-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GpbsXy2CVlocgHW6KlbwS07QOqnAmDimyuX7tl5W1WNlMrB3/3ACCSdnIvrXbY7H Ot9GQVsCbWDQ5WiWb1mADg== 0000950144-01-509045.txt : 20020410 0000950144-01-509045.hdr.sgml : 20020410 ACCESSION NUMBER: 0000950144-01-509045 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVOCAT INC CENTRAL INDEX KEY: 0000919956 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SKILLED NURSING CARE FACILITIES [8051] IRS NUMBER: 621559667 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-12996 FILM NUMBER: 1786636 BUSINESS ADDRESS: STREET 1: 277 MALLORY STATION RD STREET 2: STE 130 CITY: FRANKLIN STATE: TN ZIP: 37067 BUSINESS PHONE: 6157717575 MAIL ADDRESS: STREET 1: 227 MALLORY STATION ROAD STREET 2: SUITE 130 CITY: FRANKLIN STATE: TN ZIP: 37064 10-Q 1 g72702e10-q.txt ADVOCAT INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q CHECK ONE: [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2001 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSACTION PERIOD FROM _________ TO _________. COMMISSION FILE NO.: 1-12996 --------- ADVOCAT INC. ------------------------------------------------------ (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 62-1559667 - ------------------------------- -------------------------------- (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 277 MALLORY STATION ROAD, SUITE 130, FRANKLIN, TN 37067 ------------------------------------------------------ (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (615) 771-7575 ------------------------------------------------------ (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) NONE ------------------------------------------------------ (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 SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO 5,493,287 ------------------------------------------------------ (OUTSTANDING SHARES OF THE ISSUER'S COMMON STOCK AS OF OCTOBER 31, 2001) 1 PART I. FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS ADVOCAT INC. INTERIM CONSOLIDATED BALANCE SHEETS (IN THOUSANDS AND UNAUDITED)
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $2,874 $ 4,496 Receivables, less allowance for doubtful accounts of $5,956 and $5,035, respectively 15,264 15,111 Inventories 486 633 Prepaid expenses and other assets 2,167 2,100 ------- -------- Total current assets 20,791 22,340 ------- -------- PROPERTY AND EQUIPMENT, at cost 93,585 89,567 Less accumulated depreciation and amortization (28,491) (24,418) ------- -------- Net property and equipment 65,094 65,149 ------- -------- OTHER ASSETS: Deferred financing and other costs, net 700 572 Deferred lease costs, net 1,930 2,085 Assets held for sale or redevelopment 1,476 1,476 Investments in and receivables from joint ventures 2,514 8,333 Other 1,963 1,801 ------- -------- Total other assets 8,583 14,267 ------- -------- $94,468 $101,756 ======= ========
(Continued) 2 ADVOCAT INC. INTERIM CONSOLIDATED BALANCE SHEETS (IN THOUSANDS AND UNAUDITED) (CONTINUED)
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------- ------------ CURRENT LIABILITIES: Current portion of long-term debt $ 58,882 $ 61,229 Trade accounts payable 7,507 6,875 Accrued expenses: Payroll and employee benefits 5,275 5,241 Interest 221 232 Self-insurance reserves 4,419 4,445 Other 5,663 4,387 --------- --------- Total current liabilities 81,967 82,409 --------- --------- NONCURRENT LIABILITIES: Long-term debt, less current portion 4,682 5,016 Self-insurance reserves, less current portion 14,001 3,586 Other 2,242 5,245 --------- --------- Total noncurrent liabilities 20,925 13,847 --------- --------- COMMITMENTS AND CONTINGENCIES SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK Authorized 600,000 shares, $.10 par value, 393,658 shares Issued and outstanding at September 30, 2001 and December 31, 2000, respectively, at redemption value 3,531 3,358 --------- --------- SHAREHOLDERS' EQUITY: Preferred stock, authorized 1,000,000 shares, $.10 par value, none issued and outstanding -- -- Common stock, authorized 20,000,000 shares, $.01 par value, 5,493,000 and 5,492,000 issued and outstanding at September 30, 2001 and December 31, 2000, respectively 55 55 Paid-in capital 15,908 15,907 Accumulated deficit (27,918) (13,820) --------- --------- Total shareholders' equity (deficit) (11,955) 2,142 --------- --------- $ 94,468 $ 101,756 ========= =========
The accompanying notes are an integral part of these interim consolidated balance sheets. 3 ADVOCAT INC. INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS, AND UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 2001 2000 ----------- ----------- REVENUES: Patient revenues $ 41,882 $ 38,946 Resident revenues 10,138 10,368 Management fees 768 934 Interest 53 53 --------- --------- Net revenues 52,841 50,301 --------- --------- EXPENSES: Operating 51,154 38,598 Lease 5,177 5,272 General and administrative 3,498 3,058 Interest 1,311 1,542 Depreciation and amortization 1,433 1,239 Non-recurring charges -0- 359 --------- --------- Total expenses 62,573 50,068 --------- --------- INCOME (LOSS) BEFORE INCOME TAXES (9,732) 233 PROVISION FOR INCOME TAXES 118 84 --------- --------- NET INCOME (LOSS) $ (9,850) $ 149 ========= ========= BASIC AND DILUTED EARNINGS (LOSS) PER SHARE: Basic $ (1.79) $ .03 ========= ========= Diluted $ (1.79) $ .03 ========= ========= WEIGHTED AVERAGE SHARES: Basic 5,493 5,492 ========= ========= Diluted 5,493 5,492 ========= =========
The accompanying notes are an integral part of these interim consolidated financial statements. 4 ADVOCAT INC. INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS AND UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2001 2000 ----------- ----------- REVENUES: Patient revenues $ 119,741 $ 111,620 Resident revenues 30,745 31,177 Management fees 2,083 2,960 Interest 132 144 --------- --------- Net revenues 152,701 145,901 --------- --------- EXPENSES: Operating 132,029 112,193 Lease 15,533 15,806 General and administrative 10,104 8,754 Interest 4,196 4,432 Depreciation and amortization 4,244 3,614 Non-recurring charges -0- 622 --------- --------- Total expenses 166,106 145,421 --------- --------- INCOME (LOSS) BEFORE INCOME TAXES (13,405) 480 PROVISION FOR INCOME TAXES 284 173 --------- --------- NET INCOME (LOSS) $ (13,689) 307 ========= ========= BASIC AND DILUTED EARNINGS (LOSS) PER SHARE: Basic $ (2.49) $ .06 ========= ========= Diluted $ (2.49) $ .06 ========= ========= WEIGHTED AVERAGE SHARES: Basic 5,493 5,492 ========= ========= Diluted 5,493 5,492 ========= =========
The accompanying notes are an integral part of these interim consolidated financial statements. 5 ADVOCAT INC. INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (IN THOUSANDS AND UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- -------------------------- 2001 2000 2001 2000 -------- ------- -------- ------- NET INCOME (LOSS) $ (9,850) $ 149 $(13,689) $ 307 -------- ------- -------- ------- OTHER COMPREHENSIVE INCOME (LOSS): Foreign currency translation adjustments (531) (138) (638) (459) Income tax (provision) benefit 191 50 230 165 -------- ------- -------- ------- (340) (88) (408) (294) -------- ------- -------- ------- COMPREHENSIVE INCOME (LOSS) $(10,190) $ 61 $(14,097) $ 13 ======== ======== ======== =======
The accompanying notes are an integral part of these interim consolidated financial statements. 6 ADVOCAT INC. INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS AND UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2001 2000 --------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(13,689) $ 307 Items not involving cash: Depreciation and amortization 4,244 3,614 Provision for doubtful accounts 2,618 2,046 Provision for self insured professional liability 16,235 5,558 Equity earnings in joint ventures 27 27 Amortization of deferred balances 371 (228) Amortization of discount on non-interest bearing promissory note 200 -0- Series B redeemable convertible preferred stock dividend 173 -0- Provisions for leases in excess of cash payments 1,401 -0- Changes in other assets and liabilities: Receivables (1,963) (2,755) Inventories 197 43 Prepaid expenses and other assets 63 (935) Trade accounts payable and accrued expenses (4,955) (2,355) -------- ------- Net cash provided by operating activities 4,922 5,352 -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment, net (2,190) (1,488) Investment in TDLP (609) -0- Exchange of assets TDLP 200 -0- Mortgages receivable, net (56) 315 Deposits and other deferred balances -0- (336) Investment in and advances (to) from joint ventures, net 304 (673) TDLP partnership distributions 200 158 -------- ------- Net cash used in investing activities (2,151) (2,024) -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of debt obligations (1,921) (1,452) Net repayment of bank line of credit (960) (223) Advances to TDLP, net (1,063) (49) Increase in lease obligations -0- 68 Financing costs (449) -0- -------- ------- Net cash used in financing activities (4,393) (1,656) -------- -------
(Continued) 7 ADVOCAT INC. INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS AND UNAUDITED) (CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2001 2000 --------- ------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $(1,622) $ 1,672 CASH AND CASH EQUIVALENTS, beginning of period 4,496 1,913 ------- ------- CASH AND CASH EQUIVALENTS, end of period 2,874 $ 3,585 ======= ======= SUPPLEMENTAL INFORMATION: Cash payments of interest $ 3,834 $ 4,618 ======= ======= Cash payments (refunds) of income taxes, net $ 191 $ (100) ======= =======
NON CASH TRANSACTIONS: The Company exchanged certain mortgage and other receivables for the assets and liabilities of Texas Diversicare Limited Partnership. See Note 5. The accompanying notes are an integral part of these interim consolidated financial statements. 8 ADVOCAT INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 AND 2000 1. BUSINESS Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company") provides long-term care services to nursing home patients and residents of assisted living facilities in 12 states, primarily in the Southeast, and four Canadian provinces. The Company's facilities provide a range of health care services to their patients and residents. In addition to the nursing, personal care and social services usually provided in long-term care facilities, the Company offers a variety of comprehensive rehabilitation services as well as medical supply and nutritional support services. As of September 30, 2001, the Company operates 120 facilities consisting of 64 nursing homes with 7,230 licensed beds and 56 assisted living facilities with 5,453 units. The Company owns thirteen nursing homes, leases 36 others, and manages 15 nursing homes. The Company owns 16 assisted living facilities, leases 25 others, and manages the remaining 15 assisted living facilities. The Company holds a minority interest in seven of these managed assisted living facilities. The Company operates 51 nursing homes and 33 assisted living facilities in the United States and 13 nursing homes and 23 assisted living facilities in Canada. The Company operates facilities in Alabama, Arkansas, Florida, Georgia, Kentucky, North Carolina, Ohio, South Carolina, Tennessee, Texas, Virginia, West Virginia and the Canadian provinces of Alberta, British Columbia, Nova Scotia and Ontario. In recent periods, the long-term health care environment has undergone substantial change with regards to reimbursement and other payor sources, compliance regulations, competition among other health care providers and relevant patient liability issues. The Company continually monitors these industry developments as well as other factors that affect its business. See Item 2 for further discussion of recent changes in the long-term health care industry and the related impact on the operations of the Company. 2. BASIS OF FINANCIAL STATEMENTS The interim consolidated financial statements for the three and nine month periods ended September 30, 2001 and 2000, included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management of the Company, the accompanying interim consolidated financial statements reflect all adjustments necessary to present fairly the financial position at September 30, 2001 and the results of operations for the three and nine month periods ended September 30, 2001 and 2000, and the cash flows for the nine month periods ended September 30, 2001 and 2000. 9 The results of operations for the three and nine month periods ended September 30, 2001 and 2000 are not necessarily indicative of the operating results for the entire respective years. These interim consolidated financial statements should be read in connection with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. The accompanying consolidated financial statements have been prepared assuming that Advocat will continue as a going concern. The Company has incurred operating losses in the three and nine month periods ended September 30, 2001 and the years ended December 31, 2000, 1999 and 1998 and has limited resources available to meet its operating, capital expenditure and debt service requirements during 2001. The Company has a net working capital deficit of $61.2 million as of September 30, 2001. Effective March 9, 2001, the Company has also obtained professional liability insurance coverage that, based on historical claims experience, could be substantially less than the claims that may be incurred during 2001. The Company would be obligated to pay any claim in excess of insurance coverage. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims in excess of insurance coverage of $17.4 million at September 30, 2001. This amount includes additional, non-cash charges of approximately $8.7 million recorded in the third quarter based on a current actuarial review, including the recent effects of additional claims and higher settlements per claim. In addition, the payment of professional liability claims by the Company's insurance carriers is dependent upon the financial solvency of the individual carriers. The Company is aware that one of its insurance carriers providing coverage for prior years claims is currently under rehabilitation proceedings. The ultimate payments by the Company of professional liability claims accrued as of September 30, 2001 and claims that could be incurred during the remainder of 2001 and into the future, because such claims exceed the Company's insurance coverage or because of the inability of an insurance carrier to pay such claims, may require cash resources in the future that would be in excess of the Company's available cash or other resources. The Company is also not in compliance with certain debt covenants that allow the holders of substantially all of the Company's debt to demand immediate repayment. Although the Company does not anticipate that such demand will be made, the continued forbearance on the part of the Company's lenders cannot be assured at this time. Accordingly, the Company has classified the related debt principal amounts as current liabilities in the accompanying consolidated financial statements as of September 30, 2001 and December 31, 2000. Given that events of default exist under the Company's working capital line of credit, there can be no assurance that the lender will continue to provide working capital advances. Such events of default under the Company's debt agreements could lead to actions by the lenders that would result in an event of default under the Company's lease agreements covering a majority of its United States nursing facilities. Should such a default occur in the related lease agreements, the lessor would have the right to terminate the lease agreements. At a minimum, the Company's cash requirements during the next twelve months include funding operations (including potential payments related to professional liability claims), capital expenditures, scheduled debt service, and working capital requirements. No assurance can be given that the Company will have sufficient cash to meet its requirements during the period. 10 The Company is currently discussing potential waiver, amendment and refinancing alternatives with its lenders. If the Company's lenders force immediate repayment, the Company would not be able to repay the related debt outstanding. The Company's management has implemented a plan to enhance revenues related to the operations of the Company's nursing homes and assisted living facilities. Management believes that revenues in future periods will increase as a result of Medicare and certain state Medicaid rate increases. In addition, the Company has emphasized attracting and retaining patients and residents. Management has implemented a plan to attempt to minimize future expense increases through the elimination of excess operating costs. Management will also attempt to minimize professional liability claims in future periods by vigorously defending itself against all such claims and through the additional supervision and training of staff employees. The Company is unable to predict if it will be successful in reducing operating losses, in negotiating waivers, amendments, or refinancings of outstanding debt, or if the Company will be able to meet any amended financial covenants in the future. Any demands for repayment by lenders or the inability to obtain waivers or refinance the related debt would have a material adverse impact on the financial position, results of operations and cash flows of the Company. If the Company is unable to generate sufficient cash flow from its operations or successfully negotiate debt or lease amendments, it will explore a variety of other options, including but not limited to other sources of equity or debt financings, asset dispositions, or relief under the United States Bankruptcy code. