e10vq

-----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, CzubRinbsyyg6AVJr39YJMjPWgJnr+nL2wLmLuXnSyPLxen6itBlImUgEfGSnmN+ bE7G+do1GppTbD18kpcBWg== 0000950144-02-008634.txt : 20020814 0000950144-02-008634.hdr.sgml : 20020814 20020814115115 ACCESSION NUMBER: 0000950144-02-008634 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020814 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: 02732812 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 g77536e10vq.htm ADVOCAT INC. e10vq

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: June 30, 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 incorporation or organization)		(IRS Employer Identification No.)

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 June 30, 2002)

TABLE OF CONTENTS


Part I. FINANCIAL INFORMATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
PART II — OTHER INFORMATION
SIGNATURES
LEASE TERMINATION & OPERATIONS TRANSFER AGREEMENT
AMENDMENT TO EXHIBIT 10.1

Part I. FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS

THESE CONSOLIDATED FINANCIAL STATEMENTS HAVE NOT BEEN REVIEWED BY INDEPENDENT
PUBLIC ACCOUNTANTS — SEE NOTE 2

ADVOCAT INC.

INTERIM CONSOLIDATED BALANCE SHEETS
(in thousands and unaudited)


			June 30,			December 31,
			2002			2001

CURRENT ASSETS:
	Cash and cash equivalents		$	4,624		$	3,426
	Receivables, less allowance for doubtful accounts of $4,460 and $5,453, respectively			12,568			15,693
	Inventories			509			550
	Prepaid expenses and other assets			2,042			2,111

		Total current assets		19,743			21,780

PROPERTY AND EQUIPMENT, at cost				92,668			90,669
	Less accumulated depreciation and amortization			(30,783	)		(28,790	)

	Property and equipment, net			61,885			61,879

OTHER ASSETS:
	Deferred financing and other costs, net			418			565
	Deferred lease costs, net			1,775			1,878
	Assets held for sale or redevelopment			660			1,064
	Investments in and receivables from joint ventures			2,552			2,500
	Other			1,102			1,404

		Total other assets		6,507			7,411

			$	88,135		$	91,070

(Continued)

THESE CONSOLIDATED FINANCIAL STATEMENTS HAVE NOT BEEN REVIEWED BY INDEPENDENT
PUBLIC ACCOUNTANTS — SEE NOTE 2

ADVOCAT INC.

INTERIM CONSOLIDATED BALANCE SHEETS
(in thousands and unaudited)
(Continued)


				June 30,			December 31,
				2002			2001

CURRENT LIABILITIES:
	Current portion of long-term debt			$	22,873		$	25,006
	Short-term debt				32,896			33,719
	Trade accounts payable				6,552			8,409
	Accrued expenses:
		Payroll and employee benefits			5,403			5,482
		Interest			313			179
		Self-insurance reserves			7,794			7,894
		Other			4,755			5,520

			Total current liabilities		80,586			86,209

NONCURRENT LIABILITIES:
	Long-term debt, less current portion				4,773			4,613
	Self-insurance reserves, less current portion				19,826			14,335
	Other				3,712			2,943

			Total noncurrent liabilities		28,311			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 redemption value					3,704			3,589

SHAREHOLDERS’ DEFICIT:
	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				55			55
	Paid-in capital				15,908			15,908
	Accumulated deficit				(40,429	)		(36,582	)

			Total shareholders’ deficit		(24,466	)		(20,619	)

				$	88,135		$	91,070

The accompanying notes are an integral part of these interim consolidated balance sheets.

THESE CONSOLIDATED FINANCIAL STATEMENTS HAVE NOT BEEN REVIEWED BY INDEPENDENT
PUBLIC ACCOUNTANTS — SEE NOTE 2

ADVOCAT INC.

INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts, and unaudited)


			Three Months Ended June 30,

			2002			2001

REVENUES:
	Patient revenues		$	41,195		$	39,546
	Resident revenues			7,637			10,187
	Management fees			647			404
	Interest			34			33

		Net revenues		49,513			50,170

EXPENSES:
	Operating			39,552			41,140
	Lease			4,406			5,180
	General and administrative			3,193			3,371
	Interest			1,052			1,369
	Depreciation and amortization			1,369			1,400
	Lease termination and asset impairment charges			1,065			0

		Total expenses		50,637			52,460

LOSS BEFORE INCOME TAXES				(1,124	)		(2,290	)
PROVISION FOR INCOME TAXES				103			76

NET LOSS			$	(1,227	)	$	(2,366	)

BASIC AND DILUTED LOSS PER SHARE:
	Basic		$	(.22	)	$	(.43	)

	Diluted		$	(.22	)	$	(.43	)

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.

THESE CONSOLIDATED FINANCIAL STATEMENTS HAVE NOT BEEN REVIEWED BY INDEPENDENT
PUBLIC ACCOUNTANTS — SEE NOTE 2

ADVOCAT INC.

INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands and unaudited)


			Six Months Ended June 30,

			2002			2001

REVENUES:
	Patient revenues		$	81,886		$	77,858
	Resident revenues			17,816			20,607
	Management fees			1,326			1,315
	Interest			59			79

		Net revenues		101,087			99,859

EXPENSES:
	Operating			83,280			80,875
	Lease			9,586			10,355
	General and administrative			6,352			6,606
	Interest			2,144			2,885
	Depreciation and amortization			2,752			2,811
	Lease termination and asset impairment charges			1,065			0

		Total expenses		105,179			103,532

LOSS BEFORE INCOME TAXES				(4,092	)		(3,673	)
PROVISION FOR INCOME TAXES				196			166

NET LOSS			$	(4,288	)	$	(3,839	)

BASIC AND DILUTED LOSS PER SHARE:
	Basic		$	(.78	)	$	(.70	)

	Diluted		$	(.78	)	$	(.70	)

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.

THESE CONSOLIDATED FINANCIAL STATEMENTS HAVE NOT BEEN REVIEWED BY INDEPENDENT
PUBLIC ACCOUNTANTS — SEE NOTE 2

ADVOCAT INC.

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands and unaudited)


		Three Months Ended June 30,						Six Months Ended June 30,

		2002			2001			2002			2001

NET LOSS		$	(1,227	)	$	(2,366	)	$	(4,288	)	$	(3,839	)
OTHER COMPREHENSIVE INCOME (LOSS):
	Foreign currency translation adjustments		782			561			689			(106	)
	Income tax (provision) benefit		(281	)		(202	)		(248	)		38

			501			359			441			(68	)

COMPREHENSIVE LOSS		$	(726	)	$	(2,007	)	$	(3,847	)	$	(3,907	)

The accompanying notes are an integral part of these interim consolidated financial statements.

THESE CONSOLIDATED FINANCIAL STATEMENTS HAVE NOT BEEN REVIEWED BY INDEPENDENT
PUBLIC ACCOUNTANTS — SEE NOTE 2

ADVOCAT INC.

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands and unaudited)


				Six Months Ended June 30,

				2002			2001

CASH FLOWS FROM OPERATING ACTIVITIES:
	Net loss			$	(4,288	)	$	(3,839	)
	Items not involving cash:
		Depreciation and amortization			2,752			2,811
		Provision for doubtful accounts			685			1,396
		Provision for self insured professional liability			7,285			5,184
		Equity earnings in joint ventures			(63	)		(63	)
		Amortization of deferred balances			241			236
		Amortization of discount on non-interest bearing promissory note			11			134
		Series B redeemable convertible preferred stock dividend			115			115
		Provisions for leases in excess of cash payments			763			1,019
		Lease termination and asset impairment charges			870			0
	Changes in other assets and liabilities:
		Receivables			2,452			(939	)
		Inventories			(2	)		108
		Prepaid expenses and other assets			259			114
		Trade accounts payable and accrued expenses			(4,505	)		(2,635	)

			Net cash provided by operating activities		6,575			3,641

CASH FLOWS FROM INVESTING ACTIVITIES:
	Purchases of property and equipment, net				(2,482	)		(1,444	)
	Investment in TDLP				0			(609	)
	Mortgages receivable, net				42			86
	Investment in and advances from joint ventures, net				120			84
	TDLP partnership distributions				0			150

		Net cash used in investing activities			(2,320	)		(1,733	)

CASH FLOWS FROM FINANCING ACTIVITIES:
	Repayment of debt obligations				(1,023	)		(1,233	)
	Net repayment of bank line of credit				(2,866	)		(1,404	)
	Proceeds from issuance of debt				865			0
	Advances to TDLP, net				0			(798	)
	Financing costs				(33	)		(258	)

		Net cash used in financing activities			(3,057	)		(3,693	)

(Continued)

THESE CONSOLIDATED FINANCIAL STATEMENTS HAVE NOT BEEN REVIEWED BY INDEPENDENT
PUBLIC ACCOUNTANTS — SEE NOTE 2

ADVOCAT INC.

