nature and their carrying amounts approximate fair values, they are receivable or payable on demand, or the interest rates earned and/or paid approximate current market rates.

Recent Accounting Pronouncements
Except for rules and interpretive releases of the SEC under authority of federal securities laws, the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") is the sole source of authoritative GAAP literature recognized by the FASB and applicable to the Company. The Company has reviewed the FASB accounting pronouncements and Accounting Standards Update ("ASU") interpretations that have effectiveness dates during the periods reported and in future periods.     

In May 2014, the FASB issued ASU 2014-09, which requires revenue to be recognized in an amount that reflects the consideration expected to be received in exchange for those goods and services. This new standard requires the disclosure of sufficient quantitative and qualitative information for financial statement users to understand the nature, amount, timing and uncertainty of revenue and associated cash flows arising from contracts with customers. The new guidance does not affect the recognition of revenue from leases. In August 2015, the FASB delayed the effective date of ASU 2014-09 by one year and subsequently amended the new revenue standard under ASU 2016-10 and ASU 2016-12 in April and May 2016, respectively. ASU 2016-10 provides additional guidance for identifying performance obligations and licenses of intellectual property, and ASU 2016-12 clarifies guidance regarding collectibility, noncash considerations and completed contracts at transition. These new revenue standards are effective for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Early application is permitted under the original effective date of fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The Company is currently evaluating the impact on the Company’s financial position, results of operations and related disclosures.

In January 2016, the FASB issued ASU 2016-01, which provides revised accounting guidance related to the accounting for and reporting of financial instruments. This guidance significantly revises an entity’s accounting related to (i) the classification and measurement of investments in equity securities and (ii) the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. The ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017; earlier adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial condition, results of operations or cash flows.

In February 2016, the FASB issued ASU 2016-02, as a comprehensive new leases standard that amends various aspects of existing guidance for leases and requires additional disclosures about leasing arrangements. It will require companies to recognize lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance, ASC 840, Leases. ASU 2016-02 creates a new Topic, ASC 842, Leases. This new Topic retains a distinction between finance leases and operating leases. The classification criteria for distinguishing between finance leases and operating leases are substantially similar to the classification criteria for distinguishing between capital leases and operating leases in the previous leases guidance. The ASU is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years; earlier adoption is permitted. In the financial statements in which the ASU is first applied, leases shall be measured and recognized at the beginning of the earliest comparative period presented with an adjustment to equity. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated financial condition, results of operations and cash flows.

10


In March 2016, the FASB issued ASU 2016-09, with the intention to simplify aspects of the accounting for share-based payment transactions, including income tax impacts, classification on the statement of cash flows, and forfeitures. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2016. The various amendments within the standard require different approaches to adoption, on a retrospective, modified retrospective or prospective basis. The Company adopted the various amendments in its consolidated financial statements for the three month period ending March 31, 2017 with an effective date of January 1, 2017. The Company has elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. The adoption of ASU 2016-09 did not have a material effect on its consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, which changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which will generally result in earlier recognition of allowances for losses. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for annual and interim periods beginning after December 15, 2018. We are currently evaluating the impact of adopting ASU 2016-13 on our consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, which requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash. Therefore, amounts generally described as restricted cash will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for annual and interim periods beginning after December 15, 2017 and early adoption is permitted using a retrospective transition method to each period presented. We are currently evaluating the impact of adopting ASU 2016-09 on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, which simplifies the required periodic test for goodwill impairment and modifies the concept of impairment of goodwill under previous guidance, ASC 350, Intangibles - Goodwill and Other. Under the updated guidance, a goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, up to the total amount of goodwill allocated to that reporting unit. This simplification eliminates previous requirements to determine the implied fair value of goodwill and record a loss on impairment equal to the carrying value of goodwill less the implied fair value. Further, the ASU modifies the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. ASU 2017-04 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted on a prospective basis for annual and interim periods beginning after January 1, 2017. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial condition, results of operations or cash flows.

NOTE 2.                          EARNINGS PER SHARE 

Basic earnings per share is computed by dividing net income or loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during the respective period. Diluted earnings per share is similar to basic earnings per share except: (i) net income or loss is adjusted by the impact of the assumed conversion of convertible debt into shares of common stock; and (ii) the weighted average number of shares of common stock outstanding includes potentially dilutive securities (such as options, warrants and additional shares of common stock issuable under convertible debt outstanding during the period) when such securities are not anti-dilutive. Potentially dilutive securities from options and warrants are calculated in accordance with the treasury stock method, which assumes that proceeds from the exercise of all options and warrants with exercise prices exceeding the average market value are used to repurchase common stock at market value. The incremental shares remaining after the proceeds are exhausted represent the potentially dilutive effect of the securities. Potentially dilutive securities from convertible debt are calculated based on the assumed issuance at the beginning of the period, as well as any adjustment to income that would result from their assumed issuance. For the three months ended March 31, 2017 and 2016, approximately 2.8 million and 4.6 million shares, respectively, of potentially dilutive securities were excluded from the diluted income (loss) per share calculation because including them would have been anti-dilutive for such periods.

11



The following tables provide a reconciliation of net loss for continuing and discontinued operations and the number of shares of common stock used in the computation of both basic and diluted earnings per share:
 
 
Three Months Ended 
 March 31,
(Amounts in 000’s, except per share data)
 
2017
 
2016
Numerator:
 
 
 
 
Loss from continuing operations
 
$
(539
)
 
$
(1,422
)
Preferred stock dividends
 
(1,878
)
 
(1,777
)
Basic and diluted loss from continuing operations
 
(2,417
)
 
(3,199
)
 
 
 
 
 
Loss from discontinued operations, net of tax
 
(413
)
 
(528
)
Net loss attributable to AdCare Health Systems, Inc. common stockholders
 
$
(2,830
)
 
$
(3,727
)
 
 
 
 
 
Denominator:
 
 
 
 
Basic - weighted average shares
 
19,825

 
19,885

Diluted - adjusted weighted average shares (a)
 
19,825

 
19,885

 
 
 
 
 
Basic and diluted loss per share:
 
 
 
 
Loss from continuing operations attributable to AdCare
 
$
(0.12
)
 
$
(0.16
)
Loss from discontinued operations
 
(0.02
)
 
(0.03
)
Loss attributable to AdCare Health Systems, Inc. common stockholders
 
$
(0.14
)
 
$
(0.19
)
 
 
 
 
 
(a) Securities outstanding that were excluded from the computation, prior to the use of the treasury stock method, because they would have been anti-dilutive are as follows:
 
 
March 31,
(Share amounts in 000’s)
 
2017
 
2016
Stock options
 
333

 
373

Warrants - employee
 
1,450

 
1,559

Warrants - non employee
 
437

 
492

Shares issuable upon conversion of convertible debt
 
588

 
2,165

Total anti-dilutive securities
 
2,808

 
4,589

 
NOTE 3.                          LIQUIDITY AND PROFITABILITY

Sources of Liquidity

The Company continues to undertake measures to grow its operations and to reduce its expenses by: (i) increasing future lease revenue through acquisitions and investments in existing properties; (ii) modifying the terms of existing leases; (iii) refinancing or repaying debt to reduce interest costs and mandatory principal repayments; and (iv) reducing general and administrative expenses.

At March 31, 2017, the Company had $4.2 million in cash and cash equivalents as well as restricted cash and investments of $3.8 million. Management anticipates access to several sources of liquidity, including cash flows from operations and cash on hand. Management holds routine ongoing discussions with existing lenders and potential new lenders to refinance current debt on a longer term basis and, in recent years, has refinanced shorter term acquisition debt, with traditional longer term mortgage notes, many of which have been executed under government guaranteed lending programs. Historically, the Company has raised capital through other sources, including issuances of preferred stock and convertible debt.

Management expects to commence discussions with one of its lenders to extend maturity of a $1.2 million credit facility associated with its Northwest Oklahoma facility listed as current debt maturities at March 31, 2017.


12

On July 21, 2015, the Company entered into separate At Market Issuance Sales Agreements to sell, from time to time, up to 800,000 shares of the Company’s 10.875% Series A Cumulative Redeemable Preferred Stock, (the “Series A Preferred Stock”), through an “at-the-market” offering program (“ATM”). Since the inception of the ATM in July 2015 and through March 31, 2017, the Company has sold 650,600 shares of Series A Preferred Stock under the ATM, generating net proceeds to the Company of approximately $13.5 million (see Note 12 - Common and Preferred Stock). Management anticipates renewing its at-the-market offering program with respect to sales of Series A Preferred Stock as a source of liquidity over the next twelve months.


On June 18, 2016, a wholly-owned subsidiary of the Company (“ADK”) entered into a new master sublease agreement (the “Peach Health Sublease”) with affiliates (collectively, “Peach Health Sublessee”) of Peach Health Group, LLC (“Peach Health”), providing that Peach Health Sublessee would take possession of the facilities (the “Peach Facilities”) subleased to affiliates of New Beginnings Care, LLC (“New Beginnings”) prior to their bankruptcy. The Peach Facilities are comprised of: (i) an 85-bed skilled nursing facility located in Tybee Island, Georgia (the “Oceanside Facility”); (ii) a 50-bed skilled nursing facility located in Tybee Island, Georgia (the “Savannah Beach Facility”); and (iii) a 131-bed skilled nursing facility located in Jeffersonville, Georgia (the “Jeffersonville Facility”). Rent for the Savannah Beach Facility, the Oceanside Facility, and the Jeffersonville Facility is $0.3 million, $0.4 million and $0.6 million per annum, respectively; but such rent is only $1 per month for the Oceanside and Jeffersonville Facilities until the date such facilities are recertified by the U.S. Department of Health and Human Services Centers for Medicare and Medicaid Services (“CMS”) or April 1, 2017, whichever first occurs (the “Rent Commencement Date”). The Oceanside and Jeffersonville Facilities were recertified by CMS in February 2017 and December 2016, respectively. In addition, with respect to the Oceanside and Jeffersonville Facilities, Peach Health Sublessee is entitled to three months of $1 per month rent following the Rent Commencement Date and, following such three-month period, five months of rent discounted by 50%. In the event that the Savannah Beach Facility is decertified due to any previous non-compliance attributable to New Beginnings, rent for such facility will revert to $1 a month until it is recertified along with the other facilities. The Company also provided Peach Health with a $1.0 million line of credit to be used for working capital and capital expenditure needs (the “Peach Line” or "Peach Note"). At March 31, 2017, there was a $1.0 million outstanding balance on the Peach Line.

On September 19, 2016, the Company obtained an option to extend the maturity date of the credit facility entered into in September 2013 between a certain wholly-owned subsidiary of the Company and Housing & Healthcare Funding, LLC (the "Quail Creek Credit Facility") from September 2017 to September 2018, which option management intends to exercise. There is no assurance that we will be able to refinance or further extend the maturity date of this credit facility on terms that are favorable to the Company or at all.

On January 10, 2017, the Company repurchased $6.7 million of its outstanding 10% convertible subordinated notes due April 30, 2017 (collectively, the “2015 Notes”) pursuant to a cash tender offer for any and all of such outstanding convertible promissory notes (the "Tender Offer").

Cash Requirements

At March 31, 2017, the Company had $71.8 million in indebtedness of which the current portion is $6.9 million. This current portion is comprised of the following components: (i) convertible debt of $2.5 million; and (ii) other debt of approximately $4.4 million which includes senior debt - bond and mortgage indebtedness (for a complete listing of our debt, see Note 9 - Notes Payable and Other Debt).