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset carrying amounts or the amounts and classification of liabilities that might result should the Company be unable to continue as a going concern. The independent public accountant's report on the Company's financial statements at December 31, 2000 included a paragraph with regards to the uncertainties of the Company's ability to continue as a going concern. 3. INSURANCE MATTERS The entire United States long-term care industry has seen a dramatic increase in personal injury/wrongful death claims based on alleged negligence by nursing homes and their employees in providing care to patients and residents. As a result, the Company has numerous liability claims and disputes outstanding for professional liability and other related issues. On June 22, 2001, a jury in Mena, Arkansas issued a verdict in a professional liability lawsuit against the Company totaling $78.425 million. Professional liability insurance up to certain limits is carried by the Company and its subsidiaries for coverage of such claims. However, due to the increasing number of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts have increased substantially during the last three years. For more information regarding the Mena, Arkansas verdict and the Company's insurance coverage, see Note 7 "Liquidity and Capital Resources" in "Management's Discussion and Analysis of Financial Condition" and "Part II - Other Information, Item 2. Legal Proceedings." As a result of the substantial premium increases for the 2002 policy year, effective March 9, 2001 through March 9, 2002, the Company has obtained professional liability insurance coverage for its United States nursing homes that, based on historical claims experience, could be substantially less than the claims to be incurred. For claims made after March 9, 2001, the Company maintains general and professional liability insurance with coverage limits of $2,000,000 per medical 11 incident and total aggregate policy coverage limits of $3,000,000 for its long-term care services. The 2002 policy is on a claims made basis and the Company is self-insured for the first $50,000 per occurrence. For claims made during the period March 9, 2000 through March 9, 2001, the Company is self-insured for the first $500,000 per occurrence with no aggregate limit for the Company's United States nursing homes. The policy has coverage limits of $1,000,000 per occurrence, $3,000,000 per location and $12,000,000 in the aggregate. The Company also maintains umbrella coverage of $15,000,000 in the aggregate for claims made during the period March 9, 2000 through March 9, 2001. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. For all policy periods beginning on or after March 9, 2000, all of the Company's professional liability policies are on a claims made basis. Prior to March 9, 2000, all of these policies are on an occurrence basis. For the policy periods January 1, 1998 through February 1, 1999, the Company is self-insured for the first $250,000 per occurrence and $2,500,000 in the aggregate per year with respect to the majority of its United States nursing homes. From February 1, 1999 until March 9, 2000, all United States nursing homes became part of the $250,000/$2,500,000 deductible program. For the policy years 2000 and 1999, the Company expects to ultimately incur the full aggregate deductible amounts and has established reserves based on this expectation. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $17,427,000 and $6,859,000 at September 30, 2001 and December 31, 2000, respectively. This amount includes additional, non-cash charges of approximately $8.7 million recorded in the third quarter based on a current actuarial review, including the recent effects of additional claims and higher settlements per claim. The charge arises primarily from an escalation in the number and size of claims anticipated to affect the Company's self-insured professional liability retention. The actuarial review included estimates of known claims and a prediction of claims that may have occurred, but have not yet been reported to the Company. Based on the actuary report, the Company expects to incur increased professional liability costs in future periods, including the fourth quarter and in 2002. As discussed in Note 7, in June 2001 the Company became subject to a $78.425 million jury verdict, which judgment the Company has appealed. This judgment and other contingent claims could eventually exceed the Company's insurance coverage and its recorded liabilities. The ultimate results of the Company's professional liability claims and disputes are unknown at the present time. Any final judgments or settlements above the Company's per occurrence, per location or umbrella coverage could have a material adverse impact on the Company's financial position, cash flows and results of operations. Based on historical claims experience, the Company's professional liability insurance coverage for the period beginning March 9, 2001 could be substantially less than the claims to be incurred during 2001. The Company would be obligated to pay any claims in excess of its insurance coverage. In addition, the payment of professional liability claims by the Company's insurance carriers is dependent upon the financial solvency of the individual carriers. The Company is aware that one of its insurance carriers providing coverage for prior years claims is currently under 12 rehabilitation proceedings. The ultimate payments by the Company of professional liability claims accrued as of September 30, 2001 and claims that could be incurred during the next twelve months, because such claims exceed the Company's insurance coverage or because of the inability of an insurance carrier to pay such claims, could require cash resources during the period that would be in excess of the Company's available cash or other resources. 4. OTHER COMPREHENSIVE INCOME The Company follows the provisions of Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income". SFAS No. 130 requires the reporting of comprehensive income (loss) in addition to net income (loss) from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. Information with respect to the accumulated other comprehensive income (loss) balance is presented below:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- --------------------------- 2001 2000 2001 2000 --------- --------- --------- --------- Foreign currency items: Beginning balance $(516,000) $(379,000) $(448,000) $(173,000) Current period change, net of income tax (340,000) (88,000) (408,000) (294,000) --------- --------- --------- --------- Ending balance $(856,000) $(467,000) $(856,000) $(467,000) ========= ========= ========= =========
Positive amounts represent unrealized gains and negative amounts represent unrealized losses. 5. TEXAS DIVERSICARE LIMITED PARTNERSHIP In 1991, the Company sold six of its Texas nursing homes to Texas Diversicare Limited Partnership ("TDLP"). Included as consideration for the sale in 1991 was a wrap mortgage receivable from TDLP. As a component of the sale transaction, the Company guaranteed certain cash flow requirements of TDLP through August 2001. In addition, the Company was required to purchase up to 10.0% of the partnership units per year, beginning in January 1997 (up to a maximum of 50.0% of the total partnership units). Under this requirement, Advocat purchased 32.6% of the partnership units. The mortgage receivable matured in August 2001. The Company and TDLP agreed to an exchange of assets, via a warranty deed and bill of sale, whereby the Company's wrap mortgage and other receivables were extinguished in exchange for the assets and liabilities of the partnership. The assets were recorded based on the fair value of the respective assets, which approximate the net book value of the Company's investments in TDLP. 6. SALE OF CANADIAN SUBSIDIARY The Company signed a letter of intent to sell Diversicare Canada Management Services Co., Inc. ("Diversicare Canada"), Advocat's Canadian subsidiary, to Counsel Corporation ("Counsel"). Pursuant to the letter of intent, Counsel is to acquire 100% of the outstanding stock of Diversicare Canada for $8 million. The transaction is subject to receipt of applicable approvals and the approval of a definitive purchase agreement. The letter of intent is subject to a variety of 13 conditions, including the negotiation of definitive agreements and approval by the Company's primary bank lender. Although the letter of intent, by its terms, expired July 31, 2001, the Company is continuing its efforts to seek consents to allow the transaction to close as described. No assurances can be given that the sale of Diversicare Canada will be consummated. Diversicare Canada manages a number of nursing homes for Counsel and other owners in Canada and, additionally, leases five assisted living complexes from Counsel. The proposed sale will consist of all of Advocat's Canadian operations, including 13 nursing homes and 23 assisted living facilities. 7. ARKANSAS JURY AWARD On June 22, 2001, a jury in Mena, Arkansas issued a verdict in a professional liability lawsuit against the Company and certain of its subsidiaries totaling $78.425 million. The Company filed motions with the court, asking the trial judge to overturn or reduce the verdict. On August 3, 2001, the Company's motions were denied. The Company has appealed the verdict. The Company's insurers have posted the required bond on this judgment. The posting of this bond stays execution of the judgment during the appeals process. The Company plans to vigorously defend the judgment and has given notice of appeal to the Supreme Court of Arkansas. 8. RECLASSIFICATIONS Certain amounts in the 2000 interim financial statements have been reclassified to conform with the 2001 presentation. 9. NON-RECURRING CHARGES During 2000, the Company recorded non-recurring charges totaling $622,000 in connection with the restructuring of the lease arrangements covering the majority of its United States nursing facilities and the refinancing of certain debt obligations. Information with respect to these charges is presented below:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 2000 SEPTEMBER 30, 2000 Consulting fees $233,000 $391,000 Legal fees 125,000 215,000 Other 1,000 16,000 --------- -------- $ 359,000 $622,000 --------- --------
10. IMPLEMENTATION OF FINANCIAL ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") has been issued effective for fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. The Company adopted the provisions of SFAS No. 133, as amended, effective January 1, 2001, as required; however, the Company's adoption of SFAS No. 133, as amended, did not have a material effect on the Company's financial position or results of operations. 14 In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria which intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 requires that intangible assets with finite useful lives be amortized, and that goodwill and intangible assets with indefinite lives no longer be amortized, but instead be tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Company is required to adopt the provisions of SFAS No. 141 immediately and SFAS No. 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-SFAS No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized until the adoption of SFAS No. 142. The Company has not determined the impact, if any, the adoption of SFAS No. 141 and SFAS No. 142 will have on its financial statements. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143") effective for fiscal years beginning after June 15, 2002. SFAS 143 requires that a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The Company does not expect the future adoption of SFAS 143 to have a material effect on its financial position or results of operations. In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") effective for fiscal years beginning after December 15, 2001. SFAS 144 establishes a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. The Company has not yet determined the impact of the January 2002 adoption of SFAS 143 on its financial position or results of operations. 15 11. OPERATING SEGMENT INFORMATION The Company has three reportable segments: U.S. nursing homes, U.S. assisted living facilities, and Canadian operations, which consists of both nursing home and assisted living services. Management evaluates each of these segments independently due to the geographic, reimbursement, marketing, and regulatory differences between the segments. Management evaluates performance based on profit or loss from operations before income taxes not including nonrecurring gains and losses and foreign exchange gains and losses. The following information is derived from the Company's segments' internal financial statements and includes information related to the Company's unallocated corporate revenues and expenses:
THREE MONTHS ENDED NINE MONTHS ENDED --------------------------- --------------------------- SEPTEMBER 30, SEPTEMBER 30, --------------------------- --------------------------- 2001 2000 2001 2000 --------- --------- --------- --------- Net revenues: U.S. nursing homes $ 41,102 $ 38,390 $ 117,270 $ 110,068 U.S. assisted living facilities 7,751 7,972 23,694 24,068 Canadian operation 3,981 3,947 11,727 11,775 Corporate 7 (8) 10 (10) --------- --------- --------- --------- Total $ 52,841 $ 50,301 $ 152,701 $ 145,901 ========= ========= ========= ========= Depreciation and amortization: U.S. nursing homes $ 889 $ 698 $ 2,621 $ 1,995 U.S. assisted living facilities 432 425 1,285 1,271 Canadian operation 94 97 284 293 Corporate 18 19 54 55 --------- --------- --------- --------- Total $ 1,433 $ 1,239 $ 4,244 $ 3,614 ========= ========= ========= ========= Operating income (loss): U.S. nursing homes $ (8,427) $ 893 $ (10,544) $ 1,718 U.S. assisted living facilities (1,085) (132) (1,951) (127) Canadian operation 553 483 1,331 1,328 Corporate (773) (652) (2,241) (1,817) --------- --------- --------- --------- Total $ (9,732) $ 592 $ (13,405) $ 1,102 ========= ========= ========= =========
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------- ----------- Long-lived assets: U.S. nursing homes $ 28,730 $ 33,178 U.S. assisted living facilities 32,353 33,216 Canadian operation 11,768 12,164 Corporate 826 858 --------- --------- Total $ 73,677 $ 79,416 ========= ========= Total assets: U.S. nursing homes $ 54,249 $ 56,387 U.S. assisted living facilities 34,031 36,075 Canadian operation 16,603 17,154 Corporate 1,882 2,860 Eliminations (12,297) (10,720) --------- --------- Total $ 94,468 $ 101,756 ========= =========
16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company") provides long-term care services to nursing home patients and residents of assisted living facilities in 12 states, primarily in the Southeast, and four Canadian provinces. The Company's facilities provide a range of health care services to their patients and residents. In addition to the nursing, personal care and social services usually provided in long-term care facilities, the Company offers a variety of comprehensive rehabilitation services as well as medical supply and nutritional support services. The Company completed its initial public offering in May 1994; however, its operational history can be traced to 1980 through common senior management who were involved in different organizational structures. As of September 30, 2001, the Company operates 120 facilities, consisting of 64 nursing homes with 7,230 licensed beds and 56 assisted living facilities with 5,453 units. In comparison, at September 30, 2000, the Company operated 120 facilities composed of 64 nursing homes containing 7,230 licensed beds and 56 assisted living facilities containing 5,472 units. As of September 30, 2001, the Company owns thirteen nursing homes, leases 36 others and manages the remaining 15 nursing homes. Additionally, the Company owns 16 assisted living facilities, leases 25 others and manages the remaining 15 assisted living facilities. The Company holds a minority interest in seven of these managed assisted living facilities. The Company operates 51 nursing homes and 33 assisted living facilities in the United States and 13 nursing homes and 23 assisted living facilities in Canada. Basis of Financial Statements. The Company's patient and resident revenues consist of the fees charged for the care of patients in the nursing homes and residents of the assisted living facilities owned and leased by the Company. Management fee revenues consist of the fees charged to the owners of the facilities managed by the Company. The management fee revenues are based on the respective contractual terms of the Company's management agreements, which generally provide for management fees ranging from 3.5% to 6.0% of the net revenues of the managed facilities. As a result, the level of management fees is affected positively or negatively by the increase or decrease in the average occupancy level rates of the managed facilities. The Company's operating expenses include the costs, other than lease, depreciation and amortization expenses, incurred in the operation of the nursing homes and assisted living facilities owned and leased by the Company. The Company's general and administrative expenses consist of the costs of the corporate office and regional support functions, including the costs incurred in providing management services to other owners. The Company's depreciation, amortization and interest expenses include all such expenses across the range of the Company's operations. 17 RESULTS OF OPERATIONS The following tables present the unaudited interim statements of operations and related data for the three and nine months ended September 30, 2001 and 2000.
