10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934

For the transition period from              to             .

Commission file number 1-12996

ADVOCAT INC.

(Exact name of registrant as specified in its charter)

Delaware	62-1559667
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
1621 Galleria Boulevard, Brentwood, TN	37027
(Address of principal executive offices)	(Zip Code)

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

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

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

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

None.

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

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

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  ¨

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x

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

The aggregate market value of Common Stock held by non-affiliates on June 30, 2011 (based on the closing price of such shares on the NASDAQ Capital Market) was approximately $17,238,000. For purposes of the foregoing calculation only, all directors, named executive officers and persons known to the registrant to be holders of 5% or more of the registrant’s Common Stock have been deemed affiliates of the registrant.

On February 17, 2012, 5,824,774 shares of the registrant’s $0.01 par value Common Stock were outstanding.

Documents Incorporated by Reference

Registrant’s definitive proxy materials for its 2011 annual meeting of shareholders are incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

PART I

ITEM 1. BUSINESS

Introductory Summary.

Advocat Inc. provides long-term care services to nursing center patients in eight states, primarily in the Southeast and Southwest United States. Unless the context indicates otherwise, references herein to “Advocat,” “the Company,” “we,” “us” and “our” include Advocat Inc. and all of our subsidiaries.

The long-term care profession encompasses a broad range of non-institutional and institutional services. For those among the elderly requiring temporary or limited special services, a variety of home care options exist. As needs for assistance in activities of daily living develop, assisted living facilities become the most viable and cost effective option. For those among the elderly requiring much more intensive care, skilled nursing center care may become the only viable option. We have chosen to focus our business on the skilled nursing centers sector and to specialize in this aspect of the long-term care continuum.

Principal Address and Website.

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

Operating and Growth Strategy.

Our operating objective is to be the provider of choice of health care and related services to the elderly in the communities in which we operate. Our strategic operations development plan focuses on (i) providing a broad range of cost-effective elder care services; (ii) improving skilled mix in our nursing centers; and (iii) clustering our operations on a regional basis. Interwoven into our objectives and operating strategy is our mission:

• Committed to Compassion

• Striving for Excellence

• Serving Responsibly

• Increasing Shareholder Value

Strategic operating initiatives. Our key strategic operating initiatives include improving skilled mix in our nursing centers by enhancing our registered nurse coverage and adding specialized clinical care. The investments in nursing and clinical care were conducted in concert with additional investments in nursing center based marketing representatives to develop referral and managed care relationships. These investments have attracted and are expected to continue to attract quality payor sources for patients covered by Medicare, managed care as well as certain private pay individuals. These marketing and nurse coverage efforts have already enabled us to improve our Medicare rate by bringing in additional referrals of higher acuity patients.

Another strategic operating initiative was to implement Electronic Medical Records (“EMR”). See description of EMR implementation below. We completed the implementation of Electronic Medical Records in all our nursing centers in December 2011.

As part of our strategic operating initiatives we have accelerated our program for improving our physical plants. Since 2005, we have been completing strategic renovations of certain facilities that improve quality of care and profitability. We plan to continue these nursing center renovation projects and accelerate this strategy using the knowledge obtained in the first few years of this program. Our strategic operating initiatives will also include pursuing and investigating opportunities to acquire, lease or develop new facilities, focusing primarily on opportunities within our existing areas of operation.

We are incurring expenses in connection with these initiatives, as described in “Results of Operations.” These investments in business initiatives have increased our operating expenses during 2011 and the latter portion of 2010 and we expect to see additional costs over the next year. We have already experienced increased acuity and rate per day which have contributed to our increase in revenue in 2011. We expect to continue this trend in the future.

To achieve our objective we:

Provide a broad range of cost-effective services. Our objective is to provide a variety of services to meet the needs of the elderly requiring skilled nursing care. Our service offerings currently include skilled nursing, comprehensive rehabilitation services,

2

programming for Life Steps and Lighthouse units (described below) and other specialty programming. By addressing varying levels of acuity, we work to meet the needs of the elderly population we serve. We seek to establish a reputation as the provider of choice in each of our markets. Furthermore, we believe we are able to deliver quality services cost-effectively, compared to other healthcare providers along the spectrum of care, thereby expanding the elderly population base that can benefit from our services.

Improve skilled mix in our nursing centers. By enhancing our registered nurse coverage and adding specialized clinical care, we believe we can improve skilled mix and reimbursement. The investments in nursing and clinical care are being conducted in concert with additional investments in nursing center based marketing representatives to develop referral and managed care relationships. These investments will better attract quality payor sources for patients covered by Medicare, Managed Care (including Health Maintenance Organizations (“HMO’s”) and Medicare replacement payors) as well as certain private pay individuals. We will also continue our program for the renovation and improvement of our nursing centers to attract and retain patients.

Cluster operations on a regional basis. We have developed regional concentrations of operations in order to achieve operating efficiencies, generate economies of scale and capitalize on marketing opportunities created by having multiple operations in a regional market area.

Key elements of our growth strategy are to:

Increase revenues and profitability at existing facilities. Our strategy includes increasing center revenues and profitability through improving quality payor mix, providing an increasing level of higher acuity care, obtaining appropriate reimbursement for the care we provide, containing costs and providing high quality patient care. In addition to our nursing center renovation program, ongoing investments are being made in expanded nursing and clinical care. We continue to enhance nursing center based marketing initiatives to promote higher occupancy levels and improved skilled mix at our nursing centers.

Improve physical plants. Our nursing centers have an average age of approximately 32 years as of December 31, 2011. During 2005, we began an initiative to complete strategic renovations of certain facilities to improve occupancy, quality of care and profitability. We developed a plan to identify those facilities with the greatest potential for benefit and began the renovation program during the third quarter of 2005. Major renovations result in significant cosmetic upgrades, including new flooring, wall coverings, lighting, ceilings and furniture throughout the nursing center. Renovations also usually include certain external work to improve curb appeal, such as concrete work, landscaping, roof and signage enhancements. Many of our renovation projects will include adding functionality and space for our rehabilitation therapy offerings.

Development of additional specialty services. Our strategy includes the development of additional specialty units and programming in facilities that could benefit from these services. The specialty programming will vary depending on the needs of the specific marketplace, and may include Life Steps and Lighthouse units and other specialty programming. These services allow our facilities to improve census and payor mix. A center specific assessment of the market and the current programming being offered is conducted related to specialty programming to determine if unmet needs exist as a predictor of the success of particular niche offerings and services.

Implement Electronic Medical Records. We completed the implementation of EMR in all our nursing centers in December 2011. We believe EMR improves operations, profitability and our Continuous Quality Improvement program. EMR provides the ability to electronically record the care provided to our patients and has improved customer and employee satisfaction, improved nursing center regulatory compliance and provides real-time monitoring and scheduling of care delivery. It is anticipated that the improved documentation of care will also provide greater tracking and capture of services we provide to patients.

Acquisition, leasing and development of new centers. We continue to pursue and investigate opportunities to acquire, lease or develop new facilities, focusing primarily on opportunities that can leverage our existing infrastructure.

Nursing Centers and Services.

Advocat provides a broad range of long-term care services to the elderly including skilled nursing, ancillary health care services and assisted living. In addition to the nursing and social services usually provided in long-term care centers, we offer a variety of rehabilitative, nutritional, respiratory, and other specialized ancillary services. As of December 31, 2011, we operate 47 nursing centers containing 5,445 licensed nursing beds.

3

Our nursing centers range in size from 48 to 320 licensed nursing beds. The following table summarizes certain information with respect to the nursing centers we own or lease as of December 31, 2011:

	Number of Centers		Licensed Nursing Beds (1)		Available Nursing Beds (1)
Operating Locations:
Alabama		6		711		704
Arkansas		12		1,311		1,157
Florida		1		79		79
Kentucky		6		489		485
Ohio		1		139		110
Tennessee		5		617		576
Texas		13		1,859		1,673
West Virginia		3		240		240
		47		5,445		5,024
Classification:
Owned		9		936		846
Leased		38		4,509		4,178
Total		47		5,445		5,024

⁽¹⁾  The number of Licensed Nursing Beds is based on the licensed capacity of the nursing center. The Company reports its occupancy based on licensed nursing beds. The number of Available Nursing Beds represents Licensed Nursing Beds reduced by beds removed from service. Available Nursing Beds is subject to change based upon the needs of the facilities, including configuration of patient rooms, common usage areas and offices, status of beds (private, semi-private, ward, etc.) and renovations.