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands and unaudited)
(continued)


		Six Months Ended June 30,

		2002		2001

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		$	1,198	$	(1,785	)
CASH AND CASH EQUIVALENTS, beginning of period			3,426		4,496

CASH AND CASH EQUIVALENTS, end of period		$	4,624	$	2,711

SUPPLEMENTAL INFORMATION:
	Cash payments of interest	$	1,707	$	2,641

	Cash payments of income taxes, net	$	192	$	138

The accompanying notes are an integral part of these interim consolidated financial statements.

THESE CONSOLIDATED FINANCIAL STATEMENTS HAVE NOT BEEN REVIEWED BY INDEPENDENT
PUBLIC ACCOUNTANTS — SEE NOTE 2

ADVOCAT INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2002 AND 2001

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 ten 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 June 30, 2002, the Company operates 100 facilities consisting of 63 nursing homes with 7,198 licensed beds and 37 assisted living facilities with 3,704 units. The Company owns 13 nursing homes, leases 34 others, and manages 16 nursing homes. The Company owns 16 assisted living facilities, leases eight others, and manages the remaining 13 assisted living facilities. The Company holds a minority interest in seven of these managed assisted living facilities. The Company operates 49 nursing homes and 16 assisted living facilities in the United States and 14 nursing homes and 21 assisted living facilities in Canada. The Company operates facilities in Alabama, Arkansas, Florida, Kentucky, North Carolina, Ohio, South Carolina, Tennessee, Texas, West Virginia and the Canadian provinces of Alberta, British Columbia, Nova Scotia and Ontario.

Effective April 30, 2002, the Company entered into a Lease Termination and Operations Transfer Agreement (the “Pierce Agreement”) with Pierce Management Group and related persons (collectively, “Pierce”), pursuant to which the 13 leases with the former principal owners or affiliates of Pierce were terminated. Effective May 31, 2002, the leases on two additional assisted living facilities were assumed by Pierce. As a result, the Company was relieved of its future obligations with respect to these 15 leases. Effective June 30, 2002, the Company terminated the lease on one additional assisted living facility. The Company is in a dispute with the owner of this property which will be the subject of an arbitration hearing in October 2002. The Company has accrued for the estimated costs associated with this arbitration hearing. The Company asserts that it was entitled to terminate the lease as a result of the landlord’s failure to correct construction defects at the facility. The Company seeks return of its $285,000 security deposit and cancellation of a $200,000 letter of credit. The landlord has asserted claims against the Company of $368,000 for unpaid rents. The Company incurred lease termination charges of approximately $661,000 in the second quarter of 2002, consisting of the remaining net book value of these 16 facilities and costs of completing the transaction. The Company is currently negotiating to terminate the lease of the remaining leased assisted living facility in the United States. It is expected that this transfer will occur during the third quarter.

In recent periods, the long-term health care environment has undergone substantial change with regards to reimbursement and other payor sources, compliance regulations, competition among other health care providers and relevant patient liability issues. The Company continually monitors these industry developments as well as other factors that affect its business. See Item 2 for further discussion of recent changes in the long-term health care industry and the related impact on the operations of the Company.

2. BASIS OF PRESENTATION OF FINANCIAL STATEMENTS

The interim consolidated financial statements for the three and six month periods ended June 30, 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 June 30, 2002 and the results of operations for the three and six month periods ended June 30, 2002 and 2001, and the cash flows for the six month periods ended June 30, 2002 and 2001.

The results of operations for the three and six month periods ended June 30, 2002 and 2001 are not necessarily indicative of the operating results for the entire respective years. These interim consolidated financial statements should be read in connection with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.

These consolidated financial statements have not been reviewed by an independent public accountant. The Company terminated its former auditor, Arthur Andersen LLP, effective June 28, 2002, and is in the process of selecting a new auditor. The new auditor, once appointed, will be retained to complete a review of these financial statements. Upon completion of the review, the Company will file an amended Form 10-Q to reflect the reviewed financial statements.

The accompanying consolidated financial statements have been prepared assuming that Advocat will continue as a going concern. The Company has incurred operating losses in the three month and six month periods ended June 30, 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 $61.0 million as of June 30, 2002. The Company has $34.2 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. The ultimate payments on professional liability claims incurred as of June 30, 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 assert default rates of interest and 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 June 30, 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.

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 $34.2 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 June 30, 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

verdict in a professional liability lawsuit against the Company totaling $78.425 million. The Company has appealed this verdict. As of June 30, 2002, the Company is engaged in 63 professional liability lawsuits, including 21, 17 and 11 in the states of Florida, Arkansas and Texas, respectively. 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 the period from 1999 to 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 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 $12,000,000 in the aggregate. The Company also maintains umbrella coverage of $15,000,000 in the aggregate for claims made during the period March 9, 2000 through March 9, 2001. The Company provides reserves on an actuarial basis for known and expected claims incurred during the policy period. This policy is on a claims made basis.

Prior to March 9, 2000, all of the Company’s 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.

Through September 30, 2001, the Company’s United States assisted living facilities are self-insured, with respect to each location, for the first $50,000 per occurrence. 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.

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 $1,317,000 ($2,000,000 Canadian). The Company also maintains a $3,294,000 ($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 $26,172,000 as of June 30, 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 June 30, 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 (loss) in addition to net income (loss) from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income.

Information with respect to the accumulated other comprehensive income (loss) balance is presented below:


		Three Months Ended June 30,						Six Months Ended June 30,

		2002			2001			2002			2001

Foreign currency items:
	Beginning balance	$	(995,000	)	$	(875,000	)	$	(935,000	)	$	(448,000	)
	Current period change, net of income tax		501,000			359,000			441,000			(68,000	)

	Ending balance	$	(494,000	)	$	(516,000	)	$	(494,000	)	$	(516,000	)

Positive amounts represent unrealized gains and negative amounts represent unrealized losses.

5. RECLASSIFICATIONS

Certain amounts in the 2001 interim financial statements have been reclassified to conform with the 2002 presentation.

6. LEASE TERMINATION AND ASSET IMPAIRMENT CHARGES

The Company has recorded the following charges during the second quarter of 2002:


Assets held for sale — write down to net estimated realizable value	$	404,000
Assisted living lease terminations		661,000

	$	1,065,000

The costs associated with the assisted living lease terminations consist of the remaining net book value of those facilities and legal and other costs of completing the transaction.