(IN THOUSANDS) THREE MONTHS ENDED SEPTEMBER 30, ---------------------------------------- 2001 2000 CHANGE % -------- -------- -------- ------- REVENUES: Patient revenues $ 41,882 $ 38,946 $ 2,936 7.5 Resident revenues 10,138 10,368 (230) (2.2) Management fees 768 934 (166) (17.8) Interest 53 53 -0- 0.0 -------- -------- -------- ------- Net revenues 52,841 50,301 2,540 5.0 -------- -------- -------- --- EXPENSES: Operating 51,154 38,598 12,556 32.5 Lease 5,177 5,272 (95) (1.8) General and administrative 3,498 3,058 440 14.4 Interest 1,311 1,542 (231) (15.0) Depreciation and amortization 1,433 1,239 194 15.7 Non-recurring charges -0- 359 (359) (100.0) -------- -------- -------- ------- Total expenses 62,573 50,068 12,505 25.0 -------- -------- -------- ------- INCOME (LOSS) BEFORE INCOME TAXES (9,732) 233 (9,965) INCOME TAX PROVISION 118 84 34 -------- -------- -------- NET INCOME (LOSS) $ (9,850) $ 149 $ (9,999) ======== ======== ======== (IN THOUSANDS) NINE MONTHS ENDED SEPTEMBER 30, ---------------------------------------- 2001 2000 CHANGE % -------- -------- -------- ------- REVENUES: Patient revenues $119,741 $111,620 $ 8,121 7.3 Resident revenues 30,745 31,177 (432) (1.4) Management fees 2,083 2,960 (877) (29.6) Interest 132 144 (12) (8.3) -------- -------- -------- ------- Net revenues 152,701 145,901 6,800 4.7 -------- -------- -------- ------- EXPENSES: Operating 132,029 112,193 19,836 17.7 Lease 15,533 15,806 (273) (1.7) General and administrative 10,104 8,754 1,350 15.4 Interest 4,196 4,432 (236) (5.3) Depreciation and amortization 4,244 3,614 630 17.4 Non-recurring charges -0- 622 (622) (100.0) -------- -------- -------- ------- Total expenses 166,106 145,421 20,685 14.2 -------- -------- -------- ------- INCOME (LOSS) BEFORE INCOME TAXES (13,405) 480 (13,885) PROVISION FOR INCOME TAXES 284 173 111 -------- -------- -------- NET INCOME (LOSS) $(13,689) $ 307 $(13,996) ======== ======== =======
18
PERCENTAGE OF NET REVENUES THREE MONTHS ENDED NINE MONTHS ENDED ---------------------- ---------------------- SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 2001 2000 2001 2000 ------ ------ ------ ------ REVENUES: Patient revenues 79.2% 77.4% 78.4% 76.5% Resident revenues 19.2 20.6 20.1 21.4 Management fees 1.5 1.9 1.4 2.0 Interest 0.1 0.1 0.1 0.1 ------ ------ ------ ------ Net revenues 100.0 100.0 100.0 100.0 ------ ------ ------ ------ OPERATING EXPENSES: Operating 96.8 76.7 86.5 76.9 Lease 9.8 10.5 10.2 10.8 General and administrative 6.6 6.1 6.6 6.0 Interest 2.5 3.1 2.7 3.1 Depreciation and amortization 2.7 2.5 2.8 2.5 Non-recurring charges 0.0 0.6 0.0 0.4 ------ ------ ------ ------ Total expenses 118.4 99.5 108.8 99.7 ------ ------ ------ ------ INCOME (LOSS) BEFORE INCOME TAXES (18.4) 0.5 (8.8) 0.3 PROVISION FOR INCOME TAXES 0.2 0.2 0.2 0.1 ------ ------ ------ ------ NET INCOME (LOSS) (18.6)% 0.3 (9.0)% 0.2 ====== ====== ====== ======
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THREE MONTHS ENDED SEPTEMBER 30, 2000 Revenues. Net revenues increased to $52.8 million in 2001 from $50.3 million in 2000, an increase of $2.5 million, or 5.0%. Patient revenues increased to $41.9 million in 2001 from $38.9 million in 2000, an increase of $3.0 million, or 7.5%. The increase in patient revenues is due to increased Medicaid rates in Arkansas and other states, increased Medicare utilization and Medicare rate increases and a 0.2% increase in occupancy in 2001 as compared to 2000. Partially offsetting these increases, the Company closed a facility in August 2000. As a percent of patient revenues, Medicare increased to 20.8% in 2001 from 19.5% in 2000 while Medicaid and similar programs increased to 67.3% from 67.0% in 2000. Resident revenues decreased to $10.1 million in 2001 from $10.4 million in 2000, a decrease of $230,000, or 2.2%. The Company experienced an 8.3% decline in resident days, partially offset by an increase in rates. Ancillary service revenues, prior to contractual allowances, increased to $6.0 million in 2001 from $5.4 million in 2000, an increase of $607,000 or 11.3%. The increase is primarily attributable to increased Medicare census, partially offset by reductions in revenue availability under Medicare. Although the $1,500 per patient annual ceiling has now been lifted for a two year period on physical, speech and occupational therapy services, the impact of the relief is not expected to be sufficient to offset the substantial losses that have been incurred by the Company and the long-term care industry from the provision of therapy services. The ultimate effect on the Company's operations cannot be predicted at this time because the extent and composition of the ancillary cost limitations are subject to change. 19 Management fee revenue decreased to $768,000 in 2001 from $934,000 in 2000, a decrease of $166,000, or 17.8%. A management contract covering four nursing facilities includes a defined calculation of the "priority of distribution," which determines the amount of management fees which may be earned by the Company. The Company's management fee is the lesser of 6% of facility revenues or the amount determined by the priority of distribution calculation. The reduction of management fees is a result of increased operating costs of these facilities, including primarily professional liability and provisions for cost report settlements. Operating Expense. Operating expense, excluding the one-time, $8.7 million charge for professional liability costs, increased to $42.5 million in 2001 from $38.6 million in 2000, an increase of $3.9 million, or 10.0%. As a percent of patient and resident revenues, operating expense, excluding the one-time charge, increased to 81.7% in 2001 from 78.3% in 2000. Including the one-time charge, operating expense increased to $51.2 million in 2001 from $38.6 million in 2000, an increase of $12.6 million, or 32.5%. As a percent of patient and resident revenues, operating expense, including the one-time charge, increased to 98.3% in 2001 from 78.3% in 2000. The increase in operating expenses is primarily attributable to cost increases related to professional liability, wages, bed taxes and utilities. The Company's professional liability costs for United States nursing homes and assisted living facilities, including insurance premiums and reserves for self-insured claims and including the one-time charge, increased to $11.1 million in 2001 from $2.0 million in 2000, an increase of $9.1 million or 451.2%. The 2001 professional liability cost includes additional, non-cash charges of approximately $8.7 million recorded in the third quarter based on a current actuarial review, including the recent effects of additional claims and higher settlements per claim. The charge arises primarily from an escalation in the number and size of claims anticipated to affect the Company's self-insured professional liability retention. The actuarial review included estimates of known claims and a prediction of claims that may have occurred, but have not yet been reported to the Company. Based on the actuary report, the Company expects to incur increased professional liability costs in future periods, including the fourth quarter of 2001 and during 2002. The largest component of operating expenses is wages, which increased to $23.0 million in 2001 from $21.2 million in 2000, an increase of $1.8 million, or 8.6%. The increase in wages is due to increased costs associated with increased Medicare census and tighter labor markets in most of the areas in which the Company operates, partially offset by reduced costs associated with reduced Medicaid census. Lease Expense. Lease expense decreased to $5.2 million in 2001 from $5.3 million in 2000, a decrease of $95,000, or 1.8%. Effective October 1, 2000, the Company entered into an amended lease agreement with the primary lessor of the Company's United States nursing homes, which resulted in reduced lease costs. Partially offsetting this decrease, the majority of the Company's lease agreements include annual adjustments generally tied to inflation. General and Administrative Expense. General and administrative expense increased to $3.5 million in 2001 from $3.1 million in 2000, an increase of $440,000, or 14.4%. As a percent of total net revenues, general and administrative expense increased to 6.6% in 2001 from 6.1% in 2000. This increase is attributable to various corporate expenses, including salaries and wages, workers compensation, health insurance, employee recruitment and relocation, legal and accounting costs. 20 Interest Expense. Interest expense decreased to $1.3 million in 2001 from $1.5 million in 2000, a decrease of $231,000 or 15.0%. Interest rate reductions on the Company's variable rate debt were partially offset by an increase in 2001 in the Company's average outstanding debt balance and Series B Redeemable Convertible Preferred Stock as compared to 2000. Depreciation and Amortization. Depreciation and amortization expenses increased to $1.4 million in 2001 from $1.2 million in 2000, an increase of $194,000, or 15.7%. This increase includes depreciation on future capital expenditures required as a result of certain provisions of the lease covering the majority of the Company's United States nursing homes. Non-Recurring Charges. During the third quarter of 2000, the Company recorded non-recurring charges totaling $359,000 in connection with the proposed restructuring of the lease arrangements covering the majority of its United States nursing facilities and the proposed refinancing of certain debt obligations. Of this amount, $233,000 and $125,000 related to consulting and legal fees incurred, respectively. Income Before Income Taxes; Net Income (Loss); Earnings (Loss) Per Share. As a result of the above, the income before income taxes was a loss of $9.7 million in 2001 as compared to income of $233,000 in 2000, a decrease of $9.9 million. Excluding the one-time charge, income before income taxes was a loss of $1.1 million in 2001. The income tax provision in 2001 relates to provincial taxes in Canada. The effective combined federal, state and provincial income tax rate was 36.0% in 2000. Net income was a loss of $9.9 million in 2001 as compared to income of $149,000 in 2000, a decrease of $10.0 million. The basic and diluted earnings (loss) per share were $(1.79) each in 2001 as compared to $.03 each in 2000. Excluding the one-time charge, in 2001 the Company incurred a net loss of $1.2 million (basic and diluted loss of $0.21 per share). NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 30, 2000 Revenues. Net revenues increased to $152.7 million in 2001 from $145.9 million in 2000, an increase of $6.8 million, or 4.7%. Patient revenues increased to $119.7 million in 2001 from $111.6 million in 2000, an increase of $8.1 million, or 7.3%. The increase in patient revenues is due to increased Medicaid rates in Arkansas, increased Medicare utilization and Medicare rate increases and a 0.7% increase in occupancy in 2001 as compared to 2000. Partially offsetting these increases, the Company closed a facility in August 2000. As a percent of patient revenues, Medicare increased to 21.7% in 2001 from 20.1% in 2000 while Medicaid and similar programs decreased to 65.5% from 66.1% in 2000. Resident revenues decreased to $30.7 million in 2001 from $31.2 million in 2000, a decrease of $432,000, or 1.4%. The Company experienced a 7.5% decline in resident days, partially offset by an increase in rates. Ancillary service revenues, prior to contractual allowances, decreased to $16.8 million in 2001 from $16.9 million in 2000, a decrease of $81,000 or 0.5%. The decrease is primarily attributable to reductions in revenue availability under Medicare. Although the $1,500 per patient annual ceiling has now been lifted for a two year period on physical, speech and occupational therapy services, the impact of the relief is not expected to be sufficient to offset the substantial losses that 21 have been incurred by the Company and the long-term care industry from the provision of therapy services. The ultimate effect on the Company's operations cannot be predicted at this time because the extent and composition of the ancillary cost limitations are subject to change. Management fee revenue decreased to $2.1 million in 2001 from $3.0 million, a decrease of $877,000, or 29.6%. A management contract covering four nursing facilities includes a defined calculation of the "priority of distribution", which determines the amount of management fees which may be earned by the Company. The Company's management fee is the lesser of 6% of facility revenues or the amount determined by the priority of distribution calculation. The reduction in management fee revenue is a result of increased operating costs of these facilities, including primarily professional liability and provisions for cost report settlements. Operating Expense. Operating expense, excluding the one-time, $8.7 million charge for professional liability costs, increased to $123.4 million in 2001 from $112.2 million in 2000, an increase of $11.2 million, or 9.9%. As a percent of patient and resident revenues, operating expense, excluding the one-time charge, increased to 82.0% in 2001 from 78.6% in 2000. Including the one-time charge, operating expense increased to $132.0 million in 2001 from $112.2 million in 2000, an increase of $19.8 million, or 17.7%. As a percent of patient and resident revenues, operating expense increased to 87.7% in 2001 from 78.6% in 2000. The increase in operating expenses is primarily attributable to cost increases related to professional liability, wages, bed taxes, utilities, workers compensation and health insurance. The Company's professional liability costs for United States nursing homes and assisted living facilities, including insurance premiums and reserves for self-insured claims and including the one-time charge, increased to $16.2 million in 2001 from $5.6 million in 2000, an increase of $10.6 million or 192.1%. The 2001 professional liability cost includes additional, non-cash charges of approximately $8.7 million recorded in the third quarter based on a current actuarial review, including the recent effects of additional claims and higher settlements per claim. The charge arises primarily from an escalation in the number and size of claims anticipated to affect the Company's self-insured professional liability retention. The actuarial review included estimates of known claims and a prediction of claims that may have occurred, but have not yet been reported to the Company. Based on the actuary report, the Company expects to incur increased professional liability costs in future periods, including the fourth quarter of 2001 and during 2002. The largest component of operating expenses is wages, which increased to $65.8 million in 2001 from $61.5 million in 2000, an increase of $4.3 million, or 7.1%. The increase in wages is due to tighter labor markets in most of the areas in which the Company operates. Lease Expense. Lease expense decreased to $15.5 million in 2001 from $15.8 million in 2000, a decrease of $273,000, or 1.7%. Effective October 1, 2000, the Company entered into an amended lease agreement with the primary lessor of the Company's United States nursing homes, which resulted in reduced lease costs. Partially offsetting this decrease, the majority of the Company's lease agreements include annual adjustments generally tied to inflation. General and Administrative Expense. General and administrative expense increased to $10.1 million in 2001 from $8.8 million in 2000, an increase of $1.4 million, or 15.4%. As a percent of total net revenues, general and administrative expense increased to 6.6% in 2001 from 6.0% in 22 2000. This increase is attributable to various corporate expenses, including salaries and wages, workers compensation, health insurance, employee recruitment and relocation, legal and accounting costs. Interest Expense. Interest expense decreased to $4.2 million in 2001 from $4.4 million in 2000, a decrease of $236,000, or 5.3%. Interest rate reductions on the Company's variable rate debt were partially offset by an