Our nursing centers provide skilled nursing health care services, including room and board, nutrition services, recreational therapy, social services, housekeeping and laundry services. Our nursing centers dispense medications prescribed by the patients’ physicians, and a plan of care is developed by professional nursing staff for each patient. We also provide for the delivery of ancillary medical services at the nursing centers we operate. These specialty services include rehabilitation therapy services, such as audiology, speech, occupational and physical therapies, which are provided through licensed therapists and registered nurses, and the provision of medical supplies, nutritional support, infusion therapies and related clinical services. The majority of these services are provided using our internal resources and clinicians.

Within the framework of a nursing center, we may provide other specialty care, including:

Life Steps Unit. Nineteen of our nursing centers have units designated as Life Steps Units, our designation for patients requiring short-term rehabilitation following an incident such as a stroke, joint replacement or bone fracture. These units specialize in short-term rehabilitation with the goal of returning the patient to their previous level of functionality. These units provide enhanced services with emphasis on upgraded amenities including electric beds, televisions, telephones at bedside and feature a separate entrance for guests and visitors. The design and programming of the units generally appeal to the clinical and hospitality needs of individuals as they progress to the next appropriate level of care. Specialized therapeutic treatment regimens include orthopedic rehabilitation, neurological rehabilitation and complex medical rehabilitation. While these patients generally have a shorter length of stay, the intensive level of rehabilitation typically results in higher levels of reimbursement.

Lighthouse Unit. Twenty-two of our nursing centers have Lighthouse Units, our designation for advanced care for dementia related disorders including Alzheimer’s disease. The goal of the units is to provide a safe, homelike and supportive environment for cognitively impaired patients, utilizing an interdisciplinary team approach. Family and community involvement compliment structured programming in the secure environment instrumental in fostering as much patient independence as possible despite diminished capacity.

Enhanced Therapy Services. We have complimented our traditional therapy services with programs that provide electrotherapy, ultrasound and shortwave diathermy therapy treatments that promote pain management, wound healing, continence improvement and contractures management, improving the results of therapy treatments for our patients. We currently offer these treatment programs in all 47 of our facilities.

Other Specialty Programming. We implement other specialty programming based on a center’s specific needs. We have developed one adult day care center on the campus of a nursing center. We have developed specialty programming for bariatric patients (generally, patients weighing more than 350 pounds). These individuals have unique psychosocial and equipment needs.

4

Continuous Quality Improvement. We have in place a Continuous Quality Improvement (“CQI”) program, which is focused on identifying opportunities for improvement of all aspects of the care provided in a center, as well as overseeing the initiation and effectiveness of interventions. The CQI program was designed to support and drive nursing center efforts to meet accreditation standards and to exceed state and federal government regulations. We conduct monthly audits to monitor adherence to the standards of care established by the CQI program at each center which we operate. The center administrator, with assistance from regional nursing personnel, is primarily responsible for adherence to our quality improvement standards. In that regard, the annual operational objectives established by each center administrator include specific objectives with respect to quality of care. Performance of these objectives is evaluated quarterly by the regional vice president or manager and each center administrator’s incentive compensation is based, in part, on the achievement of the specified quality objectives. A major component of our CQI program is employee empowerment initiatives, with particular emphasis placed on selection, recruitment, retention and recognition programs. Our administrators and managers include employee retention and turnover goals in the annual center, regional and personal objectives. We also have established a quality improvement committee consisting of nursing representatives from each region and our corporate quality personnel. This committee periodically reviews our quality improvement programs and conducts center audits.

Implement Electronic Medical Records. We completed implementation of EMR in our nursing centers in December 2011. EMR improves our ability to accurately record the care provided to our patients and quickly respond to areas of need. EMR improves customer and employee satisfaction, nursing center regulatory compliance and provides real-time monitoring and scheduling of care delivery. We believe our EMR system supports our quality initiatives and positions us for higher acuity service offerings. Our EMR system includes three primary components:

• Tracking Activities of Daily Living (“ADLs”). ADLs are the routine functions that each person must perform on a daily basis including, but not limited to, getting dressed, bathing, and eating. The ADL tracking allows us to improve the documentation of the activities of our nursing, dietary and housekeeping staff in assisting with ADLs quickly, efficiently and electronically.

• Nursing Notes. Nursing notes are an important component of our medical records. Licensed nursing professionals make notes on the care and condition of each patient. The EMR system has a module for nursing notes and results in improved capture, monitoring and review of patient records.

• Medications. Our patients often receive a number of daily medications. This module assists with tracking the required medications and documenting the administration of those medications.

For all three modules, the EMR system provides a dashboard that can be reviewed at a number of kiosks throughout the nursing center, allowing our staff to securely access a list of upcoming patient care tasks and providing our supervisors a tool to help manage and monitor staff performance. We believe the EMR system provides better support and improves the quality of care for our patients. Our deployment schedule resulted in full EMR in 8 centers and ADL tracking in 13 others during 2010 and the remaining implementations were completed during 2011, at a rate of approximately five to six centers every two months. We invested approximately $110,000 per nursing center to deploy EMR in all our buildings.

Organization. Our long-term care facilities are currently organized into four regions, each of which is supervised by a regional vice president. The regional vice president is generally supported by specialists in several functions, including nursing, human resources, marketing, accounts receivable management and administration, all of whom are employed by us. The day-to-day operations of each of our nursing centers are led by an on-site, licensed administrator. The administrator of each nursing center is supported by other professional personnel, including a medical director, who assists in the medical management of the nursing center, and a director of nursing, who supervises a staff of registered nurses, licensed practical nurses and nurse aides. Other personnel include those providing therapy, dietary, activities and social service, housekeeping, laundry and maintenance and office services. The majority of personnel at our facilities, including the administrators, are our employees.

Marketing.

At a local level, our sales and marketing efforts are designed to promote higher occupancy levels, promote optimal payor mix and inform the local referral community of our high-acuity capabilities. We believe that the long-term care profession is fundamentally a local business in which both patients and their referral sources are based in the immediate geographic area in which the nursing center is located. Our marketing plan and related support activities emphasize the role and performance of administrators, admissions coordinators and social services directors of each nursing center, all of whom are responsible for contacting various referral sources such as doctors, hospitals, hospital discharge planners, churches and various community organizations. As part of our operating strategy we have increased the number of nursing center based marketing personnel to further develop relationships with physicians as well as managed care organizations. We believe these relationships with managed care organizations will provide us with significantly greater exposure to referral sources and an ability to provide increased levels of high-acuity care.

5

Our administrators are evaluated based on their ability to meet specific goals and performance standards that are tied to compensation incentives. Our regional managers and marketing coordinators assist local marketing personnel and administrators in establishing relationships and follow-up procedures with such referral sources.

In addition to soliciting admissions from these sources, we emphasize involvement in community affairs in order to promote a public awareness of our nursing centers and services. We have ongoing family councils and community based “family night” functions where organizations come to the center to educate the public on various topics such as Medicare benefits, powers of attorney, and other matters of interest. We also promote effective customer relations and seek feedback through family surveys. We typically host “open house” events once we complete a renovation of a center where members of the local community are invited to visit and see the improvements. In addition, we have regional marketing coordinators to support the overall marketing program in each local center, in order to promote higher occupancy levels and improved payor and case mixes at our nursing centers. Regional and local marketing personnel and efforts are supported by our corporate marketing personnel.

We have an internally-developed marketing program that focuses on the identification and provision of services needed by the community. The program assists each nursing center administrator in analysis of local demographics and competition with a view toward complementary service development. We believe that the primary referral area in the long-term care industry generally lies within a five-to-fifteen-mile radius of each nursing center depending on population density; consequently, local marketing efforts are more beneficial than broad-based advertising techniques.