The Company anticipates net principal disbursements of approximately $6.9 million, which includes $2.5 million of convertible debt, approximately $0.4 million of payments on shorter term vendor notes, $1.8 million of routine debt service amortization, and a $2.2 million payment of other debt which includes current senior debt of the Northwest Oklahoma facility, a skilled nursing facility located in Oklahoma City, Oklahoma (the “Northwest Oklahoma Facility”) of approximately $1.2 million. Based on the described sources of liquidity, the Company expects sufficient funds for its operations and scheduled debt service, at least through the next twelve months. On a longer term basis, at March 31, 2017, the Company has approximately $13.2 million of debt maturities due over the next two year period ending March 31, 2019. These debt maturities include the aforementioned $2.5 million of convertible promissory notes, which are convertible into shares of the common stock and which also includes the current senior debt of the Northwest Oklahoma facility of $1.2 million in addition to $4.4 million with respect to the Quail Creek Oklahoma Facility. The Company believes its long-term liquidity needs will be satisfied by cash flows from operations, cash on hand, borrowings as required to refinance indebtedness as well as other sources, including issuances of preferred stock and convertible debt.

In November 2016, the Board approved two share repurchase programs (collectively, the "November 2016 Repurchase Program"), pursuant to which AdCare was authorized to repurchase up to 1.0 million shares of the common stock and 100,000 shares of the Company’s 10.875% Series A Cumulative Redeemable Preferred Stock, no par value per share and liquidation preference of $25.00

13

per share (the “Series A Preferred Stock”) during a twelve-month period. The November 2016 repurchase program succeeded the Repurchase Program announced on November 12, 2015 (the “November 2015 Repurchase Program”), which terminated in accordance with its terms. Share repurchases under the November 2016 Repurchase Programs could be made from time to time through open market transactions, block trades or privately negotiated transactions and were subject to market conditions, as well as corporate, regulatory and other considerations. During the quarter ended March 31, 2017, the Company made no repurchases of the Series A Preferred Stock and repurchased 118,199 shares of common stock at an average purchase price of approximately $1.54 per share, exclusive of commissions and related fees, for a net disbursement of approximately $0.2 million. The Company suspended the November 2016 Repurchase Program in February 2017.

The Company is a defendant in a total of 44 professional and general liability cases. The claims generally seek unspecified compensatory and punitive damages for former patients of the Company who were allegedly injured or died while patients of facilities operated by the Company due to professional negligence or understaffing. The Company established a self-insurance reserve for these professional and general liability claims, included within “Accrued expenses and other” in the Company’s unaudited consolidated balance sheets, of $6.0 million and $6.9 million at March 31, 2017, and December 31, 2016, respectively. The Company currently believes that most of the professional and general liability actions, and particularly many of the most recently filed actions, are defensible and intends to defend them through final judgment. Accordingly, the self-insurance reserve primarily reflects the Company's estimated legal costs of litigating the pending actions. Anticipated costs associated with such litigation are reflected in the $6.0 million accrual and are expected to be paid over time as litigation continues. The duration of such legal proceedings could be greater than one year subsequent to the period ended March 31, 2017, however, management cannot reliably estimate the exact timing of payments. The Company expects to fund litigation and potential indemnity costs through cash on hand as well as other sources as described above.

During the three months ended March 31, 2017, the Company generated negative cash flow from operations and anticipates positive cash flow from operations later in the current year. In order to satisfy the Company’s capital needs, the Company seeks to: (i) refinance debt where possible to obtain more favorable terms; (ii) raise capital through the issuance of debt or equity securities; and (iii) increase operating cash flows through acquisitions. The Company anticipates that these actions, if successful, will provide the opportunity to maintain its liquidity, thereby permitting the Company to better meet its operating and financing obligations for the next twelve months. However, there is no guarantee that such actions will be successful. Management’s ability to raise additional capital through the issuance of equity securities and the terms upon which we are able to raise such capital may be adversely affected if we are unable to maintain the listing of the common stock and the Company’s Series A Preferred Stock on the NYSE MKT.

NOTE 4.                          RESTRICTED CASH AND INVESTMENTS
 
The following presents the Company's various restricted cash, escrow deposits and investments: 
(Amounts in 000’s)
 
March 31, 2017
 
December 31, 2016
Cash collateral
 
$
283

 
$
260

Replacement reserves
 
822

 
811

Escrow deposits
 
555

 
529

Total current portion
 
1,660

 
1,600

 
 
 
 
 
Restricted investments for other debt obligations and certificates of deposit
 
467

 
2,274

HUD and other replacement reserves
 
1,688

 
1,590

Total noncurrent portion
 
2,155

 
3,864

Total restricted cash and investments
 
$
3,815

 
$
5,464

Cash collateral—In securing mortgage financing from certain lending institutions, the Company and certain of its wholly-owned subsidiaries are required to deposit cash to be held as collateral in accordance with the terms of the loan agreements.
Replacement reserves—Cash reserves set aside for non-critical building repairs to be completed within the next 12 months, pursuant to loan agreements.
Escrow deposits—In connection with financing secured through our lenders, several wholly-owned subsidiaries of the Company are required to make monthly escrow deposits for taxes and insurance.

14

Restricted investments for other debt obligations and certificates of deposit—In compliance with certain financing and insurance agreements, the Company and certain wholly-owned subsidiaries of the Company are required to deposit cash and/or certificates of deposit held as collateral by the lender or in escrow with certain designated financial institutions.
HUD and other replacement reserves—The regulatory agreements entered into in connection with the financing secured through the U.S. Department of Housing and Urban Development (“HUD”) require monthly escrow deposits for replacement and improvement of the HUD project assets. 
NOTE 5.                          PROPERTY AND EQUIPMENT
 
The following table sets forth the Company’s property and equipment:
 
(Amounts in 000’s)
 
Estimated Useful
Lives (Years)
 
March 31, 2017
 
December 31, 2016
Buildings and improvements

5-40
 
$
84,740

 
$
84,108

Equipment and computer related

2-10
 
10,445

 
12,286

Land

—
 
3,988

 
3,988

Construction in process
 
—
 
36

 
602

 
 
 
 
99,209

 
100,984

Less: accumulated depreciation and amortization
 
 
 
(20,683
)
 
(21,816
)
Property and equipment, net
 
 
 
$
78,526

 
$
79,168

 
Buildings and improvements includes the capitalization of costs incurred for the respective certificates of need (the “CON”). For additional information on the CON amortization, see Note 6 - Intangible Assets and Goodwill.

For the three months ended March 31, 2017 and 2016, total depreciation was $0.7 million and $1.2 million, respectively.

NOTE 6.                          INTANGIBLE ASSETS AND GOODWILL
    
Intangible assets consist of the following: 
(Amounts in 000’s)
 
CON (included in property and equipment)
 
Bed Licenses - Separable
 
Lease Rights
 
Total
Balances, December 31, 2016
 
 

 
 

 
 

 
 

Gross
 
$
22,811

 
$
2,471

 
$
6,881

 
$
32,163

Accumulated amortization
 
(3,483
)
 
—

 
(4,127
)
 
(7,610
)
Net carrying amount
 
$
19,328

 
$
2,471

 
$
2,754

 
$
24,553

 
 
 
 
 
 
 
 
 
Amortization expense
 
(171
)
 
—

 
(167
)
 
(338
)
 
 
 
 
 
 
 
 
 
Balances, March 31, 2017
 
 
 
 
 
 
 
 
Gross
 
22,811

 
2,471

 
6,881

 
32,163

Accumulated amortization
 
(3,654
)
 
—

 
(4,294
)
 
(7,948
)
Net carrying amount
 
$
19,157

 
$
2,471

 
$
2,587

 
$
24,215

 
Amortization expense for the CON included in property and equipment was approximately $0.2 million and $0.3 million for the three month periods ended March 31, 2017 and March 31, 2016, respectively.
Amortization expense for lease rights was approximately $0.2 million and $0.2 million for the three month periods ended March 31, 2017 and March 31, 2016, respectively.

15

Expected amortization expense for all definite-lived intangibles for each of the years ended December 31 is as follows: 
(Amounts in 000’s)
 
Bed Licenses
 
Lease Rights
2017(a)
 
$
512

 
$
500

2018
 
683

 
667

2019
 
683

 
667

2020
 
683

 
482

2021
 
683

 
203

Thereafter
 
15,913

 
68

Total expected amortization expense
 
$
19,157

 
$
2,587

 (a) Estimated amortization expense for the year ending December 31, 2017, includes only amortization to be recorded after March 31, 2017.

The following table summarizes the carrying amount of goodwill:
(Amounts in 000’s)
 
March 31, 2017
 
December 31, 2016
Goodwill
 
$
2,945

 
$
2,945

Accumulated impairment losses
 
(840
)
 
(840
)
Net carrying amount
 
$
2,105

 
$
2,105

 
The Company does not amortize indefinite-lived intangibles, which consist of separable bed licenses and goodwill.
 
NOTE 7. LEASES
Operating Leases
The Company leases a total of eleven skilled nursing facilities from unaffiliated owners under non-cancelable leases, all of which have rent escalation clauses and provisions for payments of real estate taxes, insurance and maintenance costs. Each of the skilled nursing facilities that are leased by the Company are subleased to and operated by third-party tenants. The Company also leases certain office space located in Suwanee, Georgia and Atlanta, Georgia. The Atlanta office space is subleased to a third-party tenant.

As of March 31, 2017, the Company is in compliance with all operating lease financial and administrative covenants.
Future Minimum Lease Payments
Future minimum lease payments for each of the next five years ending December 31, are as follows:
 
 
(Amounts in
000’s)
2017 (a)
 
$
6,167

2018
 
8,331

2019
 
8,492

2020
 
8,671

2021
 
8,830

Thereafter
 
46,456

Total
 
$
86,947

(a) Estimated minimum lease payments for the year ending December 31, 2017 include only payments to be recorded after March 31, 2017.
Leased and Subleased Facilities to Third-Party Operators
The Company leases or subleases 26 facilities (15 owned by the Company and 11 leased to the Company) to third-party tenants on a triple net basis, meaning that the lessee (i.e., the third-party tenant of the property) is obligated under the lease or sublease, as applicable, for all costs of operating the property, including insurance, taxes and facility maintenance, as well as the lease or sublease payments, as applicable.

16

Peach Health. On June 18, 2016, ADK entered into the Peach Health Sublease with Peach Health Sublessee, providing that Peach Health Sublessee would take possession of and operate as subtenant: (i) an 85-bed skilled nursing facility located in Tybee Island, Georgia (the “Oceanside Facility”); (ii) a 50-bed skilled nursing facility located in Tybee Island, Georgia (the “Savannah Beach Facility”); and (iii) a 131-bed skilled nursing facility located in Jeffersonville, Georgia (the “Jeffersonville Facility”), The Jeffersonville and Oceanside facilities were previously decertified by CMS in February and May 2016, respectively, for deficiencies related to its operations and maintenance of the facility while operated by the previous sublessee (see Part II, Item 8, Notes to Consolidated Financial Statements, Note 7 - Leases included in the Annual Report for additional information). The Jeffersonville Facility and the Oceanside Facility were recertified by CMS as of December 20, 2016 and February 7, 2017, respectively, which are the Rent Commencement Dates for such facilities.

The Peach Health Sublease became effective for the Jeffersonville Facility on June 18, 2016, and for the Savannah Beach and Oceanside Facilities on July 13, 2016 (the date on which ADK accepted possession of the facilities from the previous sublessee). The Peach Health Sublease is structured as a triple net lease, except that ADK assumes responsibility for the cost of certain deferred maintenance at the Savannah Beach Facility and capital improvements that may be necessary for the Oceanside and Jeffersonville Facilities in connection with recertification by CMS. Rent for the Savannah Beach Facility, the Oceanside Facility and the Jeffersonville Facility is $0.3 million, $0.4 million and $0.6 million per annum, respectively; provided, however, that rent is only $1 per month for the Oceanside and Jeffersonville Facilities until the respective Rent Commencement Dates. In addition, for the Oceanside and Jeffersonville Facilities, Peach Health Sublessee is entitled to three months of $1 per month rent following the respective Rent Commencement Dates and, following such three-month period, five months of rent discounted by 50%. The annual rent for each of the Peach Facilities will escalate at a rate of 3% each year pursuant to the Peach Health Sublease, and the term of the Peach Health Sublease for all three Peach Facilities expires on August 31, 2027.

