-----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, TiTeDlmqdRUZZPB71TBFCgOBKDCnA5v84ejeGnmA39pCUo50QrnTXxf8Hn87jmHJ G0Fvsmtl50IMsyzeiikK9g== 0000950144-02-005520.txt : 20020515 0000950144-02-005520.hdr.sgml : 20020515 20020515110735 ACCESSION NUMBER: 0000950144-02-005520 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020515 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: 02649045 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 g76086e10-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: MARCH 31, 2002 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 MAY 14, 2002) 1 PART I. FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS ADVOCAT INC. INTERIM CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS, AND UNAUDITED)
MARCH 31, DECEMBER 31, 2002 2001 --------- ------------ CURRENT ASSETS: Cash and cash equivalents $ 2,207 $ 3,426 Receivables, less allowance for doubtful accounts of $5,845 and $5,453, respectively 13,890 15,693 Inventories 537 550 Prepaid expenses and other assets 1,133 2,111 -------- -------- Total current assets 17,767 21,780 -------- -------- PROPERTY AND EQUIPMENT, at cost 91,975 90,669 Less accumulated depreciation and amortization (30,115) (28,790) -------- -------- Net property and equipment 61,860 61,879 -------- -------- OTHER ASSETS: Deferred financing and other costs, net 495 565 Deferred lease costs, net 1,826 1,878 Assets held for sale or redevelopment 1,064 1,064 Investments in and receivables from joint ventures 2,505 2,500 Other 1,347 1,404 -------- -------- Total other assets 7,237 7,411 -------- -------- $ 86,864 $ 91,070 ======== ========
(Continued) 2 ADVOCAT INC. INTERIM CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS, AND UNAUDITED) (CONTINUED)
MARCH 31, DECEMBER 31, 2002 2001 --------- ------------ CURRENT LIABILITIES: Current portion of long-term debt $ 21,775 $ 25,006 Short-term debt 33,699 33,719 Trade accounts payable 7,195 8,409 Accrued expenses: Payroll and employee benefits 5,233 5,482 Interest 331 179 Self-insurance reserves 6,209 7,894 Other 4,798 5,520 -------- -------- Total current liabilities 79,240 86,209 -------- -------- NONCURRENT LIABILITIES: Long-term debt, less current portion 4,573 4,613 Self-insurance reserves, less current portion 19,800 14,335 Other 3,346 2,943 -------- -------- Total noncurrent liabilities 27,719 21,891 -------- -------- COMMITMENTS AND CONTINGENCIES SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK authorized 600,000 shares, $.10 par value, 393,658 shares issued and outstanding at March 31, 2002 and December 31, 2001, respectively, at redemption value 3,646 3,589 -------- -------- SHAREHOLDERS' EQUITY: Series A Preferred stock, authorized 400,000 shares, $.10 par value, none issued and outstanding -- -- Common stock, authorized 20,000,000 shares, $.01 par value, 5,493,000 issued and outstanding at March 31, 2002 and December 31, 2001, respectively 55 55 Paid-in capital 15,908 15,908 Accumulated deficit (39,704) (36,582) -------- -------- Total shareholders' equity (23,741) (20,619) -------- -------- $ 86,864 $ 91,070 ======== ========
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 MARCH 31, ---------------------------- 2002 2001 --------- ---------- REVENUES: Patient revenues $ 40,691 $ 38,312 Resident revenues 10,179 10,420 Management fees 679 911 Interest 25 46 -------- -------- Net revenues 51,574 49,689 -------- -------- EXPENSES: Operating 43,728 39,735 Lease 5,180 5,175 General and administrative 3,159 3,235 Interest 1,092 1,516 Depreciation and amortization 1,383 1,411 -------- -------- Total expenses 54,542 51,072 -------- -------- LOSS BEFORE INCOME TAXES (2,968) (1,383) PROVISION FOR INCOME TAXES 93 90 -------- -------- NET LOSS $ (3,061) $ (1,473) ======== ======== BASIC AND DILUTED LOSS PER SHARE: Basic $ (.56) $ (.27) ======== ======== Diluted $ (.56) $ (.27) ======== ======== 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 COMPREHENSIVE INCOME (IN THOUSANDS AND UNAUDITED)
THREE MONTHS ENDED MARCH 31, ---------------------------- 2002 2001 --------- ---------- NET LOSS $ (3,061) $ (1,473) OTHER COMPREHENSIVE INCOME (LOSS): Foreign currency translation adjustments (95) (676) Income tax benefit 35 249 -------- -------- (60) (427) -------- -------- COMPREHENSIVE LOSS $ (3,121) $ (1,900) ======== ========
The accompanying notes are an integral part of these interim consolidated financial statements. 5 ADVOCAT INC. INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS AND UNAUDITED)
THREE MONTHS ENDED MARCH 31, ---------------------------- 2002 2001 ---------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss (3,061) $ (1,473) Items not involving cash: Depreciation and amortization 1,383 1,411 Provision for doubtful accounts 752 760 Provision for self-insured professional liability 4,838 2,330 Equity in earnings in joint ventures (31) (33) Amortization of deferred balances 132 258 Amortization of discount on non-interest bearing promissory note 11 67 Series B redeemable convertible preferred stock dividends 57 58 Provision for leases in excess of cash payments 369 406 Changes in other assets and liabilities: Receivables 1,005 (933) Inventories 13 86 Prepaid expenses and other assets 1,020 354 Trade accounts payable and accrued expenses (3,067) (911) ------- -------- Net cash provided by operating activities 3,421 2,380 ------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment, net (1,348) (727) Investment in TDLP -0- (609) Mortgages receivable, net 15 155 Investment in and advances (to) from joint ventures, net 22 269 TDLP partnership distributions -0- 136 ------- -------- Net cash used in investing activities (1,311) (776) ------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from (repayment of) bank line of credit (2,812) (2,804) Repayment of debt obligations (490) (1,180) Advances to TDLP, net -0- (515) Financing costs (27) (109) ------- -------- Net cash used in financing activities (3,329) (4,608) ------- --------
(Continued) 6 ADVOCAT INC. INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS AND UNAUDITED) (CONTINUED)
THREE MONTHS ENDED MARCH 31, ---------------------------- 2002 2001 --------- ---------- DECREASE IN CASH AND CASH EQUIVALENTS $ (1,219) $ (3,004) CASH AND CASH EQUIVALENTS, beginning of period 3,426 4,496 -------- -------- CASH AND CASH EQUIVALENTS, end of period $ 2,207 $ 1,492 ======== ======== SUPPLEMENTAL INFORMATION: Cash payments of interest $ 852 $ 1,388 ======== ======== Cash payments (refunds) of income taxes, net $ -0- $ -0- ======== ========
The accompanying notes are an integral part of these interim consolidated financial statements. 7 ADVOCAT INC. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 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 March 31, 2002, the Company operates 116 facilities consisting of 62 nursing homes with 6,992 licensed beds and 54 assisted living facilities with 5,354 units. The Company owns 13 nursing homes, leases 34 others, and manages 15 nursing homes. The Company owns 16 assisted living facilities, leases 24 others, and manages the remaining 14 assisted living facilities. The Company holds a minority interest in seven of these managed assisted living facilities. The Company operates 49 nursing homes and 32 assisted living facilities in the United States and 13 nursing homes and 22 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 March 2002, the Company entered into a letter of intent with Pierce Management Group and related persons (collectively, "Pierce"), pursuant to which the 13 leases with the former principal owners or affiliates of Pierce will be terminated and leases on two additional assisted living facilities will be assumed by Pierce, each with an effective date to be determined upon satisfactory negotiation of a Lease Termination and Operations Transfer Agreement (the "Pierce Agreement"). Effective April 30, 2002, the Company completed the Pierce Agreement with respect to the 13 facilities leased from the former principal owners or affiliates of Pierce. As a result, the Company was relieved of its future obligations with respect to these 13 leases. The leases on the two additional assisted living facilities will be similarly terminated, with an effective date to be determined upon satisfactory transfer of the licenses of these facilities. It is expected that this transfer will occur effective June 1. The Company will incur a write-down in the second quarter of 2002 of the remaining net book value of these facilities, estimated to be approximately $800,000. 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. 8 2. BASIS OF FINANCIAL STATEMENTS The interim consolidated financial statements for the three month periods ended March 31, 2002 and 2001, 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 March 31, 2002 and the results of operations and the cash flows for the three month periods ended March 31, 2002 and 2001. The results of operations for the three month periods ended March 31, 2002 and 2001 are not necessarily indicative of the operating results for the entire respective years. These interim financial statements should be read in connection with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. The accompanying consolidated financial statements have been prepared assuming that Advocat Inc. (the "Company") will continue as a going concern. The Company has incurred operating losses in the three months ended March 31, 2002 and the years ended December 31, 2001, 2000 and 1999 and has limited resources available to meet its operating, capital expenditure and debt service requirements during 2002. The Company has a net working capital deficit of $61.5 million as of March 31, 2002. The Company has $33.7 million of scheduled debt maturities during the next 12 months and is in default of certain debt covenants contained in other debt instruments. Effective March 9, 2001, the Company also obtained professional liability insurance coverage that, based on historical claims experience, could be substantially less than the claims that could be incurred during 2001 and 2002 and is less than the coverage required by certain of the Company's debt and lease agreements. As a result, the Company is effectively self-insured. The ultimate payments on professional liability claims accrued as of March 31, 2002 and claims that could be incurred during the remainder of 2002 could require cash resources during 2002 that would be in excess of the Company's available cash or other resources. The Company is also not in compliance with certain lease and debt agreements, including financial covenants, insurance requirements and other obligations, that allow the Company's primary lessor the right to terminate the lease agreements and assume operating rights with respect to the leased properties and allow the holders of substantially all of the Company's debt to demand immediate repayment. Although the Company does not anticipate that such demands will be made, the continued forbearance on the part of the Company's primary lessor and 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 March 31, 2002. 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. At a minimum, the Company's cash requirements during 2002 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 these requirements. 9 The majority of the Company's lenders have the right to force immediate payment of outstanding debt. The Company's scheduled debt maturities during the next twelve months total $33.7 million. The existing defaults in the Company's lease agreements covering a majority of its United States nursing facilities allows the lessor the right to terminate the lease agreements. The property and equipment, including leasehold improvements, related to these facilities total approximately $4.8 million as of March 31, 2002. Management continues to focus on efforts to increase revenues and 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, the inability to obtain waivers or refinance the related debt or the termination of the lease agreements 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, the Company may have to 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, 2001 included a paragraph with regards to the uncertainties of the Company's ability to continue as a going concern. 3. INSURANCE MATTERS The entire long-term care profession in the United States has experienced a dramatic increase in claims related to alleged negligence in providing care to its patients - the Company is no exception in this regard. 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. The Company has appealed this verdict. The Company and its subsidiaries carry professional liability insurance up to certain limits for coverage of such claims. However, due to the increasing cost of claims against the Company and throughout the long-term care industry, the Company's professional liability insurance premiums and deductible amounts increased substantially and coverage limits have decreased substantially during 1999, 2000 and 2001. These substantial premium and deductible increases have also continued for the policy year 2002. As a result of the substantial premium and deductible increases and insurance coverage decreases for the 2002 policy year, effective March 9, 2002, the Company has obtained professional liability insurance coverage for its United States nursing homes and assisted living facilities that could be substantially less than the claims that could be incurred during the policy period from March 9, 2002 through March 9, 2003. For claims made after March 9, 2002, the 10 Company maintains general and professional liability insurance with coverage limits of $250,000 per medical incident and total aggregate policy coverage limits of $1,000,000 for its long-term care and assisted living services. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. The 2002 policy is on a claims made basis and the Company is self-insured for the first $25,000 per occurrence. For claims made during the period March 9, 2001 through March 9, 2002, the Company is self-insured for the first $50,000 per occurrence with no aggregate limit for the Company's United States nursing homes. The policy has coverage limits of $2,000,000 per occurrence and $3,000,000 in the aggregate. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. This policy is on a claims made basis. Effective October 1, 2001, the Company's United States assisted living properties were added to the Company's insurance program for United States nursing home properties. 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 $12,000,00 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. This policy is 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. Effective February 1, 1999, all United States nursing homes became part of the $250,000/$2,500,000 deductible program, including the six Texas facilities that were owned by a limited partnership of which the Company was the general partner. For the policy years 1996 through March 9, 2000, the Company expects to ultimately fully incur the aggregate deductible amount and has established reserves based on this expectation. The Company's United States assisted living facilities are self-insured, with respect to each location, for the first $50,000 per occurrence through September 30, 2001. Effective October 1, 2001, the Company's United States assisted living properties were added to the Company's insurance program for United States nursing home properties. The Company also maintains a $15,000,000 aggregate umbrella liability policy for claims in excess of the foregoing limits for these assisted living operations through September 30, 2001. 11 In Canada, the Company's professional liability claims experience and associated costs has been dramatically less than that in the United States. The Canadian facilities owned or leased by the Company are self-insured for the first $3,000 ($5,000 Canadian) per occurrence. The Company's aggregate primary coverage limit with respect to Canadian operations is $1,257,000 ($2,000,000 Canadian). The Company also maintains a $3,143,000 ($5,000,000 Canadian) aggregate umbrella policy for claims in excess of the foregoing limits for these facilities. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $24,821,000 as of March 31, 2002. Such liabilities include estimates of legal costs. The Company believes that the $78.425 million monetary judgment, if upheld by the Arkansas Supreme Court (to which the judgment is currently under appeal), will be covered by insurance pursuant to the 1997 and 1998 insurance programs. Based on the expected insurance coverage, the judgment amount has not been accrued. The ultimate results of the Company's professional liability claims and disputes are unknown at the present time. 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 two of its insurance carriers providing coverage for prior years claims have either been declared insolvent or are currently under rehabilitation proceedings. Any future judgments or settlements above the Company's per occurrence, per location or umbrella coverage or not covered by insurance due to the insolvency of the insurance carrier could have a material adverse impact on the Company's financial position, cash flows and results of operations. In addition, the ultimate payment of professional liability claims accrued as of March 31, 2002 and claims that could be incurred during 2002 could require cash resources during 2002 that would be in excess of the Company's available cash or other resources. These potential future payments could have a material adverse impact on the Company's financial position and cash flows. 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 in addition to net income 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 balance is presented below:
THREE MONTHS ENDED MARCH 31, --------------------------------- 2002 2001 --------- --------- Foreign currency items: Beginning balance $(935,000) $ (448,000) Current-period change, net of income tax (60,000) (427,000) --------- --------- Ending balance $(995,000) $(875,000) ========= =========
Positive amounts represent unrealized gains and negative amounts represent unrealized losses. 12 5. 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 MARCH 31, --------------------------- (IN THOUSANDS) 2002 2001 -------- -------- Net revenues: U.S. nursing homes 39,853 $ 37,658 U.S. assisted living facilities 7,830 8,099 Canadian operations 3,889 3,929 Corporate 2 3 -------- -------- Total $ 51,574 $ 49,689 ======== ======== Depreciation and amortization: U.S. nursing homes 827 $ 874 U.S. assisted living facilities 419 424 Canadian operations 120 95 Corporate 17 18 -------- -------- Total $ 1,383 $ 1,411 ======== ======== Operating income (loss): U.S. nursing homes (2,104) $ (997) U.S. assisted living facilities (492) 4 Canadian operations 412 422 Corporate (784) (812) -------- -------- Total $ (2,968) $ (1,383) ======== ========
13
MARCH 31, DECEMBER 31, 2002 2001 --------- ------------ Long-lived assets: U.S. nursing homes 26,447 $ 26,807 U.S. assisted living facilities 29,334 29,760 Canadian operations 12,606 12,016 Corporate 710 707 -------- -------- Total $ 69,097 $ 69,290 ======== ======== Total assets: U.S. nursing homes 52,117 $53,665 U.S. assisted living facilities 30,539 30,912 Canadian operations 17,283 17,183 Corporate 1,399 1,415 Eliminations (14,474) (12,105) -------- -------- Total $ 86,864 $ 91,070 ======== ========