7. 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 June 30,						Six Months Ended June 30,

			2002			2001			2002			2001

Net revenues:
	U.S. nursing homes		$	40,207		$	38,510		$	80,059		$	76,167
	U.S. assisted living facilities			5,162			7,843			12,992			15,943
	Canadian operation			4,139			3,817			8,028			7,746
	Corporate			5			0			8			3

		Total	$	49,513		$	50,170		$	101,087		$	99,859

Depreciation and amortization:
	U.S. nursing homes		$	827		$	858		$	1,654		$	1,732
	U.S. assisted living facilities			399			429			818			853
	Canadian operation			124			95			244			190
	Corporate			19			18			36			36

		Total	$	1,369		$	1,400		$	2,752		$	2,811

Operating income (loss):
	U.S. nursing homes		$	1,128		$	(1,120	)	$	(976	)	$	(2,117	)
	U.S. assisted living facilities			(779	)		(870	)		(1,271	)		(866	)
	Canadian operation			510			356			923			778
	Corporate			(918	)		(656	)		(1,703	)		(1,468	)

		Total	$	(59	)	$	(2,290	)	$	(3,027	)	$	(3,673	)


			June 30,			December 31,
			2002			2001

Long-lived assets:
	U.S. nursing homes		$	26,109		$	26,807
	U.S. assisted living facilities			28,266			29,760
	Canadian operation			13,393			12,016
	Corporate			624			707

		Total	$	68,392		$	69,290

Total assets:
	U.S. nursing homes		$	55,002		$	53,665
	U.S. assisted living facilities			29,003			30,912
	Canadian operation			19,223			17,183
	Corporate			2,832			1,415
	Eliminations			(17,925	)		(12,105	)

		Total	$	88,135		$	91,070

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

As of June 30, 2002, the Company operates 100 facilities, consisting of 63 nursing homes with 7,198 licensed beds and 37 assisted living facilities with 3,704 units. In comparison, at June 30, 2001, the Company operated 120 facilities composed of 64 nursing homes containing 7,230 licensed beds and 56 assisted living facilities containing 5,425 units. As of June 30, 2002, the Company owns 13 nursing homes, leases 34 others and manages the remaining 16 nursing homes. Additionally, the Company owns 16 assisted living facilities, leases eight others and manages the remaining 13 assisted living facilities. The Company holds a minority interest in seven of these managed assisted living facilities. The Company operates 49 nursing homes and 16 assisted living facilities in the United States and 14 nursing homes and 21 assisted living facilities in Canada.

Effective April 30, 2002, the Company entered into a Lease Termination and Operations Transfer Agreement (the “Pierce Agreement”) with Pierce Management Group and related persons (collectively, “Pierce”), pursuant to which the 13 leases with the former principal owners or affiliates of Pierce were terminated. Effective May 31, 2002, the leases on two additional assisted living facilities were assumed by Pierce. As a result, the Company was relieved of its future obligations with respect to these 15 leases. Effective June 30, 2002, the Company terminated the lease on one additional assisted living facility. The Company is in a dispute with the owner of this property which will be the subject of an arbitration hearing in October 2002. The Company has accrued for the estimated costs associated with this arbitration hearing. The Company incurred lease termination charges of approximately $661,000 in the second quarter of 2002, consisting of the remaining net book value of these facilities and costs of completing the transaction. The Company is currently negotiating to terminate the lease of the remaining leased assisted living facility in the United States. It is expected that this transfer will occur during the third quarter.

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.

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 Company’s accounting policies that fit this definition include the following:

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 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 the development of known claims and 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 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

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 the Centers for Medicare & Medicaid Services (“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 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 CMS 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’s revenue reduction as a result of the expiration of the temporary impact is estimated to be a range of $3.0 million to $5.0 million, based on the Medicare census and patient RUG levels experienced by the Company in 2002. 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. Partially offsetting whatever decrease is implemented, CMS has announced a Medicare rate increase of approximately 2.6% to be effective October 1, 2002. The impact of this increase is estimated to be approximately $1.1 million on an annual basis.

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

During the past five years, the 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. As of June 30, 2002, the Company is engaged in 63 professional liability lawsuits, including 21, 17 and 11 in the states of Florida, Arkansas and Texas, respectively. 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 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 the policy years 1996 through March 31, 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.

The Company has recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $26,172,000 as of June 30, 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.

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 June 30, 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 $768,000 at June 30, 2002. The differences between actual settlements and reserves are included in expense in the year finalized.

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 a pending false claims action, as described in Part 2., OTHER INFORMATION — Item 2., Legal Proceedings.

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.

Contractual Obligations and Commercial Commitments

The Company has certain contractual obligations as of June 30, 2002, summarized by the period in which payment is due, as follows (dollar amounts in thousands):


			Less than		1 to 3		4 to 5		After
Contractual Obligations	Total		1 year		Years		Years		5 Years

Debt	$	60,542	$	33,327	$	14,139	$	9,937	$	3,139
Series B Preferred Stock	$	3,704	$	0	$	0	$	0	$	3,704
Operating Leases	$	269,559	$	13,960	$	27,799	$	26,818	$	200,982

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 difference in the fair market value of the Company’s common stock at the date of termination versus 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.

Results of Operations

The following tables present the unaudited interim statements of operations and related data for the three and six months ended June 30, 2002 and 2001.


(in thousands)			Three Months Ended June 30,

			2002			2001			Change			%

REVENUES:
	Patient revenues		$	41,195		$	39,546		$	1,649			4.2
	Resident revenues			7,637			10,187			(2,550	)		(25.0	)
	Management fees			647			404			243			60.1
	Interest			34			33			1			3.0

		Net revenues		49,513			50,170			(657	)		(1.3	)

EXPENSES:
	Operating			39,552			41,140			(1,588	)		(3.9	)
	Lease			4,406			5,180			(774	)		(14.9	)
	General and administrative			3,193			3,371			(178	)		(5.3	)
	Interest			1,052			1,369			(317	)		(23.2	)
	Depreciation and amortization			1,369			1,400			(31	)		(2.2	)
	Lease termination and asset impairment charges			1,065			0			1,065			100.0

		Total expenses		50,637			52,460			(1,823	)		(3.5	)

LOSS BEFORE INCOME TAXES				(1,124	)		(2,290	)		1,166
PROVISION FOR INCOME TAX				103			76			27

NET LOSS			$	(1,227	)	$	(2,366	)	$	1,139


(in thousands)			Six Months Ended June 30,

			2002			2001			Change			%

REVENUES:
	Patient revenues		$	81,886		$	77,858			4,028			5.2
	Resident revenues			17,816			20,607			(2,791	)		(13.5	)
	Management fees			1,326			1,315			11			0.8
	Interest			59			79			(20	)		(25.3	)

		Net revenues		101,087			99,859			1,228			1.2

EXPENSES:
	Operating			83,280			80,875			2,405			3.0
	Lease			9,586			10,355			(769	)		(7.4	)
	General and administrative			6,352			6,606			(254	)		(3.8	)
	Interest			2,144			2,885			(741	)		(25.7	)
	Depreciation and amortization			2,752			2,811			(59	)		(2.1	)
	Lease termination and asset impairment charges			1,065			0			1,065			100.0

		Total expenses		105,179			103,532			1,647			1.6

LOSS BEFORE INCOME TAXES				(4,092	)		(3,673	)		(419	)
PROVISION FOR INCOME TAXES				196			166			30

NET LOSS			$	(4,288	)	$	(3,839	)	$	(449	)


*Percentage of Net Revenues*			Three Months Ended June 30,						Six Months Ended June 30,

			2002			2001			2002			2001

REVENUES:
	Patient revenues			83.2	%		78.8	%		81.0	%		78.0	%
	Resident revenues			15.4			20.3			17.6			20.6
	Management fees			1.3			0.8			1.3			1.3
	Interest			0.1			0.1			0.1			0.1

		Net revenues		100.0			100.0			100.0			100.0

EXPENSES:
	Operating			79.9			82.0			82.4			81.0
	Lease			8.9			10.3			9.5			10.4
	General and administrative			6.4			6.7			6.3			6.6
	Interest			2.1			2.8			2.1			2.9
	Depreciation and amortization			2.8			2.8			2.7			2.8
	Lease termination and asset impairment charges			2.2			0.0			1.0			0.0

		Total expenses		102.3			104.6			104.0			103.7

LOSS BEFORE INCOME TAXES				(2.3	)		(4.6	)		(4.0	)		(3.7	)
PROVISION FOR INCOME TAXES				0.2			0.1			0.2			0.1

NET LOSS				(2.5	)%		(4.7	)%		(4.2	)%		(3.8	)%

Three Months Ended June 30, 2002 Compared With Three Months Ended June 30, 2001

The following discussion is significantly impacted by termination of leases on 15 assisted living properties during the second quarter. Effective April 30, 2002, the Company entered into a Lease Termination and Operations Transfer Agreement (the “Pierce Agreement”) with Pierce Management Group and related persons (collectively, “Pierce”), pursuant to which the 13 leases with the former principal owners or affiliates of Pierce were terminated. Effective May 31, 2002, the leases on two additional assisted living facilities were assumed by Pierce. As a result, the Company was relieved of its future obligations with respect to these 15 leases. The Company incurred a write-down of approximately $661,000 in the second quarter of 2002, consisting of the remaining net book value of these facilities and costs of completing the transaction. The Company is currently negotiating a similar return of the remaining leased assisted living facility in the United States. It is expected that this transfer will occur during the third quarter. In addition, the Company terminated leases on two nursing homes during the fourth quarter of 2001.