Acquisitions, Development Projects and Divestitures.

Acquisitions and Development

On December 28, 2011, construction of Rose Terrace, our third health care center in West Virginia, was completed. The state of the art 90-bed skilled nursing center is located in Culloden, West Virginia, along the Huntington-Charleston corridor, and offers 24-hour skilled nursing care designed to meet the care needs of both short and long term nursing patients. The center utilizes a Certificate of Need we initially obtained in the June 2009 acquisition of certain assets of a skilled nursing center in Milton, West Virginia. The facility is expected to obtain its Medicare and Medicaid certifications in the first quarter of 2012. We lease this facility under a lease agreement with an initial term of 20 years, and have the option to renew the lease for two additional five-year periods. The lease agreement grants us the right to purchase the center beginning at the end of the first year of the initial term of the lease and continuing through the fifth year for a purchase price ranging from 110% to 120% of the total project cost.

In August 2009, we completed the construction of a 119 bed leased skilled nursing center, Brentwood Terrace, located in Paris, Texas, replacing an existing 102 bed leased nursing center. The new center was financed with funding from our lessor, and is leased under a long term operating lease with renewal options through 2035.

Discontinued operations

Effective March 31, 2010, we terminated operations of four nursing centers in Florida under a lease that, as amended, would have expired in August 2010. We transitioned operations at these leased facilities on March 31, 2010.

The Centers for Medicare and Medicaid Services (“CMS”) issued regulations that became effective October 1, 2009, that prohibit us from billing Medicare Part B for certain enteral nutrition, urological, ostomy and tracheostomy supplies, and these services are now provided by third parties. We are still required to provide the labor for the delivery of services but are no longer a supplier and will not be entitled to any compensation. The revenue and cost of goods sold for providing these services prior to October 2009 have been reclassified as discontinued operations.

Nursing Center Profession.

We believe there are a number of significant trends within the long-term care industry that will support the continued growth of the nursing home profession. These trends are also likely to impact our business. These factors include:

Demographic trends. The primary market for our long-term health care services is comprised of persons aged 75 and older. This age group is one of the fastest growing segments of the United States population. As the number of persons aged 75 and over continues to grow, we believe that there will be corresponding increases in the number of persons who need skilled nursing care.

Cost containment pressures. In response to rapidly rising health care costs, governmental and other third-party payors have adopted cost-containment measures to reduce admissions and encourage reduced lengths of stays in hospitals and other acute care settings. The federal government had previously acted to curtail increases in health care costs under Medicare by limiting acute

6

care hospital reimbursement for specific services to pre-established fixed amounts. Other third-party payors have begun to limit reimbursement for medical services in general to predetermined reasonable charges, and managed care organizations (such as health maintenance organizations) are attempting to limit hospitalization costs by negotiating for discounted rates for hospital and acute care services and by monitoring and reducing hospital use. In response, hospitals are discharging patients earlier and referring elderly patients, who may be too sick or frail to manage their lives without assistance, to nursing centers where the cost of providing care is typically lower than hospital care. In addition, third-party payors are increasingly becoming involved in determining the appropriate health care settings for their insureds or clients based primarily on cost and quality of care.

Limited supply of centers. As the nation’s elderly population continues to grow, life expectancy continues to expand, and there continue to be limitations on granting Certificates of Need (“CON’s”) for new skilled nursing centers, so we believe that there will be continued demand for skilled nursing beds in the markets in which we operate. The majority of states have adopted CON or similar statutes requiring that prior to adding new skilled beds or any new services, or making certain capital expenditures, a state agency must determine that a need exists for the new beds or proposed activities. We believe that this CON process tends to restrict the supply and availability of licensed skilled nursing center beds. High construction costs, limitations on state and federal government reimbursement for the full costs of construction, and start-up expenses also act to restrict growth in the supply for such centers. At the same time, skilled nursing center operators are continuing to focus on improving occupancy and expanding services to include high acuity subacute patients who require significantly higher levels of skilled nursing personnel and care.

Reduced reliance on family care. Historically, the family has been the primary provider of care for seniors. We believe that the increase in the percentage of dual income families, the reduction of average family size and the increased mobility in society will reduce the role of the family as the traditional care-giver for aging parents. We believe that this trend will make it necessary for many seniors to look outside the family for assistance as they age.

Competition.

The long-term care business is highly competitive. We face direct competition for additional centers, and our centers face competition for employees and patients. Some of our present and potential competitors for acquisitions are significantly larger and have or may obtain greater financial and marketing resources. Competing companies may offer new or more modern centers or new or different services that may be more attractive to patients than some of the services we offer.

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

Revenue Sources

We classify our revenues from patients and residents into four major categories: Medicaid, Medicare, managed care, and private pay and other. Medicaid revenues are composed of the traditional Medicaid program established to provide benefits to those in need of financial assistance in the securing of medical services. Medicare revenues include revenues received under both Part A and Part B of the Medicare program. Managed care revenues include payments for patients who are insured by a third-party entity, typically called a Health Maintenance Organization, often referred to as an HMO plan, or are Medicare beneficiaries who assign their Medicare benefits to a managed care replacement plan often referred to as Medicare replacement products. The private pay and other revenues are composed primarily of individuals or parties who directly pay for their services. Included in the private pay and other are patients who are hospice beneficiaries as well as the recipients of Veterans Administration benefits. Veterans Administration payments are made pursuant to renewable contracts negotiated with these payors.

7

The following table sets forth net patient revenues related to our continuing operations by payor source for the periods presented (dollar amounts in thousands):

	Year Ended December 31,
	2011				2010				2009
Medicaid	$	155,481	49.4	%	$	155,035	53.4	%	$	149,987	54.2	%
Medicare		108,687	34.5			88,920	30.7			85,433	30.8
Managed care		12,710	4.0			8,619	3.0			7,412	2.7
Private Pay and other		37,837	12.1			37,556	12.9			34,147	12.3
Total	$	314,715	100.0	%	$	290,130	100.0	%	$	276,979	100.0	%

The following table sets forth average daily skilled nursing census by payor source for our continuing operations for the periods presented:

	Year Ended December 31,
	2011				2010				2009
Medicaid		2,793	67.5	%		2,886	68.8	%		2,854	69.6	%
Medicare		593	14.3			544	13.0			534	13.0
Managed care		82	2.0			59	1.4			51	1.2
Private Pay and other		673	16.2			704	16.8			661	16.2
Total		4,141	100.0	%		4,193	100.0	%		4,100	100.0	%

Consistent with the nursing center industry in general, changes in the mix of a center’s patient population among Medicaid, Medicare, managed care, and private pay and other can significantly affect the profitability of the center’s operations.

Medicare and Medicaid Reimbursement

A significant portion of our revenues are derived from government-sponsored health insurance programs. Our nursing centers derive revenues under Medicaid, Medicare, managed care, private pay and other third party sources. We employ specialists in reimbursement at the corporate level and use third party services to monitor regulatory developments, to comply with reporting requirements and to ensure that proper payments are made to our operated nursing centers. It is generally recognized that all government-funded programs have been and will continue to be under cost containment pressures, but the extent to which these pressures will affect our future reimbursement is unknown.

Medicare

For the years ended December 31, 2011 and 2010, our Medicare rates were significantly impacted by changes for the Medicare fiscal years ended September 30, 2011 and 2010, respectively. Effective October 1, 2010, Medicare rates were increased by the Centers for Medicare & Medicaid Services (“CMS”) implementation of a market basket adjustment and the implementation of MDS 3.0 and Resource Utilization Group IV (“RUG IV”). The net impact of the market basket adjustment increased Medicare reimbursement to skilled nursing centers by approximately 1.7% compared to the fiscal year ended September 30, 2010. CMS also implemented MDS 3.0, a new patient assessment tool for the collection of clinical data to be used for classification into the RUG categories for all Medicare patients and those Medicaid patients in RUG-based reimbursement states. In addition to the patient assessment tool, CMS expanded RUG categories to 66 under RUG IV up from 53 under RUG III. These October 2010 Medicare reimbursement changes increased our Medicare revenue and our Medicare rate per patient day. The new regulations also resulted in an increase in costs to complete the patient assessments required by these new rules.