In connection with the Peach Health Sublease, the Company extended the Peach Line to the Peach Health Sublessee for up to $1.0 million for operations at the Peach Facilities (the “Peach Line” or “Peach Note”), with interest accruing on the unpaid balance under the Peach Line at a starting interest rate of 13.5%, increasing by 1% per annum. The entire principal amount due under the Peach Line, together with all accrued and unpaid interest thereunder, shall be due one year from the date of the first disbursement. The Peach Line is secured by a first priority security interest in Peach Health Sublessee’s assets and accounts receivable pursuant to a security agreement executed by Peach Health Sublessee (see Note 17 - Subsequent Events). At March 31, 2017, there was a $1.0 million outstanding balance on the Peach Line.

Arkansas Leases and Facilities. Until February 3, 2016, the Company subleased through its subsidiaries (the “Aria Sublessors”) nine facilities located in Arkansas (collectively, the “Arkansas Facilities”) to affiliates (the “Aria Sublessees”) of Aria Health Group, LLC (“Aria”) pursuant to separate sublease agreements (the “Aria Subleases”). Effective February 3, 2016, the Company terminated each Aria Sublease due to the applicable Aria Sublessee’s failure to pay rent pursuant to the terms of such sublease. From February 5, 2016 to October 6, 2016, nine wholly-owned subsidiaries of the Company (each, a “Skyline Lessor”) leased the Arkansas Facilities to Skyline Healthcare LLC (“Skyline”), or an affiliate of Skyline (the “Skyline Lessee”), pursuant to a Master Lease Agreement, dated February 5, 2016 (the “Skyline Lease”). The term of the Skyline Lease commenced on April 1, 2016. In connection with the Skyline Lease, the Skyline Lessors entered into an Option Agreement, dated February 5, 2016, with Joseph Schwartz, the manager of Skyline, pursuant to which Mr. Schwartz, or an entity designated by Mr. Schwartz (the “Purchaser”), had an exclusive and irrevocable option to purchase the Arkansas Facilities at a purchase price of $55.0 million, consisting of cash consideration in the amount of $52.0 million and a promissory note with a principal amount of $3.0 million. The Company completed the sale of the Arkansas Facilities to the Purchaser on October 6, 2016. For further information see Part II, Item 8, Notes to Consolidated Financial Statements, Note 7 - Leases included in the Annual Report for additional information).

17


Future minimum lease receivables from the Company’s facilities leased and subleased to third party tenants for each of the next five years ending December 31 are as follows:
 
 
(Amounts in
000's)
2017 (a)
 
$
15,731

2018
 
21,825

2019
 
22,298

2020
 
22,825

2021
 
23,402

Thereafter
 
132,193

Total
 
$
238,274

(a) Estimated minimum lease receivables for the year ending December 31, 2017, include only payments to be received after March 31, 2017.

For further details regarding the Company’s leased and subleased facilities to third-party operators, see Note 17 - Subsequent Events below and Part II, Item 8, Notes to Consolidated Financial Statements, Note 7 - Leases included in the Annual Report.


NOTE 8.                          ACCRUED EXPENSES AND OTHER
 
Accrued expenses and other consist of the following:
(Amounts in 000’s)
 
March 31, 2017
 
December 31, 2016
Accrued employee benefits and payroll related
 
$
468

 
$
442

Real estate and other taxes
 
548

 
557

Self-insured reserve (1)
 
6,048

 
6,924

Accrued interest
 
263

 
251

Other accrued expenses
 
673

 
903

Total accrued expenses and other
 
$
8,000

 
$
9,077

(1) 
The Company self-insures against professional and general liability cases and uses a third party administrator and outside counsel to manage and defend the claims. The decrease in the reserve at March 31, 2017, reflects the legal and associated settlement amounts relieved from the accrual to be paid, see Note 15 - Commitments and Contingencies.
NOTE 9.                              NOTES PAYABLE AND OTHER DEBT
 
See Part II, Item 8, Notes to Consolidated Financial Statements, Note 9 - Notes Payable and Other Debt included in the Annual Report for a detailed description of all the Company’s debt facilities. 

18

Notes payable and other debt consists of the following:
(Amounts in 000’s)
 
March 31, 2017
 
December 31, 2016
Senior debt—guaranteed by HUD
 
$
34,286

 
$
34,473

Senior debt—guaranteed by USDA (a)
 
20,831

 
22,518

Senior debt—guaranteed by SBA (b)
 
2,293

 
2,319

Senior debt—bonds
 
7,145

 
7,145

Senior debt—other mortgage indebtedness
 
5,586

 
5,639

Other debt
 
1,479

 
1,063

Convertible debt
 
2,500

 
9,200

Subtotal
 
74,120

 
82,357

Deferred financing costs, net
 
(2,099
)
 
(2,196
)
Unamortized discount on bonds
 
(188
)
 
(191
)
Total debt
 
71,833

 
79,970

Less: current portion of debt
 
6,868

 
13,154

Notes payable and other debt, net of current portion
 
$
64,965

 
$
66,816

(a)
U.S. Department of Agriculture (“USDA”)
(b)
U.S. Small Business Administration (“SBA”)

The following is a detailed listing of the debt facilities that comprise each of the above categories:
(Amounts in 000’s)
 
 
 
 
 
 
 
 
 
 
 
Facility
 
Lender
 
Maturity
 
Interest Rate (a)
 
March 31, 2017
 
December 31, 2016
Senior debt - guaranteed by HUD
 
 
 
 
 
 
 
 
 
 
The Pavilion Care Center
 
Red Mortgage
 
12/01/2027
 
 Fixed
 
4.16%
 
$
1,408

 
$
1,434

Hearth and Care of Greenfield
 
Red Mortgage
 
08/01/2038
 
 Fixed
 
4.20%
 
2,175

 
2,191

Woodland Manor
 
Midland State Bank
 
10/01/2044
 
 Fixed
 
3.75%
 
5,419

 
5,447

Glenvue
 
Midland State Bank
 
10/01/2044
 
 Fixed
 
3.75%
 
8,414

 
8,457

Autumn Breeze
 
KeyBank
 
01/01/2045
 
 Fixed
 
3.65%
 
7,315

 
7,352

Georgetown
 
Midland State Bank
 
10/01/2046
 
 Fixed
 
2.98%
 
3,704

 
3,723

Sumter Valley 
 
KeyBank
 
01/01/2047
 
 Fixed
 
3.70%
 
5,851

 
5,869

 
Total
 
 
 
 
 
 
 
 
 
$
34,286

 
$
34,473

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior debt - guaranteed by USDA (b)








Attalla

Metro City

06/30/2032

Prime + 1.50%

5.50%

$
6,335


$
7,189

Coosa

Metro City

06/30/2032

Prime + 1.50%

5.50%

5,712


6,483

Mountain Trace

Community B&T

01/24/2036

Prime + 1.75%

5.75%

4,353


4,384

Southland

Bank of Atlanta

07/27/2036

Prime + 1.50%

6.00%

4,431


4,462


Total








 
$
20,831

 
$
22,518

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior debt - guaranteed by SBA




 
 
 
 
College Park

CDC

10/01/2031

Fixed

2.81%
 
$
1,589

 
$
1,611

Southland

Bank of Atlanta

07/27/2036

Prime + 2.25%
 
5.75%
 
704

 
708

 
Total
 
 
 
 
 
 
 
 
 
$
2,293

 
$
2,319

(a)
Represents cash interest rates as of March 31, 2017 as adjusted for applicable interest rate floor limitations, if applicable. The rates exclude amortization of deferred financing costs which range from 0.08% to 0.53% per annum.
(b)
For the four skilled nursing facilities, the Company has term loans insured 70% to 80% by the USDA with financial institutions. The loans have an annual renewal fee for the USDA guarantee of 0.25% of the guaranteed portion. The loans have prepayment penalties of 4% to 6% through 2016, which decline 1% each year capped at 1% for the remainder of the term.

19

(Amounts in 000’s)

 
 
 
 
 
 
 
 
 
 
 
Facility
 
Lender
 
Maturity
 
Interest Rate (a)
 
March 31, 2017
 
December 31, 2016
Senior debt - bonds
 
 
 
 
 
 
 
 
 
 
Eaglewood Bonds Series A
 
City of Springfield, Ohio
 
05/01/2042
 
 Fixed
 
7.65%
 
$
6,610

 
$
6,610

Eaglewood Bonds Series B
 
City of Springfield, Ohio
 
05/01/2021
 
 Fixed
 
8.50%
 
535

 
535

 
Total
 
 
 
 
 
 
 
 
 
$
7,145

 
$
7,145

(a)
Represents cash interest rates as of March 31, 2017 as adjusted for applicable interest rate floor limitations, if applicable. The rates exclude amortization of deferred financing of approximately 0.26% per annum.
(Amounts in 000’s)

 
 
 
 
 
 
 
 
Facility
Lender
Maturity

Interest Rate (a)
 
March 31, 2017
 
December 31, 2016
Senior debt - other mortgage indebtedness




 
 
 
 
Quail Creek (b)
Congressional Bank
09/30/2017

LIBOR + 4.75%

5.75%
 
4,402

 
4,432

Northwest
First Commercial
12/31/2017

Prime

5.00%
 
1,184

 
1,207

 
Total
 
 
 
 
 
 
 
$
5,586

 
$
5,639

(a)
Represents cash interest rates as of March 31, 2017 as adjusted for applicable interest rate floor limitations, if applicable. The rates exclude amortization of deferred financing costs which range from 0.00% to 0.86% per annum.
(b) 
On September 19, 2016, the Company obtained an option to extend the maturity date of the Quail Creek Credit Facility from September 2017 to September 2018, which management intends to exercise.

(Amounts in 000’s)
 
 
 
 
 
 
 
 
 
 
Lender
 
Maturity
 
Interest Rate
 
March 31, 2017
 
December 31, 2016
Other debt
 
 
 
 
 
 
 
 
 
 
First Insurance Funding
 
02/28/2018
 
 Fixed
 
3.99%
 
$
193

 
$
20

Key Bank
 
10/17/2017
 
 Fixed
 
0.00%
 
495

 
496

Pharmacy Care of Arkansas
 
02/08/2018
 
 Fixed
 
2.00%
 
422

 
547

South Carolina Department of Health & Human Services (a)
 
02/24/2019
 
Fixed
 
5.75%
 
369

 
—

Total
 
 
 
 
 
 
 
$
1,479

 
$
1,063

(a) 
On February 21, 2017, the South Carolina Department of Health and Human Services (“SCHHS”) issued fiscal year 2013 Medicaid audit reports for two facilities operated by the Company during 2013. In the fiscal year 2013 Medicaid audit reports, it was determined the Company owes an aggregate $0.4 million related to patient-care related payments made by the SCHHS during 2013. Repayment of the $0.4 million began on March 24, 2017 in the form of a two-year note bearing interest of 5.75% per annum.