increase in 2001 in the Company's average outstanding debt balance and Series B Redeemable Convertible Preferred Stock as compared to 2000. Depreciation and Amortization. Depreciation and amortization expenses increased to $4.2 million in 2001 from $3.6 million in 2000, an increase of $630,000, or 17.4%. This increase includes depreciation on future capital expenditures required as a result of certain provisions of the lease covering the majority of the Company's United States nursing homes. Non-Recurring Charges. During the second quarter of 2000, the Company recorded non-recurring charges totaling $622,000 in connection with the proposed restructuring of the lease arrangements covering the majority of its United States nursing facilities and the proposed refinancing of certain debt obligations. Of this amount, $391,000 and $215,000 related to consulting and legal fees incurred, respectively. Income Before Income Taxes; Net Income (Loss); Earnings (Loss) Per Share. As a result of the above, the income before income taxes was a loss of $13.4 million in 2001 as compared to income of $480,000 in 2000, a decrease of $13.9 million. Excluding the one-time charge, income before income taxes was a loss of $4.7 million in 2001. The income tax provision in 2001 relates to provincial taxes in Canada. The effective combined federal, state and provincial income tax rate was 36.0% in 2000. Net income was a loss of $13.7 million in 2001 as compared to income of $307,000 in 2000, a decrease of $14.0 million. The basic and diluted earnings (loss) per share were $(2.49) each in 2001 as compared to $.06 each in 2000. Excluding the one-time charge, in 2001 the Company incurred a net loss of $5.0 million (basic and diluted loss of $0.97 per share). LIQUIDITY AND CAPITAL RESOURCES At September 30, 2001, the Company had negative working capital of $61.2 million and a current ratio of 0.25, compared with negative working capital of $60.1 million and a current ratio of 0.27 at December 31, 2000. The Company has incurred losses during 2001, 2000, and 1999 and has limited resources available to meet its operating, capital expenditure and debt service requirements during 2001. Certain of the Company's debt agreements contain various financial covenants, the most restrictive of which relate to current ratio requirements, tangible net worth, cash flow, net income (loss), and limits on the payment of dividends to shareholders. As of December 31, 2000 and September 30, 2001, the Company was not in compliance with certain of these financial covenants. The Company has not obtained waivers of the non-compliance. Cross-default or material adverse change provisions contained in the debt agreements allow the holders of substantially all of the Company's debt to demand immediate repayment. The Company would not be able to repay this indebtedness if the applicable lenders demanded repayment. Although the Company does not anticipate that 23 such demand will be made, the continued forbearance on the part of the Company's lenders cannot be assured at this time. Given that events of default exist under the Company's working capital line of credit, there can be no assurance that the lender will continue to provide working capital advances. Based on regularly scheduled debt service requirements, the Company has a total of $6.7 million that must be repaid or refinanced in January 2002. During the third quarter, the Company entered into an extension agreement for mortgage notes payable totaling $2.4 million. The agreement extended the maturity dates of these notes payable to August 2002. As a result of the covenant non-compliance and other cross-default provisions, the Company has classified a total of $58.9 million of debt as current liabilities as of September 30, 2001. An event of default under the Company's debt agreements could lead to actions by the lenders that would result in an event of default under the Company's lease agreements covering a majority of its United States nursing facilities. Should such a default occur in the related lease agreements, the lessor would have the right to terminate the lease agreements. The Company is currently discussing potential waiver, amendment and refinancing alternatives with its lenders. The Company's management has implemented a plan to enhance revenues related to the operations of the Company's nursing homes and assisted living facilities. Management believes that revenues in future periods will increase as a result of Medicare and certain state Medicaid rate increases. In addition, the Company has emphasized attracting and retaining patients and residents. Management has implemented a plan to attempt to minimize future expense increases through the elimination of excess operating costs. However, it is anticipated that the Company will continue to experience significant professional liability costs. The Company is unable to predict if it will be successful in reducing operating losses, in negotiating waivers, amendments, or refinancings of outstanding debt, or if the Company will be able to meet any amended financial covenants in the future. Any demands for repayment by lenders or the inability to obtain waivers or refinance the related debt would have a material adverse impact on the financial position, results of operations and cash flows of the Company. The independent public accountant's report on the Company's financial statements at December 31, 2000 included a paragraph with regards to the uncertainties of the Company's ability to continue as a going concern. As of September 30, 2001, the Company had drawn $2.6 million under its working capital line of credit. The total maximum outstanding balance of the working capital line of credit, including letters of credit outstanding, is $4.5 million. Of the total $4.5 million of maximum availability, $1.0 million is limited to certain maximum time period restrictions. There are certain additional restrictions based on certain borrowing base restrictions. As of September 30, 2001, the Company had $350,000 of letters of credit outstanding with the same bank lender, which further reduce the maximum available amount outstanding under the working capital line of credit. As of September 30, 2001, the Company had total additional borrowing availability of $1.9 million under its working capital line of credit. In conjunction with the Company's execution of the Settlement and Restructuring Agreement with Omega Healthcare Investors, Inc., the Company amended the terms of the working capital line of credit, extending the maturity through January 2004 and modifying the interest rate from LIBOR plus 2.50% to the bank's prime rate plus .50% (up to a maximum of 9.50%) effective October 1, 2000. 24 The Company has signed a letter of intent to sell Diversicare Canada Management Services Co., Inc. ("Diversicare Canada"), Advocat's Canadian subsidiary to Counsel Corporation ("Counsel"). Pursuant to the letter of intent, Counsel is to acquire 100% of the outstanding stock of Diversicare Canada for $8 million. The transaction is subject to receipt of applicable approvals and the approval of a definitive purchase agreement. The letter of intent is subject to a variety of conditions, including the negotiation of definitive agreements and approval by the Company's primary bank lender. Although the letter of intent, by its terms, expired July 31, 2001, the Company is continuing its efforts to seek consents to allow the transaction to close as described. No assurance can be given that the Company will be able to complete the sale of Diversicare Canada. Diversicare Canada manages a number of nursing homes for Counsel and other owners in Canada and, additionally, leases five assisted living complexes from Counsel. The proposed sale will include all of Advocat's Canadian operations, including 13 nursing homes and 23 assisted living facilities. Effective March 9, 2001, the Company has obtained professional liability insurance coverage that, based on historical claims experience, could be substantially less than the claims that could be incurred during 2001. The Company would be obligated to pay any claims in excess of its insurance coverage. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims in excess of insurance coverage of $17.4 million at September 30, 2001. This amount includes a one-time, non-cash charge of approximately $8.7 million recorded in the third quarter based on an actuarial review. In addition, the payment of professional liability claims by the Company's insurance carriers is dependent upon the financial solvency of the individual carriers. The Company is aware that one of its insurance carriers providing coverage for prior years claims is currently under rehabilitation proceedings. The ultimate payments by the Company of professional liability claims accrued as of December 31, 2000 and claims that could be incurred during 2001 because such claims exceed the Company's insurance coverage or because of the inability of an insurance carrier to pay such claims could require cash resources during 2001 that would be in excess of the Company's available cash or other resources. On June 22, 2001, a jury in Mena, Arkansas issued a verdict in a professional liability lawsuit against the Company and certain of its subsidiaries totaling $78.425 million. The Company filed motions with the court, asking the trial judge to overturn or reduce the verdict. On August 3, 2001, the Company's motions were denied. The Company has appealed the verdict. The Company's insurers have posted the required bond on this judgment. The posting of this bond stays execution of the judgment during the appeal process. The Company plans to vigorously defend the judgment and has given notice of appeal to the Supreme Court of Arkansas. Any future operating losses, demands for repayment by lenders, failure to refinance debt maturing during 2001 or payments of professional liability claims judgments in excess of insurance coverage would have a material adverse impact on the financial position, results of operations and cash flows of the Company. If the Company is unable to generate sufficient cash flows from its operations, unable to refinance or repay debt maturities during 2001, or unable to minimize the amount of 25 future professional liability claims payments, it will explore a variety of other options, including but not limited to other sources of equity or debt financing, asset dispositions, or relief under the United States Bankruptcy code. Net cash provided by operating activities totaled $4.9 million and $5.4 million for the nine month periods ended September 30, 2001 and 2000, respectively. These amounts primarily represent the cash flows from net operations plus changes in non-cash components of operations and by working capital changes. No assurance can be given that future cash flow will be sufficient to meet the working capital, debt service or capital expenditure requirements of the Company for the next twelve months. Net cash used in investing activities totaled $2.2 million and $2.0 million for the nine months periods ended September 30, 2001 and 2000, respectively. These amounts primarily represent purchases of property plant and equipment, investments in and advances to joint ventures and additional investments in TDLP, a limited partnership for which the Company served as the general partner. The Company has used between $2.7 million and $5.2 million for capital expenditures in the three calendar years ending December 31, 2000. Substantially all such expenditures were for facility improvements and equipment, which were financed principally through working capital. For the year ended December 31, 2001, the Company anticipates that capital expenditures for improvements and equipment for its existing facility operations will be approximately $4.2 million, including $1.0 million for non-routine projects. Net cash used in financing activities totaled $4.4 million and $1.7 for the nine month periods ended September 30, 2001 and 2000, respectively. The net cash used in financing activities primarily represents net proceeds from issuance and repayment of debt and advances to TDLP. RECEIVABLES The Company's operations could be adversely affected if it experiences significant delays in reimbursement of its labor and other costs from Medicare, Medicaid and other third-party revenue sources. The Company's future liquidity will continue to be dependent upon the relative amounts of current assets (principally cash, accounts receivable and inventories) and current liabilities (principally accounts payable and accrued expenses). In that regard, accounts receivable can have a significant impact on the Company's liquidity. Continued efforts by governmental and third-party payors to contain or reduce the acceleration of costs by monitoring reimbursement rates, by increasing medical review of bills for services, or by negotiating reduced contract rates, as well as any delay by the Company in the processing of its invoices, could adversely affect the Company's liquidity and results of operations. Accounts receivable attributable to the provision of patient and resident services at September 30, 2001 and December 31, 2000, totaled $20.7 million and $18.1 million, respectively, representing approximately 38 and 34 days in accounts receivable, respectively. Accounts receivable from the provision of management services were $299,000 and $721,000 at September 30, 2001 and December 31, 2000, respectively representing approximately 39 and 67 days in accounts receivable, respectively. The allowance for bad debt was $6.0 million and $5.0 million at September 30, 2001 and December 31, 2000, respectively. 26 The Company continually evaluates the adequacy of its bad debt reserves based on patient mix trends, agings of older balances, payment terms and delays with regard to third-party payors, collateral and deposit resources, as well as other factors. The Company continues to evaluate and implement additional procedures to strengthen its collection efforts and reduce the incidence of uncollectible accounts. HEALTH CARE INDUSTRY The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, quality of resident care and Medicare and Medicaid fraud and abuse (collectively, the "Health Care Laws"). Changes in these laws and regulations, such as reimbursement policies of Medicare and Medicaid programs as a result of budget cuts by federal and state governments or other legislative and regulatory actions, could have a material adverse effect on the Company's financial position, results of operations, and cash flows. Future federal budget legislation and federal and state regulatory changes may negatively impact the Company. All of the Company's facilities are required to obtain annual licensure renewal and are subject to annual surveys and inspections in order to be certified for participation in the Medicare and Medicaid programs. In order to maintain their operator's license and their certification for participation in Medicare and Medicaid programs, the nursing facilities must meet certain statutory and administrative requirements. These requirements relate to the condition of the facilities, the adequacy and condition of the equipment used therein, the quality and adequacy of personnel, and the quality of resident care. Such requirements are subjective and subject to change. There can be no assurance that, in the future, the Company will be able to maintain such licenses for its facilities or that the Company will not be required to expend significant sums in order to do so. Recently, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse statutes and regulations. Violations of these laws and regulations could result in exclusion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with the Health Care Laws can be subject to both future and retrospective government review and interpretation, as well as regulatory actions unknown or unasserted at this time. The Company is currently a defendant in two pending false claims actions as described under Item 1. Legal Proceedings. During 1999, 2000 and 2001, the Company also