Effective October 1, 2011, Medicare rates were reduced by a nationwide average of 11.1%, the net effect of a reduction to restore overall payments to their intended levels on a prospective basis and the application of a 2.7% market basket increase and a negative 1.0% productivity adjustment required by the Patient Protection Act. The final CMS rule also adjusts the method by which group therapy is counted for reimbursement purposes and, for patients receiving therapy, changes the timing of reassessment for purposes of determining patient RUG categories. These October 2011 Medicare reimbursement changes decreased our Medicare revenue and our Medicare rate per patient day. The new regulations also resulted in an increase in costs to provide therapy services to our patients.

The Budget Control Act of 2011 (“BCA”), enacted on August 2, 2011, increased the United States debt ceiling and linked the debt ceiling increase to corresponding deficit reductions through 2021. The BCA also established a 12 member joint committee of Congress known as the Joint Select Committee on Deficit Reduction (“Super Committee”). The Super Committee’s objective was to create proposed legislation to reduce the United States federal budget deficit by $1.5 trillion for fiscal years 2012 through 2021. Part of the BCA required this legislation to be enacted by December 23, 2011 or approximately $1.2 trillion in domestic and defense spending reductions would automatically begin January 1, 2013, split between domestic and defense spending. As no legislation was passed that would achieve the targeted savings, payments to Medicare providers are potentially subject to these automatic spending

8

reductions, limited to not more than a 2% reduction. At this time it is unclear how this automatic reduction may be applied to various Medicare healthcare programs. Reductions to Medicare reimbursement from the BCA could have a material adverse effect on our operating results and cash flows.

The Medicare Payment Advisory Commission (MedPAC) recently recommended that Congress provide no payment update in the coming fiscal year, beginning October 1, 2012, for skilled nursing center care. With an expected increase in the costs to care for our patients, a freeze in our Medicare rate will likely further negatively impact our operating results and cash flows.

Therapy Services. There are annual Medicare Part B reimbursement limits on therapy services that can be provided to an individual. The limits impose a $1,870 per patient annual ceiling on physical and speech therapy services, and a separate $1,870 per patient annual ceiling on occupational therapy services. CMS established an exception process to permit therapy services in certain situations and we provide services that are reimbursed under the exceptions process. The exceptions process has been extended several times, most recently by the Middle Class Tax Relief and Job Creation Act of 2012 which extended this exception process through December 31, 2012. It is unknown if any further extension of the therapy cap exceptions will be included in future legislation. If the exception process is discontinued, it is expected that the reimbursement limitations will reduce therapy revenues and negatively impact our operating results and cash flows.

On November 2, 2010, CMS released a final proposed rule as part of the Medicare Physician Fee Schedule (“MPFS”) that was effective January 1, 2011. The policy impacts the reimbursement we receive for Medicare Part B therapy services in our facilities. The policy provides that Medicare Part B pay the full rate for the therapy unit of service that has the highest Practice Expense (PE) component for each patient on each day they receive multiple therapy treatments. Reimbursement for the second and subsequent therapy units for each patient each day they receive multiple therapy treatments is reimbursed at a rate equal to 75% of the applicable PE component.

Medicare Part B therapy services in our centers are determined according to MPFS. Annually since 1997, the MPFS has been subject to a sustainable growth rate adjustment (“SGR”) intended to keep spending growth in line with allowable spending. Each year since the SGR was enacted, this adjustment produced a scheduled negative update to payment for physicians, therapists and other healthcare providers paid under the MPFS. Congress has stepped in with so-called “doc fix” legislation numerous times to stop payment cuts to physicians, most recently by the Middle Class Tax Relief and Job Creation Act of 2012, which stopped these payment cuts through December 31, 2012. Without the temporary fix we would have experienced an estimated 27% reduction in Medicare Part B payments. If the fix to payment cuts is discontinued, it is expected that we will see a reduction in therapy revenues that will negatively impact our operating results and cash flows.

The Middle Class Tax Relief and Job Creation Act of 2012 also resulted in a reduction of bad debt treated as an allowable cost. Medicare reimburses providers for beneficiaries’ unpaid coinsurance and deductible amounts after reasonable collection efforts at a rate between 70 and 100 percent of beneficiary bad debt. This provision reduces bad debt reimbursement for all providers to 65 percent.

Medicaid

Several states in which we operate face budget shortfalls, which could result in reductions in Medicaid funding for nursing centers. The federal government made an effort to address the financial challenges state Medicaid programs are facing by increasing the amount of Medicaid funding available to states. Pressures on state budgets are expected to continue in the future and are expected to result in Medicaid rate reductions.

We receive the majority of our annual Medicaid rate increases during the third quarter of each year. The rate changes received in the third quarters of 2011 and 2010 were the primary contributor to our 3.7% increase in average rate per day for Medicaid patients in 2011 compared to 2010.

We are unable to predict what, if any, reform proposals or reimbursement limitations will be implemented in the future, or the effect such changes would have on our operations. For the year ended December 31, 2011, we derived 34.5% and 49.4% of our total patient revenues related to continuing operations from the Medicare and Medicaid programs, respectively. Any health care reforms that significantly limit rates of reimbursement under these programs could, therefore, have a material adverse effect on our profitability.

We will attempt to increase revenues from non-governmental sources to the extent capital is available to do so. However, private payors, including managed care payors, are increasingly demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments, which can result in significant losses to health care providers if patients require expensive treatment not adequately covered by the capitated rate.

9

Employees.

As of February 1, 2012, we employed approximately 5,800 individuals in connection with our continuing operations, approximately 4,400 of which are considered full time employees. We believe that our employee relations are good. Approximately 150 of our employees are represented by a labor union.

Although we believe we are able to employ sufficient nurses and therapists to provide our services, a shortage of health care professional personnel in any of the geographic areas in which we operate could affect our ability to recruit and retain qualified employees and could increase our operating costs. We compete with other health care providers for both professional and non-professional employees and with non-health care providers for non-professional employees. This competition contributed to a significant increase in the salaries that we had to pay to hire and retain these employees. As is common in the health care industry, we expect the salary and wage increases for our skilled healthcare providers will continue to be higher than average salary and wage increases nationally.

Supplies and Equipment.

We purchase drugs, solutions and other materials and lease certain equipment required in connection with our business from many suppliers. We have not experienced, and do not anticipate that we will experience, any significant difficulty in purchasing supplies or leasing equipment from current suppliers. In the event that such suppliers are unable or fail to sell us supplies or lease equipment, we believe that other suppliers are available to adequately meet our needs at comparable prices. National purchasing contracts are in place for all major supplies, such as food, linens and medical supplies. These contracts assist in maintaining quality, consistency and efficient pricing. Based on contract pricing for food and other supplies, we expect cost increases in 2012 to be relatively the same or slightly lower than the increases we experienced in 2011.

Government Regulation.

The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, quality of patient care and Medicare and Medicaid fraud and abuse. Over the last several years, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse statutes and regulations as well as laws and regulations governing quality of care issues in the skilled nursing profession in general. Violations of these laws and regulations could result in exclusion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations is subject to ongoing government review and interpretation, as well as regulatory actions in which government agencies seek to impose fines and penalties. The Company is involved in regulatory actions of this type from time to time.