(Amounts in 000’s)
 
 
 
 
 
 
 
 
 
 
Facility
 
Maturity
 
Interest Rate (a)
 
March 31, 2017
 
December 31, 2016
Convertible debt
 
 
 
 
 
 
 
 
 
 
Issued July 2012
 
10/31/2017
 
 Fixed
 
10.00%
 
$
1,500

 
$
1,500

Issued March 2015 (b) (c)
 
04/30/2017
 
 Fixed
 
10.00%
 
1,000

 
7,700

 
Total
 
 
 
 
 
 
 
$
2,500

 
$
9,200

(a)
Represents cash interest rates as of March 31, 2017. The rates exclude amortization of deferred financing costs which range from 0.25% to 1.92% per annum.

20

(b)
On December 8, 2016, the Company announced the Tender Offer for any and all of the 2015 Notes at a cash purchase price equal to $1,000 per $1,000 principal amount of the 2015 Notes purchased, plus accrued and unpaid interest to, but not including, the payment date. The Tender Offer expired on January 9, 2017, and $6.7 million in aggregate principal amount of the 2015 Notes were tendered and paid on January 10, 2017.
(c)
On April 30, 2017, the remaining $1.0 million in aggregate principal amount of the 2015 Notes outstanding was repaid (see Note 17 - Subsequent Events).
Debt Covenant Compliance
 
As of March 31, 2017, the Company had approximately 28 credit related instruments (credit facilities, mortgage notes, bonds and other credit obligations) outstanding that include various financial and administrative covenant requirements. Covenant requirements include, but are not limited to, fixed charge coverage ratios, debt service coverage ratios, minimum EBITDA or EBITDAR, current ratios and tangible net worth requirements. Certain financial covenant requirements are based on consolidated financial measurements whereas others are based on measurements at the subsidiary level (i.e., facility, multiple facilities or a combination of subsidiaries). The subsidiary level requirements are as follows: (i) financial covenants measured against subsidiaries of the Company; and (ii) financial covenants measured against third-party operator performance. Some covenants are based on annual financial metric measurements whereas others are based on quarterly financial metric measurements. The Company routinely tracks and monitors its compliance with its covenant requirements.
The table below indicates which of the Company’s credit-related instruments were not in compliance as of March 31, 2017.
Credit Facility
 
Balance at
March 31, 2017(000's)
 
Subsidiary or Operator Level Covenant Requirement
 
Financial Covenant
 
Min/Max
Financial
Covenant
Required
 
Financial
Covenant
Metric
Achieved
 
 
 
Future
Financial
Covenant
Metric
Required
Congressional Bank - Mortgage Note - QC Property Holdings, LLC
 
$
4,401

 
Operator
 
Minimum Fixed Charge Coverage Ratio
 
1.1
 
0.3
 
(a)
 
1.1
 
 
 
 
Operator
 
Minimum Operator Occupancy
 
75%
 
70%
 
(a)
 
75%
 
 
 
 
Operator
 
Minimum Operator EBITDAR (000’s)
 
$563
 
$477
 
(a)
 
$642
(a)
Waiver for violation of covenant obtained.

Scheduled Maturities
The schedule below summarizes the scheduled maturities for the twelve months ended March 31 of the respective year (not adjusted for commitments to refinance or extend the maturities of debt as noted above):
For the twelve months ended March 31,
(Amounts in 000’s) (a)
2018
$
6,890

2019
6,326

2020
1,960

2021
2,064

2022
2,161

Thereafter
54,719

Subtotal
$
74,120

Less: unamortized discounts
(188
)
Less: deferred financing costs, net
(2,099
)
Total notes and other debt
$
71,833

(a)
Excludes maturities for a Loan Agreement entered into May 1, 2017 (see Note 17 - Subsequent Events - Meadowood Credit Facility).



21

NOTE 10. ACQUISITIONS
For information regarding the Company’s acquisitions, see Note 17 - Subsequent Events.

NOTE 11.                       DISCONTINUED OPERATIONS

For the discontinued operations, the patient care revenue, related cost of services, and facility rental expense prior to the commencement of subleasing are classified in the activities below. For a historical listing and description of the Company’s discontinued entities, see Part II, Item 8, Notes to Consolidated Financial Statements, Note 11 - Discontinued Operations included in the Annual Report.
The following table summarizes certain activity of discontinued operations for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
(Amounts in 000’s)
 
2017
 
2016
Total revenues
 
$
—

 
$
—

Cost of services
 
409

 
520

Interest expense, net
 
4

 
8

Net loss
 
(413
)
 
(528
)

NOTE 12.                       COMMON AND PREFERRED STOCK

Common and Preferred Stock Repurchase Activity

In November 2016, the Board approved two share repurchase programs (collectively, the "November 2016 Repurchase Program"), pursuant to which AdCare was authorized to repurchase up to 1.0 million shares of the common stock and 100,000 shares of the Series A Preferred Stock during a twelve-month period. The November 2016 Repurchase Program succeeded the repurchase program announced on November 12, 2015 (the “November 2015 Repurchase Program”), which terminated in accordance with its terms. Share repurchases under the November 2016 Repurchase Programs could be made from time to time through open market transactions, block trades or privately negotiated transactions and were subject to market conditions, as well as corporate, regulatory and other considerations. The Company could suspend or continue the November 2016 Repurchase Program at any time and had no obligation to repurchase any amount of the common stock or the Series A Preferred Stock under such program. The November 2016 Repurchase Program was suspended in February 2017.

During the quarter ended March 31, 2016, the Company repurchased 150,000 shares of common stock pursuant to the November 2015 Repurchase Program for $0.3 million at an average purchase price of approximately $2.05 per share, exclusive of commissions and related fees. Pursuant to the November 2015 Repurchase Program, the Company was authorized to repurchase up to 500,000 shares of its outstanding common stock during a twelve-month period.

During the quarter ended March 31, 2017, the Company made no repurchases of the Series A Preferred Stock and repurchased 118,199 shares of the common stock for $0.2 million at an average price of $1.54 per share, exclusive of commissions and related fees.

Preferred Stock Offerings and Dividends

Dividends declared and paid on shares of the Series A Preferred Stock were $0.68 per share, or $1.9 million and $1.8 million for the three months ended March 31, 2017 and 2016, respectively. No additional shares of the Series A Preferred Stock were issued under the Company’s At Market Issuance Sales Agreement (the “ATM”) during the quarter ended March 31, 2017. As of March 31, 2017, the Company had 2,761,535 shares of the Series A Preferred Stock issued and outstanding.

Holders of the Series A Preferred Stock generally have no voting rights but have limited voting rights under certain circumstances. The Company may not redeem the Series A Preferred Stock before December 1, 2017, except the Company is required to redeem the Series A Preferred Stock following a "Change of Control," as defined in the Company's Articles of Incorporation. On and after December 1, 2017, the Company may, at its option, redeem the Series A Preferred Stock, in whole or in part, by paying $25.00 per share, plus any accrued and unpaid dividends to the redemption date.


22

The change-in-control provision requires the Series A Preferred Stock to be classified as temporary equity because, although deemed a remote possibility, a purchaser could acquire a majority of the voting power of the outstanding common stock without Company approval, thereby triggering redemption. FASB ASC Topic 480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable Securities, requires classification outside of permanent equity for redeemable instruments for which the redemption triggers are outside of the issuer's control. The assessment of whether the redemption of an equity security could occur outside of the issuer's control is required to be made without regard to the probability of the event or events that may result in the instrument becoming redeemable.

For historical information regarding the Series A Preferred Stock, the ATM and prior share repurchase programs, see Part II, Item 8, Notes to Consolidated Financial Statements, Note 12 - Common and Preferred Stock included in the Annual Report.

NOTE 13.                       STOCK BASED COMPENSATION

For the three months ended March 31, 2017 and 2016, the Company recognized stock-based compensation expense as follows: 
 
 
Three Months Ended March 31,
(Amounts in 000’s)
 
2017
 
2016
Employee compensation:
 
 
 
 
Restricted stock
 
$
118

 
$
246

Stock options
 
—

 
111

Warrants
 
60

 
85

Total employee stock-based compensation expense
 
$
178

 
$
442

Non-employee compensation:
 
 
 
 
Board restricted stock
 
44

 
26

Board stock options
 
12

 
12

Total non-employee stock-based compensation expense
 
$
56

 
$
38

Total stock-based compensation expense
 
$
234

 
$
480


Stock Incentive Plan
AdCare Health Systems, Inc. 2011 Stock Incentive Plan, as amended (the “2011 Stock Incentive Plan”) expires March 28, 2021 and provides for a maximum of 2,027,393 shares of common stock to be issued. The 2011 Stock Incentive Plan permits the granting of incentive or nonqualified stock options and the granting of restricted stock. The plan is administered by the Compensation Committee of the Board (the “Compensation Committee”), pursuant to authority delegated to it by the Board. The Compensation Committee is responsible for determining the employees to whom awards will be made, the amounts of the awards, and the other terms and conditions of the awards. As of March 31, 2017, the number of securities remaining available for future issuance is 463,190.
In addition to the Company’s 2011 Stock Incentive Plan, the Company grants stock warrants to officers, directors, employees and certain consultants to the Company from time to time as determined by the Board and, when appropriate, the Compensation Committee.
The assumptions used in calculating the fair value of employee common stock options and warrants granted during the three months ended March 31, 2017 and March 31, 2016, using the Black-Scholes-Merton option-pricing model, are set forth in the following table:
 
Three Months Ended March 31,
 
2017
*
2016
Dividend yield
—
%
 
—
%
Expected volatility
—
%
 
41
%
Risk-free interest rate
—
%
 
1.43
%
Expected term (in years)
n/a

 
5.0

* No issuances of common stock options or warrants during the current period.

23

Common Stock Options
The following table summarizes the Company’s common stock option activity for the three months ended March 31, 2017:
 
 
Number of Shares (000's)
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Term (in years)
 
Aggregate Intrinsic Value (in 000's)
Outstanding, December 31, 2016
355

 
$
3.21

 
5.6
 
$
—

 
Granted
—

 
$
—

 
 
 
 
 
Forfeited
—

 
$
—

 
 
 
 
 
Expired
(22
)
 
$
3.93

 
 
 
 
Outstanding, March 31, 2017
333

 
$
3.17

 
4.8
 
$
—

Vested, March 31, 2017
298

 
$
3.08

 
4.5
 
$
—

The following table summarizes the common stock options outstanding and exercisable as of March 31, 2017:
 
Stock Options Outstanding
 
Options Exercisable
Exercise Price
Number of Shares
 
Weighted Average Remaining Contractual Term (in years)
 
Weighted Average Exercise Price
 
Vested, March 31, 2017
 
Weighted Average Exercise Price
$1.31 - $3.99
268

 
4.4
 
$
2.93

 
233

 
$
2.79

$4.00 - $4.30
65

 
6.4
 
$
4.12

 
65

 
$
4.12

Total
333

 
4.8
 
$
3.17

 
298

 
$
3.08

For options unvested at March 31, 2017, $0.04 million in compensation expense will be recognized over the next 0.7 years.
Common Stock Warrants 
The following table summarizes the Company’s common stock warrant activity for the three months ended March 31, 2017:
 
 
Number of Warrants (000's)
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Term (in years)
 
Aggregate Intrinsic Value (in 000's)
Outstanding, December 31, 2016
1,887

 
$
3.58

 
4.1
 
$
11

 
Granted
—

 
$
—

 
 
 
 
 
Forfeited
—

 
$
—

 
 
 
 
 
Expired
—

 
$
—

 
 
 
 
Outstanding, March 31, 2017
1,887

 
$
3.58

 
3.8
 
$
6

Vested, March 31, 2017
1,604

 
$
3.44

 
3.1
 
$
6


24

The following table summarizes the common stock warrants outstanding and exercisable as of March 31, 2017:
 
Warrants Outstanding
 
Warrants Exercisable
Exercise Price
Number of Shares (000's)
 
Weighted Average Remaining Contractual Term (in years)
 