6. RECLASSIFICATIONS Certain amounts in the 2001 interim financial statements have been reclassified to conform with the 2002 presentation. 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 February 1980 through common senior management who were involved in different organizational structures. As of March 31, 2002, the Company operates 116 facilities, consisting of 62 nursing homes with 6,992 licensed beds and 54 assisted living facilities with 5,354 units. In comparison, at March 31, 2001, the Company operated 120 facilities composed of 64 nursing homes containing 7,230 licensed beds and 56 assisted living facilities containing 5,245 units. As of March 31, 2002, the Company owns 13 nursing homes, leases 34 others and manages the remaining 15 nursing homes. Additionally, the Company owns 16 assisted living facilities, leases 24 others and manages the remaining 14 assisted living facilities. The Company holds a minority interest in seven of these managed assisted living facilities. The Company operates 49 nursing homes and 32 assisted living facilities in the United States and 13 nursing homes and 22 assisted living facilities in Canada. In March 2002, the Company entered into a letter of intent with Pierce Management Group and related persons (collectively, "Pierce"), pursuant to which the 13 leases with the former principal owners or affiliates of Pierce will be terminated and leases on two additional assisted living facilities will be assumed by Pierce, each with an effective date to be determined upon satisfactory negotiation of a Lease Termination and Operations Transfer Agreement (the "Pierce Agreement"). Effective April 30, 2002, the Company completed the Pierce Agreement 14 with respect to the 13 facilities leased from the former principal owners or affiliates of Pierce. As a result, the Company was relieved of its future obligations with respect to these 13 leases. The Company will incur a write-down in the second quarter of 2002 of the remaining net book value of these facilities, estimated to be approximately $800,000. The leases on the two additional assisted living facilities will be similarly terminated, with an effective date to be determined upon satisfactory transfer of the licenses of these facilities. It is expected that this transfer will occur effective June 1. 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. CRITICAL ACCOUNTING POLICIES AND JUDGMENTS The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In December 2001, the Securities and Exchange Commission ("SEC") requested that all registrants list their three to five critical accounting policies in the text of "Managements Discussion and Analysis of Financial Condition and Results of Operations." The SEC indicated that a "critical accounting policy" is one which is both important to the understanding of the financial condition and results of operations of the Company and requires management's most difficult, subjective or complex judgments often of the need to make estimates about the effect of matters that are inherently uncertain. The following accounting policies fit this definition: Revenues PATIENT AND RESIDENT REVENUES The fees charged by the Company to patients in its nursing homes and residents in its assisted living facilities include fees with respect to individuals receiving benefits under 15 federal and state-funded cost reimbursement programs. These revenues are based on approved rates for each facility that are either based on current costs with retroactive settlements or prospective rates with no cost settlement. Amounts earned under federal and state programs with respect to nursing home patients are subject to review by the third-party payors. In the opinion of management, adequate provision has been made for any adjustments that may result from such reviews. Final cost settlements, if any, are recorded when objectively determinable, generally within three years of the close of a reimbursement year depending upon the timing of appeals and third-party settlement reviews or audits. MANAGEMENT FEES Under its management agreements, the Company has responsibility for the day-to-day operation and management of each of its managed facilities. The Company typically receives a base management fee ranging generally from 3.5% to 6.0% of net revenues of each managed facility. Other than certain corporate and regional overhead costs, the services provided at the facility are at the facility owner's expense. The facility owner is also obligated to pay for all required capital expenditures. The Company generally is not required to advance funds to the owner. Other than with respect to facilities managed during insolvency or receivership situations, the Company's management fees are generally subordinated to the debt payments of the facilities it manages. In addition, the Company is generally eligible to receive incentives over and above its base management fees based on the profits at these facilities. ALLOWANCE FOR DOUBTFUL ACCOUNTS The Company's allowance for doubtful accounts is estimated utilizing current agings of accounts receivable, historical collections data and other factors. Management monitors these factors and determines the estimated provision for doubtful accounts. Historical bad debts have resulted from uncollectible private balances, some uncollectible coinsurance and deductibles and other factors. The allowance for doubtful accounts balance is assessed on a quarterly basis, with changes in estimated losses being recorded in the consolidated statements of operations in the period identified. Self-Insurance Reserves Self insurance reserves primarily represent the accrual for self insured risks associated with general and professional liability claims, employee health insurance and workers compensation. The self insurance reserves include a liability for reported claims and estimates for incurred but unreported claims. The Company's policy with respect to a significant portion of the general and professional liability claims is to use an actuary to support the estimates recorded for incurred but unreported claims. The Company's health insurance reserve is based on known claims incurred and an estimate of incurred but unreported claims determined by an analysis of historical claims paid. The Company's workers compensation reserve relates to periods of self insurance prior to May 1997 and consists only of known claims incurred. The workers compensation reserve is based on an estimate of the future costs to be incurred for the known claims. Expected insurance coverages are reflected as a reduction of the reserves. The self 16 insurance reserves are assessed on a quarterly basis, with changes in estimated losses being recorded in the consolidated statements of operations in the period identified. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Asset Impairment In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of", the Company evaluates the recoverability of the carrying values of its properties on a property by property basis. On a quarterly basis, the Company reviews its properties for recoverability when events or circumstances, including significant physical changes in the property, significant adverse changes in general economic conditions, and significant deteriorations of the underlying cash flows of the property, indicate that the carrying amount of the property may not be recoverable. The need to recognize an impairment is based on estimated future cash flows from a property compared to the carrying value of that property. If recognition of an impairment is necessary, it is measured as the amount by which the carrying amount of the property exceeds the fair value of the property. MEDICARE REIMBURSEMENT During 1997, the federal government enacted the Balanced Budget Act of 1997 ("BBA"), which contained numerous Medicare and Medicaid cost-saving measures. The BBA required that nursing homes transition to a prospective payment system ("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 contained 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 care industry. During 1999 and 2000, certain amendments to the BBA were 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 has continued to provide additional increases in certain Medicare payment rates during 2001. In July 2001 CMS published a final rule updating payment rates for skilled nursing facilities under PPS. The new rules increased payments to skilled nursing facilities by an average of 10.3% beginning on October 1, 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 17 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. Under the current law, Medicare reimbursements for nursing facilities were scheduled to be reduced by as much as 17% at the end of the Federal Government's fiscal year (September 30, 2002), with the expiration of several temporary payment increases enacted as part of the 1999 and 2000 Medicare enhancement bills. On April 23, 2002, the Health and Human Services Secretary announced that the Centers for Medicare & and Medicaid would leave in place the current prospective payment patient classification system for skilled nursing facilities, reducing the scheduled Medicare reductions by approximately one-half. Two other temporary payment increases are still scheduled to expire October 1, 2002. The Company has estimated that the revenue reduction as a result of the expiration of the temporary impact would be at least $3.8 million, based on the Medicare census and patient RUG levels experienced by the Company in 2001. The actual impact can not be determined at this time and is dependent on the changes that are legislatively implemented and on the Company's Medicare census and patient RUG levels. During 1999, 2000 and 2001, the Company experienced certain adverse regulatory issues with respect to certain facilities, including a decertification from the Medicare and Medicaid programs during 2000. The Company also continued to experience the increased regulatory scrutiny that has been exerted on the industry in the form of increased fines and penalties. SELF-INSURANCE RESERVES The entire long-term care profession in the United States has experienced a dramatic increase in claims related to alleged negligence in providing care to its patients - the Company is no exception in this regard. 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. The Company has appealed the verdict. The Company and its subsidiaries carry professional liability insurance up to certain limits for coverage of such claims. However, the insurance coverage limits available to the Company has declined significantly beginning in 1999. Based on the insurance coverage in effect at the time of the Mena claim, the verdict amount has not been accrued. However, due to the increasing cost of claims against the both Company and throughout the long-term care profession in general, the Company's professional liability insurance premiums and deductible amounts increased substantially and insurance coverage limits decreased substantially during 1999, 2000 and 2001. These substantial premium and deductible increases and insurance coverage limit decreases have also continued for the policy year 2002. As a result of the substantial premium and deductible increases and insurance coverage limit decreases for the 2002 policy year, effective March 9, 2002, the Company has obtained professional liability insurance coverage for its 18 United States nursing homes and assisted living facilities that is likely to be substantially less than the claims that could be incurred during the policy period from March 9, 2002 through March 9, 2003. As a result, the Company is effectively self-insured. For claims made after March 9, 2002, the Company maintains general and professional liability insurance with coverage limits of $250,000 per medical incident and total aggregate policy coverage limits of $1,000,000 for its long-term care and assisted living services. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. The 2002 policy is on a claims made basis and the Company is self-insured for the first $25,000 per occurrence. For claims made during the period March 9, 2001 through March 9, 2002, the Company is self-insured for the first $50,000 per occurrence with no aggregate limit for the Company's United States nursing homes. The policy has coverage limits of $2,000,000 per occurrence and $3,000,000 in the aggregate. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. This policy is on a claims made basis. Effective October 1, 2001, the Company's United States assisted living properties were added to the Company's insurance program for United States nursing home properties. 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 $12,000,00 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. This policy is 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. Effective February 1, 1999, all United States nursing homes became part of the $250,000/$2,500,000 deductible program, including the six TDLP facilities. For the policy years 2000 and 1999, the Company expects to ultimately fully incur the aggregate deductible amount and has established reserves based on this expectation. The Company's United States assisted living facilities are self-insured, with respect to each location, for the first $50,000 per occurrence through September 2001. Effective October 1, 2001, the Company's United States assisted living properties were added to the Company's insurance program for United States nursing home properties. The Company also maintains a $15,000,000 aggregate umbrella liability policy for claims in excess of the foregoing limits for these assisted living operations. In Canada, the Company's professional liability claims experience and associated costs has been dramatically less than that in the United States. The Canadian facilities owned or leased by the Company are self-insured for the first $3,000 ($5,000 Canadian) per occurrence. The Company's aggregate primary coverage limit with respect to Canadian operations is $1,257,000 19 ($2,000,000 Canadian). The Company also maintains a $3,143,000 ($5,000,000 Canadian) aggregate umbrella policy for claims in excess of the foregoing limits for these facilities. The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $24,821,000 as of March 31, 2002. Such liabilities include estimates of legal costs. The Company believes that the $78.425 million monetary judgment, if upheld by the Arkansas State Supreme Court, will be covered by insurance pursuant to the 1997 and 1998 insurance programs. Based on the insurance coverage in effect at the time of the Mena claim, the verdict amount has not been accrued. The ultimate results of the Company's professional liability claims and disputes are unknown at the present time. 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 two of its insurance carriers providing coverage for prior years claims have either been declared insolvent or are currently under rehabilitation proceedings. Any future judgments or settlements above the Company's per occurrence, per location or umbrella coverage or not covered by insurance due to the insolvency of the insurance carrier could have a material adverse impact on the Company's financial position, cash flows and results of operations. In addition, the ultimate payment of professional liability claims accrued as of March 31, 2002 and claims that could be incurred during 2002 could require cash resources during 2002 that would be in excess of the Company's available cash or other resources. These potential future payments could have a material adverse impact on the Company's financial position and cash flows. With respect to workers' compensation insurance, substantially all of the Company's employees became covered under either an indemnity insurance plan or state-sponsored programs in May 1997. Prior to that time, the Company was self-insured for the first $250,000, on a per claim basis, for workers' compensation claims in a majority of its United States nursing facilities. However, the insurance carrier providing coverage above the Company's self insured retention has been declared insolvent by the applicable state insurance agency. As a result, the Company is completely self insured for workers compensation exposures prior to May 1997. The Company has been and remains a non-subscriber to the Texas workers' compensation system and is, therefore, completely self-insured for employee injuries with respect to its Texas operations. The Company has provided reserves for the settlement of outstanding self-insured claims at amounts believed to be adequate as of March 31, 2002. The differences between actual settlements and reserves are included in expense in the year finalized. The Company is self-insured for health insurance benefits for certain employees and dependents for amounts up to $150,000 per individual annually. The Company provides reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate. The liability for reported claims and estimates for incurred but unreported claims is $787,000 at March 31, 2002. The differences between actual settlements and reserves are included in expense in the year finalized. 20 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 state operating 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 such laws and regulations can be subject to future 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 below. 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. The Company, in its capacity as the manager of four nursing homes owned by Emerald Coast Healthcare, Inc. ("Emerald"), was named in the complaint, as amended, which accused 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. 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 second amended complaint also accused the Company of (i) receiving payment by mistake of fact, (ii) unjust enrichment and (iii) civil theft. At a hearing held January 31, 21 2002, the court granted the Company's motion to dismiss the false claims count based on the State's failure to state a cause of action, but did not grant motions to dismiss the equitable counts of unjust enrichment and payment by mistake, or the civil theft claim. The Company is appealing the judge's decision. The Court ruling allowed the State of Florida to file a third amended complaint, which was filed on March 11, 2002. The Company has filed a motion to dismiss, with prejudice, the State's complaint. A hearing is scheduled for May 24, 2002 on this motion. The Company believes that it has meritorious defenses in this case, and intends to vigorously pursue these defenses in litigation. 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. During 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. 22 CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The Company has certain contractual obligations as of March 31, 2002, summarized by the period in which payment is due, as follows (dollar amounts in thousands):
- ---------------------------------------------------------------------------------------------------------------- LESS THAN 1 1 TO 3 4 TO 5 AFTER CONTRACTUAL OBLIGATIONS TOTAL YEAR YEARS YEARS 5 YEARS - ---------------------------------------------------------------------------------------------------------------- Debt $60,047 $33,771 $10,844 $9,141 $6,291 - ---------------------------------------------------------------------------------------------------------------- Operating Leases $400,671 $19,280 $38,606 $37,705 $305,080 - ----------------------------------------------------------------------------------------------------------------
In March 2002, the Company entered into a letter of intent with Pierce, pursuant to which the 13 leases with the former principal owners or affiliates of Pierce will be terminated and leases on two additional assisted living facilities will be assumed by Pierce, each with an effective date to be determined upon satisfactory negotiation of the Pierce Agreement. Effective April 30, 2002, the Company completed the Pierce Agreement with respect to the 13 facilities leased from the former principal owners or affiliates of Pierce. As a result, the Company was relieved of its future obligations with respect to these 13 leases. The operating lease section of the table above includes commitments of $95.9 million (including $4.2 million commitments less than one year) related to these terminated leases. The leases on the two additional assisted living facilities will be similarly terminated, with an effective date to be determined upon satisfactory transfer of the licenses of these facilities. It is expected that this transfer will occur effective June 1. The operating lease section of the table above includes commitments of $16.8 million (including $0.8 million commitments less than one year) related to these two additional leases, expected to be terminated effective June 1, 2002. The Company has employment agreements with certain members of management that provide for the payment to these members of amounts up to 2.5 times their annual salary in the event of a termination without cause, a constructive discharge (as defined), or upon a change of control of the Company (as defined). The maximum contingent liability under these agreements is approximately $2.5 million. In addition, upon the occurrence of any triggering event, certain executives may elect to require the Company to purchase options granted to them for a purchase price equal to the excess, if any, of the fair market value of the Company's common stock at the date of termination over the stated option exercise price. The terms of such agreements are from one to three years and automatically renew for one year if not terminated by the employee or the Company. A subsidiary of the Company has provided guarantees of certain cash flow deficiencies and quarterly return obligations of Diversicare VI Limited Partnership ("Diversicare VI"), which may obligate the subsidiary to make interest-free loans to Diversicare VI. Such cash flow obligations have never been called upon. There is no assurance that all or any portion of the loans made to Diversicare VI will be repaid. 23 RESULTS OF OPERATIONS The following tables present the unaudited interim statements of operations and related data for the three months ended March 31, 2002 and 2001.