Revenues. Net revenues decreased to $49.5 million in 2002 from $50.2 million in 2001, a decrease of $0.7 million, or 1.3%. Patient revenues increased to $41.2 million in 2002 from $39.5 million in 2001, an increase of $1.7 million, or 4.2%. The increase in patient revenues is due to increased Medicare utilization, Medicare rate increases which became effective in October 2001 and increased Medicaid rates in certain states, partially offset by a 1.2% decline in occupancy in 2002 as compared to 2001 and the nursing home lease terminations during the fourth quarter of 2001. As a percent of total census in the United States, Medicare days increased to 11.1% in 2002 from 8.1% in 2001. As a percent of patient revenues, Medicare increased to 27.9% in 2002 from 23.1% in 2001, while Medicaid and similar programs decreased to 59.5% from 64.0% in 2001.

Resident revenues decreased to $7.6 million in 2002 from $10.2 million in 2001, a decrease of $2.6 million, or 25.0%. This decline is primarily attributable to the assisted living facility lease terminations, which resulted in reduced revenue of approximately $2.7 million.

Ancillary service revenues, prior to contractual allowances, increased to $7.2 million in 2002 from $5.4 million in 2001, an increase of $1.8 million or 33.4%. The increase is primarily attributable to increased Medicare census, partially offset by the nursing home closures in the fourth quarter of 2001 and 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.

Management fee revenue increased to $647,000 in 2002 from $404,000 in 2001, an increase of $243,000, or 60.1%. The increase is primarily attributable to increased census in the Company’s Canadian operations.

Operating Expense. Operating expense decreased to $39.5 million in 2002 from $41.1 million in 2001, a decrease of $1.6 million, or 3.9%. As a percent of patient and resident revenues, operating expense decreased to 81.0% in 2002 from 82.7% in 2001. The decrease in operating expenses is primarily attributable to a reduction in bad debt expense and the assisted living and nursing home lease terminations. Partially offsetting these decreases are cost increases related to wages, professional liability costs and nursing and ancillary expenses to support the increased Medicare utilization. The largest component of operating expenses is wages, which totaled approximately $21.7 in both 2002 and 2001. The Company experienced an increase in wages as a result of the increased Medicare census and competitive labor markets in most of the areas in which the Company operates. These increases were offset by reduced costs associated with reduced Medicaid census and the assisted living and nursing home lease terminations. The Company’s professional liability costs for United States nursing homes and assisted living facilities, including insurance premiums and reserves for self-insured claims, increased to $2.5 million in 2002 from $2.0 million in 2001, an increase of $432,000 or 21.2%. 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 years claims have either been declared insolvent or are currently under rehabilitation proceedings. The actuarial reviews include 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 decreased to $4.4 million in 2002 from $5.2 million in 2001, a decrease of $774,000, or 14.9%. The decrease in lease expense is primarily attributable to the assisted living lease terminations. Partially offsetting this decrease, the majority of the Company’s lease agreements include annual adjustments generally tied to inflation.

General and Administrative Expense. General and administrative expense decreased to $3.2 million in 2002 from $3.4 million in 2001, a decrease of $178,000, or 5.3%. As a percent of total net revenues, general and administrative expense decreased to 6.4% in 2002 from 6.7% in 2001. This decrease is attributable to various corporate expenses, lower workers compensation audit premiums and a reduction in travel and entertainment in 2002, partially offset by increases in salaries and wages and legal costs.

Interest Expense. Interest expense decreased to $1.1 million in 2002 from $1.4 million in 2001, a decrease of $317,000, or 23.2%. 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 approximately $1.4 million in both 2002 and 2001.

Lease Termination and Asset Impairment Charges. The Company has recorded the following charges during the second quarter of 2002:


Assets held for sale — write down to estimated net realizable value	$	404,000
Assisted living lease termination		661,000

	$	1,065,000

Loss Before Income Taxes; Net Loss; Loss Per Share. As a result of the above, the loss before income taxes was $1.1 million in 2002 as compared to $2.3 million in 2001, a decrease of $1.2 million. The income tax provision in 2002 and 2001 relate to provincial taxes in Canada. Net loss was $1.2 million in 2002 as compared to $2.4 million in 2001, a decrease of $1.2 million. The basic and diluted loss per share were $0.22 each in 2002 as compared to $0.43 each in 2001.

Six Months Ended June 30, 2002 Compared With Six Months Ended June 30, 2001

Revenues. Net revenues increased to $101.1 million in 2002 from $99.9 million in 2001, an increase of $1.2 million, or 1.2%. Patient revenues increased to $81.9 million in 2002 from $77.9 million in 2001, an increase of $4.0 million, or 5.2%. 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 0.9% decline in occupancy in 2002 as compared to 2001 and the nursing home lease terminations during the fourth quarter of 2001. As a percent of total census in the United States, Medicare days increased to 10.5% in 2002 from 8.1% in 2001. As a percent of patient revenues, Medicare increased to 26.7% in 2002 from 22.6% in 2001 while Medicaid and similar programs decreased to 60.7% from 64.6% in 2001.

Resident revenues decreased to $17.8 million in 2002 from $20.6 million in 2001, a decrease of $2.8 million, or 13.5%. This decline is primarily attributable to the assisted living facility lease terminations, which resulted in reduced revenue of approximately $2.7 million.

Ancillary service revenues, prior to contractual allowances, increased to $13.9 million in 2002 from $10.8 million in 2001, an increase of $3.1 million or 28.5%. The increase is primarily attributable to increased Medicare census, partially offset by the nursing home lease terminations in the fourth quarter of 2002 and 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.

Management fee revenue was approximately $1.3 million in both 2002 and 2001.

Operating Expense. Operating expense increased to $83.3 million in 2002 from $80.9 million in 2001, an increase of $2.4 million, or 3.0%. As a percent of patient and resident revenues, operating expense increased to 83.5% in 2001 from 82.1% in 2000. The increase in operating expenses is primarily attributable to cost increases related to wages, professional liability costs and nursing and ancillary expenses to support the increased Medicare utilization. Partially offsetting these increases is a reduction in bad debt expenses and the assisted living and nursing home lease terminations. The largest component of operating expenses is wages, which increased to $43.6 million in 2002 from $42.4 million in 2001, an increase of $1.2 million, or 2.9%. The increase in wages is due to competitive labor markets in most of the areas in which the Company operates, partially offset by reduced costs associated with reduced Medicaid census, the nursing home lease terminations in the fourth quarter of 2001 and the assisted living facility terminations. The Company’s professional liability costs for United States nursing homes and assisted living facilities, including insurance premiums and reserves for self-insured claims, increased to $7.3 million in 2002 from $4.0 million in 2001, an increase of $3.3 million or 83.7%. 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 years claims have either been declared insolvent or are currently under rehabilitation proceedings. The actuarial reviews include 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 decreased to $9.6 million in 2002 from $10.4 million in 2001, a decrease of $769,000, or 7.4%. The decrease in lease expense is primarily attributable to the assisted living lease terminations. Partially offsetting this decrease, the majority of the Company’s lease agreements include annual adjustments generally tied to inflation.

General and Administrative Expense. General and administrative expense decreased to $6.4 million in 2002 from $6.6 million in 2001, a decrease of $254,000, or 3.8%. As a percent of total net revenues, general and administrative expense increased to 6.3% in 2002 from 6.6% in 2001. This decrease is attributable to various corporate expenses, lower workers compensation audit premiums and a reduction in travel and entertainment in 2002, partially offset by increases in salaries and wages and legal costs.

Interest Expense. Interest expense decreased to $2.1 million in 2002 from $2.9 million in 2001, a decrease of $741,000, or 25.7%. 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 approximately $2.8 million in both 2002 and 2001.