Weighted Average Exercise Price
 
Vested at March 31, 2017
 
Weighted Average Exercise Price
$0 - $1.99
218

 
0.6
 
$
1.82

 
218

 
$
1.82

$2.00 - $2.99
335

 
1.3
 
$
2.58

 
335

 
$
2.58

$3.00 - $3.99
500

 
2.5
 
$
3.59

 
500

 
$
3.59

$4.00 - $4.99
811

 
6.4
 
$
4.39

 
528

 
$
4.23

$5.00 - $5.90
23

 
6.1
 
$
5.90

 
23

 
$
5.90

Total
1,887

 
3.8
 
$
3.58

 
1,604

 
$
3.44

For warrants unvested at March 31, 2017, $0.2 million in compensation expense will be recognized over the next 0.7 years.
Restricted Stock
The following table summarizes the Company’s restricted stock activity for the three months ended March 31, 2017:
 
 
Number of Shares (000's)
 
Weighted Avg. Grant Date Fair Value
Unvested, December 31, 2016
404

 
$
2.84

 
Granted
—

 
$
—

 
Vested
(37
)
 
$
2.14

 
Forfeited
(3
)
 
$
2.49

Unvested, March 31, 2017
364

 
$
2.91

For restricted stock unvested at March 31, 2017, $0.7 million in compensation expense will be recognized over the next 2.8 years.
NOTE 14. .                      VARIABLE INTEREST ENTITIES
Non-consolidated Variable Interest Entities
Aria. On April 30, 2015, the Company entered into a lease inducement (the “Aria Lease Inducement”) with Aria Health Consulting, LLC with respect to the Aria Subleases. The Aria Lease Inducement provided for a one-time payment from the Company to Aria Health Consulting, LLC equal to $2.0 million minus the security deposits and first month’s base and special rent for all Aria Subleases. On April 30, 2015, in connection with the Aria Lease Inducement, eight of the Aria Subleases were amended to, among other things, provide that the Aria Sublessees shall, collectively, pay to the Aria Sublessors special rent in the amount of $29,500 per month payable in advance on or before the first day of each month (except for the first special rent payment, which was subtracted from the lease inducement fee paid by the Company under the Aria Lease Inducement).
On July 17, 2015, the Company made a short-term loan to Highlands Arkansas Holdings, LLC, an affiliate of Aria (“HAH”), for working capital purposes, and, in connection therewith, HAH executed a promissory note (the “ HAH Note”) in favor of the Company. Since July 17, 2015, the HAH Note has been amended from time to time and currently has an outstanding principal amount of $1.0 million and matured on December 31, 2016. On October 6, 2015, HAH and the Company entered into a security agreement, whereby HAH granted the Company a security interest in all accounts arising from the business of HAH and the Aria Sublessees, and all rights to payment from patients, residents, private insurers and others arising from the business of HAH and the Aria Sublessees (including any proceeds thereof), as security for payment of the HAH Note, as amended, and certain rent and security deposit obligations of the Aria Sublessees under Aria Subleases. On March 1, 2017, the Company was advised that $0.8 million is available for repayment of the HAH Note in accordance with its terms. Accordingly, the Company has charged a $0.2 million bad debt expense to the Company’s unaudited consolidated statement of operations for the three months ended March 31, 2017. For further information, see Note 7 - Leases.

The Aria Lease Inducement and HAH Note entered into by the Company create a variable interest that may absorb some or all of the expected losses of the Variable Interest Entity (“VIE”). The Company does not consolidate the operating activities of the Aria

25

Sublessees as the Company does not have the power to direct the activities that most significantly impact the VIE’s economic performance.

Effective February 3, 2016, each Aria Sublessor terminated the applicable Aria Sublease due to the applicable Aria Sublessee’s failure to pay rent pursuant to the terms of such sublease.

Peach Health. In connection with the Peach Health Sublease, the Company extended the Peach Line to Peach Health Sublessee in an amount of up to $1.0 million, with interest accruing on the unpaid balance under the Peach Line at a rate of 13.5% per annum. The entire principal amount due under the Peach Line, together with all accrued and unpaid interest thereunder, shall be due one year from the date of the first disbursement. The Peach Line is secured by a first priority security interest in Peach Health Sublessee’s assets and accounts receivable pursuant to a security agreement executed by Peach Health Sublessee. As of March 31, 2017, $1.0 million was outstanding on the Peach Line. For further information on the Peach Health Sublease and Peach line, see Note 7 - Leases and Note 17 - Subsequent Events.

The LOC creates a variable interest that may absorb some or all of a VIE’s expected losses. The Company does not consolidate the operating activities of the affiliates of Peach Health as the Company does not have the power to direct the activities that most significantly impact the VIE’s economic performance.

NOTE 15.                       COMMITMENTS AND CONTINGENCIES

Regulatory Matters

Laws and regulations governing federal Medicare and state Medicaid programs are complex and subject to interpretation. Compliance with such laws and regulations can be subject to future governmental review and interpretation as well as significant regulatory action including fines, penalties, and exclusion from certain governmental programs. As of March 31, 2017, all of the Company’s facilities leased and subleased to third-party operators and managed for third-parties are certified by CMS and operational (see Note 7 - Leases).

Legal Matters

The Company is party to various legal actions and administrative proceedings and is subject to various claims arising in the ordinary course of business, including claims that the services the Company provided during the time it operated skilled nursing facilities resulted in injury or death to the patients of the Company’s facilities and claims related to professional and general negligence, employment, staffing requirements and commercial matters. Although the Company intends to vigorously defend itself in these matters, there is no assurance that the outcomes of these matters will not have a material adverse effect on the Company’s business, results of operations and financial condition.

The Company previously operated, and the Company’s tenants now operate, in an industry that is extremely regulated. As such, in the ordinary course of business, the Company’s tenants are continuously subject to state and federal regulatory scrutiny, supervision and control. Such regulatory scrutiny often includes inquiries, investigations, examinations, audits, site visits and surveys, some of which are non-routine. In addition, we believe that there has been, and will continue to be, an increase in governmental investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims, as well as an increase in enforcement actions resulting from these investigations. Adverse determinations in legal proceedings or governmental investigations against or involving the Company, for the Company’s prior operations, or the Company’s tenants, whether currently asserted or arising in the future, could have a material adverse effect on the Company’s business, results of operations and financial condition.

Professional and General Liability Claims. As of March 31, 2017, the Company was a defendant in a total of 44 professional and general liability actions commenced on behalf of former patients, of which 28 cases were filed in the State of Arkansas by the same plaintiff attorney who represented the plaintiffs in the lawsuit captioned Amy Cleveland et. al. v. APHR&R Nursing, LLC et. al. filed on March 4, 2015 with the Circuit Court of Pulaski County, Arkansas, 16th Division, 6th Circuit. These actions generally seek unspecified compensatory and punitive damages for former patients of the Company who were allegedly injured or died while patients of facilities operated by the Company due to professional negligence or understaffing. Three of the pending actions are covered by insurance, except that any award of punitive damages would be excluded from such coverage. The actions are in various stages of discovery, and the Company intends to vigorously litigate the claims.

The Company established a self-insurance reserve for these professional and general liability claims, included within “Accrued expenses and other” in the Company’s unaudited consolidated balance sheets of $6.0 million and $6.9 million at March 31, 2017, and December 31, 2016, respectively. The decrease in the reserve at March 31, 2017, reflects the legal and associated settlement

26

amounts relieved from the accrual to be paid. For additional information regarding the Company’s self-insurance reserve, please see Part II, Item 8, Notes to Consolidated Financial Statements, Note 15 - Commitments and Contingencies included in the Annual Report.

Ohio Attorney General Action. On October 27, 2016, the Attorney General of Ohio (the “OAG”) filed in the Court of Common Pleas, Franklin County, Ohio a complaint against The Pavilion Care Center, LLC, Hearth & Home of Greenfield, LLC (each a subsidiary of the Company), and certain other parties (including parties for which the Company provides or provided management services). The lawsuit alleges that defendants submitted improper Medicaid claims for independent laboratory services for glucose blood tests and capillary blood draws and further alleges that defendants (i) engaged in deception, (ii) willfully received Medicaid payments to which they were not entitled or in a greater amount than that to which they were entitled, and (iii) obtained payments under the Medicaid program to which they were not entitled pursuant to their provider agreements and applicable Medicaid rules and regulations. The OAG is seeking, among other things, triple the amount of damages proven at trial (plus interest) and not less than $5,000 and not more than $10,000 for each deceptive claim or falsification. As previously disclosed, the Company received a letter from the OAG in February 2014 demanding repayment of allegedly improper Medicaid claims related to glucose blood tests and capillary blood draws and penalties of approximately $1.0 million, and the Company responded to such letter in July 2014 denying all claims. The Company filed an answer to the complaint on January 27, 2017 in which it denied the allegations. Although there is no assurance as to the ultimate outcome of this matter or its impact on the Company’s business or its financial condition, the Company believes it has meritorious defenses and intends to vigorously defend the claim.

NOTE 16.                       RELATED PARTY TRANSACTIONS

For additional information regarding the Company’s related party transactions, see Part II, Item 8, Notes to Consolidated Financial Statements, Note 18 - Related Party Transactions included in the Annual Report.

Park City Capital
On March 31, 2015, the Company accepted a Subscription Agreement from Park City Capital Offshore Master, Ltd. (“Park City Offshore”), an affiliate of Michael J. Fox, for a 2015 Note with an aggregate principal amount of $1,000,000 and, in connection therewith, issued such note to Park City Capital Offshore on April 30, 2015. The 2015 Note was offered to Park City Offshore on the same terms and conditions as all other investors in the offering. In January 2017, the Company repurchased the $1,000,000 2015 Note held by Park City Offshore pursuant to the terms of the Tender Offer for any and all of the outstanding 2015 Notes (for a description of the Tender Offer, see Note 9 - Notes Payable and Other Debt). Mr. Fox is a an affiliate of Park City Offshore, a director of the Company since October 2013, Lead Independent Director since April 1, 2015, and a beneficial owner of greater than 5% of the outstanding common stock.
Doucet Asset Management, LLC
On June 10, 2014 and on subsequent dates, Doucet Capital, LLC, Doucet Asset Management, LLC, Christopher L. Doucet and Suzette A. Doucet jointly filed with the SEC a Schedule 13D reporting beneficial ownership of greater than 5% of the common stock.
In January 2017, the Company repurchased the 2015 Notes in aggregate principal amount of $250,000 held by Mr. and Ms. Doucet pursuant to the terms of the Tender Offer for any and all of the outstanding 2015 Notes (for a description of the Tender Offer, see Note 9 - Notes Payable and Other Debt).
On January 19, 2017, Doucet Capital, LLC, Doucet Asset Management, LLC and Mr. and Ms. Doucet jointly filed with the SEC a Schedule 13D reporting beneficial ownership of less than 5% of the common stock as a result of the 2015 Notes repurchased by the Company pursuant to the Tender Offer.
Promissory Note Issued By Brogdon
On November 10, 2016, the Company and Mr. Brogdon (a beneficial owner of greater than 5% of the outstanding common stock)agreed to further amend the promissory note issued by Mr. Brogdon on December 31, 2013 to the Company to extend its maturity date to December 31, 2017. As a condition to such amendment, Winter Haven Homes, Inc. (“Winter Haven”), an entity owned and controlled by Mr. Brogdon, has agreed to waive payment of certain charges otherwise due and owing from the Company to Winter Haven from January 1, 2016 to July 31, 2016. As of March 31, 2017, principal due and payable under the promissory note issued by Mr. Brogdon to the Company was $268,663, which has been fully allowed for in the Company’s unaudited consolidated statement of operations during the quarter ended March 31, 2017.