(IN THOUSANDS) THREE MONTHS ENDED MARCH 31, ---------------------------------------------- 2002 2001 CHANGE % -------- -------- ------ --- REVENUES: Patient revenues $ 40,691 $ 38,312 2,379 6.2 Resident revenues 10,179 10,420 (241) (2.3) Management fees 679 911 (232) (25.5) Interest 25 46 (21) (45.7) -------- -------- ----- --- Net revenues 51,574 49,689 1,885 3.8 -------- -------- ----- --- EXPENSES: Operating 43,728 39,735 3,993 10.0 Lease 5,180 5,175 5 0.1 General and administrative 3,159 3,235 (76) (2.3) Interest 1,092 1,516 (424) (28.0) Depreciation and amortization 1,383 1,411 (28) (2.0) -------- -------- ----- --- Total expenses 54,542 51,072 3,470 6.8 -------- -------- ----- --- LOSS BEFORE INCOME TAXES (2,968) (1,383) (1,585) PROVISION FOR INCOME TAXES 93 90 3 -------- -------- ----- NET LOSS $ (3,061) $ (1,473) $(1,588) ======== ======== =======
PERCENTAGE OF NET REVENUES THREE MONTHS ENDED MARCH 31, ---------------------------- 2002 2001 --------- --------- REVENUES: Patient revenues 78.9% 77.1% Resident revenues 19.7 21.0 Management fees 1.3 1.8 Interest 0.1 0.1 ----- ----- Net revenues 100.0% 100.0% ----- ----- OPERATING EXPENSES: Operating 84.8 80.0 Lease 10.0 10.4 General and administrative 6.1 6.5 Interest 2.1 3.1 Depreciation and amortization 2.7 2.8 ----- ----- Total expenses 105.7 102.8 ----- ----- LOSS BEFORE INCOME TAXES (5.7) (2.8) PROVISION FOR INCOME TAXES 0.2 0.2 ----- ----- NET LOSS (5.9)% (3.0)% ----- -----
24 THREE MONTHS ENDED MARCH 31, 2001 COMPARED WITH THREE MONTHS ENDED MARCH 31, 2000 Revenues. Net revenues increased to $51.6 million in 2002 from $49.7 million in 2001, an increase of $1.9 million, or 3.8%. Patient revenues increased to $40.7 million in 2002 from $38.3 million in 2001, an increase of $2.4 million, or 6.2%. The increase in patient revenues is due to increased Medicare utilization, Medicare rate increases at several facilities which became effective in October 2001 and increased Medicaid rates in certain states, partially offset by a 0.6% decline in occupancy in 2002 as compared to 2001. In addition, the Company terminated leases on two nursing homes during the fourth quarter of 2001. As a percent of total census in the United States, Medicare days increased to 9.8% in 2002 from 7.4% in 2001. As a percent of patient revenues, Medicare increased to 24.8% in 2002 from 21.5% in 2001 while Medicaid and similar programs decreased to 63.0% from 65.1% in 2001. Resident revenues decreased to $10.2 million in 2002 from $10.4 million in 2001, a decrease of $200,000, or 2.3%. The Company experienced increased revenue rates, offset by a 6.5% decline in resident days. Ancillary service revenues, prior to contractual allowances, increased to $6.6 million in 2002 from $5.4 million in 2001, as increase of $1.2 million or 23.4%. The increase is primarily attributable to increased Medicare census, partially offset by reductions in revenue availability under Medicare and is consistent with the Company's expectations. 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. Operating Expense. Operating expense increased to $43.7 million in 2002 from $39.7 million in 2001, an increase of $4.0 million, or 10.0%. As a percent of patient and resident revenues, operating expense increased to 86.0% in 2002 from 81.5% in 2001. The increase as a percent of patient and resident revenues is primarily attributable to cost increases related to wages and professional liability, partially offset by a reduction in costs as a result of the termination of leases on two nursing homes effective during the fourth quarter of 2001. The largest component of operating expenses is wages, which increased to $22.3 million in 2002 from $21.5 million in 2001, an increase of $0.8 million, or 3.7%. The increase in wages is due to tighter labor markets in most of the areas in which the Company operates, partially offset by the facility lease terminations noted above. The Company's professional liability costs for United States nursing homes, including insurance premiums and reserves for self-insured claims, increased to $4.8 million in 2001 from $2.0 million in 2001, an increase of $2.8 million or 136.3%. The 2002 professional liability cost includes non-cash charges recorded based on current actuarial reviews, including the recent effects of additional claims and higher settlements per claim. The increased charges arise primarily from an escalation in the number and size of claims anticipated to affect the Company's self-insured professional liability retention. In addition, effective March 9, 2001, the Company obtained professional liability insurance coverage that provided significantly lower benefits than prior policy years. During 2001, the Company determined that two of its insurance carriers providing coverage for prior rehabilitation years claims have either been declared insolvent or are currently under 25 proceedings. 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. Lease Expense. Lease expense totaled $5.2 million in both 2002 and 2001. General and Administrative Expense. General and administrative expense totaled $3.2 million in both 2002 and 2001. As a percent of total net revenues, general and administrative expense decreased to 6.1% in 2002 from 6.5% in 2001. Increases in various corporate expenses, including salaries and wages and workers compensation were offset by decreases in employee recruitment and relocation and consulting fees. The 2001 period included a provision for severance benefits for the former Chief Financial Officer of the Company. Interest Expense. Interest expense decreased to $1.1 million in 2002 from $1.5 million in 2001, a decrease of $424,000, or 28.0%. The decrease is attributable to interest rate reductions on the Company's variable rate debt and a decrease in 2002 in the Company's average outstanding debt balance. Depreciation and Amortization. Depreciation and amortization expenses totaled $1.4 million in both 2002 and 2001. Loss Before Income Taxes; Net Loss; Loss Per Share. As a result of the above, the loss before income taxes was $3.0 million in 2002 as compared to $1.4 million in 2001, a decrease of $1.6 million. The income tax provision in 2002 and 2001 relate to provincial taxes in Canada. Net loss was $3.1 million in 2002 as compared to $1.5 million in 2001, a decrease of $1.6 million. The basic and diluted loss per share were $0.56 each in 2002 as compared to $0.27 each in 2001. LIQUIDITY AND CAPITAL RESOURCES At March 31, 2002, the Company had negative working capital of $61.5 million and a current ratio of 0.22, compared with negative working capital of $64.4 million and a current ratio of 0.25 at December 31, 2001. The Company has incurred losses during 2002, 2001 and 2000 and has limited resources available to meet its operating, capital expenditure and debt service requirements during 2002. 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), required insurance coverages, and limits on the payment of dividends to shareholders. As of March 31, 2002, the Company was not in compliance with certain of the financial covenants contained in the Company's debt and lease agreements. 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 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 26 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 $33.7 million of debt (including short term debt and current portions of long term debt) that must be repaid or refinanced during the next twelve months. As a result of the covenant non-compliance and other cross-default provisions, the Company has classified a total of $55.5 million of debt as current liabilities as of March 31, 2002. An event of default under the Company's debt agreements could lead to actions by the lenders that could 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 and assume operating rights with respect to the leased properties. The net book value of property and equipment, including leasehold improvements, related to these facilities total approximately $4.8 million as of March 31, 2002. The Company is potentially subject to a reduction in Medicare revenue, estimated to be at least $3.8 million, based on the Medicare census and patient RUG levels experienced by the Company in 2001. Management continues to focus on efforts to increase revenues and to minimize future expense increases through the elimination of excess operating costs. Management will also attempt to minimize professional liability claims in the future periods by vigorously defending it 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, the inability to obtain waivers or refinance the related debt, or the termination of the lease agreements 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, the Company may have to 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, 2001 included a paragraph with regards to the uncertainties of the Company's ability to continue as a going concern. As of March 31, 2002, the Company had drawn $55,000 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 $4,500,000. Of the total $4,500,000 of maximum availability, $1,000,000 is limited to certain maximum time period restrictions. There are certain additional restrictions based on certain borrowing base restrictions. As of March 31, 2002, the Company had $200,000 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 March 31, 2002, the Company had total additional borrowing availability of $4,245,000 under 27 its working capital line of credit. The working capital line of credit matures January 2004 with interest at either LIBOR plus 2.50% or the bank's prime rate plus .50% (up to a maximum of 9.50%). 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 and 2002 and is less than the coverage required by certain of the Company's debt and lease agreements. The ultimate payments on professional liability claims accrued as of March 31, 2002 and claims that could be incurred during 2002 could require cash resources during 2002 that would be in excess of the Company's available cash or other resources. Any future operating losses, demands for repayment by lenders, failure to refinance debt maturing during 2002, payments of professional liability claims judgments in excess of insurance coverage or significant reductions in Medicare reimbursement 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 2002, or unable to minimize the amount of 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 $3.4 million and $2.4 million for the three month periods ended March 31, 2002 and 2001, respectively. These amounts primarily represent the cash flows from net operations plus changes in non-cash components of operations and by working capital changes. Net cash used in investing activities totaled $1,311,000 and $776,000 for the three months periods ended March 31, 2002 and 2001, respectively. These amounts primarily represent purchases of property plant and equipment (including approximately $670,000 related to an addition to one of the Company's facilities in Canada), investments in and advances to joint ventures and, with respect to 2001 only, additional investments in TDLP, a limited partnership for which the Company served as the general partner. The Company has used between $2.4 million and $4.4 million for capital expenditures in the three calendar years ending December 31, 2001. Substantially all such expenditures were for facility improvements and equipment, which were financed principally through working capital. For the year ended December 31, 2002, the Company anticipates that capital expenditures for improvements and equipment for its existing facility operations will be approximately $4.0 million, including $1.0 million for non-routine projects. For the three months ended March 31, 2002 and 2001, the Company received funds pertaining to joint ventures in the amount of $22,000 and $269,000, respectively. In general, the Company has been appointed as manager of the joint venture projects. 28 Net cash used in financing activities totaled $3.3 million and $4.6 million for the three month periods ended March 31, 2002 and 2001, respectively. The net cash used in financing activities primarily represents net proceeds from issuance and repayment of debt. 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 March 31, 2002 and December 31, 2001, totaled $18.9 million and $20.5 million, respectively, representing approximately 33 and 37 days in accounts receivable, respectively. Accounts receivable from the provision of management services were $726,000 and $578,000 at March 31, 2002 and December 31, 2001, respectively representing approximately 96 and 71 days in accounts receivable, respectively. The allowance for bad debt was $5.8 million and $5.5 million as of March 31, 2002 and December 31, 2001, respectively. 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 in an effort to strengthen its collection efforts and reduce the incidence of uncollectible accounts. 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. 29 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. 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 In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." 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 SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." 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 adopted the provisions of SFAS No. 141 and the adoption did not have a material effect on the Company's financial position or results of operations. The Company has adopted the provisions of SFAS No. 142 as of January 1, 2002 and the adoption did not have a material effect on the Company's financial position or results of operations. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" 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 30 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 SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" effective for fiscal years beginning after December 15, 2001. SFAS No. 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 adopted the provisions of SFAS No. 144 and the adoption did not have a material effect on the Company's 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. This discussion and analysis should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2001. 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, 2001 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. 31 PART II -- OTHER INFORMATION Item 1. Legal Proceedings. The provision of health care services entails an inherent risk of liability. In recent years, participants in the health care industry have become subject to an increasing number of lawsuits alleging malpractice, product liability, or related legal theories, many of which involve large claims and significant defense costs. The entire long-term care profession in the United States has experienced a dramatic increase in claims related to alleged negligence in providing care to its patients - the Company is no exception in this regard. As a result, the Company has numerous liability claims and disputes outstanding for professional liability and other related issues. It is expected that the Company will continue to be subject to such suits as a result of the nature of its business. Further, as with all health care providers, the Company is potentially subject to the increased scrutiny of regulators for issues related to compliance with health care fraud and abuse laws. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Health Care Industry." 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: On March 22, 2002, the Company filed a Report on Form 8-K announcing that Wallace E. Olson had joined the Company's Board of Directors. 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. May 15, 2002 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 Lease Termination and Operations Transfer Agreement dated the 31st day of March, 2002 by and between (i) Diversicare Assisted Living Services NC, LLC, a Tennessee limited liability company and Advocat Inc., a Delaware corporation, and (ii) Pierce Management Group First Partnership, a North Carolina general partnership, Pierce Management Group Fifth Partnership, a North Carolina general partnership, Pierce, Pierce And Hall, a North Carolina general partnership, Guy S. Pierce, individually, A. Steve Pierce and wife Mary Lou Pierce and A. Steve Pierce, individually. EX-10.1 3 g76086ex10-1.txt LEASE TERMINATION AND OPERATIONS TRANSFER EXHIBIT 10.1 LEASE TERMINATION AND OPERATIONS TRANSFER AGREEMENT THIS LEASE TERMINATION AND OPERATIONS TRANSFER AGREEMENT (the "Agreement") is made and entered into as of the 31st day of March, 2002 by and between (i) DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company ("Lessee") and ADVOCAT INC., a Delaware corporation ("Advocat"), and (ii) PIERCE MANAGEMENT GROUP FIRST PARTNERSHIP, a North Carolina general partnership ("PMG I"), PIERCE MANAGEMENT GROUP FIFTH PARTNERSHIP, a North Carolina general partnership ("PMG V"), PIERCE, PIERCE AND HALL, a North Carolina general partnership ("PPH"), GUY S. PIERCE, individually ("Guy Pierce"), A. STEVE PIERCE and wife MARY LOU PIERCE (the "Pierces") and A. STEVE PIERCE, individually ("Steve Pierce") (PMG I, PMG V, PPH, Guy Pierce, the Pierces and Steve Pierce being hereinafter referred to collectively as the "Lessors" and individually as a "Lessor"). RECITALS A. Pursuant to the thirteen (13) Lease Agreements (With Option to Purchase) identified on Exhibit A attached hereto by and between Lessee and, as applicable, PMG I, PMG V, PPH and the Pierces (each a "Lease" and collectively, the "Leases"), and the Sublease Agreement identified on Exhibit A attached hereto by and between Lessee and Guy Pierce (the "Sublease"), Lessee is currently the lessee of the twelve (12) adult care home facilities (with apartment units, as and where so stated), the manager's home and the office building identified on Exhibit A attached hereto, all located in the State of North Carolina as more particularly set forth in Exhibit A attached hereto. B. Pursuant to the two (2) Assignment and Assumption of Leases identified on Exhibit A attached hereto between Lessee and PMG I (the "Assignments"), the rights and obligations of PMG I, as lessee, under the two (2) Lease Agreements with Hazel Powell identified on Exhibit A attached hereto (the "Assigned Leases") were assigned to and assumed by Lessee, so that Lessee is currently the lessee of the adult care home facility and the manager's home identified on Exhibit A attached hereto and located in Rocky Mount, North Carolina. The adult care home facilities (with apartment units, as and where so stated), manager's homes and the office building identified on Exhibit A attached hereto that are leased by Lessee pursuant to the Leases, the Sublease and the Assigned Leases are hereinafter referred to individually as a "Facility" and collectively as the "Facilities". C. Advocat has guaranteed the payment and performance by Lessee of its obligations under each of the Leases, the Sublease and the Assigned Leases pursuant to and in accordance with the terms and provisions of the five (5) Guaranty of Lease Agreements and the Guaranty of Sublease Agreement identified on Exhibit B attached hereto (each a "Guaranty" and collectively the "Guarantys"). D. The Leases, the Sublease and the Assignments were made, executed and delivered in connection with the acquisition by Lessee, as Buyer, of certain assets of the Lessors and certain affiliates and related parties, as Sellers and Owners, pursuant to an Asset Purchase Agreement dated July 23, 1997, as amended by Amendment No. 1 to Asset Purchase Agreement dated September 30, 1997 (the "Asset Purchase Agreement"). Lessors and Lessee now wish to terminate each of the Leases with possession and operation of all of the Leased Property (as described and defined in each of the Leases) and the Subleased Property (as defined and described in the Sublease) being returned to the applicable Lessor. Lessee and PMG I further wish to terminate the Assignments, with possession and operation of the premises and property that are the subject of the Assigned Leases being returned to PMG I. In connection with such termination, Lessee is willing to transfer to each Lessor certain assets related to each Facility and each Lessor is willing to assume certain obligations with respect to each Facility, subject to the terms and conditions set forth in this Agreement. In addition, the parties hereto desire to make certain releases and other agreements relating to the Facilities, certain other adult care home facilities, and certain affiliates of the parties hereto, all as more particularly set forth herein. E. In order to facilitate an orderly transfer of the operations of each Facility from Lessee to each Lessor, Lessee and Lessors desire to document certain terms and conditions relevant to the termination of the Leases, the Sublease, the Assignments and the transfer of operational control and responsibility for each Facility. NOW, THEREFORE, in consideration of the foregoing premises and the mutual covenants and agreements of the parties set forth herein, the parties hereto agree as follows: AGREEMENT 1. Termination and Assignment; Surrender of Leased Property; Releases of Guarantys. 