Lease Termination and Asset Impairment Charges. The Company has recorded the following charges during the second quarter of 2002:


Assets held for sale — write down to net realizable value	$	404,000
Assisted living lease termination		661,000

	$	1,065,000

Loss Before Income Taxes; Net Loss; Loss Per Share. As a result of the above, the loss before income taxes was $4.1 million in 2002 as compared to $3.7 million in 2001, a decrease of $419,000. The income tax provision in 2002 and 2001 relate to provincial taxes in Canada. Net loss was $4.3 million in 2002 as compared to $3.8 million in 2001, a decrease of $449,000. The basic and diluted loss per share were $0.78 each in 2002 as compared to $0.70 each in 2001.

Liquidity and Capital Resources

At June 30, 2002, the Company had negative working capital of $60.8 million and a current ratio of 0.24, 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 June 30, 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 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 $34.2 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 $55.8 million of debt as current liabilities as of June 30, 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 June 30, 2002.

The Company is potentially subject to a reduction in Medicare revenue, estimated to be a range of $3.0 million to $5.0 million, based on the Medicare census and patient RUG levels experienced by the Company in 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 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 June 30, 2002, the Company had no drawings 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 June 30, 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 June 30, 2002, the Company had total additional borrowing availability of $4,300,000 under 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 June 30, 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.

Net cash provided by operating activities totaled $6.6 million and $3.6 million for the six month periods ended June 30, 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 $2.3 million and $1.7 million for the six months periods ended June 30, 2002 and 2001, respectively. These amounts primarily represent purchases of property plant and equipment and investments in and advances to joint ventures. 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 $4.2 million, including $1.0 million for non-routine projects. For the six months ended June 30, 2002 and 2001, the Company received distributions pertaining to joint ventures in the amount of $120,000 and $84,000, respectively.

Net cash used in financing activities totaled $3.1 million and $3.7 million for the six month periods ended June 30, 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 June 30, 2002 and December 31, 2001, totaled $16.3 million and $20.5 million, respectively, representing approximately 31 and 37 days in accounts receivable, respectively. Accounts receivable from the provision of management services were $605,000 and $578,000 at June 30, 2002 and December 31, 2001, respectively representing approximately 87 and 71 days in accounts receivable, respectively. The allowance for bad debt was $4.5 million and $5.5 million at June 30, 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 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 receives revenues and incurs expenses in Canadian dollars with respect to Canadian management activities and operations of the Company’s eight Canadian retirement facilities (three of which are owned) and two owned Canadian nursing homes. Although not material to the Company as a whole, if the currency exchange rate fluctuates, the Company may experience currency translation gains and losses with respect to the operations of these activities and the capital resources dedicated to their support. While such currency exchange rate fluctuations have not been material to the Company in the past, there can be no assurance that the Company will not be adversely affected by shifts in the currency exchange rates in the future.

Stock Exchange

On November 10, 1999, the Company’s stock began being quoted on the NASD’s OTC Bulletin Board under the symbol AVCA. Previously, the Company’s common stock was traded on the New York Stock Exchange under the symbol AVC.

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 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.

PART II — OTHER INFORMATION

Item 3. Legal Proceedings.

As of June 30, 2002, the Company is engaged in 63 professional liability lawsuits, including 21, 17 and 11 in the states of Florida, Arkansas and Texas, respectively. 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, 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 the period from 1999 to 2002.

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, 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 filed a motion to dismiss, with prejudice, the State’s complaint. At a hearing on May 24, 2002, the Company’s motion was denied and the Company is currently proceeding with its defenses in the case. The Company believes that it has meritorious defenses in this case, and intends to vigorously pursue these defenses in litigation.

On August 5, 2002, Advocat Inc. (the “Company”) was served notice that the State of Arkansas was suing the Company and certain subsidiaries, including a nursing home operated in Eureka Springs, Arkansas. The State of Arkansas allegations against the Company and certain subsidiaries includes violation of the Arkansas Abuse of Adults Act and violation of the Arkansas Medicaid False Claims Act. These allegations are made with respect to a resident (designated in the complaint as “Resident #1”) of the Eureka Springs facility.

The Company believes that it has meritorious defenses in this case and will vigorously defend itself. The Company further notes that the Arkansas Department of Human Services — Office of Long Term Care conducted a thorough investigation of the care of Resident #1 and that the Office of Long Term Care issued no citations as a result of their investigation of Resident #1.

While the Company cannot currently predict with certainty the ultimate impact of the above cases on the Company’s financial condition, cash flows or results of operations, an unfavorable outcome in any of the lawsuits or 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.

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 4. Submission of Matters to a Vote of Security Holders

(a) The annual meeting of shareholders was held on May 30, 2002.

(b) Matters voted upon at the meeting:

1. Election of Directors


Wallace E. Olson

For			5,127,733
Withheld			72,993
Eligible Shares			5,493,287

(Continuing directors include Charles W. Birkett, Edward G. Nelson, William C. O’Neil, Jr.)

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:

Form 8-K filed June 28, 2002 regarding the dismissal of independent accountants, Arthur Andersen, LLP.

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.

August 14, 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


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 made and entered into as of the 31st day of March, 2002 by and between (i) Diversicare Assisted Living Services, Inc., a Tennessee corporation, and (ii) Guy S. Pierce, an individual, and any person or entity to whom the Agreement is assigned in accordance with Section 17 thereof.

10.2		FIRST AMENDMENT TO LEASE TERMINATION AND OPERATIONS TRANSFER AGREEMENT made and entered into as of the 31st day of May, 2002 by and between (i) DIVERSICARE ASSISTED LIVING SERVICES, INC., a Tennessee corporation and DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company and (ii) GUY S. PIERCE, an individual.