experienced the increased regulatory scrutiny that has been exerted on the industry in the form of increased fines and penalties. During 2000, one of the Company's facilities in Texas was decertified from the Medicaid and Medicare programs and, as a result, ceased operations. The Company is actively engaged in the application and appeal process for the recertification and licensure of this facility. Medicare Reimbursement Changes. During 1997, the federal government enacted the Balanced Budget Act of 1997 ("BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The BBA requires that nursing homes transition to a prospective payment system 27 ("PPS") under the Medicare program during a three-year "transition period," commencing with the first cost reporting period beginning on or after July 1, 1998. The BBA also contains certain measures that have and could lead to further future reductions in Medicare therapy reimbursement and Medicaid payment rates. Revenues and expenses have both been reduced significantly from the levels prior to PPS. The BBA has negatively impacted the entire long-term health care industry. During 1999 and 2000, certain amendments to the BBA have been enacted, including the Balanced Budget Reform Act of 1999 ("BBRA") and the Benefits Improvement and Protection Act of 2000 ("BIPA"). The BBRA has provided legislative relief in the form of increases in certain Medicare payment rates during 2000. The BIPA is expected to continue to provide additional increases in certain Medicare payment rates during 2001. Although refinements resulting from the BBRA and the BIPA have been well received by the United States nursing home industry, it is the Company's belief that the resulting revenue enhancements are still significantly less than the losses sustained by the industry due to the BBA. Current levels of or further reductions in government spending for long-term health care would continue to have an adverse effect on the operating results and cash flows of the Company. The Company will attempt to maximize the revenues available from governmental sources within the changes that have occurred and will continue to occur under the BBA. In addition, the Company will attempt to increase revenues from non-governmental sources, including expansion of its assisted living operations, to the extent capital is available to do so, if at all. FOREIGN CURRENCY TRANSLATION The Company has obtained its financing primarily in U.S. dollars; however, it incurs revenues and expenses in Canadian dollars with respect to Canadian management activities and operations of the Company's eight Canadian retirement facilities (three of which are owned) and two owned Canadian nursing homes. Although not material to the Company as a whole, if the currency exchange rate fluctuates, the Company may experience currency translation gains and losses with respect to the operations of these activities and the capital resources dedicated to their support. While such currency exchange rate fluctuations have not been material to the Company in the past, there can be no assurance that the Company will not be adversely affected by shifts in the currency exchange rates in the future. STOCK EXCHANGE On November 10, 1999, the Company's stock began being quoted on the NASD's OTC Bulletin Board under the symbol AVCA. Previously, the Company's common stock was traded on the New York Stock Exchange under the symbol AVC. 28 INFLATION Management does not believe that the Company's operations have been materially affected by inflation. The Company expects salary and wage increases for its skilled staff to continue to be higher than average salary and wage increases, as is common in the health care industry. To date, these increases as well as normal inflationary increases in other operating expenses have been adequately covered by revenue increases. RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") has been issued effective for fiscal years beginning after June 15, 2000. SFAS No. 133, as amended, requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. The Company adopted the provisions of SFAS No. 133, as amended, effective January 1, 2001, as required; however, the Company's adoption of SFAS No. 133, as amended, did not have a material effect on the Company's financial position or results of operations. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after September 30, 2001. SFAS No. 141 also specifies criteria which intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 requires that intangible assets with finite useful lives be amortized, and that goodwill and intangible assets with indefinite lives no longer be amortized, but instead tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Company is required to adopt the provisions of SFAS No. 141 immediately and SFAS No. 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after September 30, 2001 will not be amortized, but will continue to be evaluated for impairment in 29 accordance with the appropriate pre-SFAS No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized until the adoption of SFAS No. 142. The Company has not determined the impact, if any, of the adoption of SFAS No. 141 and SFAS No. 142 on its financial statements. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143") effective for fiscal years beginning after June 15, 2002. SFAS 143 requires that a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The Company does not expect the future adoption of SFAS 143 to have a material effect on its financial position or results of operations. In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") effective for fiscal years beginning after December 15, 2001. SFAS 144 establishes a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. The Company has not yet determined the impact of the January 2002 adoption of SFAS 144 on its financial position or results of operations. FORWARD-LOOKING STATEMENTS The foregoing discussion and analysis provides information deemed by Management to be relevant to an assessment and understanding of the Company's consolidated results of operations and its financial condition. It should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2000. Certain statements made by or on behalf of the Company, including those contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties including, but not limited to, changes in governmental reimbursement, government regulation and health care reforms, the increased cost of borrowing under the Company's credit agreements, covenant waivers from the Company's lenders, possible amendments to the Company's credit agreements, ability to control ultimate professional liability costs, the impact of future licensing surveys, changing economic conditions as well as others. Investors also should refer to the risks identified in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as risks identified in the Company's Form 10-K for the year ended December 31, 2000 for a discussion of various risk factors of the Company and that are inherent in the health care industry. Given these risks and uncertainties, the Company can give no assurances that these forward-looking statements will, in fact, transpire and, therefore, cautions investors not to place undue reliance on them. Actual results may differ materially from those described in such forward-looking statements. Such cautionary statements identify important factors that could cause the Company's actual results to materially differ from those projected in forward-looking statements. In addition, the Company disclaims any intent or obligation to update these forward-looking statements. 30 PART II -- OTHER INFORMATION Item 2. Legal Proceedings. On October 17, 2000, the Company was served with a civil complaint by the Florida Attorney General's office, in the case of State of Florida ex rel. Mindy Myers v. R. Brent Maggio, et al. In this case, the State of Florida has accused multiple defendants of violating Florida's False Claims Act. At a hearing held April 25, 2001 in the Circuit Court of Leon County, Florida, the Court dismissed the State of Florida's complaint in its entirety based on the State's failure to plead false claims violations with sufficient particularity as required by law. On October 15, 2001, the State of Florida filed a second amended complaint against the same defendants. The Company, in its capacity as the manager of four nursing homes owned by Emerald Coast Healthcare, Inc. ("Emerald"), is named in the amended complaint, which accuses the Company of making illegal kickback payments to R. Brent Maggio, Emerald's sole shareholder, and fraudulently concealing such payments in the Medicaid cost reports filed by the nursing homes. The second amended complaint also accuses the Company of (i) receiving payment by mistake of fact, (ii) unjust enrichment and (iii) civil theft. The Company believes that the claims are without merit and the Company intends to vigorously pursue its defense in this amended complaint. Under the Federal False Claims Act, health care companies may be named as a defendant in an action which is filed under court seal, without being informed of this fact until the government has substantially completed its investigation. In such cases, there sometimes occurs a provision for "partial lifting of the seal," in which the trial court orders that the seal may be lifted for purposes of giving the named defendant the opportunity to informally present its defenses and discuss settlement prospects with the government. In cases in which the judge orders such a "partial lifting of the seal," the defendant becomes aware of the case but is precluded from discussing it publicly. The one case to which the Company had referred in previous filings was U.S.A ex rel. Susan Elaine Connor and Cathy L. Johnson v. Cambridge Medical Center a/k/a Mayfield Rehabilitation & Special Care Center a/k/a Diversicare Leasing Corp. USDC, Middle District of Tennessee, No. 3:98-0605. In November 2001, the court entered an order indicating that the department of justice had chosen not to intervene in this case. The Company does not know whether the individual relators will pursue this action, but the Company plans to vigorously defend the case if it does proceed. While the Company cannot currently predict with certainty the ultimate impact of either of the above cases on the Company's financial condition, cash flows or results of operations, an unfavorable outcome in any state or federal False Claims Act case could subject the Company to fines, penalties and damages. Moreover, the Company could be excluded from the Medicare, Medicaid or other federally-funded health care programs, which could have a material adverse impact on the Company's financial condition, cash flows or results of operations. The entire United States long-term care industry has seen a dramatic increase in personal injury/wrongful death claims based on alleged negligence by nursing homes and their employees in providing care to patients and residents. As a result, the Company has numerous liability claims and disputes outstanding for professional liability and other related issues. On June 22, 2001, a 31 jury in Mena, Arkansas issued a verdict in a professional liability lawsuit against the Company totaling $78.425 million. Professional liability insurance up to certain limits is carried by the Company and its subsidiaries for coverage of such claims. However, due to the increasing number of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts have increased substantially during 1999, 2000 and 2001. For more information regarding the Mena, Arkansas verdict and the Company's insurance coverage, see Notes 3 and 7 in "Notes to Interim Consolidated Financial Statements". In addition to the pending false claims actions described above, the Company has also received notices from the Centers for Medicare and Medicaid Services ("CMMS") concerning post-payment medical reviews of claims for several of the Company's Texas facilities. The reviews have resulted in the denial of previously paid claims for infusion therapy and certain other therapy services rendered by outside providers to patients at the Company's facilities for the years 1997 - 1999. The government has already recovered, and will continue to recover, some of the alleged overpayment amounts by offset against current amounts due the facilities. The Company believes that the medical reviews were imposed as the result of a governmental investigation of Infusion Management Services ("IMS"), an unrelated company that provided infusion therapy services to residents at the Company's facilities and which some time ago entered into a settlement agreement with the government regarding allegations of violations of applicable laws. The Company is in the process of appealing the denied claims. The Company also contends that the government has already recovered the payments in question through its settlement with IMS. The Company cannot at this time predict whether its efforts to recover the recouped money and obtain payment of the denied claims will be successful, and the denial of these claims could have a material adverse impact on the Company's financial condition, cash flows or results of operations. Item 3. Defaults Upon Senior Securities. The Company is not currently in compliance with certain covenants of its loan agreements and certain other indebtedness. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." Item 6. Exhibits and Reports on Form 8-K. (a) The exhibits filed as part of the report on Form 10-Q are listed in the Exhibit Index immediately following the signature page. (b) Reports on Form 8-K: None 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ADVOCAT INC. November 14, 2001 By: /s/ William R. Council, III ------------------------------------------- William R. Council, III Executive Vice-President, Secretary, Principal Financial Officer and Chief Accounting Officer and An Officer Duly Authorized to Sign on Behalf of the Registrant 33
Exhibit Number Description of Exhibits - ------- ----------------------- 3.1 Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement No. 33-76150 on Form S-1). 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement No. 33-76150 on Form S-1). 3.3 Amendment to Certificate of Incorporation dated March 23, 1995 (incorporated by reference to Exhibit A of Exhibit 1 to the Company's Form 8-A filed March 30, 1995). 3.4 Certificate of Designation of Registrant (incorporated by reference to Exhibit 3.4 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2001). 4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4 to the Company's Registration Statement No. 33-76150 on Form S-1). 4.2 Rights Agreement dated March 13, 1995, between the Company and Third National Bank in Nashville (incorporated by reference to Exhibit 1 to the Company's Current Report on Form 8-K dated March 13, 1995). 4.3 Summary of Shareholder Rights Plan adopted March 13, 1995 (incorporated by reference to Exhibit B of Exhibit 1 to Form 8-A filed March 30, 1995). 4.4 Rights Agreement of Advocat Inc. dated March 23, 1995 (incorporated by reference to Exhibit 1 to Form 8-A filed March 30, 1995). 4.5 Amended and Restated Rights Agreement dated as of December 7, 1998 (incorporated by reference to Exhibit 1 to Form 8-A/A filed December 7, 1998). 10.1 Termination, Assignment And Release Agreement is dated as of the 30th day of September, 2001 and is by and among (I) Counsel Nursing Properties, Inc., a Delaware corporation and Counsel Corporation [US], a Delaware corporation and the successor by name change to Diversicare Corporation of America, (ii) Diversicare Leasing Corp., a Tennessee corporation and Advocat Inc., a Delaware corporation, and (iii) Omega Healthcare Investors, Inc., a Maryland corporation, OHI Sunshine, Inc., a Florida corporation, and Sterling Acquisition Corp., a Kentucky corporation. 10.2 Settlement and Release Agreement entered into and effective as of 11:30, CST, on August 31, 2001 by and between Texas Diversicare Limited Partnership, a Texas limited partnership and Diversicare Leasing Corp., a Tennessee corporation.