1.1 Termination Date. If all of the conditions to the completion of the transactions contemplated herein are satisfied, the closing of the transactions contemplated herein (the "Termination Date") shall occur and be effective as of 12:01 a.m. on May 1, 2002, or such other date as the parties shall mutually agree. 1.2 Termination of Leases and Sublease. Effective as of the Termination Date each of the Leases and the Sublease shall and will be cancelled and terminated, and all of their respective terms and conditions (including without limitation the option to purchase the Leased Property provided to Lessee under the Leases) shall and will be deemed to be of no further force and effect, with the same effect as if the Termination Date was the expiration date of each Lease and the Sublease. Each Lessor and Lessee hereby declares that, effective as of the Termination Date, except as otherwise expressly provided in Section 9.3, all obligations and duties of the Lessee pursuant to the Leases and the Sublease are hereby terminated. On the Termination Date, Lessee and each Lessor shall execute and deliver a Notice of Termination of Lease for each Lease, in the form attached hereto as Exhibit C, evidencing the termination of each Lease and sufficient for recording in the real estate records of the counties in which each Facility is located. 2 1.3 Termination of Assignments. Effective as of the Termination Date, each of the Assignments shall and will be cancelled and terminated, and all of the terms and conditions thereof shall and will be deemed to be of no further force and effect. PMG hereby declares that, effective as of the Termination Date, all obligations and duties of Lessee under and pursuant to each of the Assignments are hereby terminated. On the Termination Date, Lessee will assign to PMG I, and PMG I will assume, all of the rights and obligations of the Lessee under each of the Assigned Leases pursuant to an Assignment and Assumption of Leases in the form attached hereto as Collective Exhibit D to be executed by Lessee and PMG I. On or before the Termination Date, PMG I shall obtain the acknowledgment and consent, in writing, of the Lessor under the Assigned Leases, and that of any other necessary party, to the assignment of the Assigned Leases back to PMG I and the release of Lessee from its duties and obligations as lessee under each of the Assigned Leases. 1.4 Delivery of Leased Property; Transfer of Lessee's Personal Property. On the Termination Date, Lessee will vacate and surrender to each Lessor, as applicable, and will deliver possession and control to each Lessor, as applicable of the following: (i) all of the Leased Property that is the subject of each Lease, (ii) all of the Subleased Property that is the subject of the Sublease, and (iii) the premises and other property that is the subject of the Assigned Leases. On the Termination Date, Lessee will also transfer, assign and deliver to the applicable Lessor for each Facility all of Lessee's right, title and interest in and to, and the possession and control of, all equipment, motor vehicles, machinery, furniture, fixtures, trade fixtures, inventory of goods and supplies and all other tangible and intangible personal property owned or leased by Lessee and located at or used in connection with and necessary for the operation of each Facility ("Lessee's Personal Property"), including (x) the right to the use of the name under which each Facility is doing business or has done business during Lessee's use and occupancy, and (y) the operations, policies and procedures manual of each Facility as in place at the time the Facility was leased to Lessee; but excluding (i) any leased property that is the subject of a Declined Contract (as defined in Paragraph 8), (ii) Lessee's wide area network and associated software provided on the Diversicare wide area network, (iii) Lessee's continuous quality improvement program, manuals and materials, management information systems, policy, procedure and educational manuals and materials, and similar proprietary property of Lessee, and (iv) any rights in or to the use of the name "Advocat" or "Diversicare", or any derivative thereof, and subject to the rights of any lessors of any of Lessee's Personal Property. The computers and component parts at the Kernersville office building belonging to the Lessors that were removed and stored in the warehouse of Lessors when Lessee moved its headquarters from that Facility will be reinstalled by Lessee in the Kernersville office building prior to, and will be operable on, the Termination Date. On the Termination Date, Lessee will make, execute and deliver a Bill of Sale and Assignment in the form attached hereto as Exhibit E sufficient to transfer Lessee's interest in Lessee's Personal Property to the applicable Lessor. The presence of the Lessee's Personal Property at each Facility on the Termination Date shall constitute delivery thereof. Any items of Lessee's Personal Property containing the name or logo of "Diversicare" or "Advocat", or any derivative thereof, at any Facility as of the Termination Date shall be replaced and either destroyed by Lessors or returned to Lessee. As of the Termination Date, Lessors will discontinue the use of any stationary or other supplies at any Facility which contain reference to such names. 3 1.5 Termination and Release of Advocat Guarantys. Effective as of the Termination Date, each of the Lessors shall and does hereby irrevocably and unconditionally release and forever discharge Advocat, its successors and assigns, of and from any and all claims, demands, actions, causes of action, rights, remedies or suits which each and everyone of the Lessors ever had, now has or might have against Advocat, its successor and assigns, arising out of, related to or connected with each and every one of the Guarantys. Each Lessor hereby declares that, effective as of the Termination Date, each and every one of the Guarantys shall be and hereby is cancelled and terminated and that Advocat shall and does not have any obligations or liabilities whatsoever under any one or all of the Guarantys to any of the Lessors named therein or any other party. On the Termination Date, Lessors shall deliver to Advocat the executed original of each Guaranty, clearly marked to indicate its termination and the release and discharge of Advocat from any liability or obligation with respect thereto. 1.6 Termination and Release of Pierce Non-Compete Agreements. Effective as of the Termination Date, Guy Pierce, Steve Pierce, the Pierces, PMG I, PMG V, PPH and each of the other persons or entities identified as Sellers and Owners under the Asset Purchase Agreement shall be and hereby are released and discharged from the covenants and agreements not to compete against Advocat or Lessee contained and set forth in (i) Article XIV of the Asset Purchase Agreement, (ii) Paragraph 7 of the Employment Agreement by and between Lessee and Guy Pierce dated as of October 1, 1997 and (iii) Paragraph 7 of the Consulting Agreement by and between Lessee and Steve Pierce dated as of October 1, 1997 (collectively, the "NonCompete Restrictions"). Advocat and Lessee hereby declare that, effective as of the Termination Date, each of the NonCompete Restrictions, including the NonCompete Period and the NonCompete Area described therein, shall be and hereby are cancelled and terminated and will be deemed to be of no further force and effect, with the same effect as if the Termination Date was the expiration date of each of the NonCompete Restrictions. As a condition to and in consideration of such release of the NonCompete Restrictions and the transactions contemplated hereby, Guy Pierce and Steve Pierce hereby covenant and agree with Advocat and Lessee that, effective as of the Termination Date, during the NonCompete Period (as defined herein) and within the NonCompete Area (as defined herein), neither Guy Pierce nor Steve Pierce, nor any partnership, corporation, limited liability company or other entity of which they may be or become a shareholder, partner or member (including, without limitation any of the Lessors) shall directly or indirectly: (1) except for the Facilities acquired pursuant to this Agreement and except for any adult care homes which they may acquire by purchase or lease that are already in operation as of the date of this Agreement, acquire, lease, manage, consult for, serve as agent or subcontractor for, finance, invest in, own any part of, or exercise management control over any health care operation or business which provides any services competitive with the services provided by the Business (as defined herein); or (2) interfere with or attempt to interfere with any past or present relationship, contractual or legal, between Advocat, Lessee or any affiliate of Advocat or Lessee, on the one hand, and any customer, resident, physician, physician group, or healthcare provider with whom Advocat, Lessee or any affiliate of Advocat or Lessee contracts with in connection with the operation of the Business in the NonCompete Area, on the other hand. The "Business" shall mean the business of an adult care home (as that term is defined in current Chapter 131D of the NCGS General Statutes). The "NonCompete Period" shall commence on the Termination Date and terminate on the fifth (5th) anniversary thereof. The "NonCompete Area" 4 shall mean the area within North Carolina or Virginia and within a fifteen (15) mile radius of each location, whether owned or leased, from which the Business is operated or conducted on the Termination Date by Advocat, Lessee or the subsidiaries of Lessee known as Diversicare Assisted Living Services, Inc., Diversicare Assisted Living Services NC I, LLC and Diversicare Assisted Living Services NC II, LLC. Provided that nothing contained in this Section 1.6 shall prohibit Guy Pierce, Steve Pierce or any of their affiliates from owning, as a passive investor, not more than five percent (5%) of the outstanding securities of any class of any publicly-traded securities of any publicly held company listed on a well-recognized national securities exchange or on an interdealer quotation system of the National Association of Securities Dealers, Inc. As a condition to and in consideration of the transactions contemplated hereby, Advocat and Lessee hereby covenant and agree with Lessors that, effective as of the Termination Date, during the NonCompete Period, neither Advocat nor Lessee, nor any affiliates (as defined in the Securities Act of 1933, as amended) of Advocat or Lessee shall directly or indirectly, except for any adult care homes which they or their affiliates currently own or operate or which they or their affiliates may acquire by purchase or lease that are already in operation as of the date of this Agreement, acquire, lease, manage, consult for, serve as agent or subcontractor for, finance, invest in, own any part of, or exercise management control over any health care operation or business which provides any services competitive with the services provided by the Business which are located within the states of North Carolina or Virginia and within 15 miles of any of the Facilities which are subject to any of the Leases. Provided that nothing contained in this Section 1.6 shall prohibit Advocat or Lessee or any of their affiliates from owning, as a passive investor, not more than five percent (5%) of the outstanding securities of any class of any publicly traded securities of any publicly held company listed on a well-recognized national securities exchange or an interdealer quotation system of the National Association of Securities Dealers, Inc. In the event of a breach of the covenants set forth herein, the parties hereto recognize that monetary damages shall be inadequate to compensate the protected party intended to have the benefit of the covenants set forth herein (the "Protected Party"), and the Protected Party shall be entitled, without the posting of a bond, to an injunction restraining such breach, with the costs (including attorney's fees) of securing such injunction to be jointly and severally borne by the party committing such breach. Nothing contained herein shall be construed as prohibiting any Protected Party from pursuing any other remedy available to it for such breach or threatened breach. All parties hereto hereby acknowledge the necessity of protection against the competition of described herein and that the nature and scope of such protection has been carefully considered by the parties. The NonCompete Period and the NonCompete Area are expressly represented and agreed to be fair, reasonable and necessary. The consideration provided for in this Agreement is deemed to be sufficient and adequate to compensate the parties hereto for agreeing to the restrictions contained in this Section 1.6. If, however, any court determines that any of the forgoing restrictions are not reasonable, such restrictions shall be modified, rewritten or interpreted to include as much of their nature and scope as will render them enforceable. 5 1.7 Other Agreements. 1.7.1 Effective as of the Termination Date, the Lessors, Van Pierce and his spouse, and each of the other persons or entities identified as Sellers or Owners in the Asset Purchase Agreement, shall not be required to return to Lessee the monies deposited by Lessee with said parties, or any of them, as the last month's Rent under the Leases and the sublease, as reflected on the closing statement prepared and delivered in connection with the Closing of the Asset Purchase Agreement. All of said sums so deposited by Lessee shall belong to and shall be and remain the property of the Lessors, Van Pierce and spouse, or such other Sellers or Owners, as applicable. 1.7.2 Effective as of the Termination Date, Steve Pierce shall be and is hereby declared to be released and discharged from any liability that Steve Pierce now has or may to Lessee or its subsidiary, Diversicare Assisted Living Services NC II, LLC with respect to the Waste Water Treatment Facility situated at the adult care home facility known as Senter's Rest Home, Hector's Creek, Harnett County, North Carolina, which facility was acquired by Lessee pursuant to the Asset Purchase Agreement and is now owned by said subsidiary. 1.7.3 On or before the Termination Date, Steve Pierce will cause the townhome used as the manager's residence for the adult care facility known as Heritage Care of Seven Lakes, West End, Moore County, North Carolina to be conveyed to Diversicare Assisted Living Services NC I, LLC, or its designee, in accordance with the terms and provisions of the Asset Purchase Agreement. 1.8 Carolina Rest Home. The parties hereby acknowledge that the Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between PMG I, as Lessor, and Lessee for the adult care home facility known as Carolina Rest Home in Roanoke Rapids, North Carolina has already been terminated due to casualty damage that occurred on November 8, 2000, that the Leased Property described therein has been vacated and surrendered by Lessee to PMG I, and that PMG I and Lessee have no current or further obligations or duties thereunder. From and after the Effective Date, Lessee will continue to cooperate with and assist PMG I in the collection of the insurance proceeds payable in respect of such casualty loss by Lessee's insuror in accordance with the terms and conditions of the Lease for the Carolina Rest Home facility. 