1 EX-10.1 3 g77536exv10w1.txt LEASE TERMINATION & OPERATIONS TRANSFER AGREEMENT 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, INC., a Tennessee corporation ("Lessee"), and (ii) GUY S. PIERCE, an individual, and any person or entity to whom this Agreement is assigned in accordance with Section 17 hereof ("Assignee"). RECITALS A. Pursuant to each Lease And Option to Purchase identified on Exhibit A attached hereto by and between Lessee and, as applicable, Pleasant Care Associates, L.P. and Eakes Investment Company, L.P., as Lessors (each a "Lease" and collectively, the "Leases"), Lessee is currently the lessee of the two (2) adult care home facilities identified on Exhibit A attached hereto (each a "Facility" and together the "Facilities"), located in the State of North Carolina and the State of Virginia as more particularly set forth in Exhibit A attached hereto. B. Lessee and Assignee wish to assign all of Lessee's right, title and interest in, and under, the Leases to Assignee, with possession and operation of the premises and property that are the subject of the Leases (the "Leased Property") being turned over to Assignee. In connection with such assignment, Assignee is willing to assume certain obligations with respect to each Facility, subject to the terms and conditions set forth in this Agreement. C. In order to facilitate an orderly transfer of the operations of each Facility from Lessee to Assignee, Lessee and Assignee desire to document certain terms and conditions relevant to 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; Surrender of Leased Property; Releases. 1.1 Transfer Date. If all of the conditions to the completion of the transactions contemplated herein are satisfied, the closing of the transactions contemplated herein (the "Transfer Date") shall occur and be effective as of 12:01 a.m. on the date that the applicable governmental agencies of the State of North Carolina and the State of Virginia having jurisdiction over each Facility has approved the transfer of operations of the Facilities to Assignee in accordance with applicable state laws relating to the change of ownership/transfer of license of each Facility. 1.2 Assignment of Lease. On the Transfer Date, Lessee will assign to Assignee all of its right, title and interest in, to and under each Lease and Assignee will assume all of the rights 1 and obligations of the Lessee under each Lease pursuant to an Assignment and Assumption of Lease in the form attached hereto as Exhibit B to be executed by Lessee and Assignee. On or before the Transfer Date, Assignee shall obtain the acknowledgment and consent, in writing, of each Lessor under each Lease, to the assignment of the Leases to Assignee and the release of Lessee from its duties and obligations under each Lease. A short form memorandum of each Lease having been previously recorded, on the Transfer Date the parties shall execute for each Lease a Notice of Assignment of Lease in form sufficient for recording in order to provide record notice of the assignment of each Lease by Lessee to Assignee. 1.3 Delivery of Leased Property; Transfer of Lessee's Personal Property. On the Transfer Date, Lessee will vacate and surrender to Assignee, and will deliver possession and control to Assignee, all of the Leased Property that is the subject of each Lease. On the Transfer Date, Lessee will also transfer, assign and deliver to Assignee 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 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 the operations, policies and procedures manuals specific to each Facility, if any, as were in place at the Facility at the time the Facility was leased to Lessee by the owner thereof, 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. On the Transfer Date, Lessee will make, execute and deliver a Bill of Sale and Assignment in the form attached hereto as Exhibit C sufficient to transfer Lessee's interest in Lessee's Personal Property to Assignee. The presence of the Lessee's Personal Property at each Facility on the Transfer 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 Transfer Date shall be replaced and either destroyed by Assignee or returned to Lessee. As of the Transfer Date, Assignee will discontinue the use of any stationary or other supplies at any Facility which contain reference to such names. 1.4 Transfer As To Both Facilities. It is understood and agreed that this Agreement is intended to and does provide for the assignment of the Lease and transfer of operations for both Facilities, irrespective of the fact that they are located in separate states requiring the approval of separate governmental agencies and are owned by different third party lessors, and that the closing of assignment of the Lease and transfer of operations of each Facility, and the obligation of the Lessee to consummate the transactions contemplated by this Agreement, is conditioned upon the closing of the assignment of the Lease and transfer of operations of the other Facility as provided for herein. 2 2. As Is/Where Is. All of the Leased Property and Lessee's Personal Property will be transferred and delivered to Assignee by Lessee on the Transfer Date, and will be accepted by Assignee, "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. Assignee has, or will have on or before the Transfer Date, examined and inspected the Leased Property and Lessee's Personal Property and knows and is satisfied with, or will know and be satisfied with, its condition and Assignee 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 Leased Property and Lessee's Personal Property. Prior to the Transfer Date, Assignee 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 Assignee. 3. Transfer of Resident Trust Funds. 3.1 On or before the Transfer Date, Lessee shall deliver to Assignee 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 Transfer Date for residents at each Facility. On the Transfer Date, Lessee shall transfer the Resident Trust Funds and any other residents' property at each Facility to Assignee and Assignee 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. 3.2 Lessee will indemnify, defend and hold Assignee 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 Assignee 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 Transfer Date. Assignee 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 Assignee pursuant to the terms hereof. 4. Employees. 4.1 Employment of Existing Employees. On the Transfer Date, Assignee shall, subject to the provisions of Section 4.2 below, have the right and option of offering to employ any or 3 all of Lessee's employees that work at each Facility. Lessee shall terminate the employment of any employees at each Facility that Assignee does not elect to employ. In order to determine compliance with Section 4.2, below, Assignee shall advise Lessee in writing on or before ten (10) days prior to the Transfer Date of those employees of Lessee that Assignee has elected not to employ. Lessee shall remain liable for all Employee Liabilities (as herein defined) relating to all employees of Lessee at each Facility that accrue up to the Transfer Date. Assignee shall assume and be responsible for all Employee Liabilities with respect to all employees of Lessee at each Facility hired by Assignee that accrue on or after the Transfer Date. Without limiting the generality of the foregoing, Lessee shall remain liable from and after the Transfer 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 Assignee 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 each Facility and health insurance, payroll and payroll taxes, unemployment and FICA expenses. 4.2 WARN Act. Anything in this Agreement to the contrary notwithstanding, Assignee shall employ such number of Lessee's employees at each Facility and shall retain for a period of ninety (90) days following the Closing Date such number of Lessee's employees at each 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 or the State of Virginia) 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 or the State of Virginia). For purposes of determining compliance by Assignee with the foregoing provisions, employees at each Facility terminated by Lessee during the period of ninety (90) days immediately prior to the Transfer Date for other than cause, retirement or voluntary departure, all of whom are listed in Exhibit D, shall be taken into consideration. Assignee 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 Transfer Date listed on Exhibit D with the terminations of employment of Lessee's employees at each Facility on or after the Transfer 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 Assignee 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 D is not attached hereto, Lessee and Assignee agree that the provisions of this Section 4.2 shall nonetheless be effective and binding upon Lessee and Assignee provided that Exhibit D is delivered by Lessee to Assignee and is attached hereto on or before the Transfer 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 Transfer Date. On or before the Transfer Date, Lessee shall provide Assignee with a schedule setting forth by resident its outstanding accounts receivable as of the Transfer Date. 4 5.2 Payments received by Assignee after the Transfer Date from third party payors and private pay residents which relate to periods prior to the Transfer Date, Assignee shall collect as Lessee's agent for the limited purpose of such collection. Assignor shall remit to Lessee the gross proceeds of such collection with 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 Assignor each agree to provide the other party with any information in its possession reasonably requested by such party with respect to 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 or Medicare prior to the Transfer Date and pay all amounts required thereunder for any periods prior to the Transfer 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 Transfer Date for which payment is due to Medicaid or any other third party payor after the Transfer Date arising from services provided by Lessee at each Facility prior to the Transfer Date. After the Transfer Date, Assignee 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 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 the operation of the Facilities from and after the Transfer Date, Assignee will apply for and obtain its own provider account numbers for each Facility prior to the Transfer Date and shall not be entitled to use the 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 Assignee as of the Transfer 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 Transfer Date and to charge Lessee for expenses payable after the Transfer Date that are attributable to the period prior to the Transfer Date. 6.2. There shall be no proration of utility charges or any other payables or expenses attributable to each Facility as of the Transfer Date, it being the intent of the parties that the Lessee shall pay the bills therefore for the period prior to the Transfer Date and Lessors shall pay the bills therefore for the period on and after the Transfer Date. Utilities for each Facility will be cut off in Lessee's name on the last day prior to the Transfer Date and Lessee shall be entitled to the return of any deposit in respect thereof. Assignee shall be responsible for obtaining utility services in its name 5 for the Facilities, ensuring that the same are available on the Transfer Date, and making any deposits necessary therefore prior to the Transfer 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 Transfer 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 Transfer Date shall be settled within thirty (30) days after the Transfer 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 Transfer 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. Assignee will be responsible for the monthly installment of rent, if any, due and payable on and as of the Transfer Date under the Leases. 7. Access to Records. 