Licensure and Certification. All our nursing centers must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing centers are subject to CON laws, which require us to obtain government approval for the construction of new nursing centers or the addition of new licensed beds to existing centers. Our nursing centers must comply with detailed statutory and regulatory requirements on an ongoing basis in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid certification are similar and relate to quality and adequacy of personnel, quality of medical care, record keeping, dietary services, patient rights, and the physical condition of the nursing center and the adequacy of the equipment used therein. Each center is subject to periodic inspections, known as “surveys” by health care regulators, to determine compliance with all applicable licensure and certification standards. Such requirements are both subjective and subject to change. If the survey concludes that there are deficiencies in compliance, the center is subject to various sanctions, including but not limited to monetary fines and penalties, suspension of new admissions, non-payment for new admissions and loss of licensure or certification. Generally, however, once a center receives written notice of any compliance deficiencies, it may submit a written plan of correction and is given a reasonable opportunity to correct the deficiencies. There can be no assurance that, in the future, we will be able to maintain such licenses and certifications for our facilities or that we will not be required to expend significant sums in order to comply with regulatory requirements.

Health care and health insurance reform. In March 2010, significant legislation concerning health care and health insurance was passed, including the “Patient Protection and Affordable Care Act”, (“Patient Protection Act”) along with the “Health Care and Education Reconciliation Act of 2010” (“Reconciliation Act”) collectively defined as the “Legislation.” We expect this Legislation to impact our Company, our employees and our patients in a variety of ways. Some aspects of these new laws are immediate while others will be phased in over the next ten years when all mandates become effective. This Legislation significantly changes the future responsibility of employers with respect to providing health care coverage to employees in the United States. Two of the main

10

provisions of the Legislation become effective in 2014, whereby most individuals will be required to either have health insurance or pay a fine and employers with 50 or more employees will either have to provide minimum essential coverage or will be subject to additional taxes. We have not estimated the financial impact of the Legislation and the costs associated with complying with the increased levels of health insurance we will be required to provide our employees and their dependents in future years. We expect the Legislation will result in increased operating expenses.

We also anticipate this Legislation will continue to impact our Medicaid and Medicare reimbursement as well, though the timing and ultimate level of that impact is currently unknown as we anticipate that many of the provisions of the Legislation may be subject to further clarification and modification through the rule making process. The Legislation expands the role of home based and community services, which may place downward pressure on our sustaining population of Medicaid patients. The provisions of the legislation discussed above are examples of recently-enacted federal health reform provisions that we believe may have a material impact on the long-term care industry and on our business. However, the foregoing discussion is not intended to constitute, nor does it constitute, an exhaustive review and discussion of the legislation.

Medicare and Medicaid. Medicare is a federally-funded and administered health insurance program for the aged and for certain chronically disabled individuals. Part A of the Medicare program covers inpatient hospital services and certain services furnished by other institutional providers such as skilled nursing facilities. Part B covers the services of doctors, suppliers of medical items, various types of outpatient services and certain ancillary services of the type provided by long-term and acute care facilities. Medicare payments under Part A and Part B are subject to certain caps and limitations, as provided in Medicare regulations. Medicare benefits are not available for intermediate and custodial levels of nursing center care or for assisted living center arrangements.

Medicaid is a medical assistance program for the indigent, operated by individual states with financial participation by the federal government. Criteria for medical indigence and available Medicaid benefits and rates of payment vary somewhat from state to state, subject to certain federal requirements. Basic long-term care services are provided to Medicaid beneficiaries, including nursing, dietary, housekeeping and laundry, restorative health care services, room and board and medications. Federal law requires that a state Medicaid program must provide for a public process for determination of Medicaid rates of payment for nursing center services. Under this process, proposed rates, the methodologies underlying the establishment of such rates and the justification for the proposed rates are published. This public process gives providers, beneficiaries and concerned state patients a reasonable opportunity for review and comment. Certain of the states in which we now operate are actively seeking ways to reduce Medicaid spending for nursing center care by such methods as capitated payments and substantial reductions in reimbursement rates.

As a component of CMS administration of the government’s reimbursement programs, a new ratings system was implemented in December 2008 to assist the public in choosing a skilled care provider. While data for the consumer has been available for several years, the display of quality with a “Star” ranking with a “5 Star” ranking being the highest and a “1 Star” ranking being the lowest was new in 2008. The “5 Star” system is an attempt to simplify all the data for each nursing center to a “Star” ranking. The overall Star rating is determined by three components (three years survey results, quality measure calculations, and staffing data), with each of the components receiving star rankings as well. As this initiative becomes a bigger part of our business environment we remain diligent in continuing to provide outstanding patient care to achieve high rankings for our facilities, as well as assuring that our rankings are correct and appropriately reflect our quality results.

Health Insurance Portability and Accountability Act of 1996 Compliance. The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) has mandated an extensive set of regulations to standardize electronic patient health, administrative and financial data transactions, and to protect the privacy of individually identifiable health information. We have a HIPAA compliance committee and designated privacy and security officers.

The HIPAA transaction standards are intended to simplify the electronic claims process and other healthcare transactions by encouraging electronic transmission rather than paper submission. These regulations provide for uniform standards for data reporting, formatting and coding that we must use in certain transactions with health plans. The HIPAA security regulations establish detailed requirements for safeguarding protected health information that is electronically transmitted or electronically stored. Some of the security regulations are technical in nature, while others are addressed through policies and procedures. We implemented or upgraded computer and information systems as we believe necessary to comply with the new regulations.

The HIPAA regulations related to privacy establish comprehensive federal standards relating to the use and disclosure of individually identifiable health information (“protected health information”). The privacy regulations establish limits on the use and disclosure of protected health information, provide for patients’ rights, including rights to access, to request amendment of, and to receive an accounting of certain disclosures of protected health information, and require certain safeguards for protected health information. In addition, each covered entity must contractually bind individuals and entities that furnish services to the covered entity or perform a function on its behalf, and to which the covered entity discloses protected health information, to restrictions on the use and disclosure of that protected health information. In general, the HIPAA regulations do not supersede state laws that are more stringent or grant greater privacy rights to individuals. Thus, we must reconcile the HIPAA regulations and other state privacy laws.

11

Although we believe that we are in material compliance with these HIPAA regulations, the HIPAA regulations are expected to continue to impact us operationally and financially and may pose increased regulatory risk.

Self-Referral and Anti-Kickback Legislation. The health care industry is subject to state and federal laws which regulate the relationships of providers of health care services, physicians and other clinicians. These self-referral laws impose restrictions on physician referrals to any entity with which they have a financial relationship, which is a broadly defined term. We believe our relationships with physicians are in compliance with the self-referral laws. Failure to comply with self-referral laws could subject us to a range of sanctions, including civil monetary penalties and possible exclusion from government reimbursement programs. There are also federal and state laws making it illegal to offer anyone anything of value in return for referral of patients. These laws, generally known as “anti-kickback” laws, are broad and subject to interpretations that are highly fact dependent. Given the lack of clarity of these laws, there can be no absolute assurance that any health care provider, including us, will not be found in violation of the anti-kickback laws in any given factual situation. Strict sanctions, including fines and penalties, exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for violation of the anti-kickback laws.

Reporting Obligations under Section 111 of the Medicare, Medicaid and SCHIP Extension Act of 2007 (“MMSEA”). Since January 1, 2010, we have reported specific information regarding all claimants and claim settlements involving Medicare participants so CMS can recover Medicare funds expended to provide healthcare treatment to the claimant. The requirements are to ensure that CMS is notified so that it may recoup the amounts paid for services from the settlement proceeds. This does not result in us making additional payments to CMS for these services provided and does not result in an incremental cost to us. Strict sanctions, including fines and penalties, exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for non-compliance with these reporting obligations.

Available Information.

We file reports with the Securities and Exchange Commission (“SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. Copies of our reports filed with the SEC may be obtained by the public at the SEC’s Public Reference Room by calling the SEC at 1-800-SEC-0330. We file such reports with the SEC electronically, and the SEC maintains an Internet site at www.sec.gov that contains our reports, proxy and information statements, and other information filed electronically. We also make available, free of charge through our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and other materials filed with the SEC as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC via a link to the SEC’s EDGAR system. Our website address is www.advocatinc.com. The information provided on our website is not part of this report, and is therefore not incorporated by reference unless such information is otherwise specifically referenced elsewhere in this report.

In addition, copies of the Company’s annual report will be made available, free of charge, upon written request.