1.9 New River Country Center. Anything herein to the contrary notwithstanding, Lessors and Lessee agree that promptly following the execution of this Agreement, Lessee shall, at Lessee's cost and expense, proceed to close and cease the operations of the New River Country Center Facility located in Sparta, North Carolina (the "Sparta Facility"). Lessee will diligently, and at Lessee's cost and expense, complete the closure of the Sparta Facility in accordance with all applicable laws, ordinances and regulations pertaining to the closure of an adult care home facility, including the giving of all applicable notices to the residents of the Sparta Facility and any governmental agencies having jurisdiction over the Sparta Facility. PMG I will cooperate in good faith with Lessee and take any and all actions as may be required of PMG I, as the Lessor and owner of the Sparta Facility, to complete the closure of the Sparta Facility by Lessee in the manner provided 6 herein. Without limiting the generality of the foregoing, PMG I and Lessee will cooperate with each other as necessary or appropriate to provide for the orderly transfer of the residents of the Facility to other adult care home facilities, wherever located, including, if so requested by PMG I and agreed to by a resident, transfer to any of the other Facilities that are the subject of this Agreement or any other adult care home facilities which are owned, operated and/or managed by any of the Lessors. In consideration of Assignee bearing the cost and expense of closing the Sparta Facility, PMG I agrees that amount of the current monthly installment of rent due under the Lease for the Sparta Facility for the month of April, 2002 shall be reduced by one half (1/2) and that such reduced payment shall be the final payment of rent due from Lessee under the Lease for the Sparta Facility. Thereafter, no further payments of rent or any additional charges shall be due and payable by Lessee in respect of the Sparta Facility regardless of the fact that Lessee may continue to occupy the Sparta Facility from and after May 1, 2002 in order to complete the closure of the Sparta Facility as provided herein. 2. As Is/Where Is. All of the Leased Property, the Subleased Property, the premises and property that are the subject of the Assignment Leases, and Lessee's Personal Property (collectively, the "Real and Personal Property") will be transferred and delivered to Lessor by Lessee on the Termination Date, and will be accepted by Lessor, "as is," "where is," with no warranty of habitability, use or fitness for habitation with respect to any real estate and improvements and with no warranties, including the warranty of merchantability or fitness for a particular purpose, with respect to all of the other property, and all of which warranties (both express and implied) Lessee hereby disclaims. Lessors have, or will have on or before the Termination Date, examined and inspected the Real and Personal Property and knows and is satisfied with, or will know and be satisfied with its condition and Lessors are not now relying, and will not later rely, upon any representations or warranties made (or asserted to have been made) by Lessee, Advocat or anyone claiming to act by, through or under or on their behalf concerning the Real and Personal Property. Prior to the Termination Date, Lessors shall have the right, upon reasonable advance notice and during normal business hours, to enter the Facilities for the purpose of inspecting the Real and Personal Property and determining Lessee's compliance with the terms of this Agreement, subject to any security, health, safety or privacy requirements or rights of the residents and employees of each Facility. Lessee shall have the right to have a representative present at all times during any such inspection by Lessors. 3. Transfer of Resident Trust Funds. 3.1 On or before the Termination Date, Lessee shall deliver to Lessor a true, correct and complete accounting (properly audited and reconciled) of all security deposits, resident accounts and resident trust funds (collectively, the "Resident Trust Funds") and an inventory of all other residents' property, if any, held by Lessee on the Termination Date for residents at the Facilities. On the Termination Date, Lessee shall transfer the Resident Trust Funds and any other residents' property at the Facilities to Lessor and Lessor hereby agrees that it will accept such Resident Trust Funds and any other residents' property in trust for the residents, in accordance with applicable statutory and regulatory requirements. 7 3.2 Lessee will indemnify, defend and hold Lessor harmless from all liabilities, claims and demands, including reasonable attorneys' fees, in the event the amount of the Resident Trust Funds, or other residents' property, if any, transferred to Lessor do not represent the full amount of the Resident Trust Funds or other property shown to have been delivered to Lessee as custodian for the residents at the Facility or for claims which arise from actions or omissions of Lessee with respect to the Resident Trust Funds or other property prior to the Termination Date. Lessors will indemnify, defend and hold Lessee harmless from all liabilities, claims and demands, including reasonable attorneys' fees, in the event a claim is made against Lessee by a resident for his/her Resident Trust Funds or property where such funds or property were properly calculated and transferred to Lessors pursuant to the terms hereof. 4. Employees. 4.1 Employment of Existing Employees. On the Termination Date, Lessor shall, subject to the provisions of Section 4.2 below, have the right and option of offering to employ any or all of Lessee's employees that work at the Facilities. Lessee shall terminate the employment of any employees at the Facilities that Lessor does not elect to employ. In order to determine compliance with Section 4.2, below, Lessor shall advise Lessee in writing on or before ten (10) days prior to the Termination Date of those employees of Lessee that Lessor has elected not to employ. Lessee shall remain liable for all Employee Liabilities (as herein defined) relating to all employees of Lessee at the Facilities that accrue up to the Termination Date. Lessor shall assume and be responsible for all Employee Liabilities with respect to all employees of Lessee at the Facilities hired by Lessor that accrue on or after the Termination Date. Without limiting the generality of the foregoing, Lessee shall remain liable from and after the Termination Date for all obligations of Lessee, if any, to provide continuation of health insurance coverage in accordance with COBRA to those employees of Lessee not hired by Lessor and eligible to utilize COBRA as a result of the termination of their employment by Lessee as herein provided. As used herein, "Employee Liabilities" means wages, salaries, earned and accrued vacation, holiday and sick pay, all accrued paid days off and sick days, and earned or accrued bonuses, if any, due to employees at the Facilities and health insurance, payroll and payroll taxes, unemployment and FICA expenses. 4.2 WARN Act. Anything in this Agreement to the contrary notwithstanding, Lessors shall employ such number of Lessee's employees at the Facilities and shall retain for a period of ninety (90) days following the Closing Date such number of Lessee's employees at the Facility as shall be necessary to avoid any potential liability by Lessee for a violation of the Workers Adjustment Retraining and Notification Act (the "WARN Act") (or any similar law of the State of North Carolina) attendant to Lessee's failure to notify such employees of a "mass layoff" or "plant closing" as defined in the WARN Act (or any similar law of the State of North Carolina). For purposes of determining compliance by Lessors with the foregoing provisions, employees at each Facility terminated by Lessee during the period of ninety (90) days immediately prior to the Termination Date for other than cause, retirement or voluntary departure, all of whom are listed in Exhibit F, shall be taken into consideration. Lessors shall indemnify Lessee from and against any liability for any WARN Act violations resulting from the aggregation of the terminations of employment by Lessee during the ninety (90) days immediately preceding the Termination Date 8 listed on Exhibit F with the terminations of employment of Lessee's employees at the Facilities on or after the Termination Date in violation of this Section 4.2. Nothing herein contained shall be deemed either to affect or to limit in any way the management prerogatives of Lessors with respect to employees, or to create or to grant to such employees any third party beneficiary rights or claims or causes of action of any kind or nature. In the event at the time of the execution of this Agreement, Exhibit F is not attached hereto, Lessee and Lessors agree that the provisions of this Section 4.2 shall nonetheless be effective and binding upon Lessee and Lessors provided that Exhibit F is delivered by Lessee to Lessors and is attached hereto on or before the Termination Date. 5. Accounts Receivable. 5.1 Lessee shall retain its right, title and interest in and to all unpaid accounts receivable with respect to each Facility which relate to the period prior to the Termination Date. On or before the Termination Date, Lessee shall provide each Lessor with a schedule setting forth by resident its outstanding accounts receivable as of the Termination Date. 5.2 Payments received by any Lessor after the Termination Date from third party payors and private pay residents which relate to periods prior to the Termination Date, Lessor shall collect as Lessee's agent for the limited purpose of such collection. Lessor shall remit to Lessee the gross proceeds of such collection within thirty (30) days following the end of each month thereafter for a maximum of six (6) months. Lessee shall be responsible for collecting all receivables thereafter. Lessee and Lessor each agree to provide the other party with any information in its possession reasonably requested by such party with respect accounts receivable and amounts received. 5.3 Lessee shall timely file or cause to be filed all cost reports required to be filed with respect to the purchase of services by Medicaid prior to the Termination Date and pay all amounts required thereunder for any periods prior to the Termination Date. Lessee shall be entitled to receive any refund or other benefit which may result from the filing of said reports. Lessee shall remain liable for the refund of any overpayments made to Lessee prior to the Termination Date for which payment is due to Medicaid or any other third party payor after the Termination Date arising from services provided by Lessee at a Facility prior to the Termination Date. After the Termination Date, Lessors shall assist Lessee in any way reasonably necessary to complete such cost reports in a timely manner. 5.4 Each party hereto covenants and agrees to remit or forward, with reasonable promptness, to the other (i) any payments received, which payments are on or in respect of accounts or notes receivable owned by (or are otherwise payable to) the other or (ii) any notifications, mailings or other written communications (including such communications from Medicaid or other government payor) received by such party which pertain to the other party or such other party's operation of any Facility. It is understood and agreed that, in connection with their operation of the Facilities from and after the Termination Date, Lessors will apply for and obtain their own provider account numbers for each Facility prior to the Termination Date and shall not be entitled to use 9 Lessee's provider account number(s) for the Facilities, which shall remain the sole and exclusive property of Lessee. 6. Prorations; Liabilities. 6.1. Revenues and expenses pertaining to Assumed Contracts (as defined in Section 8), and real and personal property taxes attributable to each Facility shall be prorated between Lessee and Lessors as of the Termination Date. In general, such prorations shall be made so as to reimburse Lessee for prepaid expense items and to charge Lessee for prepaid revenue items that are attributable to the period after the Termination Date and to charge Lessee for expenses payable after the Termination Date that are attributable to the period prior to the Termination Date. 6.2. There shall be no proration of utility charges or any other payables or expenses attributable to each Facility as of the Termination Date, it being the intent of the parties that the Lessee shall pay the bills therefore for the period prior to the Termination Date and Lessors shall pay the bills therefore for the period on and after the Termination Date. Utilities for each Facility will be cut off in Lessee's name on the last day prior to the Termination Date and Lessee shall be entitled to the return of any deposit in respect thereof. Lessors shall be responsible for obtaining utility services in their own names for their respective Facilities, ensuring that the same are available on the Termination Date, and making any deposits necessary therefore prior to the Termination Date. Lessee will notify its suppliers, other than the Assumed Contracts, that the cut off date for their provision of supplies or services to the Facilities will be the last day prior to the Termination Date. 6.3. All prorations required hereunder shall be made on the basis of actual days elapsed in the relevant accounting or revenue period and shall be based on the most recent information available to Lessee. All amounts owing from one party hereto to the other party hereto that require adjustment after the Termination Date shall be settled within thirty (30) days after the Termination Date, or, in the event the information necessary for such adjustment is not available within said 30-day period, then as soon thereafter as practicable. 6.4. Notwithstanding the fact that the Termination Date is the first day of a calendar month, there shall be no proration of and Lessee shall not be required to pay all or any portion of the monthly installment of rent which, by the terms of each Lease, is due on the first day of each calendar month. Likewise, PMGI and Guy Pierce will be responsible for the monthly installment of rent, if any, due and payable on and as of the Termination Date under the Assigned Leases and the Sublease. 7. Access to Records. 7.1 On the Termination Date, Lessee shall deliver to each Lessor all of the books and records for each Lessor's respective Facility, including, but not limited to, resident medical and financial records and employee records for those employees of Lessee at the Facility hired by Lessor in accordance with Section 4.1 hereof. The turnover of records and information with respect to residents of each Facility which are in the possession of Lessee shall be subject to applicable legal 10 requirements and rights governing the confidentiality of resident records, but Lessee shall cooperate with Lessor in facilitating requests to residents of the Facility to consent to the transfer to Lessor of such records and information. 7.2 After the Termination Date, each Lessor shall allow Lessee and its agents and representatives to have reasonable access to (upon reasonable prior notice and during normal business hours), and to make copies of, the books and records (including, subject to obtaining, residents' or resident's authorized representative consent, medical records for pre-Termination Date residents) and supporting material of each Facility relating to the period prior to the Termination Date, to the extent reasonably necessary to enable Lessee (i) to investigate and defend malpractice, employee or other claims, (ii) to prepare work papers for financial reports, tax returns and cost reports, (iii) to answer any questions raised relating to patient billing with respect to the pre-Termination Date period, (iv) to investigate any claims for overpayment made to Lessee, and (v) to verify accounts receivable collections due Lessee. Lessee shall be entitled to remove the originals of any records delivered to Lessor for purposes of litigation involving a resident or employee to whom such record relates, but only if an officer of or counsel for Lessee certifies that such original must be produced in order to comply with applicable law or the order of a court of competent jurisdiction in connection with such litigation, and if such is consistent with applicable law governing resident records. Any record so removed shall promptly be returned to Lessor following its use. For a period of six (6) months after the Termination Date, Lessors shall allow Lessee and its agents and representatives shall have access to (upon reasonable prior notice and during normal business hours but not more than one (1) time in each calendar month) the cash receipts journals of each Facility and other records relating to cash receipts or other forms of payment received or collected in respect of each Facility from and after the Termination Date for the purpose of verifying the allocation of cash receipts or other forms of payment in accordance with Section 5 hereof. Following its receipt of the final remittance of receivables from Lessors at the end of the six (6) month period as provided for in Section 5.2, above, Lessee shall have the one-time right, if it so elects, to have access to such cash receipts journals and other records of each Facility for the purpose of performing an audit, at Lessee's sole cost and expense, in order to verify Lessor's compliance with Section 5; provided that Lessee gives Lessors written notice of its election to perform such audit within fifteen (15) days after its receipt of such final remittance and thereafter promptly commences and diligently prosecutes such audit to completion. Lessors shall reasonably cooperate with Lessee in the performance of such audit. 7.3 Lessors agree to maintain such books, records and other material comprising records of the operations of the Facilities prior to the Termination Date that have been received by Lessors from Lessee or otherwise, including, but not limited to, resident records and records of resident funds, to the extent required by law, but in no event less than three (3) years, and shall allow Lessee a reasonable opportunity not to exceed thirty (30) days to remove such documents, at Lessee's expense, at such time after such record retention period as may be required by law if Lessors shall decide to destroy or dispose of such documents. Lessors shall provide Lessee not less than forty-five (45) days, nor more than ninety (90) days, prior written notice of such destruction or disposal. If Lessee desires to obtain any such documents, it may do so by notifying the applicable Lessor in writing at any time prior to the scheduled date of destruction or disposal, in which event such Lessor 11 shall not destroy such documents and the parties shall promptly arrange for the delivery of such documents to Lessee, at Lessee's expense. 