7.1 On the Transfer Date, Lessee shall deliver to Assignee all of the books and records for each Facility, including, but not limited to, resident medical and financial records and employee records for those employees of Lessee at each Facility hired by Assignee 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 requirements and rights governing the confidentiality of resident records, but Lessee shall cooperate with Assignee in facilitating requests to residents of each Facility to consent to the transfer to Assignee of such records and information. 7.2 After the Transfer Date, Assignee 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-Transfer Date residents) and supporting material of each Facility relating to the period prior to the Transfer 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-Transfer 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 Assignee 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 Assignee following its use. For a period of six (6) months after the Transfer Date, Assignor shall allow Lessee and its agents and representatives shall have 6 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 Transfer 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 Assignor 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 Assignor's compliance with Section 5; provided that Lessee gives Assignor 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. Assignor shall reasonably cooperate with Lessee in the performance of such audit. 7.3 Assignee agrees to maintain such books, records and other material comprising records of the operations of each Facility prior to the Transfer Date that have been received by Assignee 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 Assignee shall decide to destroy or dispose of such documents. Assignee 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 Assignee in writing at any time prior to the scheduled date of destruction or disposal, in which event Assignee 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 Transfer Date, Lessee shall transfer and assign to Assignee all of Lessee's interest in, and Assignee 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 Assignee from asking existing residents or requiring newly admitted residents to sign new Occupancy Agreements with the Assignee) 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 E, to be executed on the Transfer Date by Lessee and Assignee. Lessee will cooperate with Assignee in obtaining any required consent, waiver or approval in connection with the assignment to and assumption by Assignee of Lessee's interests and obligations under the Assumed Contracts, but Lessee shall have no liability to Assignee for any damages incurred by Assignee 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 Assignee with respect to any 7 obligations under (a) the Assumed Contracts which relate to the period prior to the Transfer Date even if the same are not payable until after the Transfer Date, it being specifically understood and agreed that Assignee's liability shall be limited to its acts and omissions thereunder from and after the Transfer Date or (b) the contracts and agreements specifically listed and described in Exhibit F hereto which Assignee has advised Lessee in writing prior to the Transfer Date it is not prepared to assume as of the Transfer Date (the "Declined Contracts"). Lessee will provide Assignee with copies of all Service Contracts for Assignee's inspection and approval prior to the Transfer Date. In the event that at the time of the execution of this Agreement Exhibit F is not attached hereto, Lessee and Assignee agree that the provisions of this Section 8 shall be effective and binding upon Lessee and Assignee provided that Exhibit F is delivered and accepted by Assignee and Lessee and attached hereto on or before the Transfer Date. 9. Mutual Releases. 9.1 Release by Lessee. Effective as of the Transfer Date, Lessee shall and does hereby release and forever discharge Assignee, its employees, agents and representatives from any and all liabilities or obligations, of whatever kind or nature, known or unknown, that Assignee, its agents, employees or representatives, has, had or may have to Lessee arising out of or based upon each Lease, or the use and occupancy of each Facility by Lessee, or its agents, employees and representatives, except with respect to (i) any breach of this Agreement by Assignee or (ii) any future performance of Assignee required by this Agreement or (iii) any claim for indemnification pursuant to Section 9.3., below. 9.2 Release by Assignee. Effective as of the Transfer Date, Assignee shall and does hereby release and forever discharge Lessee, its employees, agents and representatives, from any and all liabilities or obligations, of whatever kind or nature, known or unknown, that Lessee, or its agents, employees and representatives, has, had or may have to Assignee arising out of or based upon each Lease, or the use and occupancy of each Facility by Lessee, or its agents, employees and representatives, except with respect to (i) any breach of this Agreement by Lessee or (ii) any future performance of Lessee required by this Agreement or (iii) any claim for indemnification pursuant to Section 9.3., below. 9.3 Claims by a Straddle Patient. Any claim by a resident relating to professional negligence or similar matters involving a resident of a Facility served prior to the Transfer Date and/or subsequent to the Transfer 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 Assignee 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 Transfer Date, Lessee shall respond to, and will hold harmless and indemnify Assignee 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 Transfer Date, Assignee shall respond to, and will hold harmless and indemnify Assignee 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 Assignee 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 Assignee and Lessee cannot agree to the allocation of both indemnity and 8 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 Assignee 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 Assignee and is enforceable against Assignee in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy laws and general principles of equity. 10.2 Lessee 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 Agreement to do so, and this Agreement has been duly and validly executed and delivered by Lessee and is enforceable against Lessee in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy laws and general principles of equity. 10.3 Assignee covenants and agrees that, as of the Transfer Date, (i) Assignee will have all licenses, permits and approvals required of Assignee by the State of North Carolina and the State of Virginia to operate each 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 Facility will be duly certified to participate, and does participate, in the Medicaid and/or Medicare programs, if any, available in each such state under valid Medicaid and/or Medicare contracts. 10.4 Lessee covenants and agrees that between the date hereof and the Transfer Date: (i) Lessee will provide all necessary information requested by Assignee 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 each Facility, and any other information reasonably required to effect an orderly transfer of each Facility, (ii) Lessee shall use its reasonable best efforts to keep the business and organization of each Facility intact and to preserve for Assignee the goodwill of the suppliers, distributors, residents and others having business relations with Lessee with respect to each Facility; and (iii) except in the case of an emergency or if required by law, Lessee shall not move or solicit the move of any residents presently situated at either Facility. 10.5 Lessee represents and warrants that, except as otherwise provided in this Agreement, between the date hereof and the Transfer 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 Transfer Date without the prior written consent of the Assignee, which 9 consent shall not be unreasonably withheld, and (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 Transfer 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 Transfer Date, Lessee will cause the same to be removed prior to the Transfer 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. 11. Conditions to Close. In addition to the condition expressed in Section 1.4 hereof, the obligations of Lessee and Assignee to consummate the transactions contemplated by this Agreement are subject to the satisfaction of the following conditions on or prior to the Transfer 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 Transfer Date; (b) As of the Transfer Date, each party shall have performed its obligations hereunder and all documents to be made executed and/or delivered on the Transfer 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) Assignee 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 Lessee, the consent of AmSouth Bank, and in the case of the Assignee, the consent of the lessors under the Leases and release of Lessee described in Section 1.2, above, and, if applicable or necessary, the holders of any mortgages on the Facilities; (f) Assignee shall have obtained all of the licenses, permits, approvals and certifications described in Section 10.3, above, necessary for the continued operation as an adult care home of each Facility to be turned over to it by Lessee pursuant to this Agreement; and 10 (g) The termination of the Pierce Leases described in that certain Lease Termination Agreement and Operations Transfer Agreement of even date herewith by and among Assignee and certain of its affiliates, Diversicare Assisted Living Services NC, LLC and Advocat Inc. and the consummation of the transfer of operations, assignments, releases and other transactions described therein shall have been completed as contemplated and described in said Agreement. 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 Transfer Date as follows: (a) By 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 Assignee or Lessee; or (ii) in the event Assignee breach or violate any material provision of this Agreement or fail to perform any material covenant or agreement to be performed by Assignee under the terms of this Agreement, and Lessee has provided written notice thereof to Assignee giving reasonable specificity and Assignee have not cured same within a reasonable period of time and such breach is not waived by Lessee in writing. (b) By Assignee (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 Assignee or Lessee; or (ii) in the event Lessee breaches or violates any material provision of this Agreement or fails to perform any material covenant or agreement to be performed by Lessee under the terms of this Agreement and Assignee have provided written notice thereof to Lessee giving reasonable specificity and Lessee has not cured same within a reasonable period of time and such breach is not waived by Assignee in writing. (c) By Assignee or by Lessee if the Transfer Date hereunder shall not have taken place by September 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. 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: 11 (a) If to Assignee: 6752 Lake Brandt Road Summerfield, NC 27358 Attn: Guy S. Pierce (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; provided that no assignment of the rights and interests of the Assignee hereunder shall be effective unless and until the intended assignee executes and delivers to Lessee on or before the Transfer Date a written assignment and assumption agreement, in form satisfactory to Lessee, whereby such intended assignee agrees to assume and be bound by all of the terms and provisions of this Agreement and the duties and obligations of the Assignee hereunder. 18. No Joint Venture; Third Party Beneficiaries. Nothing contained herein shall be construed as forming a joint venture or partnership among Assignee 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. 12 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.] 