ITEM 1A. RISK FACTORS

There have been a number of material developments both within the Company and the long-term care industry. These developments have had and are likely to continue to have a material impact on us. This section summarizes these developments, as well as other risks that should be considered by our shareholders and prospective investors.

We are substantially self-insured and have significant potential professional liability exposure.

The provision of health care services entails an inherent risk of liability. Participants in the health care industry are subject to an increasing number of lawsuits alleging malpractice, negligence, product liability or related legal theories, many of which involve large claims and significant defense costs. Like many other companies engaged in the long-term care profession in the United States, we have numerous pending liability claims, disputes and legal actions for professional liability and other related issues. We expect to continue to be subject to such suits as a result of the nature of our business. See “Item 3. Legal Proceedings” for further descriptions of pending claims and see “Item 7. Management’s Discussion and Analysis of Financial Condition – Accounting Policies and Judgments – Professional Liability and Other Self-Insurance Reserves” for discussion of our reserve for self-insured claims and of our ability to meet our anticipated cash needs.

For claims made after March 9, 2001, we have purchased professional liability insurance coverage for our nursing centers that, based on historical claims experience, is likely to be substantially less than the amount required to satisfy claims that are expected to be incurred. We have essentially exhausted all of our insurance coverage for claims first asserted prior to July 1, 2011.

12

We have seen an increase in the number of suits filed in professional liability matters and have had substantial adjustments to our accrual for professional liability claims which has caused significant changes in our net earnings.

In recent periods we have seen an increase in the number of suits filed for professional liability matters. Each year, we record adjustments to our accrual for self-insured risks associated with professional liability claims. While these adjustments to the accrual result in changes to reported expenses and income, they are not directly related to changes in cash because the accrual is not funded. These self-insurance reserves are assessed on a quarterly basis, with changes in estimated losses being recorded in the consolidated statements of income in the period identified. Any increase in the accrual decreases income in the period, and any reduction in the accrual increases income during the period. Our actual professional liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given quarter. For the years ended December 31, 2011, 2010 and 2009, we recorded professional liability expense of $11.0 million, $5.4 million and $8.2 million, respectively.

Our outstanding indebtedness is subject to various financial covenants and floating rates of interest which could be subject to fluctuations based on changing interest rates.

We have long term indebtedness of $29.9 million at December 31, 2011. Certain of our debt agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. As of December 31, 2011, we were in compliance with these financial covenants. Our failure to comply with those covenants could result in an event of default, which, if not cured or waived, could result in the acceleration of some or all of our debts. Such non-compliance could result in a material adverse impact to our financial position, results of operations and cash flows. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” for additional discussion of our covenants.

In connection with the refinancing transaction in March 2011 discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources,” we entered into an interest rate swap with respect to a mortgage loan to mitigate the floating interest rate risk of such borrowing. The interest rate swap converted the variable rate on our mortgage indebtedness to a fixed interest rate for the five year term of this indebtedness, decreasing our exposure to risks of variable rates of interest. While limiting our risk to increases in interest rates by utilizing the interest rate swap, we forgo benefits that might result from downward fluctuations in interest rates. We also are exposed to the risk that our counterpart to the swap agreement will default on its obligations.

We are highly dependent on reimbursement by third-party payors.

Substantially all of our nursing center revenues are directly or indirectly dependent upon reimbursement from third-party payors, including the Medicare and Medicaid programs, and private insurers. For the year ended December 31, 2011, our patient revenues from continuing operations derived from Medicaid, Medicare, managed care and private pay (including private insurers) sources were approximately 49.4%, 34.5%, 4.0%, and 12.1%, respectively. Changes in the mix of our patients among Medicare, Medicaid, managed care and private pay categories and among different types of private pay sources may affect our net revenues and profitability. Our net revenues and profitability are also affected by the continuing efforts of all payors to contain or reduce the costs of health care. Efforts to impose reduced payments, greater discounts and more stringent cost controls by government and other payors are expected to continue.

The Federal Government makes frequent changes to the reimbursement provided under the Medicare program and future changes could significantly reduce the reimbursement we receive. Also, a number of state governments, including several of the states in which we operate, have announced projected budget shortfalls and/or deficit spending situations. Possible actions by these states include reductions of Medicaid reimbursement to providers such as us or the failure to increase Medicaid reimbursements to cover increased operating costs, or implementation of alternatives to long-term care, such as community and home-based services.

Any changes in reimbursement levels or in the timing of payments under Medicare, Medicaid or private pay programs and any changes in applicable government regulations could have a material adverse effect on our net revenues, net income and cash flows. We are unable to predict what reform proposals or reimbursement limitations will be adopted in the future or the effect such changes will have on our operations. We are limited in our ability to reduce the direct costs of providing care when decreases in reimbursement rates are imposed. No assurance can be given that such reforms will not have a material adverse effect on us. See “Item 1. Business – Government Regulation and Reimbursement.”

13

We are subject to significant government regulation.

The health care industry is subject to numerous laws and regulations of federal, state and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government health care program participation requirements, reimbursement for patient services, quality of patient care and Medicare and Medicaid fraud and abuse. Various federal and state laws regulate relationships among providers of services, including employment or service contracts and investment relationships. The operation of long-term care centers and the provision of services are also subject to extensive federal, state, and local laws relating to, among other things, the adequacy of medical care, distribution of pharmaceuticals, equipment, personnel, operating policies, environmental compliance, compliance with the Americans with Disabilities Act, fire prevention and compliance with building codes.

Long-term care facilities are subject to periodic inspection to assure continued compliance with various standards and licensing requirements under state law, as well as with Medicare and Medicaid conditions of participation. The failure to obtain or renew any required regulatory approvals or licenses could adversely affect our growth and could prevent us from offering our existing or additional services. In addition, health care is an area of extensive and frequent regulatory change. Changes in the laws or new interpretations of existing laws can have a significant effect on methods and costs of doing business and amounts of payments received from governmental and other payors. Our operations could be adversely affected by, among other things, regulatory developments such as mandatory increases in the scope and quality of care to be afforded patients and revisions in licensing and certification standards. We attempt at all times to comply with all applicable laws; however, there can be no assurance that we will remain in compliance at all times with all applicable laws and regulations or that new legislation or administrative or judicial interpretation of existing laws or regulations will not have a material adverse effect on our operations or financial condition. Federal or state proceedings seeking to impose fines and penalties for violations of applicable laws and regulations, as well as federal and state changes in these laws and regulations may negatively impact us. See “Item 1. Business – Government Regulation.” See also “Item 3. Legal Proceedings.”

The health care industry has been the subject of increased regulatory scrutiny recently.

The Office of Inspector General (“OIG”), the enforcement arm of the Medicare and Medicaid programs, formulates a formal work plan each year for nursing centers. The OIG’s most recent work plan indicates that quality of care, assessment and monitoring, poorly performing nursing facilities, hospitalizations, criminal background checks, Medicare part B services, accuracy of nursing facilities Minimum Data, transparency of ownership, and civil monetary penalty funds will be an investigative focus in 2012. We cannot predict the likelihood, scope or outcome of any such investigations on our facilities.

We are subject to claims under the self-referral and anti-kickback legislation.

In the United States, various state and federal laws regulate the relationships between providers of health care services, physicians, and other clinicians. These self-referral laws impose restrictions on physician referrals for designated health services to entities with which they have financial relationships. These laws also prohibit the offering, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare or state health care program patients or patient care opportunities for the purchase, lease or order of any item or service that is covered by the Medicare and Medicaid programs. To the extent that we, any of our facilities with which we do business, or any of the owners or directors have a financial relationship with each other or with other health care entities providing services to long-term care patients, such relationships could be subject to increased scrutiny. There can be no assurance that our operations will not be subject to review, scrutiny, penalties or enforcement actions under these laws, or that these laws will not change in the future. Violations of these laws may result in substantial civil or criminal penalties for individuals or entities, including large civil monetary penalties and exclusion from participation in the Medicare or Medicaid programs. Such exclusion or penalties, if applied to us, could have a material adverse effect on our profitability.