27

NOTE 17.                       SUBSEQUENT EVENTS

The Company has evaluated all subsequent events through the date the consolidated financial statements were issued and filed with the SEC. The following is a summary of the material subsequent events.

Acquisition and Lease of Meadowood Retirement Village

On March 8, 2017, AdCare executed a purchase and sale agreement with Meadowood Retirement Village, LLC and Meadowood Properties, LLC (the “Meadowood Purchase Agreement”) to acquire an assisted living and memory care community with 106 operational beds in Glencoe, Alabama (“the Meadowood Facility”) for $5.5 million cash. In addition, on March 21, 2017, AdCare executed a long-term lease with an affiliate of C.R. Management (the “Meadowood Operator”) to lease the facility upon purchase. Lease terms include: (i) a 13-year initial term with one five-year renewal option; (ii) base rent of $37,500 per month; (iii) a rental escalator of 2.0% per annum in the initial term and 2.5% per annum in the renewal term; (iv) a cross renewal provision, whereby the Meadowood Operator may exercise the lease renewal for the Meadowood Facility if its affiliate exercises the lease renewal option for Coosa Valley Health Care, a 124-bed skilled nursing facility located in Gadsden, Alabama (the Coosa Valley Facility”) ; and (v) a security deposit equal to one month of base rent. The Company completed the purchase of the Meadowood Facility on May 1, 2017 pursuant to the Meadowood Purchase Agreement, at which time the lease commenced and operations of the Meadowood Facility transferred to the Meadowood Operator.

Meadowood Credit Facility

On May 1, 2017, in connection with the Meadowood Purchase Agreement, a wholly-owned subsidiary of the Company entered into a Loan Agreement (the “Meadowood Credit Facility”) with the Exchange Bank of Alabama, which provides for a $4.1 million principal amount secured credit facility maturing on May 1, 2022. Interest on the Meadowood Credit Facility accrues on the principal balance thereof at 4.5% per annum. The Meadowood Credit Facility is secured by the Meadowood Facility.

Peach Note Modification

On April 6, 2017, the Company modified certain terms of the Peach Note (pursuant to which the Company extended a $1.0 million line of credit to Peach Health in connection with the Peach Health Sublesse's securing a $2.5 million working capital loan from a third party lender (the “Peach Working Capital Facility”). Borrowings under the Peach Working Capital Facility are based on a borrowing base of eligible accounts receivable. The modifications of the Peach Note include: (i) reducing the loan balance to $0.8 million and restricting further borrowings; (ii) extending the maturity of the loan to October 1, 2020 and adding a six month extension option by the Peach Health Sublessee assuming certain conditions precedent are met at the time of the exercise of the option; (iii) increasing the interest rate from 13.5% per annum by 1% per year; and (iv) establishing a four year amortization schedule. Payment of principal and interest under the Peach Note shall be governed by certain financial covenants limiting distributions under the Peach Working Capital Facility. Furthermore, the Company guaranteed Peach Health Sublessee’s borrowings under the Peach Working Capital Facility subject to certain burn-off provisions (i.e., the Company’s obligations under such guaranty cease after the later of 18 months or achievement of a certain financial ratio by Peach Health Sublessee).

Repayment of 2015 Notes

On April 30, 2017, the Company repaid in cash the outstanding $1.0 million in aggregate principal amount of the 2015 Notes, plus accrued and unpaid interest in accordance with the terms of such notes, and all related obligations owed under the 2015 Notes were extinguished at that time.

Amendments to Bylaws

Effective April 2, 2017, the Board amended the first sentence of Section 3.06 of the Company’s Bylaws (the “Bylaws”) to clarify that a Board committee may consist of one Board member. Prior to such amendment, the first sentence of Section 3.06 of the Bylaws read as follows: “The Board of Directors by resolution may create one or more committees and appoint members of the Board of Directors to serve on such committees at the discretion of the Board of Directors.” As a result of such amendment, the first sentence of Section 3.06 of the Bylaws now reads as follows: “The Board of Directors by resolution may create one or more committees and appoint one or more members of the Board of Directors to serve on such committees at the discretion of the Board of Directors.”



28

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview
The Company is a self-managed real estate investment company that invests primarily in real estate purposed for long-term care and senior living. Our business primarily consists of leasing and subleasing healthcare facilities to third-party tenants. As of March 31, 2017, the Company owned, leased, or managed for third parties 29 facilities primarily in the Southeast (see the section entitled Acquisitions below for information regarding an additional facility acquired subsequent to March 31, 2017, which is not included in the tables below).
 
The operators of the Company’s facilities provide a range of health care and related services to patients and residents, including skilled nursing and assisted living services, social services, various therapy services, and other rehabilitative and healthcare services for both long-term and short-stay patients and residents.

The following table provides summary information regarding the number of facilities and related operational beds/units as of March 31, 2017:

 
 
Owned
 
Leased
 
Managed for Third Parties
 
Total
 
 
Facilities
 
Beds/Units
 
Facilities
 
Beds/Units
 
Facilities
 
Beds/Units
 
Facilities
 
Beds/Units
State
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Alabama
 
2

 
304

 
—

 
—

 
—

 
—

 
2

 
304

Georgia
 
4

 
463

 
10

 
1,168

 
—

 
—

 
14

 
1,631

North Carolina
 
1

 
106

 
—

 
—

 
—

 
—

 
1

 
106

Ohio
 
4

 
279

 
1

 
94

 
3

 
332

 
8

 
705

Oklahoma
 
2

 
197

 
—

 
—

 
—

 
—

 
2

 
197

South Carolina
 
2

 
180

 
—

 
—

 
—

 
—

 
2

 
180

Total
 
15

 
1,529

 
11

 
1,262

 
3

 
332

 
29

 
3,123

Facility Type
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Skilled Nursing
 
14

 
1,449

 
11

 
1,262

 
2

 
249

 
27

 
2,960

Assisted Living
 
1

 
80

 
—

 
—

 
—

 
—

 
1

 
80

Independent Living
 
—

 
—

 
—

 
—

 
1

 
83

 
1

 
83

Total
 
15

 
1,529

 
11

 
1,262

 
3

 
332

 
29

 
3,123


The following table provides summary information regarding the number of facilities and related operational beds/units by operator affiliation as of March 31, 2017:

Operator Affiliation
 
Number of Facilities (1)
 
Beds / Units
Beacon Health Management
 
7

 
585

C.R. Management
 
7

 
830

Wellington Health Services
 
4

 
641

Peach Health Group
 
3

 
252

Symmetry Healthcare
 
3

 
286

Southwest LTC
 
2

 
197

Subtotal
 
26

 
2,791

AdCare Managed
 
3

 
332

Total
 
29

 
3,123


(1)
Represents the number of facilities leased or subleased to separate tenants, of which each tenant is an affiliate of the entity named in the table above. For a more detailed discussion, see Note 7 - Leases located in Part I, Item 1, of this Quarterly Report

29

on Form 10-Q; Part II, Item 8, Notes to Consolidated Financial Statements, Note 7 - Leases included in the Annual Report; and “Portfolio of Healthcare Investments” included in Part I, Item 1, Business included in the Annual Report.

Liquidity Overview

During the three months ended March 31, 2017, the Company generated negative cash flow from operations and anticipates positive cash flow from operations later in the current year. At March 31, 2017, we had: (i) $4.2 million in cash and cash equivalents; (ii) restricted cash of $3.8 million; and (iii) $71.8 million in indebtedness, of which the current portion is $6.9 million. This current portion is comprised of the following components: (i) convertible debt of $2.5 million; and (ii) remaining debt of approximately $4.4 million which includes senior debt - bond and mortgage indebtedness.

In November 2016, the Board approved two share repurchase programs (collectively, the "November 2016 Repurchase Program"), pursuant to which AdCare was authorized to repurchase up to 1.0 million shares of common stock and 100,000 shares of the Series A Preferred Stock during a twelve-month period. The November 2016 Repurchase Program succeeded the Repurchase Program announced on November 12, 2015 (the “November 2015 Repurchase Program”), which terminated in accordance with its terms. Share repurchases under the November 2016 Repurchase Programs may be made from time to time through open market transactions, block trades or privately negotiated transactions and are subject to market conditions, as well as corporate, regulatory and other considerations. During the quarter ended March 31, 2017, the Company made no repurchases of Series A Preferred Stock and repurchased 118,199 shares of common stock at an average purchase price of approximately $1.54 per share, exclusive of commissions and related fees, for a net disbursement of approximately $0.2 million. The Company suspended the November 2016 Repurchase Program in February 2017.

Over the next twelve months, we anticipate access to several sources of liquidity, including cash flows from operations and cash on hand. We hold routine ongoing discussions with existing lenders and potential new lenders to refinance current debt on a longer term basis and, in recent years, have refinanced shorter term acquisition debt, with traditional longer term mortgage notes, many of which have been executed under government guaranteed lending programs. We anticipate net principal disbursements of approximately $6.9 million, which includes $2.5 million of convertible debt, approximately $0.4 million of payments on shorter term vendor notes, $1.8 million of routine debt service amortization, and a $2.2 million payment of other debt which is inclusive of anticipated proceeds on refinancing of the Northwest Oklahoma facility of approximately $1.2 million. Based on the described sources of liquidity, we expect sufficient funds for our operations and scheduled debt service, at least through the next twelve months.

On a longer term basis, at March 31, 2017, the Company has approximately $13.2 million of debt maturities due over the next two year period ending March 31, 2019. These debt maturities include the aforementioned $2.5 million of convertible promissory notes, which are convertible into shares of the common stock as well as the aforementioned $1.2 million for the Northwest Oklahoma facility, in addition to $4.4 million with respect to the Quail Creek Oklahoma facility. We believe our long-term liquidity needs will be satisfied by these same sources, as well as borrowings as required to refinance indebtedness.

In order to satisfy our capital needs, we seek to: (i) refinance debt where possible to obtain more favorable terms; (ii) raise capital through the issuance of debt or equity securities; and (iii) increase operating cash flows through acquisitions. We anticipate that these actions, if successful, will provide the opportunity to maintain our liquidity, thereby permitting the Company to better meet its operating and financing obligations. However, there is no guarantee that such actions will be successful. Our ability to raise additional capital through the issuance of equity securities and the terms upon which we are able to raise such capital may be adversely affected if we are unable to maintain the listing of the common stock and Company’s 10.875% Series A Cumulative Redeemable Preferred Stock, no par value per share and liquidation preference of $25.00 per share (the “Series A Preferred Stock”), on the NYSE MKT.

For a more detailed discussion, see Note 3 - Liquidity and Profitability to the Company’s Notes to Consolidated Financial Statements located in Part I, Item 1, of this Quarterly Report on Form 10-Q.

Acquisitions
On March 8, 2017, the Company executed a purchase and sale agreement with Meadowood Retirement Village, LLC and Meadowood Properties, LLC (the “Meadowood Purchase Agreement”) to acquire an assisted living and memory care community with 106 operational beds in Glencoe, Alabama (“Meadowood”) for $5.5 million cash. In addition, on March 21, 2017, the Company executed a long-term lease with an affiliate of C.R. Management (the “Meadowood Operator”) to lease the facility upon purchase. Lease terms include: (i) a 13-year initial term with one five-year renewal option; (ii) base rent of $37,500 per month; (iii) a rental escalator of 2.0% per annum in the initial term and 2.5% per annum in the renewal term; (iv) a cross renewal provision, whereby the tenant may exercise the lease renewal option if the affiliates tenant exercises the lease renewal option of the Coosa

30

Valley facility; and (v) a security deposit equal to one month of base rent. The Company completed the purchase of Meadowood on May 1, 2017 pursuant to the Meadowood Purchase Agreement, at which time the lease commenced and operations of the Meadowood facility transferred to the Meadowood Operator.