EX-10.1 3 g72702ex10-1.txt TERMINATION, ASSIGNMENT AND RELEASE AGREEMENT EXHIBIT 10.1 TERMINATION, ASSIGNMENT AND RELEASE AGREEMENT This TERMINATION, ASSIGNMENT AND RELEASE AGREEMENT ("Agreement") is dated as of the 30th day of September, 2001 and is by and among (i) COUNSEL NURSING PROPERTIES, INC., a Delaware corporation ("CNP") and COUNSEL CORPORATION [US], a Delaware corporation ("CC[US]") and the successor by name change to Diversicare Corporation of America ("DCA"), (ii) DIVERSICARE LEASING CORP., a Tennessee corporation ("DLC") and ADVOCAT INC., a Delaware corporation ("Advocat"), and (iii) OMEGA HEALTHCARE INVESTORS, INC., a Maryland corporation ("Omega"), OHI SUNSHINE, INC., a Florida corporation ("OHI"), and STERLING ACQUISITION CORP., a Kentucky corporation ("Sterling"). RECITALS: A. Pursuant to that certain Master Lease dated as of August 14, 1992 between DCA and Omega (the "Master Lease") DCA leased from Omega nineteen (19) licensed nursing facilities located in the states of Tennessee, Arkansas and Alabama. B. CNP is the owner of three (3) parcels of real property located in the State of Florida in the counties of DeSoto, Hardee and Lake, respectively, and more particularly described in Exhibit "A" attached hereto and incorporated herein by reference, each one of which has been improved with one (1) or more buildings and related improvements for the operation of a licensed nursing home facility or adult care center known, respectively, as DeSoto Manor Nursing Center, Hardee Manor Care Center and Leesburg Nursing Center (each such property herein a "Mortgaged Facility" and collectively the "Mortgaged Facilities"). C. Pursuant to that certain Florida Loan Agreement dated as of August 14, 1992, as amended by that certain First Amendment to Florida Loan Agreement dated as of August 17, 1993, and as further amended by that certain Consent, Assignment and Amendment Agreement (the "Consent, Assignment and Amendment Agreement") dated May 10, 1994 by and among DCA, CNP, Advocat, DLC, and Omega (as so amended, the "Loan Agreement"), CNP obtained a first mortgage loan in the amount of Seven Million Thirty-One Thousand Two Hundred Fifty and No/100 Dollars ($7,031,250.00) (the "Mortgage Loan") from Omega. D. The Mortgage Loan is evidenced by that certain Mortgage Note dated as of August 14, 1992 made by CNP and payable to Omega, as amended and restated by that certain Amended and Restated Mortgage Note dated as of August 14, 1993 (as so amended and restated, the "Mortgage Note"). E. The Mortgage Loan is guaranteed by CC[US], as the successor by name change to DCA, pursuant to that certain Guaranty Agreement made by DCA in favor of Omega and dated as of August 14, 1992 (the "CC[US] Guaranty") and is secured by certain instruments, including, but not limited to, (i) that certain Mortgage and Security Agreement and Fixture Filing made and executed by CNP in favor of Omega on August 11, 1992 and recorded in each of DeSoto, Hardee and Lake County, Florida (the "Mortgage") and (ii) that certain Security Agreement made by CNP in favor of Omega dated as of August 14, 1992 and related UCC-1 Financing Statements (together, the "CNP 1 Security Instruments"), and (iii) the deposit requirements of that certain Letter of Credit Agreement dated as of August 14, 1992 by and between Omega and DCA (the "Letter of Credit Agreement"). F. CNP leased the Mortgaged Facilities to DLC pursuant to the terms and conditions of that certain Florida Lease Agreement dated as of May 10, 1994 (the "Florida Lease"), which Florida Lease was made with the consent and approval of Omega. G. Pursuant to terms of the Florida Lease, and that certain Assignment and Assumption Agreement dated as of May 10, 1994 (the " Assumption Agreement"), DLC assumed the payment and performance of the debts, liabilities and obligations of CNP under the Loan Agreement, the Mortgage Note, the Mortgage, and the CNP Security Instruments and agreed to make rental payments under the Florida Lease at such times and in such amounts as would satisfy the payments due under the Mortgage Note. Simultaneously with the making of the Florida Lease and the Assumption Agreement, Advocat executed and delivered a Guaranty in favor of Omega dated May 10, 1994 (the "Advocat Guaranty") pursuant to which Advocat guaranteed the payment and performance of the obligations of DLC under the Florida Lease. DLC has further executed a certain UCC-3 Financing Statement (the "DLC Financing Statement") for filing in the State of Florida to evidence the assumption by DLC of the obligations of CNP under the CNP Security Instruments and to reflect DLC as the assignee of the debtor on the related UCC-1 Financing Statements that are a part of the CNP Security Instruments. H. Pursuant to the terms of the Consent, Assignment and Amendment Agreement, DCA assigned its interest in the Master Lease and certain related documents listed in Exhibit "A" to the Consent, Assignment and Amendment Agreement (collectively, the "Master Lease Documents") to CNP; CNP accepted such assignment and immediately assigned all of its interest in the Master Lease Documents to DLC. Pursuant to the terms of the Consent, Assignment and Amendment Agreement, DLC accepted such assignment and assumed the obligations of DCA under the Master Lease Documents. Such assignments were made without release of DCA. Pursuant to the Consent, Assignment and Amendment Agreement, DCA remained primarily liable for the payment and performance of all obligations under the Master Lease Documents and DCA specifically confirmed and ratified (i) its guaranties of each of the Florida Loan Obligations (as defined below); and (ii) its liabilities under the Master Lease (the "Master Lease Obligations"). I. CNP and DLC have elected to terminate the Florida Lease as between themselves, and, pursuant to Article 4 of the Florida Lease and Section 7 of the Mortgage Note, have elected to have CNP convey the Mortgaged Facilities and all Personal Property (as defined in the Florida Lease) located at the Mortgaged Facilities to OHI and Sterling, in full satisfaction of the Mortgage Loan and, by this document, the parties wish to evidence the termination of the Florida Lease between CNP and DLC and the release and discharge of CNP, CC[US], Advocat, and DLC of their respective debts, obligations and liabilities in respect to the Florida Loan and, except as hereinafter specifically provided with respect to Leesburg Nursing Center, the Florida Lease, and the release and discharge of CC[US] and DLC of their respective debts, obligations and liabilities in respect of the Master Lease Documents. NOW, THEREFORE, in consideration of the foregoing premises, the conveyance of the Mortgaged Facilities and Personal Property to Omega, and for other good and valuable 2 consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: ARTICLE 1 DEFINITIONS 1.1 Definitions. For purposes of this Agreement, except as otherwise expressly provided or unless the context requires otherwise, (i) the terms defined in this Article have the meanings assigned to them in this Article and include the plural as well as the singular and (ii) all capitalized terms used herein and not otherwise defined herein have the meanings assigned to them in accordance with the Florida Loan Documents or the Florida Lease Documents, as hereinafter defined. "Advocat Guaranty" shall mean and refer to that certain Advocat, Inc. Guaranty dated May 10, 1994 made by Advocat in favor of Omega, and any modifications, renewals or extensions thereof or thereto. "Assumption Agreement" shall mean and refer to that certain Assignment and Assumption Agreement (Omega Financing) dated as of May 10, 1994 made by and among Counsel Healthcare Assets, Inc., an Ontario corporation, CNP and DCA, as Assignors, and DLC, as Assignee, and any modifications, renewals or extensions thereof or thereto. "CC[US] Guaranty" shall mean and refer to that certain Guaranty Agreement dated as of August 14, 1992 made by DCA in favor of Omega, and any modifications, renewals or extensions thereof or thereto. "Collateral Assignment" shall mean and refer to that certain Collateral Assignment of Warranties, Guarantees and Sureties dated August 14, 1992 made by CNP and assigning to Omega as collateral security for the Mortgage Loan all of CNP's rights in any warranties, guaranties or sureties relating to the Mortgaged Facilities, and any extensions, renewals or modifications thereof or thereto. "Consent, Assignment and Amendment Agreement" shall mean and refer to that certain Consent, Assignment and Amendment Agreement dated May 14, 1994 by and among DCA, CNP, Advocat, DLC and Omega, and any extensions, renewals or modifications thereof or thereto. "CNP Security Instruments" shall mean and refer to that certain Security Agreement securing payments and performance of the Mortgage Loan made by CNP in favor of Omega dated as of August 14, 1992 and related UCC-1 Financing Statements, and any modifications, renewals and extensions thereof or thereto. "DLC Financing Statement" shall mean and refer to the UCC-3 Financing Statement filed in the State of Florida with respect to the Mortgaged Facilities to evidence DLC as the assignee of CNP as the debtor there under, and any modifications, renewals and extensions thereof or thereto. "Florida Lease Documents" shall mean and refer to, collectively, the Florida Lease and all documents, instruments, certificates and financing statements required or permitted there under. 3 "Florida Loan Documents" shall mean and refer to the Loan Agreement, the Mortgage Note, the Mortgage, the CNP Security Instruments, the DLC Financing Statement, the Collateral Assignment, the Letter of Credit Agreement and all documents, instruments, certificates and financing statements required or permitted there under. "Florida Loan Obligations" shall mean and refer to the obligations of CNP and DLC to Omega under the Florida Lease Loan Documents. "Letter of Credit Agreement" shall mean and refer to that certain Letter of Credit Agreement dated as of August 14, 1992 by and between Omega and DCA with DCA providing for a letter of credit in full or partial satisfaction of the performance deposit obligations of CNP under the Loan Agreement, and any extensions, renewals or modifications thereof or thereto. "Loan Agreement" shall mean and refer to that certain Florida Loan Agreement dated as of August 14, 1992, as amended by that certain First Amendment to Florida Loan Agreement dated as of August 17, 1993, and as further amended by that certain Consent, Assignment and Amendment Agreement dated May 10, 1994 by and among DCA, CNP, Advocat, DLC, and Omega, pursuant to which CNP obtained the Mortgage Loan from Omega. "Master Lease" shall mean and refer to that certain Master Lease dated August 14, 1992 between DCA and Omega, as assigned by DCA to CNP, and as further assigned by CNP to DLC, such assignments having been made pursuant to the terms of the Consent, Assignment and Amendment Agreement. "Master Lease Documents" shall mean and refer to, collectively, the Master Lease and those other documents enumerated in Exhibit "A" to the Consent, Assignment and Amendment Agreement, namely, the Agreement of Acquisition and the Lease by and among Omega and DCA, the Security Agreement made by DCA in favor of Omega, the Letter of Credit Agreement and the Security Agreement made by DLC in favor of Omega. "Master Lease Obligations" shall mean and refer to, collectively, the obligations of CC[US] and DLC under the Master Lease Documents. "Mortgage" shall mean and refer to that certain Mortgage and Security Agreement and Fixture Filing executed and delivered by CNP on August 11, 1992 in favor of Omega to secure the Mortgage Loan and recorded as an encumbrance against the Mortgaged Facilities in each of DeSoto, Hardee and Lake County, Florida, and any modifications, renewals and extensions thereof or thereto. "Mortgage Loan" shall mean and refer to that certain mortgage loan in the original principal amount of $7,031,250.00 made by Omega to CNP and evidenced and secured by the Loan Documents, and any renewals or extensions thereof. "Mortgage Note" shall mean and refer to that certain Mortgage Note in the original principal amount of Seven Million Thirty-One Thousand Two Hundred Fifty and No/100 Dollars ($7,031,250.00) dated as of August 14, 1992 made by CNP and payable to Omega, as amended and restated by that certain Amended and Restated Mortgage Note dated as of August 14, 1993, and any modifications, extensions and renewals thereof or thereto. 4 "Mortgaged Facility" or "Mortgaged Facilities" shall mean and refer to, individually or collectively, as the case may be, the nursing home or adult care facilities owned by CNP and located in the counties of DeSoto, Hardee and Lake, respectively, in the State of Florida that are the subject of the Florida Lease and the Mortgage Loan. ARTICLE 2 TERMINATION AND ASSIGNMENT OF FLORIDA LEASE 2.1 Termination of Lease as to Certain Facilities. The Florida Lease shall be and is hereby canceled and terminated, and all of its terms and conditions shall be and are hereby deemed to be of no further force and effect, with respect to each of the Mortgaged Facilities known as Hardee Manor Care Center (the "Hardee Facility") and DeSoto Manor Nursing Center (the "DeSoto Facility") as of the ____ day of September, 2001 (the "Lease Termination Date"). From and after the Lease Termination Date, each of the parcels of real property located in the State of Florida in the counties of DeSoto and Hardee and more particularly described on Exhibit A attached hereto, and the nursing home facilities located thereon, shall no longer be subject to the terms and conditions of the Florida Lease. As of the Lease Termination Date, each of CNP and DLC shall be and hereby is released in full from each and all of their respective covenants, agreements, duties, responsibilities, liabilities and obligations under the Florida Lease as to the Hardee Facility and the DeSoto Facility, and CNP and DLC each hereby releases and forever discharges the other from any claims or demands that either of them now has or may have against the other with respect to either of such Mortgaged Facilities under the Florida Lease. 2.2 Memorandum of Termination. Concurrently herewith, CNP and DLC shall execute and deliver to Omega, in recordable form, a memorandum of this Agreement or other appropriate instrument evidencing the termination of the Florida Lease as to each of the Hardee Facility and the DeSoto Facility for recording in the real estate records of the counties in which each of such Mortgaged Facilities is located. 2.3 Assignment of Lease as to Leesburg Facility. The Florida Lease shall remain in effect with respect to the Mortgaged Facility known as Leesburg Nursing Center (the "Leesburg Facility") from and after the date hereof. By deed and bill of sale made concurrently herewith, CNP has conveyed to OHI the real property described on Exhibit A attached hereto located in Lake County, Florida and the improvements and other assets comprising the Leesburg Facility. Effective as of the date hereof, CNP hereby transfers, conveys, assigns, and sets over to OHI all of the right, title and interest of CNP as Lessor in, to and under the Florida Lease with respect to the Leesburg Facility. OHI does hereby assume and agree to perform, keep and observe all of the duties and obligations to be performed, kept, observed and discharged by the Lessor under the Florida Lease with respect to the Leesburg Facility from and after the date hereof. From and after the date hereof, all references to "Lessor" in the Florida Lease shall be deemed to mean and refer to OHI. DLC does hereby attorn to and recognize OHI as the Lessor under the Florida Lease with respect to the Leesburg Facility from and after the date hereof. OHI does hereby recognize DLC as the Lessee under the Florida Lease with respect to the Leesburg Facility and acknowledges and agrees that, subject to the observance and performance of the duties, responsibilities and obligations of the Lessee under the Florida Lease with respect to the Leesburg Facility, DLC shall continue to have and enjoy all the rights of the Lessee to hold, occupy, use and enjoy the Leesburg Facility during the 5 remainder of the term of the Florida Lease (subject to Sections 2.5 and 2.6. hereof). Effective as of the date hereof, CNP shall be and hereby is released in full from each and all of its respective covenants, agreements, duties, responsibilities, liabilities and obligations under the Florida Lease with respect to the Leesburg Facility and CNP and DLC each hereby releases and forever discharges the other from any claims or demands that either of them now has or may have against the other with respect to the Leesburg Facility under the Florida Lease. OHI and DLC agree that in consideration of the satisfaction of the Mortgage Note provided for herein, effective as of the date hereof Section 2.3 of the Florida Lease shall be and hereby is amended to provide that the Annual Rental due and payable by DLC under the Florida Lease is and shall hereafter be the sum of One Dollar ($1.00) and that Paragraphs A through D of Section 2.3 of the Florida Lease providing for certain adjustments to Annual Rent are hereby deleted and declared to be of no further force and effect. Annual Rent, as herein provided, shall be due and payable on January 1st of each year during the remainder of the term of the Florida Lease. 