We operate in an industry that is highly competitive.

The long-term care industry generally, and the nursing home business particularly, is highly competitive. We face direct competition for the acquisition of facilities. In turn, our facilities face competition for employees and patients. Our ability to compete is based on several factors and include, but are not limited to building age, appearance, reputation, relationships with referral sources, availability of patients, survey history and CMS rankings. Some of our present and potential competitors are significantly larger and have or may obtain greater financial and marketing resources than we can. Some hospitals that provide long-term care services are also a potential source of competition. In addition, we may encounter substantial competition from new market entrants. Consequently, there can be no assurance that we will not encounter increased competition in the future, which could limit our ability to attract patients or expand our business, and could materially and adversely affect our business or decrease our market share.

14

Healthcare reform legislation could adversely affect our revenue and financial condition.

In recent years, there have been initiatives on the federal and state levels for comprehensive reforms affecting the availability, payment and reimbursement of healthcare services in the United States. In March 2010, significant legislation concerning health care and health insurance was passed which will significantly change the future of health care in the United States. If the reforms are phased in over the next ten years as currently enacted, they may significantly increase our costs to provide employee health insurance and have an adverse effect on our financial condition and results of operations. It is also expected that this new legislation will impact our operations and reimbursement from Federal programs such as Medicare and Medicaid as well as private insurance. The timing and ultimate level of that impact is currently unknown as we anticipate that many of the provisions of the Legislation may be subject to further clarification and modification through the rule making process.

Investing in our business initiatives and development could adversely impact our results of operations and financial condition.

We plan to invest in business initiatives and development that will increase our operating expenses for the next one or two years. These initiatives may or may not be successful in growing our census or revenues. There is typically a time delay between incurring such expenses and the attaining of revenues and cash flows expected from these initiatives and development. As a result, our revenue and operating cash flow may not increase enough during a reporting period to cover these increased expenses. Such additional revenues may not materialize at the level we anticipate, if at all.

Our ability and intent to pay cash dividends in the future may be limited.

We currently pay a $0.055 quarterly dividend on our common shares and while the Board of Directors intends to pay quarterly dividends, the Board will make the determination of the amount of future cash dividends, if any, to be declared and paid based on, among other things, our financial condition, funds from operations, the level of our capital expenditures and future business prospects.

We have a number of policies in place that could be considered anti-takeover protections.

We have adopted a shareholder rights plan (the “Plan”). On August 14, 2009, our board of directors (“Board”) amended the Plan to change the definition of “Acquiring Person” to be such person that acquires 20% or more of the shares of Common Stock of the Company, up from the 15% that previously defined an acquiring person. The Plan is intended to encourage potential acquirers to negotiate with our Board and to discourage coercive, discriminatory and unfair proposals. Our Certificate of Incorporation (the “Certificate”) provides for the classification of our Board into three classes, with each class of directors serving staggered terms of three years. Our Certificate requires the approval of the holders of two-thirds of the outstanding shares to amend certain provisions of the Certificate. Section 203 of the Delaware General Corporate Law restricts the ability of a Delaware corporation to engage in any business combination with an interested shareholder. We are also authorized to issue up to 795,000 shares of preferred stock, the rights of which may be fixed by our Board without shareholder approval. Provisions in certain of our executive officers’ employment agreements provide for post-termination compensation, including payment of amounts up to 1 times their annual salary, following certain changes in control (as defined in such agreements). Our stock incentive plans provide for the acceleration of the vesting of options in the event of certain changes in control (as defined in such plans). Certain changes in control also constitute an event of default under our bank credit facility. The foregoing matters may, together or separately, have the effect of discouraging or making more difficult an acquisition or change of control of the company.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

We own 9 and lease 38 long-term care facilities as discussed in “Item 1 Business – Nursing Centers and Services.” A description of our lease agreements follows.

Description of Lease Agreements.

Our current operations include 38 nursing centers subject to operating leases, including 36 owned by Omega and two owned by other parties, including the recently completed West Virginia nursing center. In our role as lessee, we are responsible for the day-to-day operations of all operated centers. These responsibilities include recruiting, hiring and training all nursing and other personnel, and providing patient care, nutrition services, marketing, quality improvement, accounting, and data processing services for each center. The lease agreements pertaining to our 38 leased facilities are “triple net” leases, requiring us to maintain the premises, provide insurance, pay taxes and pay for all utilities. The average remaining term of our lease agreements, including renewal options, is approximately 20 years.

15

Omega Master Lease. We lease 28 nursing centers from Omega pursuant to one lease agreement dated October 1, 2000 (the “Omega Master Lease”). The Omega Master Lease has an initial term, as amended, that expires September 30, 2018, provides for a renewal option of an additional twelve years, assuming no defaults, and provides for annual increases in lease payments equal to the lesser of two times the increase in the Consumer Price Index or 3.0%.

Effective August 11, 2007, we completed the acquisition of the leases and leasehold interests in seven facilities from Senior Management Services of America North Texas (“SMSA”) which are leased from a subsidiary of Omega. In connection with this acquisition, we amended the Omega Master Lease to include the seven SMSA facilities (“SMSA Amendment”), increasing the number of facilities under the Omega Master Lease to 35. The substantive terms of the previous SMSA lease, including payment provisions and lease period including renewal options, were not changed by the SMSA Amendment. The SMSA Amendment provides for an initial term and renewal periods at our option through May 31, 2035 for the seven SMSA facilities. The SMSA Amendment provides for annual increases in lease payments equal to the increase in the Consumer Price Index, not to exceed 2.5%.

In August 2009, we completed the construction of a 119 bed skilled nursing center, Brentwood Terrace, located in Paris, Texas, replacing an existing 102 bed nursing center leased from Omega. The replacement center was financed with funding from Omega and is leased from Omega under a long term operating lease with renewal options through 2035. Annual rent was approximately $0.8 million for the year ended December 31, 2011 and is based on a calculation of 10.25% of the total cost of the replacement center. The Brentwood Terrace nursing center lease provides for annual increases in lease payments equal to the increase in the Consumer Price Index, not to exceed 2.5%.

The Omega Master Lease requires us to fund annual capital expenditures currently equal to $412 per licensed bed, subject to adjustment for increases in the Consumer Price Index. Upon expiration of, or in the event of a default under the Omega Master Lease, we are required to transfer all of the leasehold improvements, equipment, furniture and fixtures of the leased facilities to Omega.

In April 2011, we entered into an amendment to the Master lease with Omega under which Omega agreed to provide an additional $5.0 million to fund renovations to four nursing centers located in Arkansas, Kentucky, Ohio and Texas that are leased from Omega. The annual base rent related to these facilities will be increased to reflect the amount of capital improvements to the respective facilities as the related expenditures are made. The increase is based on a rate of 10.25% per year of the amount financed under this amendment. This arrangement is similar to amendments entered into in 2009, 2006 and 2005 that provided financing totaling $15.0 million that was used to fund renovations at twelve nursing centers leased from Omega. As of December 31, 2011, renovation projects using these funds have been completed at twelve leased facilities, and are in progress at three additional facilities. Approximately $17.2 million allotted by Omega to fund renovations has been used. Plans are being developed for additional renovation projects including those that would potentially be funded through Omega.

The Omega Master Lease prohibits us from operating any additional facilities within a certain radius of each leased nursing center. We are generally required to maintain comprehensive insurance covering the facilities we lease as well as personal and real property damage insurance and professional liability insurance. The failure to pay rentals within a specified period or to comply with the required operating and financial covenants generally constitutes a default, if uncured, this default permits Omega to terminate the lease and assume the property and the contents within the facilities.

Other Leases. We operate a 150 bed nursing center located in Tennessee subject to a lease with a term that expires March 2019 and renewal options through March 2026. Rent for this center is approximately $0.8 million.

We operate the recently opened Rose Terrace nursing center in West Virginia subject to a lease with an initial lease term that expires December 2031 and renewal options through December 2041. The lease agreement grants us the right to purchase the center beginning in December 2012 and continuing through December 2016 for a purchase price ranging from 110% to 120% of the total project cost.