In connection with the Meadowood Purchase Agreement, on May 1, 2017, a wholly-owned subsidiary of the Company entered into a Loan Agreement (the “Meadowood Credit Facility”) with the Exchange Bank of Alabama, which provides for a $4.1 million principal amount secured credit facility maturing on May 1, 2022. Interest on the Meadowood Credit Facility accrues on the principal balance thereof at 4.5% per annum. The Meadowood Credit Facility is secured by the Meadowood facility.


31

Divestitures
There were no divestitures for the three months ended March 31, 2017. For historical information regarding the Company’s divestitures, please see Part II, Item 8, Notes to Consolidated Financial Statements, Note 11 - Discontinued Operations included in the Annual Report.

Critical Accounting Policies
 
We prepare our financial statements in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Article 8 of Regulation S-X. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis we review our judgments and estimates, including, but not limited to, those related to doubtful accounts, income taxes, stock compensation, intangible assets and loss contingencies. We base our estimates on historical experience, business knowledge and on various other assumptions that we believe to be reasonable under the circumstances at the time. Actual results may vary from our estimates. These estimates are evaluated by management and revised as circumstances change.
For a discussion of our critical accounting policies and recent accounting pronouncements not yet adopted by the Company see Note 1 - Organization and Significant Accounting Policies to the Company's Notes to Consolidated Financial Statements located in Part I, Item 1, of this Quarterly Report on Form 10-Q.
Results of Operations  

The following table sets forth, for the periods indicated, unaudited statement of operations items and the amount and percentage of change of these items. The results of operations for any particular period are not necessarily indicative of results for any future period. The following data should be read in conjunction with our consolidated financial statements and the notes thereto, which are included herein.
 
 
 
Three Months Ended March 31,
 
(Amounts in 000’s)
 
2017
 
2016
 
Percent Change
 
Revenues:
 
 

 
 

 
 

 
Rental revenues
 
$
5,775

 
$
6,849

 
(15.7
)%
 
Management fee and other revenues
 
360

 
233

 
54.5
 %
 
Total revenues
 
6,135

 
7,082

 
(13.4
)%
 
Expenses:
 
 

 
 

 
 
 
Facility rent expense
 
2,171

 
2,179

 
(0.4
)%
 
Depreciation and amortization
 
1,135

 
1,713

 
(33.7
)%
 
General and administrative expenses
 
1,622

 
2,542

 
(36.2
)%
 
Other operating expenses
 
555

 
203

 
NM

 
Total expenses
 
5,483

 
6,637

 
(17.4
)%
 
Income from operations
 
652

 
445

 
46.5
 %
 
Other expense:
 
 

 
 

 
 
 
Interest expense, net
 
1,032

 
1,825

 
(43.5
)%
 
Loss on extinguishment of debt
 
63

 
—

 
NM

 
Other expense
 
95

 
42

 
NM

 
Total other expense, net
 
1,190

 
1,867

 
(36.3
)%
 
Income (loss) from continuing operations before income taxes
 
(538
)
 
(1,422
)
 
(62.2
)%
 
Income tax expense
 
1

 
—

 
NM

 
Income (loss) from continuing operations
 
(539
)
 
(1,422
)
 
(62.1
)%
 
Loss from discontinued operations, net of tax
 
(413
)
 
(528
)
 
(21.8
)%
 
Net loss
 
$
(952
)
 
$
(1,950
)
 
(51.2
)%
 




32

Three Months Ended March 31, 2017 and 2016

Rental Revenues—Total rental revenue decreased by $1.1 million, or 15.7%, to $5.8 million for the three months ended March 31, 2017, compared with $6.8 million for the same period in 2016. The decrease reflects the sale of the Arkansas Facilities during the three months ended December 31, 2016. The Company recognizes all rental revenues on a straight line rent accrual basis except with respect to the Oceanside and Jeffersonville Facilities under the Peach Health Sublease (which were recertified by CMS, in February 2017 and December 2016, respectively), the Aria Subleases (which were terminated for non-payment of rent) and the Skyline Lease (which terminated upon sale of the Arkansas Facilities), for which rental revenue is recognized based on cash amount owed, and the sublease with affiliates of New Beginnings (which terminated in connection with the bankruptcy of such entities), for which rental revenue is recognized when cash is received.
Management Fee and Other Revenues—Management fee and other revenues increased by $0.2 million, or 54.5 %, to $0.4 million for the three months ended March 31, 2017, compared with $0.2 million for the same period in 2016, with a $0.1 million increase from the recognition of interest income.
Facility Rent Expense—Facility rent expense was $2.2 million for the three months ended March 31, 2017, and $2.2 million for the same period in 2016. Rent expense year over year is now comparable due to the completion of the Company's transition to a healthcare property holding and leasing company. For further information see Note 7 - Leases, to the Company’s Notes to Consolidated Financial Statements located in Part I, Item 1, of this Quarterly Report on Form 10-Q.
Depreciation and Amortization—Depreciation and amortization decreased by $0.6 million or 33.7%, to $1.1 million for the three months ended March 31, 2017, compared with $1.7 million for the same period in 2016. The decrease is primarily due to the sale of the Arkansas Facilities during the quarter ended December 31, 2016, that were classified as held for sale beginning May 2016, with the subsequent cessation of depreciation expense.
General and Administrative—General and administrative costs decreased by $0.9 million or 36.2%, to $1.6 million for the three months ended March 31, 2017, compared with $2.5 million for the same period in 2016. The net decrease is due to a continued reduction in overhead and specifically the following: (i) a decrease in salaries, wages and employee benefits expense of approximately $0.3 million, (ii) a decrease in stock-based compensation expense of approximately $0.2 million and a decrease in legal, contract services, IT and other expenses of approximately $0.4 million.
Other Operating Expenses—Other operating expense increased by $0.4 million or 173.4%, to $0.6 million for the three months ended March 31, 2017, compared with $0.2 million for the same period in 2016. The increase is due to bad debt expenses in the current year period.
Interest Expense, Net—Interest expense, decreased by $0.8 million or 43.5% to $1.0 million for the three months ended March 31, 2017, compared with $1.8 million for the same period in 2016. Sequentially, interest expense decreased $0.5 million, or 31.6%, compared with $1.5 million in the fourth quarter of 2016. The decrease is mainly due to the repayment of $36.0 million of debt in connection with the Arkansas Facilities and the sale thereof in October 2016 and $6.7 million principal repayment of the 2015 convertible debt on January 10, 2017.
Loss on Debt Extinguishment—Loss on extinguishment of debt of $0.1 million for the three months ended March 31, 2017, was due to a pre payment penalty incurred on March 20, 2017, when mortgage indebtedness related to the Coosa Valley Facility, and Attalla Health Care, a 182-bed skilled nursing facility located in Attalla, Alabama, was reduced by $0.7 million and $0.8 million, respectively through the application of restricted cash held as collateral against such indebtedness.
Loss from Discontinued Operations—The loss from discontinued operations decreased by $0.1 million to $0.4 million for the three months ended March 31, 2017, compared with $0.5 million for the same period in 2016. The decrease is primarily due to lower bad debt expense. Current year expenses comprise legal, collection activities and bad debt.
Liquidity and Capital Resources

For information regarding the Company’s liquidity, see Note 3 - Liquidity and Profitability, to the Company’s Notes to Consolidated Financial Statements located in Part I, Item 1, of this Quarterly Report on Form 10-Q and Liquidity Overview, to the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations located in Part I, Item 2, of this Quarterly Report on Form 10-Q.


33

Cash Flows
The following table presents selected data from our consolidated statement of cash flows for the periods presented:
 
 
Three Months Ended March 31,
(Amounts in 000’s)
 
2017
 
2016
Net cash provided by (used in) by operating activities - continuing operations
 
$
749

 
$
(941
)
Net cash used in operating activities - discontinued operations
 
(1,051
)
 
(639
)
Net cash provided by investing activities - continuing operations
 
1,320

 
4,145

Net cash used in investing activities - discontinued operations
 
—

 
(1
)
Net cash used in financing activities - continuing operations
 
(10,739
)
 
(2,752
)
Net cash used in financing activities - discontinued operations
 
(140
)
 
(268
)
Net change in cash and cash equivalents
 
(9,861
)
 
(456
)
Cash and cash equivalents at beginning of period
 
14,045

 
2,720

Cash and cash equivalents at end of period
 
$
4,184

 
$
2,264

 
Three Months Ended March 31, 2017

Net cash provided by operating activities—continuing operations for the three months ended March 31, 2017 was approximately $0.7 million, consisting primarily of our loss from operations less changes in working capital, and noncash charges (primarily depreciation and amortization, share-based compensation, rent revenue in excess of cash received, amortization of debt discounts and related deferred financing costs and bad debt expense) all primarily the result of routine operating activity. Net cash used in operating activities—discontinued operations was approximately $1.1 million. This amount was to fund legal and associated settlement costs related to our legacy professional and general liability claims, in addition to settling legacy vendor liabilities.
Net cash provided by investing activities—continuing operations for the three months ended March 31, 2017 was approximately $1.3 million. This is the result of a net decrease in restricted cash deposits of approximately $1.6 million partially off-set by capital expenditures of $0.3 million on building improvements for the facility located in Tybee Island, Georgia (the “Oceanside Facility”) and the facility located in Jeffersonville, Georgia (the “Jeffersonville Facility”) to assist with the sublessee in connection with recertification efforts.
Net cash used in financing activities—continuing operations was approximately $10.7 million for the three months ended March 31, 2017. This is primarily the result of repayments of $6.7 million of convertible debt, $2.0 million of other existing debt obligations and $2.0 million payment of preferred stock dividends.
Three Months Ended March 31, 2016
 
Net cash used in operating activities—continuing operations for the three months ended March 31, 2016 was $0.9 million, consisting primarily of our loss from operations less changes in working capital, and noncash charges (primarily depreciation and amortization, share-based compensation, rent revenue in excess of cash received, and amortization of debt discounts and related deferred financing costs) primarily the result of routine operating activity. Net cash used in operating activities—discontinued operations was approximately $0.6 million. 
Net cash provided by investing activities—continuing operations for the three months ended March 31, 2016 was approximately $4.1 million. This is primarily the result of a net increase in restricted cash deposits of approximately $3.8 million and proceeds from sale of property and equipment of approximately $0.3 million.
Net cash used in financing activities—continuing operations was approximately $2.8 million for the three months ended March 31, 2016. This is primarily the result of repayments of existing debt obligations of approximately $4.5 million, payments of dividends of approximately $1.8 million, and the repurchase of outstanding shares of the common stock of approximately $0.3 million. These uses were offset by net cash proceeds received from issuances of shares of the Series A Preferred Stock and additional debt borrowings of approximately $3.7 million and $0.2 million, respectively. Net cash used in financing activities—discontinued operations was approximately $0.3 million.

Notes Payable and Other Debt

34


For information regarding the Company’s debt financings, please refer to Note 9 - Notes Payable and Other Debt, to the Company’s Notes to Consolidated Financial Statements located in Part I, Item 1, of this Quarterly Report on Form 10-Q; and Part II, Item 8, Notes to Consolidated Financial Statements, Note 9 - Notes Payable and Other Debt included in the Annual Report.

Receivables

Our operations could be adversely affected if we experience significant delays in receipt of rental income from our operators. Our future liquidity will continue to be dependent upon the relative amounts of current assets (principally cash and accounts receivable) and current liabilities (principally accounts payable and accrued expenses). In that regard, accounts receivable can have a significant impact on our liquidity.