2.4 Memorandum of Assignment. Concurrently herewith, CNP, OHI and DLC shall execute and deliver, in recordable form, a memorandum of this Agreement or other appropriate instrument evidencing the assignment of the Florida Lease with respect to the Leesburg Facility for recording in the real estate records of the county in which the Leesburg Facility is located. 2.5 Termination of Lease as to Leesburg. The Florida Lease shall continue in effect with respect to the Leesburg Facility until the Commencement Date of that certain Master Lease between OHI, as Lessor, and LandCastle Diversified LLC, as Lessee (the "New Lease"), which Commencement Date is conditioned upon the Florida Department of Human Services approving the change of ownership application for the Leesburg Facility and the issuance of a license to operate the Leesburg Facility in favor of Leesburg Health & Rehab L.L.C. (the "New Operator"). The Florida Lease shall be terminated with respect to the Leesburg facility and deemed to be of no further force and effect as of the Commencement Date of the New Lease. As of the Commencement Date of the New Lease, each of OHI and DLC shall be and hereby is released in full from each and all of their respective covenants, agreements, duties, responsibilities, liabilities, and obligations under the Florida Lease with respect to the Leesburg Facility and OHI and DLC each hereby releases and forever discharges the other from any claims or demands that either of them has or may have against the other with respect to the Leesburg Facility under the Florida Lease. On the Commencement Date of the New Lease, OHI and DLC shall execute and deliver, in recordable form, a memorandum or other appropriate instrument evidencing the termination of the Florida Lease with respect to the Leesburg Facility for recording in the real estate records of the counties in which the Leesburg Facility is located. 2.6 Closure of Leesburg Facility. In the event that the Commencement Date of the New Lease and the transfer of operation of the Leesburg Facility to the New Operator does not occur on or before January 31, 2002, then Omega, OHI, DLC and Advocat agree that DLC shall have a period of ninety (90) days after such date to attempt to sell the Leesburg Facility as an operating nursing home. DLC shall promptly commence and actively pursue marketing the Leesburg Facility during said ninety (90) day period. The parties will cooperate with each other in good faith and use commercially reasonable efforts in attempting to sell the Leesburg Facility as an operating nursing home. If DLC is unable to accomplish such sale with in said ninety (90) day period, then Omega, OHI, Advocat and DLC agree that the Florida Lease shall be terminated, the Leesburg Facility shall 6 be closed, and the real estate and other assets comprising the Leesburg Facility sold as soon as reasonably practical thereafter. Advocat and DLC shall be responsible for the cost and expense of the closing of the Leesburg Facility. The proceeds of the sale of the Leesburg Facility as an operating nursing home or the sale of the real estate and other assets comprising the Leesburg Facility after its closure shall be shared in accordance with that certain Revenue Sharing Agreement between Omega, OHI, Advocat and DLC made and executed concurrently herewith. 2.7 Facilities Conveyed in As-Is Condition. By deed made and delivered concurrently herewith, CNP has conveyed the real property and improvements comprising the Hardee Facility to Sterling and has conveyed the real property and improvements comprising each of the DeSoto Facility and the Leesburg Facility to OHI. CNP makes no representations or warranties of any kind, express, implied, statutory or otherwise, with respect to the condition of the real property and improvements comprising each of the Hardee Facility, the DeSoto Facility and the Leesburg Facility, including without limitation any warranty of habitability, suitability or fitness for any particular use or purpose or the environmental condition of the property. OHI and Sterling each agree that the real property and improvements comprising each of the Hardee Facility, the DeSoto Facility and the Leesburg Facility are being conveyed by CNP, and Sterling accepts the Hardee Facility, and OHI accepts the DeSoto Facility and the Leesburg Facility, in "as is" and "where is" condition. The provisions of this Section 2.7 shall survive the conveyance of each of the Hardee Facility, the DeSoto Facility and the Leesburg Facility by CNP to Sterling and OHI. ARTICLE 3 SATISFACTION, RELEASE AND DISCHARGE OF LOAN OBLIGATIONS 3.1 Satisfaction of Mortgage Loan. Omega hereby accepts the transfer and conveyance of the Mortgaged Facilities and the Personal Property from CNP made concurrently herewith in full payment and satisfaction of the Mortgage Loan and all amounts due under the Mortgage Note for principal, interest, the Participation Factor described therein and all other sums due there under. 3.2 Omega Release of CNP and CC[US]. Omega does hereby irrevocably and unconditionally release and forever discharge each of CNP and CC[US], and their respective directors, officers, successors and assigns (collectively, the "Indemnified Persons") of and from any and all claims, demands, actions, causes of action, rights, remedies or suits which Omega ever had, now has or might hereafter have against either of CNP or CC[US], under, arising out of, relating to or connected with (i) each and every one of the Florida Loan Documents and any other documents or instruments evidencing, securing or otherwise relating to the Mortgage Loan, (ii) CC[US]'s guarantee of the Florida Loan Obligations as provided in the Consent, Assignment and Amendment Agreement, (iii) the CC[US] Guaranty, (iv) the Master Lease Documents and (v) the Master Lease Obligations. Omega agrees that, from and after the date hereof, neither CNP nor CC[US] shall have any debts, liabilities or obligations to Omega under or in respect of any of the Florida Loan Documents, the CC[US] Guaranty, the Master Lease Documents, the Assignment and Assumption Agreement or the Consent, Assignment and Amendment Agreement. 3.3 Omega Release of DLC and Advocat. Omega does hereby irrevocably and unconditionally release and forever discharge each of DLC and Advocat, and their respective directors, officers, successors and assigns (collectively, the "Indemnified Persons"), of and from any and all claims, demands, actions, causes of action, rights, remedies or suits which Omega ever had, 7 now has or might have against either of DLC or Advocat, under, arising out of, relating to, or connected with (i) each and every one of the Florida Loan Documents (except as specifically provided in Section 3.7 hereof with respect to the DLC Financing Statement), the Florida Lease Documents (except as specifically provided in Article 2 hereof with respect to the Leesburg Facility), the Assumption Agreement and any other documents or instruments evidencing securing or otherwise relating to the Mortgage Loan and the Florida Lease, (ii) the Consent, Assignment and Amendment Agreement, (iii) the Master Lease Documents and (iv) the Advocat Guaranty. Omega agrees that, from and after the date hereof, neither DLC nor Advocat shall have any debts, liabilities or obligations to Omega under or in respect of any of the Florida Loan Documents (except as specifically provided in Section 3.7 hereof with respect to the DLC Financing Statement), the Florida Lease Documents (except as specifically provided in Article 2 hereof with respect to the Leesburg Facility), the Assignment and Assumption Agreement, the Consent, Assignment and Amendment Agreement, the Master Lease Documents or the Advocat Guaranty. Anything herein to the contrary notwithstanding, it is understood and agreed that the release by Omega of Advocat and DLC set forth in this Section 3.3 does not and shall not be deemed to modify, amend, release or otherwise affect in any manner whatsoever the liabilities and obligations of DLC and Advocat to Sterling under, arising out of, relating to, or connected with the Consolidated Amended and Restated Master Lease dated as of November 8, 2000 by and between Sterling and DLC (the "Sterling Master Lease"), the Restated and Amended Security Agreement dated as of November 8, 2000 by and between Sterling and DLC, the Guaranty of Advocat dated as of November 8, 2000 made by Advocat in favor of Sterling, and any other agreements, documents or instruments which evidence, secure or otherwise relate to the liabilities and obligations of DLC or Advocat under or with respect to the Sterling Master Lease (collectively, the "Sterling Transaction Documents"), including without limitation the Subordinated Note dated as of November 3, 2000 made by Advocat in favor of Omega (the "Subordinated Note"). DLC and Advocat each agree that their respective obligations and liabilities under or with respect to the Sterling Master Lease and the other Sterling Transaction Documents, including without limitation the Subordinated Note, are not released or discharged by this Agreement and the same are and shall remain in full force and effect in accordance with their respective terms. 3.4 CNP Release of DLC. CNP hereby irrevocably and unconditionally releases and forever discharges DLC, and its directors, officers, successors and assigns, of and from (a) any and all liabilities or obligations of DLC to CNP and (b) any and all claims, demands, actions, causes of action, rights, remedies or suits which CNP ever had, now has or might hereafter have against DLC, in the case of each of (a) and (b), under, arising out of, relating to, or connected with the Florida Loan Documents. CNP hereby agrees that from and after the date hereof DLC shall not have any obligations to CNP under or in respect of the Assumption Agreement, the Consent, Assignment and Amendment Agreement or the Florida Lease in connection with any liabilities or obligations of, or indebtedness owed by, CNP to Omega under or in respect of any of the Florida Loan Documents, the Florida Lease Documents or the Master Lease Documents. 3.5 DLC Release of CNP. DLC hereby irrevocably and unconditionally releases and forever discharges CNP and its directors, officers, successors and assigns, of and from (a) any and all liabilities or obligations of CNP to DLC and (b) any and all claims, demands, actions, causes of action, rights, remedies or suits which DLC ever had, now has or might hereafter have against CNP, in the case of each of (a) and (b), under, arising out of, relating to, or connected with the Florida Loan Documents. DLC hereby agrees that from and after the date hereof CNP shall not have any obligations to DLC under or in respect of the Assumption Agreement, the Consent, Assignment and 8 Amendment Agreement or the Florida Lease in connection with any liabilities or obligations of, or indebtedness owed by DLC to Omega under or in respect of any of the Florida Loan Documents, the Florida Lease Documents or the Master Lease Documents. 3.6 Representations and Warranties. Each of the parties hereto hereby represents and warrants to the other parties that it has full power, authority and legal right to execute and deliver this Agreement and to keep, observe and perform all the terms and provisions of this Agreement on its part to be kept, observed or performed hereunder, and that this Agreement constitutes the legal, valid and binding obligations of such party enforceable against such party in accordance with its terms. Each of the parties hereto further hereby represents and warrants to each of the other parties that it has not heretofore assigned, transferred or attempted or purported to, and will not, assign or transfer to any person, firm corporation or other entity any claims against the other parties hereby released or discharged in this Agreement. 3.7 Release of Liens and Collateral Security. Omega hereby releases and discharges in full all liens, mortgages, pledges, charges, security interests and other encumbrances granted by CNP, DLC and CC[US] in favor of Omega as security for (i) the obligations of CNP or DLC under the Florida Loan Documents, (ii) the obligations of CNP or (except as specifically provided herein) DLC under the Florida Lease Documents, (iii) the obligations of CC[US] under the CC[US] Guaranty, or (iv) the obligations of CC[US] under the Master Lease Documents, including without limitation the Mortgage, the CNP Security Instruments and the DLC Financing Statements. The Collateral Assignment and the Letter of Credit Agreement are each hereby terminated and declared to be of no further force and effect. Anything herein to the contrary notwithstanding, Omega, Advocat and DLC agree that the DLC Financing Statement shall be released and terminated only as to the DeSoto Facility but shall remain in effect with respect to the Leesburg Facility and the Hardee Facility to evidence and continue the perfection of the security interest in the collateral described in and covered by the DLC Financing Statement located at, used in connection with, or arising from or in connection with the operation and use by DLC of, the Hardee Facility and the Leesburg Facility (the "Collateral"). The DLC Financing Statement shall be released and terminated with respect to the Leesburg Facility upon termination of the Florida Lease or closure of the Leesburg Facility as provided in Article 2 hereof. The Hardee Facility has simultaneously herewith been made a leased property under, and subjected to the terms and provisions of, the Sterling Master Lease, and the Amended and Restated Security Agreement made in connection therewith. The DLC Financing Statement shall remain in effect with respect to the Hardee Facility in accordance with the terms of such Amended and Restated Security Agreement. DLC hereby acknowledges, confirms and ratifies the security interest evidenced by the DLC Financing Statement and granted by DLC in the Collateral as security for (i) with respect to the Hardee Facility, the Liabilities described in the Amended and Restated Security Agreement and (ii) with respect to the Leesburg Facility, the continued performance by DLC of its obligations under the Florida Lease on and after the date hereof. Omega, Advocat and DLC each agree to prepare, execute, deliver and file any additional UCC-3 Financing Statements necessary or appropriate to reflect the continuation of the security interest in the Collateral and to otherwise assure that the benefits of the DLC Financing Statement as to the Hardee Facility and the Leesburg Facility continue to be realized. 3.8 Delivery of Documents. Concurrently herewith (i) CNP shall execute and deliver to Omega appropriate warranty deeds to the Mortgaged Facilities and bills of sale for the Personal Property located thereon; (ii) Omega shall execute and deliver to CNP a full release of the lien 9 evidenced by the Mortgage and shall execute and deliver to CNP and DLC a full release and termination of the UCC-1 and UCC-3 Financing Statements relating to the Mortgaged Facilities, the Florida Lease and the security interest of Omega evidenced thereby; and (iii) Omega shall deliver to CC[US] the executed original of the Mortgage Note and shall deliver to each of the CNP and Advocat, respectively, the CNP Guaranty and the Advocat Guaranty. Omega shall clearly mark each of the Mortgage Note, the CC[US] Guaranty and the Advocat Guaranty to indicate the satisfaction of the indebtedness and obligations with respect to the Mortgage Loan and the Florida Lease evidenced thereby and the release and discharge of CNP, CC[US] and Advocat, respectively, from any further liability or obligation with respect thereto. In the event that there still exists any letter of credit outstanding under the Letter of Credit Agreement to satisfy the Performance Deposit obligations of CNP under the Loan Agreement, Omega shall return the original of such existing letter of credit to the issuer thereof for cancellation. 