13 IN WITNESS WHEREOF, the parties hereby execute this Agreement as of the day and year first set forth above. DIVERSICARE ASSISTED LIVING SERVICES, INC. By: /s/ Charles Rinne -------------------------------- Name: Charles Rinne ------------------------------ Title: President ----------------------------- /s/ Guy S. Pierce ------------------------------------ Guy S. Pierce 14 EXHIBIT A LEASES 1. OAKREST MANOR 1012 Justis Street Chesapeake, Virginia Lease And Option to Purchase dated April 28, 1999 by and between Pleasant Care Associates, LP, a Virginia Limited Partnership, as Lessor, and Diversicare Assisted Living Services, Inc., a Tennessee corporation, as Lessee, for the adult care facility known as Oakcrest Manor. 2. VINTAGE INN Highway 17 N. Williamston, North Carolina Lease And Option to Purchase dated April 28, 1999 by and between Eakes Investment Company, LP, a North Carolina Limited Partnership, as Lessor, and Diversicare Assisted Living Services, Inc., a Tennessee corporation, as Lessee, for the adult care facility known as Vintage Inn. 15 EXHIBIT B ASSIGNMENT AND ASSUMPTION OF LEASE ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES, INC., a Tennessee corporation ASSIGNEE: GUY S. PIERCE THIS ASSIGNMENT AND ASSUMPTION OF LEASE (the "Assignment") is made and entered into as of _______________, 2002 by and between GUY S. PIERCE, an individual ("Assignee") and DIVERSICARE ASSISTED LIVING SERVICES, INC., a Tennessee corporation ("Assignor"). For good and valuable consideration, the receipt of which is hereby acknowledged, and pursuant to that certain Lease Assignment and Operations Transfer Agreement dated as of March _____, 2002 by and among Assignor and Assignee and certain affiliates described herein (the "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 that certain Lease With Option to Purchase described on Exhibit A attached hereto, 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 (the "Lease"), 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 their terms and conditions. 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 the and after the effective date hereof by all of the terms, conditions, covenants and agreements of each 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. 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. 16 4. Effective Date. This Assignment shall be effective as of 12:01 a.m., EST, on _____________________, 2002. 6. Governing Law. This Assignment shall be interpreted, construed and governed according to the laws of the State of _____________________________. 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. IN WITNESS WHEREOF, the parties hereto have caused this Assignment to be executed to be effective as of the effective date stated herein. ASSIGNEE: --------------------------------------- GUY S. PIERCE ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES, INC. By: ---------------------------------- Its: ---------------------------------- 17 EXHIBIT C BILL OF SALE AND ASSIGNMENT ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES, INC., a Tennessee corporation liability company ASSIGNEE: GUY S. PIERCE THIS BILL OF SALE AND ASSIGNMENT ("Assignment") is made and entered into effective as of the ______ day of _________, 2002 by and between Guy S. Pierce, an individual ("Assignee) and Diversicare Assisted Living Services NC, LLC, a Tennessee corporation ("Assignor"). W I T N E S S E T H: - - - - - - - - - - WHEREAS, Assignor and Assignee have entered into a certain Lease Assignment and Operations Transfer Agreement dated as of March __, 2002 (the "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 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 Facility 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 18 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 Facility (including both hard and microfiche copies) and all books and records used in operating the Facility; (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 Facility and that are expressly assumed by Assignee pursuant to the Agreement; (g) All trade names under or by which the Facility may be operated or known and all trademarks, trade names and goodwill related to the Facility or the operation of the business of the Facilities; and (h) All books and records pertaining to the above described Assets, including the operations, policies and procedures manuals specific to the Facility, if any, as were in place at the Facility at the time the Facility was leased to Assignor by the owner thereof. 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 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 herein to the contrary notwithstanding, Assignee shall be entitled to receive all operations, policies and procedures manuals specific to the Facility, if any, as were in place at the Facility at the time the Facility was leased to Assignor by the owner thereof. 3. Rights Assigned. It is acknowledged that as to any Assets, or any part thereof, located at and used, held or maintained in connection with the operation of the Facility 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 19 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 ____ day of ________, 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. 20 IN WITNESS WHEREOF, Assignor and Assignee have caused this Instrument to be executed as of effective date stated herein. ASSIGNOR: DIVERSICARE ASSISTED LIVING SERVICES, INC. By: ---------------------------------- Its: ---------------------------------- ASSIGNEE: --------------------------------------- Guy S. Pierce 21 EXHIBIT A MOTOR VEHICLES 22 EXHIBIT D TERMINATED EMPLOYEES NONE 23 EXHIBIT E 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 ______ day of ________, 2002 by and between GUY S. PIERCE, an individual ("Assignee") and DIVERSICARE ASSISTED LIVING SERVICES, INC., a corporation ("Assignor"). W I T N E S S E T H: - - - - - - - - - - Assignor and Assignee, and certain of their affiliates, have entered into a Lease Assignment and Operations Transfer Agreement dated as of March ___, 2002 (the "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 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 facility described on Exhibit A attached hereto (the "Facility"), 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 Facility ("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 24 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 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. 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. 25 7. Effective Date. This Assignment shall be effective as of 12:01 a.m., EST, on the _____ day of _________, 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, INC. By: ------------------------------------ Its: ------------------------------------ ASSIGNEE: ----------------------------------------- Guy S. Pierce 26 EXHIBIT A TO ASSIGNMENT OF OCCUPANCY AGREEMENTS, SECURITY AND OTHER DEPOSITS, SERVICE AGREEMENTS AND ASSUMPTION AGREEMENT Adult Care Home Facility 27 EXHIBIT F DECLINED CONTRACTS Assignee has advised Assignor that Lessor does not intend to assume any of the Service Contracts applicable to the Facility. 28 EX-10.2 4 g77536exv10w2.txt AMENDMENT TO EXHIBIT 10.1 EXHIBIT 10.2 FIRST AMENDMENT TO LEASE TERMINATION AND OPERATIONS TRANSFER AGREEMENT This FIRST AMENDMENT TO LEASE TERMINATION AND OPERATIONS TRANSFER AGREEMENT (the "Amendment") is made and entered into as of this 31st day of May, 2002 by and between (i) DIVERSICARE ASSISTED LIVING SERVICES, INC., a Tennessee corporation ("DALS") and DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company ("DALSNC") and (ii) GUY S. PIERCE, an individual ("Pierce"). RECITALS A. DALS and Pierce have entered into that certain Lease Termination and Operations Transfer Agreement dated as of the 31st day of March, 2002 (the "Transfer Agreement") relating to the transfer and assignment by DALS to Pierce of all of the right, title and interest of the Lessee in, to and under (i) that certain Lease and Option to Purchase dated April 28, 1999 with Pleasant Care Associates, LP, a Virginia Limited Partnership, as Lessor, for an adult care facility located in Chesapeake, Virginia and known as "Oakcrest Manor" and (ii) that certain Lease and Option to Purchase dated April 28, 1999 with Eakes Investment Company, LP, a North Carolina General Partnership, as Lessor, for an adult care facility located in Williamston, North Carolina and known as "Vintage Inn" (each a "Lease" and collectively the "Leases"). B. The Transfer Agreement describes DALS as the "Lessee" under each of the Leases and DALS is the "Lessee" referred to in the Transfer Agreement. DALSNC is currently not a party to the Transfer Agreement. C. The parties have discovered that the correct Lessee of the Lease for the Vintage Inn facility is DALSNC and desire to amend the Transfer Agreement to add DALSNC as a party thereto with respect to the Vintage Inn facility. NOW THEREFORE, in consideration of the foregoing premises, the mutual covenants and agreements the parties set forth herein, and other good and valuable consideration, the parties hereto agree as follows: 1. DALSNC, as the Lessee under the Lease for the Vintage Inn facility, is hereby added as a party to the Transfer Agreement to the same extent and with the same effect as though the Transfer Agreement had been originally made, executed and delivered by DALSNC. The term "Lessee", as and where used in the Transfer Agreement, shall mean DALSNC when referring to the Vintage Inn facility. The term "Lessee", as and where used in the Transfer Agreement, shall mean DALS when referring to the Oakcrest Manor facility. 2. DALSNC hereby assumes and agrees to perform, keep, observe, and discharge all of the representations, covenants, agreements, undertakings, liabilities and obligations to be performed, kept, observed and discharged by the Lessee under the Transfer Agreement with respect to the Vintage Inn facility. 1 3. The terms, covenants, conditions, representations, agreements and other provisions of the Transfer Agreement shall, when referring to the Vintage Inn facility, be binding upon and shall inure to the benefit of, and shall be enforceable by and against, DALSNC and not DALS. The terms, covenants, conditions, representations, agreements and other provisions of the Transfer Agreement shall, when referring to the Oakcrest Manor facility, be binding upon and shall inure to the benefit of, and shall be enforceable by and against, DALS and not DALSNC. 4. This Amendment shall be binding upon and inure to the benefit of the parties hereto, their respective legal representatives, heirs, successors and assigns. 5. Except as set forth herein, the Transfer Agreement remains unmodified and in full force and effect and its terms and provisions, as amended herein, are hereby ratified and affirmed by the parties hereto. 6. Signatures to this Amendment transmitted by facsimile or telecopy shall be valid and effective to bind the party so signing, it being expressly agreed that each party to this Amendment shall be bound by its own facsimile or telecopied signature and shall accept the facsimile or telecopied signature of the other party to this Amendment. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written. DIVERSICARE ASSISTED LIVING SERVICES, INC., a Tennessee corporation By: /s/ Charles Rinne ---------------------------------------- Its: President & COO ---------------------------------------- DIVERSICARE ASSISTED LIVING SERVICES NC, LLC, a Tennessee limited liability company By: /s/ Charles Rinne ---------------------------------------- Its: President ---------------------------------------- /s/ Guy S. Pierce ---------------------------------- Guy S. Pierce 2 -----END PRIVACY-ENHANCED MESSAGE-----

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			*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 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.

	(a)		The annual meeting of shareholders was held on May 30, 2002.

	(b)		Matters voted upon at the meeting:

	(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:

			Form 8-K filed June 28, 2002 regarding the dismissal of independent accountants, Arthur Andersen, LLP.