Accounts receivable, net totaled $2.3 million at March 31, 2017 and $2.4 million at December 31, 2016 of which $0.9 million and $0.9 million, respectively, related to patient care receivables from our legacy operations.
The allowance for doubtful accounts was $6.7 million and $7.5 million at March 31, 2017 and December 31, 2016, respectively. We continually evaluate the adequacy of our bad debt reserves based on aging of older balances, payment terms and historical collection trends after facility operations transfer to third-party operators. We continue to evaluate and implement additional processes to strengthen our collection efforts and reduce the incidence of uncollectible accounts.
Operating Leases
For information regarding the Company’s operating leases, please refer to Note 7 - Leases, to the Company’s Notes to Consolidated Financial Statements located in Part I, Item 1, of this Quarterly Report on Form 10-Q, and Part II, Item 8, Notes to Consolidated Financial Statements, Note 7 - Leases included in the Annual Report.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk. 

Disclosure in response to Item 3. of Form 10-Q is not required to be provided by smaller reporting companies.


35

Item 4.  Controls and Procedures.
 
Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive and Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Our management, with the participation of our Chief Executive and Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”). Based on such evaluation, our Chief Executive and Financial Officer has concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective.
Changes in Internal Control Over Financial Reporting  

There has been no change in the Company’s internal controls over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

36

Part II.  Other Information

Item 1.  Legal Proceedings.

See Part I, Item 3, Legal Proceedings included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 for a description of all significant legal proceedings. 

Item 1A.  Risk Factors.
 
For a detailed description of certain risk factors that could affect our business, operations and financial condition, see Part I, “Item 1A. Risk Factors” of the Annual Report. The risk factors described in the Annual Report (“Risk Factors”) do not describe all risks applicable to our business, and we intend it only as a summary of certain material factors. The Risk Factors should be considered in connection with evaluating the forward-looking statements contained in this Quarterly Report because the Risk Factors could cause the actual results and conditions to differ materially from those projected in forward-looking statements. If any of the risks actually occur, our business, financial condition or results of operations could be negatively affected. In that case, the trading price of the common stock and Series A Preferred Stock could decline.
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

The following table sets forth information for the three months ended March 31, 2017 of repurchases of the common stock:
Period
Total number of shares (or units) purchased
 
Average price paid per share (or unit)
 
Total number of shares (or units) purchased as part of publicly announced plans or programs
 
Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs
Common Stock
 
 
 
 
 
 
 
January 1, 2017 - January 31, 2017 (1)
116,684

 
$
1.54

 
116,684

 
714,300

February 1, 2017 - February 28, 2017
—

 
$
—

 
—

 
714,300

March 1, 2017 - March 31, 2017 (2)
1,515

 
$
1.61

 
1,515

 
712,785

Total
118,199

 
$
1.54

 
118,199

 
712,785

(1)On November 14, 2016, the Company announced that the Board authorized two share repurchase programs, pursuant to which the Company is authorized to repurchase up to 1.0 million shares of common stock and 100,000 shares of the Series A Preferred Stock during a twelve-month period, expiring on November 10, 2017. Share repurchases may be made from time to time through open market transactions, block trades or privately negotiated transactions and are subject to market conditions, as well as corporate, regulatory and other considerations. The repurchase programs may be suspended or discontinued at any time. In February 2017, the Company suspended the repurchase programs.

(2)On January 10, 2017, the Company agreed to a private repurchase of a previous employee’s vested restricted stock, which occurred in March 2017, in connection with a consulting agreement.
For further information see Note 12 - Common and Preferred Stock to our Consolidated Financial Statements included in Part II, Item 8., "Financial Statements".

Item 3.  Defaults upon Senior Securities.
 
None. 

Item 4.  Mine Safety Disclosures.
 
Not applicable.

Item 5.  Other Information.


37


On May 1, 2017, in connection with the Meadowood Purchase Agreement, a wholly-owned subsidiary of the Company entered into the Meadowood Credit Facility with the Exchange Bank of Alabama, which provides for a $4.1 million principal amount secured credit facility maturing on May 1, 2022. Interest on the Meadowood Credit Facility accrues on the principal balance thereof at 4.5% per annum. The Meadowood Credit Facility is secured by the Meadowood facility.


Item 6.  Exhibits.
 
The agreements included as exhibits to this Quarterly Report are included to provide information regarding the terms of these agreements and are not intended to provide any other factual or disclosure information about the Company, its business or the other parties to these agreements. These agreements may contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and: 
•
should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate; 
•
have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;
•
may apply standards of materiality in a way that is different from what may be viewed as material to investors; and
•
were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.
 
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time, and should not be relied upon by investors. 

38

EXHIBIT INDEX
 
Exhibit No.
Description
Method of Filing
 
 
 
2.1
Asset Purchase Agreement, dated March 8, 2017, by and between Meadowood Retirement Village, LLC, and Meadowood Properties, LLC, and AdCare Health Systems, Inc.
Filed herewith
3.1
Declaration of Conversion of AdCare Health Systems, Inc., an Ohio corporation, to AdCare Health Systems, Inc., a Georgia corporation
Incorporated by reference to Appendix A of the Registrant’s Proxy Statement on Schedule 14A filed on October 29, 2013
3.2
Certificate of Conversion of AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 3.2 of the Registrant’s Current Report on Form 8-K filed on December 18, 2013
3.3
Certificate for Conversion for Entities Converting Within or Off the Records of the Ohio Secretary of State.
Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on December 18, 2013
3.4
Articles of Incorporation of AdCare Health Systems, Inc., filed with the Secretary of State of the State of Georgia on December 12, 2013
Incorporated by reference to Exhibit 3.3 of the Registrant’s Current Report on Form 8-K filed on December 27, 2013
3.5
Articles of Correction to Articles of Incorporation of AdCare Health Systems, Inc., filed with the Secretary of State of the State of Georgia on December 12, 2013.
Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on December 27, 2013
3.6
Bylaws of AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 3.4 of the Registrant’s Current Report on Form 8-K filed on December 27, 2013
3.7
Amendment No. 1 to the Bylaws of AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 3.7 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013
3.8
Articles of Amendment to the Articles of Incorporation of AdCare Health Systems, Inc., as amended, filed with the Secretary of State of the State of Georgia on April 7, 2015.
Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on April 13, 2015
3.9
Articles of Amendment to the Articles of Incorporation of AdCare Health Systems, Inc., as amended, filed with the Secretary of State of the State of Georgia on May 28, 2015
Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on June 2, 2015
3.10
Articles of Amendment to the Articles of Incorporation of AdCare Health Systems, Inc., as amended, filed with the Secretary of State of the State of Georgia on December 11, 2015.
Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on December 14, 2015
3.11
Amendment No. 2 to the Bylaws of AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 3.2 of the Registrant’s Current Report on Form 8-K filed on December 14, 2015
3.12
Amendment No. 3 to the Bylaws of AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 3.12 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2016
4.1
Specimen Common Stock Certificate of AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on December 18, 2013
4.2*
2004 Stock Option Plan of AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 4.1 of the Registrant’s Registration Statement on Form S-8 (Registration No. 333-131542) filed October 27, 2011
4.3*
2005 Stock Option Plan of AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 4.2 of the Registrant’s Registration Statement on Form S-8 (Registration No. 333-131542) filed October 27, 2011
4.4*
AdCare Health Systems, Inc. 2011 Stock Incentive Plan
Incorporated by reference to Exhibit 4.3 of the Registrant’s Registration Statement on Form S-8 (Registration No. 333-131542) filed October 27, 2011

39

4.5*
Form of Non-Statutory Stock Option Agreement
Incorporated by reference to Exhibit 4.4 of the Registrant’s Registration Statement on Form S-8 (Registration No. 333-131542) filed October 27, 2011
4.6*
Form of Incentive Stock Option Agreement
Incorporated by reference to Exhibit 4.5 of the Registrant’s Registration Statement on Form S-8 (Registration No. 333-131542) filed October 27, 2011
4.7
Form of 8% Subordinated Convertible Note Due 2015 issued by AdCare Health Systems, Inc.
Incorporated by reference to Exhibit 99.3 to the Registrant’s Current Report on Form 8-K filed July 5, 2012
4.8
Form of Warrant to Purchase Common Stock of the Company
Incorporated by reference to Exhibit 4.3 to the Registrant’s Registration Statement on Form S-3 (File No. 333-175541)
4.9
Warrant to Purchase 50,000 Shares of Common Stock, dated December 28, 2012, issued by AdCare Health Systems, Inc. to Strome Alpha Offshore Ltd.
Incorporated by reference to Exhibit 4.21 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2012
4.10
Form of Warrant, dated March 28, 2014, issued by AdCare Health Systems, Inc. to the placement agent and its affiliates in connection with the offering of 10% Subordinated Convertible Notes Due April 30, 2015
Incorporated by reference to Exhibit 4.3 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2014

4.11
Form of Warrant granted to management to Purchase Shares of AdCare Health Systems, Inc. dated November 20, 2007
Incorporated by reference to Exhibit 10.19 of the Registrant’s Annual Report on Form 10-KSB as amended March 31, 2008
4.12
Registration Rights Agreement, dated March 31, 2015, by and among AdCare Health Systems, Inc. and the Purchasers of the Company’s 10% Convertible Subordinated Notes Due April 30, 2017
Incorporated by reference to Exhibit 4.1 of the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2015
4.13
Form of 10% Convertible Subordinated Notes Due April 30, 2017
Incorporated by reference to Exhibit 4.2 of the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2015
4.14
Form of 10% Convertible Subordinated Notes Due April 30, 2017 (Affiliate Form)
Incorporated by reference to Exhibit 4.3 of the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015
4.15
Amendment to Subordinated Convertible Note Issued March 31, 2015, dated July 30, 2015, by and between AdCare Health Systems, Inc., and Cantone Asset Management, LLC and Cantone Research, Inc.
Incorporated by reference to Exhibit 10.105 of the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015
10.1
Lease Agreement, dated March 22, 2017, by and between Meadowood Property Holdings, LLC and CRM of Meadowood, LLC
Filed herewith
10.2
Amendment to Promissory Note, dated April 7, 2017, issued by OS Tybee, LLC, SB Tybee, LLC and JV Jeffersonville, LLC, in favor of AdCare Health Systems, Inc.

Filed herewith
10.3
Loan Agreement, dated May 1, 2017, between Meadowood Property Holdings, LLC and the Exchange Bank of Alabama in the original amount of $4.1 million
Filed herewith
10.4
Guaranty Agreement, dated April 6, 2017, executed by AdCare Health Systems, Inc in favor of CONGRESSIONAL BANK, a Maryland chartered commercial bank
Filed herewith
31.1
Certification of CEO and CFO pursuant to Section 302 of the Sarbanes-Oxley Act
Filed herewith
32.1
Certification of CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley Act
Filed herewith

40

101
The following financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of March 31, 2017 (unaudited) and December 31, 2016; (ii) Consolidated Statements of Operations for the three months ended March 31, 2017 and 2016 (unaudited); (iii) Consolidated Statements of Stockholders’ Deficit for the three months ended March 31, 2017 (unaudited); (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016 (unaudited); and (v) the Notes to Consolidated Financial Statements (unaudited).
Filed herewith

* Identifies a management contract or compensatory plan or arrangement


41

SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused the report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
ADCARE HEALTH SYSTEMS, INC.
 
 
 
(Registrant)
 
 
 
 
Date:
May 15, 2017
 
/s/ Allan J. Rimland
 
 
 
Allan J. Rimland
 
 
 
Chief Executive Officer, Chief Financial Officer, President and Corporate Secretary (Principal Executive and Financial Officer)
 
 
 
 
Date:
May 15, 2017
 
/s/ E. Clinton Cain
 
 
 
E. Clinton Cain
 
 
 
Senior Vice President, Chief Accounting Officer and Controller (Principal Accounting Officer)

42