3.9 Cooperation. At all times following the execution of this Agreement, each party agrees to cooperate in good faith with the others to execute and deliver, or cause to be executed and delivered, such documents, and to do, or cause to be done, such other acts or things as might be necessary or as might be reasonably requested by any other party to give effect the intent of this Agreement and assure that the benefits of this Agreement are realized by each of the parties hereto. ARTICLE 4 MISCELLANEOUS PROVISIONS 4.1 Amendment; Modification. This Agreement may not be amended or modified except by a written instrument executed by all of the parties hereto. 4.2 Notices. Any notice hereunder shall be given in writing and shall be deemed to have been duly given either personally delivered or mailed, registered or certified mail, postage prepaid, or by national overnight delivery service (such as Federal Express or DHL) and properly addressed as follows: If to CNP and/or CC[US]: c/o Counsel Corporation Exchange Tower, Suite 1300 Two First Canadian Place Toronto, Ontario M5X 1E3 Attention: Allan C. Silber with a copy to: Stikeman Elliott Suite 5300 Commerce Court West Toronto, ON M5L 1B9 Attention: Darin Renton 10 If to Advocat and/or DLC: Suite 130 277 Mallory Station Road Franklin, Tennessee 37067 Attention: Dr. Charles Birkett with a copy to: Harwell Howard Hyne Gabbert & Manner, P.C. 1800 First American Center 315 Deaderick Street Nashville, Tennessee 37238 Attention: Mark Manner, Esq. If to Omega, OHI and/or Sterling: c/o Omega Healthcare Investors, Inc. 900 Victors Way, Suite 350 Ann Arbor, Michigan 48108 Attention: Taylor Pickett with a copy to: Dykema Gossett, PLLC 39577 Woodward Avenue, Suite 300 Bloomfield Hills, MI 48304 Attention: Fred J. Fechheimer or to such other address as any of the foregoing parties may designate. Notice shall be deemed to have been given on the date of delivery if such delivery is made on a business day, or, if not, on the first business day after delivery, or if delivery is refused, on the date delivery was first attempted, provided that a notice sent by facsimile transmission shall be deemed given upon confirmation by the sender from recipient that such notice was received. 4.3 Governing Law. This Agreement shall be construed and enforced in accordance with the laws of the State of Florida. 4.4 Multiple Counterparts. This Agreement may be executed simultaneously in one or more counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument. 4.5 Captions. The captions of sections and sub-sections of this Agreement have been inserted solely for convenience and reference, and shall not control or affect the meaning or construction of any provisions of this Agreement. 11 4.6 Integration; Waivers. This Agreement and all the Exhibits hereto constitute the entire agreement between the parties pertaining to the subject matter contained herein and therein and supersede all prior agreements, representations and understandings of the parties performing to the subject matter contained herein. No supplement, modification or amendment of this Agreement shall be binding, unless expressed as such and executed in writing by all of the parties hereto. No waiver of any provision of this Agreement shall be deemed to be effective unless in writing and signed by the party to be bound. 4.7 Binding Effect. This Agreement shall be binding upon and shall inure to the benefit of each of the parties hereto and their respective legal representatives, successors and assigns. 12 IN WITNESS WHEREOF, this Agreement has been executed and delivered by the parties as of the date set forth on page 1 hereof. COUNSEL CORPORATION [US] COUNSEL NURSING PROPERTIES, INC. By: /s/ Stephen Weintraub By: /s/ Stephen Weintraub -------------------------------- ------------------------------- Its: Vice President and Secretary Its: Vice President and Secretary -------------------------------- ------------------------------- ADVOCAT INC. DIVERSICARE LEASING CORP. By: /s/ William R. Council III By: /s/ William R. Council III -------------------------------- ------------------------------- Its: Executive Vice President and Its: Executive Vice President and Chief Financial Officer Chief Financial Officer -------------------------------- ------------------------------- OMEGA HEALTHCARE INVESTORS, INC. OHI SUNSHINE, INC. By: /s/ Scott Kellman By: /s/ Scott Kellman -------------------------------- ------------------------------- Its: Chief Operating Officer Its: Chief Operating Officer -------------------------------- ------------------------------- STERLING ACQUISITION CORP. By: /s/ Scott Kellman ------------------------------- Its: Chief Operating Officer ------------------------------- 13 EXHIBIT "A" MORTGAGED FACILITIES I. DESOTO COUNTY Name of Facility: DeSoto Manor Nursing Home Facility Address: 1002 North Brevard Avenue, Arcadia, Florida 34266 Legal Description: Begin at the Southeast corner of Northeast 1/4 of Southwest 1/4 of Section 30, Township 37 South, Range 25 East; thence North 00 degrees 02 minutes East along the East line of said tract, 280.00 feet to Point of Beginning; thence continue same line 400.00 feet; thence South 89 degrees 44 minutes 06 seconds West, 460.14 feet to the East Boundary of the Baptist Church Property; thence South 00 degrees 08 minutes East 400.00 feet to the North boundary of the DeSoto Hospital property; thence North 89 degrees 44 minutes 06 seconds East 458.98 feet to the Point of Beginning. II. LAKE COUNTY Name of Facility: Leesburg Nursing Center Facility Address: 715 East Dixie Avenue, Leesburg, Florida 34748 Legal Description: Parcel A: A part of the Northwest 1/4 of the Southwest 1/4 of Section 25, Township 19 South, Range 24 East, Lake County, Florida, being more particularly described as follows: Begin at the intersection of the South right-of-way of Dixie Avenue and the West right-of-way line of Lake Street; run thence Southerly along the said West right-of-way of Lake Street a distance of 450.0 feet; thence Westerly parallel with the South right-of-way of Dixie Avenue 200.0 feet; thence Northerly parallel with the West right-of-way of Lake Street 450.0 feet to the South right-of-way of Dixie Avenue; run thence Easterly along said South right-of-way of Dixie Avenue 200.0 feet to the Point of Beginning. Parcel B: A part of the Northwest 1/4 of the Southwest 1/4 of Section 25, Township 19 South, Range 24 East, Lake County, Florida, being more particularly described as follows: 14 From the Northwest corner of the Southwest 1/4 of Section 25, run Southerly along the West line of Section 25 a distance of 60.43 feet to the South right-of-way line of Dixie Avenue; thence Easterly along the South right-of-way of Dixie Avenue 1285.48 feet to the West right-of-way of Lake Street; thence Southerly along the West right-of-way of Lake Street 450.0 feet to the Point of Beginning; thence West parallel with said South right-of-way of Dixie Avenue 200.0 feet; thence South parallel with the right-of-way of Lake Street, 150.0 feet; thence East parallel with Dixie Avenue 200.0 feet to Lake Street; thence North along right-of-way of Lake Street 150.0 feet to the Point of Beginning. III. HARDEE COUNTY Name of Facility: Hardee Manor Care Center Facility Address: 401 Orange Place, Wauchula, Florida 33873 Legal Description: All of Blocks E and F of MOONLIGHT PARK SUBDIVISION, to the City of Wauchula, in Section 9, Township 34 South, Range 25 East and in Plat Book 4, Page 9, public records of Hardee County, Florida. Being the same property conveyed to Grantor herein by Warranty Deed recorded in Book 244, Page 522, in the Office of the Circuit Court Clerk, Hardee County, Florida. AND That portion of Ninth Avenue lying between Orange Place and Grove Street and between Blocks E and F of MOONLIGHT PARK SUBDIVISION to the City of Wauchula, public records of Hardee County, Florida. Being the same property conveyed to Grantor herein by Warranty Deed recorded in Book 257, Page 497, in the office of Circuit Court clerk, Hardee County, Florida. 15 EX-10.2 4 g72702ex10-2.txt SETTLEMENT AND RELEASE AGREEMENT EXHIBIT 10.2 SETTLEMENT AND RELEASE AGREEMENT This Settlement and Release Agreement (the "Agreement") is entered into and effective as of 11:30, CST, on August 31, 2001 by and between Texas Diversicare Limited Partnership, a Texas limited partnership (the "Partnership") and Diversicare Leasing Corp., a Tennessee corporation ("DLC"). RECITALS WHEREAS, The Partnership executed and delivered a Wraparound Promissory Note (the "Wraparound Note") in the original amount of $ 7,500,000, dated August 30, 1991 to Diversicare Nursing Centers, Inc., a Florida corporation, which was assigned by Counsel Nursing Properties, Inc. (successor to Diversicare Nursing Centers, Inc. by merger) to DLC on August 10, 1994; WHEREAS, The Partnership is the owner of six nursing homes located in the state of Texas, in the counties of Caldwell, Goliad, Lampasas, Refugio and DeWitt; WHEREAS, The six nursing homes are known as Chisolm Trail Nursing and Rehabilitation Center, Goliad Nursing and Rehabilitation Center, Hillcrest Manor Nursing and Rehabilitation Center, Lampasas Nursing and Rehabilitation Center, Refugio Nursing and Rehabilitation Center, and Yorktown Nursing and Rehabilitation Center (collectively the "Nursing Homes"); WHEREAS, the Wraparound Note is secured by all of the real and personal property of the Nursing Homes pursuant to a Wraparound Deed of Trust dated August 30, 1991 (the "Wraparound Deed of Trust" and collectively with the Wraparound Note, the "Wraparound Mortgage") executed by the Partnership; WHEREAS, The Wraparound Note provides for a balloon payment of the remaining principal balance of approximately $ 6,500,000 on August 30, 2001; WHEREAS, The Partnership failed to make the required payment on August 30, 2001, and is now in default under the Wraparound Mortgage; WHEREAS, DLC has sent written notice to the Partnership demanding payment and informing the Partnership of its intent to foreclose on the assets of the Partnership if payment is not received immediately. WHEREAS, The Partnership has informed DLC that it does not have available sufficient assets to pay the outstanding amount under the Wraparound Note; and WHEREAS, DLC and the Partnership have agreed to the transfer of the assets of the Partnership to DLC in full settlement of the outstanding amounts under the Wraparound Note in exchange for the release of all remaining obligations of the Partnership under the Wraparound Mortgage. The parties have agreed to this settlement and release in lieu of DLC foreclosing on the Nursing Homes which secure the Wraparound Mortgage. NOW, THEREFORE, in consideration of the mutual premises, the conveyance of the real and personal property of the Nursing Homes to DLC in lieu of foreclosure, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties, intending to be legally bound hereby, agree as follows: 1 Satisfaction of Wraparound Mortgage. DLC hereby accepts the transfer and conveyance of the real estate and personal property from the Partnership made concurrently herewith in full payment and satisfaction of the Wraparound Promissory Note and all amounts due under the Wraparound Promissory Note for principal, interest, penalty, late fees and all other sums due thereunder. 2 DLC Release of the Partnership. DLC does hereby irrevocably and unconditionally release and forever discharge the Partnership, and its general partner and their respective directors, officers, successors and assigns (collectively, the "Indemnified Persons") of and from any and all claims, demands, actions, causes of action, rights, remedies or suits which DLC ever had, now has or might hereafter have against the Partnership, under, arising out of, relating to or connected with (i) the Wraparound Promissory Note, (ii) the Wraparound Deed of Trust, and (iii) any other documents or instruments evidencing, securing or otherwise relating to the Wraparound Mortgage. DLC agrees that, from and after the date hereof, the Partnership shall not have any debts, liabilities or obligations to DLC under or in respect of the Wraparound Mortgage. Anything herein to the contrary notwithstanding, it is understood and agreed that the release by DLC of the Partnership set forth in this Paragraph 2 does not and shall not be deemed to modify, amend, release or otherwise affect in any manner whatsoever the liabilities and obligations of the Partnership under (i) the Partnership Services Agreement entered into between the Partnership, Diversicare Incorporated, an Ontario corporation and Counsel Property Corporation, an Ontario corporation, dated as of November 2, 1990 (the "Partnership Services Agreement") as assigned to DLC pursuant to an Assignment and Assumption Agreement dated May 10, 1994, or (ii) the Guaranteed Return Loan Security Agreement (the "Guaranteed Return Agreement") between the same parties and dated the same date. 3 Release of Liens and Collateral Security. DLC hereby releases and discharges in full all liens, mortgages, pledges, charges, security interests and other encumbrances granted by the Partnership in favor of DLC as security for the obligations of the Partnership under the Wraparound Mortgage, including without limitation the Wraparound Deed of Trust, the Wraparound Promissory Note and any financing statements filed with respect to the foregoing. 4 Delivery of Documents. In connection herewith, (i) the Partnership shall execute and deliver to DLC appropriate warranty deeds to the Nursing Homes and bills of sale for the personal property located thereon; (ii) DLC shall execute and deliver to the Partnership a full release of the lien evidenced by the Wraparound Deed of Trust and shall execute and deliver to the Partnership a full release and termination of any UCC-1 and UCC-3 Financing Statements relating to the Nursing Homes and the security interest of DLC evidenced thereby; and (iii) DLC shall deliver to the Partnership the executed original of the Wraparound Promissory Note. DLC shall clearly mark the Wraparound Promissory Note to indicate the satisfaction of the indebtedness and obligations with respect to the Wraparound Mortgage Note evidenced thereby and the release and discharge of the Partnership from any further liability or obligation with respect thereto. 5 Cooperation. At all times following the execution of this Agreement, each party agrees to cooperate in good faith with the others to execute and deliver, or cause to be executed and delivered, such documents, and to do, or cause to be done, such other acts or things as might be necessary or as might be reasonably requested by any other party to give effect the intent of this Agreement and assure that the benefits of this Agreement are realized by each of the parties hereto. 6 Amendment; Modification. This Agreement may not be amended or modified except by a written instrument executed by all of the parties hereto. 7 Governing Law. This Agreement shall be construed and enforced in accordance with the laws of the State of Texas. 8 Multiple Counterparts. This Agreement may be executed simultaneously in one or more counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument. 9 Captions. The captions of paragraphs of this Agreement have been inserted solely for convenience and reference, and shall not control or affect the meaning or construction of any provisions of this Agreement. 10 Binding Effect. This Agreement shall be binding upon and shall inure to the benefit of each of the parties hereto and their respective legal representatives, successors and assigns. IN WITNESS WHEREOF, intending to be legally bound, each of the undersigned has executed this Agreement as of the time and date set forth above. TEXAS DIVERSICARE LIMITED PARTNERSHIP, by its General Partner, DIVERSACARE GENERAL PARTNER, INC. By: /s/ Charles H. Rinne --------------------------------- Authorized Signing Officer DIVERSICARE LEASING CORP. By: /s/ William R. Council III --------------------------------- Authorized Signing Officer -----END PRIVACY-ENHANCED MESSAGE-----