8. Assumed/Declined Contracts. Effective as of the Termination Date, Lessee shall transfer and assign to the applicable Lessor all of Lessee's interest in, and the applicable Lessor shall assume the obligations of Lessee under and agree to perform and be bound by all of the terms and conditions of, the following (collectively, the "Assumed Contracts"): (i) all admission policy agreements, patient's rights agreements and/or any other patient or resident tenancy or occupancy agreements (collectively the "Occupancy Agreements") with existing residents of each Facility (provided, however, that nothing herein shall prevent Lessor from asking existing residents or requiring newly admitted residents to sign new Occupancy Agreements with the Lessor) and (ii) all of the operating contracts and agreements with third parties for the sale, lease or provision of goods, services or equipment in connection with the operation of each Facility (collectively, the "Service Contracts") other than the Declined Contracts, if any (as hereinafter defined). Such assignment and assumption shall be made pursuant to an Assignment and Assumption Agreement in the form attached hereto as Exhibit G, to be executed on the Termination Date by Lessee and each applicable Lessor. Lessee will cooperate with Lessor in obtaining any required consent, waiver or approval in connection with the assignment to and assumption by Lessor of Lessee's interests and obligations under the Assumed Contracts, but Lessee shall have no liability to Lessor for any damages incurred by Lessor as a result of its failure or inability to obtain any consent or waiver necessary to assume any Assumed Contract. Nothing herein shall be construed as imposing any liability on Lessor with respect to any obligations under (a) the Assumed Contracts which relate to the period prior to the Termination Date even if the same are not payable until after the Termination Date, it being specifically understood and agreed that Lessor's liability shall be limited to its acts and omissions thereunder from and after the Termination Date or (b) the contracts and agreements specifically listed and described in Exhibit H hereto which Lessor has advised Lessee in writing prior to the Termination Date it is not prepared to assume as of the Termination Date (the "Declined Contracts"). Lessee will provide Lessors with copies of all Service Contracts for Lessor's inspection and approval prior to the Termination Date. In the event that at the time of the execution of this Agreement Exhibit H is not attached hereto, Lessee and Lessor agree that the provisions of this Section 8 shall be effective and binding upon Lessee and Lessor provided that Exhibit H is delivered and accepted by Lessor and Lessee and attached hereto on or before the Termination Date. 9. Mutual Releases. 9.1 Release by Advocat and Lessee. Effective as of the Termination Date, each of Advocat and Lessee shall and do hereby release and forever discharge each Lessor, their employees, agents and representatives from any and all liabilities or obligations, of whatever kind or nature, known or unknown, that any of the Lessors, their agents, employees or representatives, has, had or may have to Advocat or Lessee arising out of or based upon the Leases, the Sublease, or the Assignments, or the use and occupancy of the Facilities by Advocat, Lessee, or their agents, employees and representatives, except with respect to (i) any breach of this Agreement by Lessors or (ii) any future performance of Lessors required by this Agreement or (iii) any claims or cross-claims made in the litigation brought by J.L. and Lucille Lemoynes relating to employment at the 12 Jacksonville Facility currently pending in the local courts of Onslow County, North Carolina (the "Pending Litigation") or (iv) any claim for indemnification pursuant to Section 9.3, below. 9.2 Release by Lessors. Effective as of the Termination Date, each Lessor shall and does hereby release and forever discharge each of Advocat and Lessee, their employees, agents and representatives, from any and all liabilities or obligations, of whatever kind or nature, known or unknown, that any of Advocat, Lessee, or their agents, employees and representatives, has, had or may have to any one or all of the Lessors arising out of or based upon the Leases, the Sublease, or the Assignments, or the use and occupancy of the Facilities by Advocat, Lessee, or their agents, employees and representatives, except with respect to (i) any breach of this Agreement by Advocat or Lessee or (ii) any future performance of Advocat or Lessee required by this Agreement or (iii) any claims or cross-claims in the Pending Litigation or (iv) any claim for indemnification pursuant to Section 9.3, below. 9.3 Claims by a Straddle Patient or Third Parties. Any claim by a resident relating to professional negligence or similar matters involving a resident of a Facility served prior to the Termination Date and/or subsequent to the Termination Date or any claims made by or for any third parties for personal injury or death occurring at a Facility will be the responsibility of either Lessors or Lessee in accordance with the following guidelines: (i) if it is a claim in which clearly the incident giving rise to liability arose during Lessee's use and occupancy of the Facility but prior to the Termination Date, Lessee shall respond to, and will hold harmless and indemnify the applicable Lessor from and against, the claim and defense expenses; (ii) if it is a claim in which clearly the incident giving rise to liability arose subsequent to the Termination Date, the applicable Lessor shall respond to, and will hold harmless and indemnify Lessee from and against, the claim and defense expenses; and (iii) in the event that the incident giving rise to liability as to time is not clear, Lessee and the applicable Lessor will jointly defend the claim and each will fully cooperate with the other in such defense. Once the claim is settled, closed or otherwise disposed of, if the applicable Lessor and Lessee cannot agree to the allocation of both indemnity and expenses, then the matter shall be submitted to binding arbitration in accordance with the rules and procedures of the American Arbitration Association. 10. Representations, Warranties and Covenants. 10.1 Each Lessor hereby represents and warrants that it has all necessary power and authority to enter into this Agreement and to execute all documents and instruments referred to herein or contemplated hereby and all necessary action has been taken to authorize the individual executing this Agreement to do so, and this Agreement has been duly and validly executed and delivered by Lessor and is enforceable against Lessor in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy laws and general principles of equity. 10.2 Advocat and Lessee each hereby represents and warrants that it has all necessary power and authority to enter into this Agreement and to execute all documents and instruments referred to herein or contemplated hereby and to consummate the transaction provided for herein, and all necessary action has been taken to authorize the individual executing this 13 Agreement to do so, and this Agreement has been duly and validly executed and delivered by each of them and is enforceable against each of them in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy laws and general principles of equity. 10.3 Lessors covenant and agree that, as of the Termination Date, (i) Lessors will have all licenses, permits and approvals required of each Lessor by the State of North Carolina to operate each adult care home Facility as a fully licensed, adult care home facility, except to the extent that there has been a waiver of such compliance from the applicable governmental authorities having jurisdiction thereof and (ii) each adult care home Facility will be duly certified to participate, and does participate, in the Medicaid programs in the State of North Carolina under valid Medicaid contracts. 10.4 Lessee covenants and agrees that between the date hereof and the Termination Date: (i) Lessee will provide all necessary information requested by Lessors for the preparation and filing of any and all necessary applications or notifications to any federal or state governmental authority having jurisdiction over a change in the operational control of the Facilities, and any other information reasonably required to effect an orderly transfer of the Facilities, (ii) except in the case of the Sparta Facility, Lessee shall use its reasonable best efforts to keep the business and organization of the Facilities intact and to preserve for Lessors the goodwill of the suppliers, distributors, residents and others having business relations with Lessee with respect to the Facilities; and (iii) except in the case of an emergency or if required by law, or as provided for herein in the case of the Sparta Facility Lessee shall not move or solicit the move of any residents presently situated at any of the Facilities. 10.5 Lessee represents and warrants that, except as otherwise provided in this Agreement, between the date hereof and the Termination Date (i) Lessee will continue to carry on its business and activities relating to the Facilities in the substantially same manner as it did prior to the date hereof, (ii) Lessee will continue to perform its obligations as Lessee under the Leases, (iii) Lessee will not enter into any new contract or other agreement that will be an obligation affecting any Facility subsequent to the Termination Date without the prior written consent of the applicable Lessor, which consent shall not be unreasonably withheld, (iv) Lessee will not dispose of any equipment, machinery, furnishings, fixtures or inventory, except in the ordinary course of business. 10.6 Lessee represents and warrants that, to the best of Lessee's knowledge, Lessee has permitted no liens or encumbrances (except for the current year's taxes to be prorated as of the Termination Date) to be placed upon any of the Leased Property and that if any such lien or encumbrance is placed or permitted to be placed on any of the Leased Property between the date hereof and the Termination Date, Lessee will cause the same to be removed prior to the Termination Date. For purposes of this Section 10.6, the term "Lessee's Knowledge" shall be deemed to mean and be limited to the personal knowledge of the following officers or representatives of Lessee: Ken Raupauch, David Bolling, Charles Rinne, Dr. Charles Birkett, and Will Council, but shall in no event be deemed to include the personal knowledge of Guy S. Pierce, who was formerly employed by Lessee. 14 11. Conditions to Close. The obligations of Lessors and of Advocat and Lessee to consummate the transactions contemplated by this Agreement are subject to the satisfaction of the following conditions on or prior to the Termination Date or the dates designated elsewhere in this Agreement for the satisfaction of such conditions: (a) All of the representations and warranties of the parties contained herein shall be true and correct in all material respects as of the date of this Agreement and as of the Termination Date; (b) As of the Termination Date, each party shall have performed its obligations hereunder and all documents to be made executed and/or delivered on the Termination Date shall have been tendered; (c) There shall exist no actions, suits, arbitrations, claims, attachments, proceedings, assignments for the benefit of creditors, insolvency, bankruptcy, reorganization or other proceedings, pending or threatened against any party hereto that would materially and adversely affect the ability of any party hereto to perform its obligations under this Agreement; (d) There shall exist no pending or threatened action, suit or proceeding with respect to any party hereto before or by any court or administrative agency (i) which seeks to restrain, suspend or prohibit resident admission(s) to a Facility, (ii) which seeks to impose a provisional license or the failure to comply with which could result in the imposition of a provisional license as to any Facility or (iii) which seeks to restrain or prohibit, or to obtain damages or a discovery order with respect to, this Agreement or the consummation of the transactions contemplated hereby; (e) Lessors, Advocat and Lessee shall have obtained all consents, releases and approvals from all third parties from whom such consents, releases or approvals are necessary to consummate the transactions contemplated hereby, including without limitation, the case of Advocat and Lessee, the consent of AmSouth Bank, and in the case of the Lessors, the holders of mortgages on the Facilities; (f) Each Lessor shall have obtained all of the licenses, permits, approvals and certifications described in Section 10.3, above, necessary for its continued operation as an adult care home of each adult care home Facility to be vacated and surrendered to it by Lessee pursuant to this Agreement; and 12. Termination. Notwithstanding anything in this Agreement to the contrary, this Agreement and the obligations of the parties hereunder may be terminated on or prior to the Termination Date as follows: (a) By Advocat and Lessee (i) in the event the transactions contemplated by this Agreement have been prohibited or enjoined by reason of any final judgment, decree or order entered or issued by a court of competent jurisdiction in litigation or proceedings involving either Lessors or Lessee; or (ii) in the event Lessors breach or violate any material provision of this Agreement or fail 15 to perform any material covenant or agreement to be performed by Lessors under the terms of this Agreement, and Advocat or Lessee has provided written notice thereof to Lessors giving reasonable specificity and Lessors have not cured same within a reasonable period of time and such breach is not waived by Advocat and Lessee in writing. (b) By Lessors (i) in the event the transactions contemplated by this Agreement have been prohibited or enjoined by reason of any final judgment, decree or order entered or issued by a court of competent jurisdiction in litigation or proceedings involving either Lessors or Advocat or Lessee; or (ii) in the event Advocat or Lessee breaches or violates any material provision of this Agreement or fails to perform any material covenant or agreement to be performed by Advocat or Lessee under the terms of this Agreement and Lessors have provided written notice thereof to Advocat and Lessee giving reasonable specificity and Advocat or Lessee has not cured same within a reasonable period of time and such breach is not waived by Lessors in writing. (c) By Lessors or by Advocat or Lessee if the Termination Date hereunder shall not have taken place by May 1, 2002, or by such later date as shall be agreed upon by an appropriate amendment to this Agreement if the parties agree in writing to an extension, provided that a party shall not have the right to terminate under this Section 11 if the conditions precedent to such party's obligation to close have been fully satisfied and such party has failed or refused to close within a reasonable time after being requested in writing to close by the other party. 13. Further Assurances. Each of the parties hereto agrees to execute and deliver any and all further agreements, documents or instruments necessary to effectuate this Agreement and the transactions referred to herein or contemplated hereby or reasonably requested by the other party to perfect or evidence their rights hereunder. Lessors and Lessees both agree to use their best efforts to obtain the written consent and agreement of the lessors of the adult care facilities known as Oakcrest Manor, Chesapeake, Virginia and Vintage Inn, Williamston, North Carolina to the assignment of the current leases for those facilities with Diversicare Assisted Living Services, Inc. and the transfer of the operation of the facilities to Guy S. Pierce, or its assignee, in accordance with that certain Lease Termination and Operations Transfer Agreement by and between PMG I and Diversicare Assisted Living Services, Inc. of even date herewith. It is the intent of the parties hereto that the operation of such facilities will be transferred simultaneously with the Termination Date, or as soon thereafter as possible. 14. Notices. All notices to be given by any party to this Agreement to the other party hereto shall be in writing, and shall be (a) given in person, (b) deposited in the United States mail, certified or registered, postage prepaid, return receipt requested or (c)sent by national overnight courier service, each addressed as follows: (a) If to Lessors: 8831 Goodwill Church Road P.O. Box 1487 Kernersville, N.C. 27285 Attn: Steve Pierce 16 (b) If to Lessee or Advocat: 277 Mallory Station Road Suite 130 Franklin, TN 37067 Attn: Charles Rinne Any such notice personally delivered shall be deemed delivered when actually received, any such notice deposited in the United States mail, registered or certified, return receipt requested, with all postage prepaid, shall be deemed to have been given on the earlier of the date received or the date when delivery is first refused, and any notice deposited with an overnight courier service for deliver shall be deemed delivered on the business day following such deposit. Any party to whom notices are to be sent pursuant to this Agreement may from time to time change its address for further communications thereunder by giving notice in the manner prescribed herein to all other parties hereto. 15. Payment of Expenses. Each party hereto shall bear its own legal, accounting and other expenses incurred in connection with the preparation and negotiation of this Agreement and the consummation of the transaction contemplated hereby, whether or not the transaction is consummated. 16. Entire Agreement; Amendment; Waiver. This Agreement, together with the other agreements referred to herein, constitutes the entire understanding among the parties with respect to the subject matter hereof, superseding all negotiations, prior discussions and preliminary agreements. This Agreement may not be modified or amended except in writing signed by the parties hereto. No waiver of any term, provision or condition of this Agreement in any one or more instances, shall be deemed to be or be construed as a further or continuing waiver of any such term, provision or condition of this Agreement. No failure to act shall be construed as a waiver of any term, provision, condition or rights granted hereunder. 17. Binding Effect. This Agreement shall be binding upon and shall inure to the benefit of the respective legal representatives, heirs, successors and assigns of the parties hereto. 18. No Joint Venture; Third Party Beneficiaries. Nothing contained herein shall be construed as forming a joint venture or partnership among Lessors and Advocat or Lessee with respect to the subject matter hereof. The parties hereto do not intend that any third party shall have any rights under this Agreement. 19. Captions. The section headings contained herein are for convenience only and shall not be considered or referred to in resolving questions of interpretation. 20. Counterparts. This Agreement may be executed and delivered via facsimile and in one or more counterparts and all such counterparts taken together shall constitute a single original Agreement. 21. Governing Law. This Agreement shall be governed and construed in accordance with the laws of the State of North Carolina. [THE REST OF THIS PAGE INTENTIONALLY LEFT BLANK] 17 IN WITNESS WHEREOF, the parties hereby execute this Agreement as of the day and year first set forth above. DIVERSICARE ASSISTED LIVING SERVICES NC, LLC By: /s/ Charles Rinne ------------------------------------------------- Name: Charles Rinne Title: President ADVOCAT, INC. By: /s/ Charles Rinne ------------------------------------------------- Name: Charles Rinne Title: President PIERCE MANAGEMENT GROUP FIRST PARTNERSHIP By: /s/ A. S. Pierce ------------------------------------------------- Name: A. S. Pierce Title: Owner PIERCE MANAGEMENT GROUP FIFTH PARTNERSHIP By: /s/ A. S. Pierce ------------------------------------------------- Name: A. S. Pierce Title: Owner PIERCE, PIERCE AND HALL By: /s/ A. S. Pierce ------------------------------------------------- Name: A. S. Pierce Title: Managing Member /s/ Guy S. Pierce ---------------------------------------------------- GUY S. PIERCE /s/ A. Steve Pierce ---------------------------------------------------- A. STEVE PIERCE /s/ Mary Lou Pierce ---------------------------------------------------- MARY LOU PIERCE 18 EXHIBIT A PIERCE LEASES I. LEASED FACILITIES 1. CHRISTIAN CARE OF NEW BERN 104 Efird Boulevard P.O. Box 12383 New Bern, Craven County, NC 28560 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility and apartment units known as Christian Care of New Bern 2. CREEKSIDE MANOR 6206 Reidsville Road Kernersville, Forsyth County, NC 27284 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility known as Creekside Manor 3. CATAWBA VILLAGE 3430 Lester St. P.O. Box 129 Conover, Catawba County, NC 28613 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility known as Catawba Village (formerly known as Heritage Care of Conover) 4. HERITAGE CARE OF ELIZABETH CITY Timmerman Drive P.O. Box 2045 Elizabeth City, Pasquotank County, NC 27909 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility and apartment units known as Heritage Care of Elizabeth City 5. HERITAGE CARE OF ELKIN 500 Johnson Ridge Road P.O. Box 828 Elkin, Surry County, NC 28621 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility known as Heritage Care of Elkin 6. LIGHT HOUSE VILLAGE 182 Village Drive P.O. Box 109680 Jacksonville, Onslow County, NC 28540 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility known as Light House Village (formerly known as Jacksonville Christian Care) 7. MAGNOLIA VILLAGE 3407 Oak Street P.O. Box 1189 New Bern, Craven County, NC 28563 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility known as Magnolia Village (formerly known as New Bern Rest Home) 8. NEW RIVER COUNTRY CENTER 473 Ball Park Road P.O. Box 219 Sparta, Alleghany County, NC 28675 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility known as New River Country Center (formerly known as New River Country Care) 9. PINEWOOD MANOR Earley Station Road Route 1, Box 19K Ahoskie, Hartford County, NC 27910 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility known as Pinewood Manor 2 10. EDENTON PRIME TIME 105 Mark Street P.O. Box 987 Edenton, Chowan County, NC 27932 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce, Pierce and Hall, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility and apartment units known as Edenton Prime Time 11. FREMONT REST CENTER 300 South St. P.O. Box 548 Fremont, Wayne County, NC 27830 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group Fifth Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for the adult care home facility known as Fremont Rest Center 12. CHRISTIAN CARE - HENDERSON 1000 Health Care Center Road P.O. Box 1498 Henderson, Vance County, NC 27536 Sublease Agreement dated as of September 30, 1997 between Guy S. Pierce, as Sublessee and Diversicare Assisted Living Services NC, LLC, as Sublessee, for the adult care home facility known as Christian Care Henderson (formerly known as Christian Care - Henderson - Pinecrest) II. MANAGER'S HOME 1. PINEWOOD MANOR Earley Station Road, Route 1, Box 19K Ahoskie, Hertford County, NC 27910 Lease Agreement (With Option to Purchase) dated as of September 30, 1997 by and between Pierce Management Group First Partnership, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for manager's home at the Pinewood Manor adult care home facility 2. HERITAGE CARE OF ELKIN 500 Johnson Ridge Road P.O. Box 828 Elkin, Surry County, NC 28621 [IS THERE A SEPARATE LEASE ON THIS MANAGERS HOME?] 3 III. OFFICE BUILDING 1. OFFICE BUILDING Goodwill Church Road Kernersville, Forsyth County, NC Lease Agreement (With Option to Purchase) dated as of September 30, 1997 between A. Steve Pierce and Mary Lou Pierce, as Lessor, and Diversicare Assisted Living Services NC, LLC, as Lessee, for land and office building IV. ASSIGNED/ASSUMED LEASES 1. HERITAGE RETIREMENT - ROCKY MOUNT 1650 Cokey Road Rocky Mount, Edgecombe County, NC 27801 Lease Agreement dated as of July 14, 1997 by and between Hazel Powell, as Lessor, and Pierce Management Group First Partnership, as Lessee, assigned and assumed by Assignment and Assumption of Lease Agreement dated as of October 1, 1997 by and between Pierce Management Group First Partnership, as Assignor and Diversicare Assisted Living Services NC, LLC, as Assignee, for the adult care home facility known as Heritage Retirement - Rocky Mount (formerly known as Heritage Care of Rocky Mount) 2. HERITAGE RETIREMENT - ROCKY MOUNT 132-136 Maize Drive Rocky Mount, Edgecombe County, NC 27801 Lease Agreement dated October 1, 1992 by and between C.P. Powell and Hazel Powell, as Lessor, and A. Steve Pierce and Mary Lou Pierce, as Lessee, assigned and assumed by Assignment and Assumption of Lease dated as of October 1, 1997 between A. Steve Pierce and Mary Lou Pierce, as Assignor, and Diversicare Assisted Living Services NC, LLC, as Assignee, for manager's home at the Heritage Retirement - Rocky Mount adult care home facility 4 EXHIBIT B ADVOCAT GUARANTYS 1. Guaranty of Lease Agreements executed September 30, 1997, to be effective as of October 1, 1997, by Advocat, Inc., as Guarantor, in favor of Pierce Management Group First Partnership, a North Carolina general partnership. (10 adult care home facilities and the Pinewood Manor manager's home) 2. Guaranty of Lease Agreement executed September 30, 1997, to be effective as of October 1, 1997, by Advocat Inc., a Delaware corporation, as Guarantor, in favor of Pierce Management Group Fifth Partnership. (Fremont Rest Center adult care home facility) 3. Guaranty of Lease Agreement executed September 30, 1997, to be effective as of October 1, 1997, by Advocat Inc., a Delaware corporation, as Guarantor, in favor of Pierce, Pierce and Hall, a North Carolina general partnership. (Edenton Prime Time adult care home facility) 4. Guaranty of Lease Agreement executed September 30, 1997, to be effective October 1, 1997, by Advocat Inc., a Delaware corporation, as Guarantor, in favor of Pierce Management Group First Partnership, a North Carolina general partnership. (Heritage - Retirement - Rocky Mount adult care home facility) 5. Guaranty of Lease Agreement executed September 30, 1997, to be effective October 1, 1997, by Advocat Inc., a Delaware corporation, as Guarantor, in favor of A. Steve Pierce and Mary Lou Pierce. (Kernersville office building) 6. Guaranty of Sublease Agreement executed September 30, 1997, to be effective October 1, 1997, by Advocat Inc., a Delaware corporation, as Guarantor, in favor of Guy S. Pierce. (Christian Care - Henderson adult care home facility) EXHIBIT C STATE OF ____________________ COUNTY OF __________________ NOTICE OF TERMINATION OF LEASE AGREEMENT This NOTICE OF TERMINATION OF LEASE AGREEMENT ("Agreement") is made and entered into as of this ___ day of _______________, 2002, to be effective as of the effective date stated herein by and between _____________________________________, ("Lessor") and DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Delaware limited liability Company ("Lessee"). WITNESSETH: WHEREAS, Lessor and Lessee have previously entered into a Lease Agreement (With Option to Purchase) [Sublease Agreement] (the "Lease") dated as of September 30, 1997 providing for the lease by Lessee from Lessor of certain real property, improvements, fixtures and equipment known as _________________________________ and located in ___________________ North Carolina (collectively, the "Leased Property"); and WHEREAS, a memorandum of the Lease is of record in ____________________________ to which reference is here made; and WHEREAS, Lessor and Lessee have elected to terminate the Lease and in connection therewith, the parties have entered into that certain Lease Termination and Operations Transfer Agreement dated March, 2002 (the "Termination Agreement") relating to the termination of the Lease, the surrender of possession and return to Lessor of the Leased Property, and the transfer of certain personal property of the Lessee to Lessor necessary or useful in the operation of the Leased Property; and NOW THEREFORE, in consideration of the foregoing premises, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and further for the purpose of providing notice of the termination of the Lease in accordance with the Termination Agreement, the parties hereby state, acknowledge and confirm as follows: 1. Termination. The Lease shall be and is hereby canceled and terminated in its entirety, and all of its terms and conditions shall and are hereby deemed to be of no further force and effect, effective as of 12:01 a.m. EST, May 1, 2002 (the "Effective Date"). As of the Effective Date, except as otherwise specifically provided in the Termination Agreement, each of Lessor and Lessee shall be released in full from each and all of its respective covenants, agreements, duties, responsibilities, liabilities and obligations (present and future) under the Lease and Lessor and Lessee each hereby releases and forever discharges the other from any claims or demands that either party now has or may have against the other with respect thereto. 2. Surrender of Leased Property. Lessee shall and does hereby vacate and surrender possession of the Leased Property to Lessor as of the Effective Date and the Lessor accepts the Leased Property from Lessee in "as is" condition as of the Effective Date. IN WITNESS WHEREOF, the parties hereto have caused this Termination of Lease Agreement to be executed as of the effective date set forth herein. LESSOR: [-----------------------------] By: ---------------------------------------- Its: --------------------------------------- LESSEE: DIVERSICARE ASSISTED LIVING SERVICES NC, LLC By: ---------------------------------------- Its: --------------------------------------- [NOTARY ACKNOWLEDGEMENTS] COLLECTIVE EXHIBIT D [HERITAGE ROCKY MOUNT - FACILITY LEASE] ASSIGNMENT AND ASSUMPTION OF LEASE ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company ASSIGNEE: PIERCE MANAGEMENT GROUP FIRST PARTNERSHIP, a North Carolina partnership THIS ASSIGNMENT AND ASSUMPTION OF LEASE (the "Assignment") is made and entered into as of March 1, 2002 by and between PIERCE MANAGEMENT GROUP FIRST PARTNERSHIP, a North Carolina general partnership("Assignee") and DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company ("Assignor"). For good and valuable consideration, the receipt of which is hereby acknowledged, and pursuant to that certain Lease Termination and Operations Transfer Agreement dated as of March ____, 2002 by and among Assignor and Assignee and certain affiliates described herein (the "Termination Agreement"), Assignor and Assignee hereby agree as follows: 1. Assignment of Lease. Assignor hereby transfers, grants, conveys, assigns and sets over to Assignee, its successors and assigns, all of Assignor's right, title, and interest as Lessee in, to and under that certain Lease Agreement dated July 14, 1997 by and between Hazel Powell (widow), of Rocky Mount, North Carolina, as Lessor, and Lessee for certain real property and all buildings, equipment and appurtenances located thereon situated on Cokey Road in Rocky Mount, Edgecombe County, North Carolina and known as Heritage Care of Rocky Mount (the "Lessee"), and any and all amendments, modifications, restatements, renewals or replacements thereof or thereto, together with any and all rights to extend or renew and all other options or rights provided for therein, for the benefit and use of the Assignee as and from the effective date hereof and during the term and interest of the Lessee therein. Reference is here made to the Lease for a full statement of its terms and conditions. Assignee was assigned all of the right, title and interest, and assumed all of the obligations, of the Lessee under the Lease pursuant to an Assignment and Assumption of Lease dated as of October 1, 1997 by and between Assignor and Assignee (the "Assignment"). 2. Assumption by Assignee. Assignee hereby assumes, and does hereby covenant and agree with Assignor to fully and faithfully pay, perform, keep, observe, meet and discharge, from and after the effective date hereof, all of the duties, responsibilities, undertakings and obligations of the Lessee that accrue under the Lease from and after the effective date hereof, including, without limitation, the payment of rent, and Assignee agrees to be bound from and after the effective date hereof by all of the terms, conditions, covenants and agreements of the Lease. Assignee hereby covenants and agrees that it will indemnify and hold and save harmless the Assignor from and against all liabilities, obligations, claims, demands, costs or expenses incurred or suffered by, or asserted against, Assignor as a result of or on account of the failure of Assignee to observe and perform any of the duties, responsibilities and obligations of the Lessee which shall accrue or arise under the Lease on and after the effective date hereof. 3. Termination of Assignment. The Assignment is terminated as of the effective date hereof and declared to be of no further force and effect, and Lessee shall have no further duties or obligations under or in respect of the Assignment. 4. No Change. It is understood and agreed by the parties hereto that this Assignment does not extend the terms of the Lease or change the consideration given therefor in any form. This instrument shall not have the effect of in any way modifying, amending, supplementing or abridging the Lease or any of its provisions as the same are now or may hereafter be in force and effect. 5. Effective Date. This Assignment shall be effective as of 12:01 a.m., EST, on May 1, 2002. 6. Governing Law. This Assignment shall be interpreted, construed and governed according to the laws of the State of North Carolina. 7. Binding Effect. This Assignment shall be binding upon and shall inure to the benefit of the respective legal representatives, successors and assigns of the Assignor, and Assignee. [THE REST OF THIS PAGE INTENTIONALLY LEFT BLANK] IN WITNESS WHEREOF, the parties hereto have caused this Assignment to be executed to be effective as of the effective date stated herein. ASSIGNEE: PIERCE MANAGEMENT GROUP FIRST PARTNERSHIP By: ---------------------------------------- Its: --------------------------------------- ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES NC, LLC By: ---------------------------------------- Its: --------------------------------------- COLLECTIVE EXHIBIT D [HERITAGE ROCKY MOUNT - MANAGER'S HOME] ASSIGNMENT AND ASSUMPTION OF LEASE ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company ASSIGNEE: A. STEVE PIERCE and MARY LOU PIERCE, as Partners THIS ASSIGNMENT AND ASSUMPTION OF LEASE (the "Assignment") is made and entered into as of March 1, 2002 by and between A. STEVE PIERCE and MARY LOU PIERCE, as Partners ("Assignee") and DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company ("Assignor"). For good and valuable consideration, the receipt of which is hereby acknowledged, and pursuant to that certain Lease Termination and Operations Transfer Agreement dated as of March ___, 2002 as amended, by and among Assignor and Assignee and certain affiliates described therein (the "Termination Agreement"), Assignor and Assignee hereby agree as follows: 1. Assignment of Lease. Assignor hereby transfers, grants, conveys, assigns and sets over to Assignee, its successors and assigns, all of Assignor's right, title, and interest as Lessee in, to and under that certain Lease Agreement dated October 1, 1992 by and between C. P. Powell and wife, Hazel H. Powell, of Rocky Mount, North Carolina, as Lessor, and A. Steve Pierce and Daniel W. Tuttle, partners, as the original Lessee thereunder, Assignor being the successor to the interest of the said A. Steve Pierce and Daniel W. Tuttle as Lessee thereunder, for a parcel of land together with the buildings or other improvements situated thereon described as 132-136 Mazie Drive in Rocky Mount, Edgecombe County, North Carolina (the "Lease"), and any and all amendments, modifications, restatements, renewals or replacements thereof or thereto, together with any and all rights to extend or renew and all other options or rights provided for therein, for the benefit and use of the Assignee as and from the effective date hereof and during the term and interest of the Lessee therein. Reference is here made to the Lease for a full statement of its terms and conditions. Assignor was assigned all of the right, title and interest, and assumed all of the obligations, of the Lessee under the Lease pursuant to an Assignment and Assumption of Lease dated as of October 1, 1997 by and between Assignor and Assignee (the "Assignment"). 2. Assumption by Assignee. Assignee assumes, and does hereby covenant and agree with Assignor to fully and faithfully pay, perform, keep, observe, meet and discharge, from and after the effective date hereof, all of the duties, responsibilities, undertakings and obligations of the Lessee that accrue under the Lease from and after the effective date hereof, including, without limitation, the payment of rent, and Assignee agrees to be bound from and after the effective date hereof by all of the terms, conditions, covenants and agreements of the Lease. Assignee hereby covenants and agrees that it will indemnify and hold and save harmless the Assignor from and against all liabilities, obligations, claims, demands, costs or expenses (including reasonable attorneys fees) incurred or suffered by, or asserted against, Assignor as a result of or on account of the failure of Assignee to observe and perform any of the duties, responsibilities and obligations of the Lessee which shall accrue or arise under the Lease on and after the effective date hereof. 3. Termination of Assignment. The Assignment is terminated as of the effective date hereof and declared to be of no further force and effect, and Lessee shall have no further duties or obligations under or in respect of the Assignment. 4. No Change. It is understood and agreed by the parties hereto that this Assignment does not extend the terms of the Lease or change the consideration given therefor in any form. This instrument shall not have the effect of in any way modifying, amending, supplementing or abridging the Lease or any of its provisions as the same are now or may hereafter be in force and effect. 5. Effective Date. This Assignment shall be effective as of 12:01 a.m., EST, on May 1, 2002. 6. Governing Law. This Assignment shall be interpreted, construed and governed according to the laws of the State of North Carolina. 7. Binding Effect. This Assignment shall be binding upon and shall inure to the benefit of the respective legal representatives, successors and assigns of the Assignor, and Assignee. [THE REST OF THIS PAGE INTENTIONALLY LEFT BLANK] 2 IN WITNESS WHEREOF, the parties hereto have caused this Assignment to be executed to be effective as of the effective date stated herein. ASSIGNEE: By: ---------------------------------------- A. Steve Pierce By: ---------------------------------------- Mary Lou Pierce ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES NC, LLC By: ---------------------------------------- Its: --------------------------------------- 3 EXHIBIT E BILL OF SALE AND ASSIGNMENT ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company ASSIGNEE: --------------------------------------------------------------------- THIS BILL OF SALE AND ASSIGNMENT ("Assignment") is made and entered into effective as of the Effective Date set forth herein by and between ___________________________________________________________________ ("Assignee) and Diversicare Assisted Living Services NC, LLC, a Tennessee limited liability company ("Assignor"). WITNESSETH: WHEREAS, Assignor and Assignee, and certain of their affiliates, have entered into a certain Lease Termination and Operations Transfer Agreement dated as of March __, 2002 (the "Termination Agreement") pursuant to which Assignor has agreed to transfer and deliver to Assignee certain personal property used by Assignor in the operation of certain adult care home facilities and related properties (the "Facilities") described therein; NOW THEREFORE, in consideration of the foregoing premises, and other good and valuable consideration, the receipt and sufficient of which is hereby acknowledged, and pursuant to the Termination Agreement, the parties hereto agree as follows: 1. Sale and Assignment. Assignor hereby bargains, sells, conveys, assigns, transfers, and delivers to Assignee, its successors and assigns, forever, all right, title and interest of Assignor in and to the following property owned, leased, used or held by Assignor and located at or used in connection with, and necessary to the operation of, the Facilities described on Exhibit A attached hereto (collectively the "Assets"): (a) All furniture, furnishings, trade fixtures, fittings, computers, appliances, apparatus, equipment, machinery, tools, leasehold improvements and fixtures, and all other tangible personal property of every kind and description, together with all accessions, additions, attachments, accessories, appurtenances and replacements parts thereto and thereof (collectively, "Personal Property"); (b) All assignable warranties, surety agreements or guaranties (express or implied) issued in connection with or arising out of the purchase, construction, repair or replacement of any of the foregoing Personal Property, and all rights of Assignor which have accrued or may accrue thereunder; (c) All inventories of consumable and disposable goods and supplies of every kind and description, including without limitation, raw materials, work in progress, stock in trade, finished goods, supplies, paper, food, cleaning materials, disposables, linens, office supplies, drugs and medical supplies (collectively, "Inventory"); (d) All resident, medical, clinical, personnel files and other records related to the Facilities (including both hard and microfiche copies) and all books and records used in operating the Facilities; (e) All motor vehicles including, but not limited to, those vehicles listed on Exhibit A, attached hereto (collectively, the "Vehicles"); (f) All contract and leasehold rights and interests pursuant to contracts for purchase or lease of personal property, construction contracts, contracts for purchase, sale or lease of equipment, goods or services currently furnished or to be furnished in connection with the Facilities and that are expressly assumed by Assignee pursuant to the Termination Agreement; (g) All trade names under or by which the Facilities may be operated or known and all trademarks, trade names and goodwill related to the Facilities or the operation of the business of the Facilities; and (h) All books and records pertaining to the above described Assets, including the policies procedures and operations manual specific to each Facility as in place at the time such Facility was leased to Lessee. 2. Excluded Assets. The following items of property are expressly excluded from the transfer of the Assets provided for herein and for purposes of this Assignment are not, and shall not be deemed to be, a part of the "Assets" described herein: (i) any leased property that is the subject of a Declined Contract (as defined in Paragraph 8 of the Termination Agreement, (ii) Assignor's wide area network and associated software provided on the Diversicare wide area network, (iii) Assignor's continuous quality improvement program, manuals and materials, management information systems, policy, procedure and educational manuals and materials, and similar proprietary property of Assignor, and (iv) any rights in or to the use of the name "Advocat" or "Diversicare", or any derivative thereof. Anything to the contrary herein notwithstanding, Lessor shall be entitled to receive all operations, policies and procedures manual specific to individual Facilities as in place at the time the Facility was leased to Lessee. 3. Rights Assigned. It is acknowledged that as to any Assets, or any part thereof, 2 located at and used, held or maintained in connection with the operation of the Facilities that are leased and not owned by Assignor, Assignor is not selling or conveying such Assets but is only assigning its rights, if any, in and to those Assets to Assignee and the term "Assets" includes, as to those items, the leasehold interest only of Assignor, together with any options to purchase any of said items and any additional or greater rights with respect to such items which Assignor may have the right to hereafter acquire. 4. As Is/Where Is. The Assets hereby conveyed and assigned are being transferred to and accepted by Assignee "as-is" "where-is", without any warranty, express or implied, statutory or otherwise, and including without limitation any warranty as to condition, merchantability or fitness for a particular purpose, all of which warranties (both express and implied) Assignor hereby disclaims. 5. Delivery of Documents; Further Assurances. Simultaneously with the execution of this Assignment, Assignor has caused to be delivered to Assignee all agreements, books, instruments, documents, records, invoices, manuals, warranties and other materials, records and documents evidencing or relating to the Assets transferred hereby. If additional records or documents evidencing or relating to the Assets are subsequently found or received by Assignor, Assignor will immediately forward them to Assignee. Assignor further agrees to cooperate with Assignee and to execute and deliver, or cause to be executed and delivered, any and all such further documents, instruments, materials or records, including motor vehicle certificates of title, as may be necessary or required or reasonably requested by Assignee in order to further perfect Assignee's right, title and interest in and to the Assets and to otherwise carry out the intent and purpose of this Assignment. 6. Attorney-In-Fact. To assure the full effectiveness of this Assignment with respect to the Vehicles transferred hereby, Assignor hereby constitutes and appoints Assignee its true and lawful attorney, with full power of substitution, for Assignor and in its name and stead or otherwise, to demand or receive from time to time any and all of the Vehicles, to give receipts and releases for or in respect of the same or any part thereof, and from time to time to institute and prosecute in the name of Assignor or otherwise any and all proceedings at law, in equity or otherwise, which Assignee reasonably may deem proper, in order to collect, assert or enforce any claim, right or title of any kind of Assignee in or to the Vehicles and to defend or compromise any or all actions, suits or proceedings with respect to any of the Vehicles and in general, to do all acts and things in relation to the Vehicles as Assignee reasonably may deem desirable; Assignor declaring that the appointment made and the powers granted by this Assignment are coupled with an interest and are not and shall not be revocable by Assignor. 7. Effective Date. This Assignment shall be effective as of 12:01 a.m., EST, on the lst day of May, 2002. 8. Binding Effect. This Assignment shall be binding upon and shall inure to the benefit of the respective legal representatives, successors and assigns of the Assignor and Assignee. 3 IN WITNESS WHEREOF, Assignor and Assignee have caused this Instrument to be executed as of effective date stated herein. ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES NC, LLC By: ---------------------------------------- Its: --------------------------------------- ASSIGNEE: [-------------------------------] By: ---------------------------------------- Its: --------------------------------------- 4 EXHIBIT A MOTOR VEHICLES EXHIBIT F TERMINATED EMPLOYEES None EXHIBIT G ASSIGNMENT OF OCCUPANCY AGREEMENTS, SECURITY AND OTHER DEPOSITS, SERVICE AGREEMENTS AND ASSUMPTION AGREEMENT THIS ASSIGNMENT OF OCCUPANCY AGREEMENTS, SECURITY AND OTHER DEPOSITS, SERVICE AGREEMENTS AND ASSUMPTION AGREEMENT (the "Assignment") is made effective as of the Effective Date set forth herein by and between ______________________________ ("Assignee") and DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company ("Assignor"). WITNESSETH: Assignor and Assignee, and certain of their affiliates, have entered into a Lease Termination and Operations Transfer Agreement dated as of March ___, 2002 (the "Termination Agreement") pursuant to which Assignor will surrender, transfer and deliver to Assignee possession and control of certain real and personal property located in North Carolina for use and operation as adult care home facilities. NOW, THEREFORE, in consideration of the foregoing premises, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and pursuant to the Termination Agreement, the parties hereto agree as follows: 1. Assignment. Assignor hereby assigns, transfers, sells, conveys and delivers to Assignee, its successors and assigns, forever, all right, title and interest of Assignor in and to the following assets (the "Assets"): (i) All admissions policy agreements, patient's rights agreements and/or any other patient or resident tenancy or occupancy agreements (collectively, "Occupancy Agreements") with residents or patients covering rooms or units in the adult care home facilities described on Exhibit A attached hereto, and any and all security or other deposits and/or trust accounts related to the Occupancy Agreements (the "Accounts"); and (ii) All operating contracts or agreements with third parties for the sale, lease or provisions of goods, services or equipment in connection with the use, enjoyment, occupancy or operation by Assignor of the adult care home facilities described on Exhibit A attached hereto ("Service Agreements"). 2. Delivery and Receipt of Documents. Simultaneously with the execution of this Assignment, Assignor have delivered or caused to be delivered the originals or true, correct and complete copies of the Occupancy Agreements and the Service Agreements, and any modifications, renewals or extensions thereof, to the extent the same are available and in written form, together with appropriate documentation, evidencing the Accounts, the name of each resident and the amount held on his or her behalf hereby transferred, and all other agreements, instruments, ledgers, books of account or other records or documents relating to the Assets hereby assigned and transferred. If additional records or documents are found or received, Assignor will immediately forward them to Assignee. 3. Assumption of Occupancy Agreements. Assignee hereby assumes and agrees to perform all of the terms, covenants and conditions of the Occupancy Agreements required to be performed on the part of Assignor which shall arise or accrue on or after the effective date hereof, including, but not limited to, the obligation to repay to residents, in accordance with the terms of such Occupancy Agreements, all Accounts, trust account deposits and any security deposits actually delivered by Assignor to and received by Assignee in accordance with the Termination Agreement and required to be repaid by the terms of such Occupancy Agreements. In connection herewith, Assignee agrees to indemnify and save and hold harmless Assignor from any and all liabilities, obligations, claims, costs, expenses (including, without limitation, reasonable attorneys' fees) or causes of action existing in favor of or asserted by other parties to the Occupancy Agreement, or hereafter incurred or suffered by Assignor, arising out of or relating to Assignee's failure to perform any of the obligations of Assignor under the Occupancy Agreements on and after the effective date hereof or to repay any trust account or security deposits actually received by Assignee where required to do so. Nothing herein shall be construed so as to limit Assignee's rights under the Occupancy Agreements or at law or in equity to terminate such Occupancy Agreements, and Assignee shall not be liable to Assignors or any other party for such proper termination, nor shall anything herein prevent Assignee from asking residents to sign new Occupancy Agreements with Assignee. 4. Assumption of Service Agreements. Assignee hereby assumes and agrees to perform all of the terms, covenants and conditions of the Service Agreements required to be performed on the part of Assignor which shall arise or accrue on and after the effective date hereof, and hereby agrees to indemnify, save and hold harmless Assignor from any and all liabilities, obligations, claims, costs, expenses (including, without limitation, reasonable attorneys' fees) or causes of action existing in favor of or asserted by other parties to the Service Agreements, or hereafter incurred or suffered by Assignor, arising out of or relating to Assignee's failure to perform any of the obligations of Assignor under the Service Agreements on and after the effective date hereof. Nothing herein shall be construed so as to limit Assignee's rights under the Service Agreements or at law or in equity to terminate such Service Agreements after the effective date hereof, and Assignee shall not be liable to Assignor or any other party for such proper termination. 5. Indemnification by Assignor. Assignor hereby agrees to indemnify, save and hold harmless Assignee from and against all liabilities, obligations, claims, costs, expenses (including, without limitation, reasonable attorneys' fees) or causes of action existing in favor of or asserted by other parties to the Occupancy Agreements or the Services Agreements, or hereafter incurred or suffered by Assignee, arising out of or resulting from Assignor's failure to perform any of the obligations of Assignor under the Occupancy Agreements or the Service Agreements prior to the effective date hereof. 2 6. Binding Effect. This Assignment shall be binding upon and shall inure to the benefit of the respective legal representatives, successors and assigns of Assignors and Assignee. 7. Effective Date. This Assignment shall be effective as of 12:01 a.m., EST, May 1, 2002. IN WITNESS WHEREOF, the parties hereto have executed this Assignment to be effective as of the effective date stated herein. ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES NC, LLC By: ---------------------------------------- Its: --------------------------------------- ASSIGNEE: [ ] ---------------------------------------- By: ---------------------------------------- Its: --------------------------------------- 3 EXHIBIT A TO ASSIGNMENT OF OCCUPANCY AGREEMENTS, SECURITY AND OTHER DEPOSITS, SERVICE AGREEMENTS AND ASSUMPTION AGREEMENT Adult Care Home Facilities EXHIBIT H DECLINED CONTRACTS Lessors have advised Lessee that Lessors do not intend to assume any of the Service Contracts applicable to the Facilities, except for the following contracts or agreements: 1. The offsite apartment lease for the administrator at the Light House Village Facility. 2. The NTFC Capital Corporation telephone equipment lease for the telephone system at the Heritage Care of Elizabeth City Facility. -----END PRIVACY-ENHANCED MESSAGE-----