We lease approximately 27,000 square feet of office space in Brentwood, Tennessee that houses our executive offices, and centralized management support functions. In addition, we lease our regional office with approximately 4,000 square feet of office space in Ashland, Kentucky. Lease periods on these facilities range up to seven years. Regional executives for Alabama, Arkansas, Florida and Tennessee work from offices of up to 1,500 square feet each. We believe that our leased properties are adequate for our present needs and that suitable additional or replacement space will be available as required.

16

ITEM 3. LEGAL PROCEEDINGS

The provision of health care services entails an inherent risk of liability. Participants in the health care industry are subject to lawsuits alleging malpractice, product liability, violations of the False Claims Act and other legal theories, many of which involve large claims and significant defense costs. Like many other companies engaged in the long-term care profession in the United States, we have numerous pending liability claims, disputes and legal actions for professional liability and other related issues. It is expected that we will continue to be subject to such suits as a result of the nature of our business. Further, as with all health care providers, we are periodically subject to regulatory actions seeking fines and penalties for alleged violations of health care laws and are potentially subject to the increased scrutiny of regulators for issues related to compliance with health care fraud and abuse laws and with respect to the quality of care provided to patients of our centers. Like other health care providers, in the ordinary course of our business, we are also subject to claims made by employees and other disputes and litigation arising from the conduct of our business.

As of December 31, 2011, we are engaged in 38 professional liability lawsuits. Four lawsuits are currently scheduled for trial or mediation during the next ten months and it is expected that additional cases will be set for trial. Our cash expenditures for professional liability costs of continuing operations were $8.0 million in 2011. This included the settlement of nine professional liability cases in July 2011 for a total of $4.6 million, of which $0.7 million was paid from insurance proceeds and the majority of our portion of these settlements was paid during the third quarter of 2011. In October 2011, we agreed to settle five professional liability cases for a total of $3.2 million. These settlements will be paid in quarterly installments through 2012. In addition to the settlement payments described above, we will have additional cash expenditures in the ordinary course of business for other settlements and self-insured professional liability costs throughout the year.

The ultimate results of any of our professional liability claims and disputes cannot be predicted. We have limited, and sometimes no, professional liability insurance with regard to most of these claims. A significant judgment entered against us in one or more of these legal actions could have a material adverse impact on our financial position and cash flows.

In January 2009, a purported class action complaint was filed in the Circuit Court of Garland County, Arkansas against us and certain of our subsidiaries and Garland Nursing & Rehabilitation Center (the “Center”). The complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Center over the past five years. The lawsuit has not been certified as a class action, and no motion to certify the class has been filed by Plaintiffs’ counsel to date. We intend to defend the lawsuit vigorously.

We cannot currently predict with certainty the ultimate impact of any of the above cases on our financial condition, cash flows or results of operations. An unfavorable outcome in any of the lawsuits, any regulatory action, any investigation or lawsuit alleging violations of fraud and abuse laws or of elderly abuse laws or any state or Federal False Claims Act case could subject us to fines, penalties and damages, including exclusion from the Medicare or Medicaid programs, and could have a material adverse impact on our financial condition, cash flows or results of operations.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

17

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information. Our common stock is traded on the NASDAQ Capital Market and began trading there on September 12, 2006 under the symbol “AVCA.” The following table sets forth the high and low bid prices of our common stock, as reported by NASDAQ.com, for each quarter in 2010 and 2011:

Period	High		Low		Dividends
2010 - 1st Quarter	$	8.44	$	5.40	$	0.05
2010 - 2nd Quarter	$	6.98	$	4.65	$	0.055
2010 - 3rd Quarter	$	5.95	$	4.00	$	0.055
2010 - 4th Quarter	$	5.95	$	4.49	$	0.055
2011 - 1st Quarter	$	7.40	$	4.97	$	0.055
2011 - 2nd Quarter	$	7.60	$	5.82	$	0.055
2011 - 3rd Quarter	$	7.12	$	5.10	$	0.055
2011 - 4th Quarter	$	6.80	$	5.29	$	0.055

Our common stock has been traded since May 10, 1994. On February 17, 2012, the closing price for our common stock was $6.00, as reported by NASDAQ.com.

Holders. On February 17, 2012, there were approximately 242 holders of record. Most of our shareholders have their holdings in the street name of their broker/dealer.

Dividends. We pay a quarterly dividend of $0.055 per common share. While the Board of Directors intends to pay quarterly dividends, the Board will make the determination of the amount of future cash dividends, if any, to be declared and paid based on, among other things, the Company’s financial condition, funds from operations, the level of its capital expenditures and its future business prospects. We are required to pay dividends at an annual rate of 7% of the stated value on our outstanding Series C Redeemable Preferred Stock, payable quarterly. As a result, we have paid a quarterly dividend on the outstanding Series C Redeemable Preferred Stock of $86,000.

Equity Compensation Plan Information

The following table provides aggregate information as of December 31, 2011, with respect to shares of our common stock that may be issued under our existing equity compensation plans:

Plan Category	Number of Securities to be  Issued Upon Exercise of Outstanding Options, Warrants and Rights		Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights		Number of Securities Available for Future Issuance Under Equity Compensation Plans (excluding Securities Reflected in Column (a))
	(a)		(b)		(c)(1)
Equity Compensation Plans Approved by Security Holders		451,000	$	6.68		533,000
Equity Compensation Plans Not Approved by Security Holders		None		None		None
Total		451,000	$	6.68		533,000

⁽¹⁾  Includes 139,000 shares available for issuance under the 2005 Long-Term Incentive Plan, 100,000 shares reserved for issuance under the Advocat Inc. 2008 Stock Purchase Plan for Key Personnel and 294,000 shares available for issuance under the 2010 Long-Term Incentive Plan. The 2010 Long-Term Incentive Plan was approved in 2010 and allows for the granting of options and stock appreciation rights for our common stock and is administered by the compensation committee of the Board.

18

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected financial data of Advocat presented in the following table have been derived from our consolidated financial statements, and should be read in conjunction with the annual financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations. The SMSA facilities are included in selected financial data effective August 11, 2007 and the single nursing center lease in Texas is included effective November 1, 2007. This selected financial data for all periods shown have been reclassified to present the effects of certain divestitures as discontinued operations.

	Year Ended December 31,
	2011			2010			2009			2008			2007
	(in thousands, except per share amounts)
Statement of Operations Data
REVENUES:
Patient revenues, net	$	314,715		$	290,130		$	276,979		$	263,837		$	219,911
EXPENSES:
Operating		243,929			229,081			219,567			207,998			167,852
Lease		22,939			22,600			21,791			21,331			18,388
Professional liability		10,962			5,364			8,228			1,532			(1,559	)
General and administrative		25,589			19,680			17,926			17,973			17,062
Depreciation and amortization		6,592			5,825			5,446			5,065			3,884
Asset Impairment		344			—			—			—			—
		310,355			282,550			272,958			253,899			205,627
OPERATING INCOME		4,360			7,580			4,021			9,938			14,284
OTHER INCOME (EXPENSE):
Foreign currency transaction gain (loss)		—			—			191			(1,005	)		808
Other income		—			—			549			—			—
Interest income		11			2			161			453			1,016
Interest expense		(2,366	)		(1,634	)		(1,877	)		(2,870	)		(3,545	)
Debt retirement costs		(112	)		(127	)		—			—			(116	)
		(2,467	)		(1,759	)		(976	)		(3,422	)		(1,837	)
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		1,893			5,821			3,045			6,516			12,447
PROVISION FOR INCOME TAXES		(509	)		(1,858	)		(1,165	)		(2,208	)		(4,953	)
NET INCOME FROM CONTINUING OPERATIONS		1,384			3,963			1,880			4,308			7,494
DISCONTINUED OPERATIONS, net of taxes		(17	)		(114	)		721			1,427			1,893
NET INCOME	$	1,367		$	3,849		$	2,601		$	5,735		$	9,387
INCOME (LOSS) PER COMMON SHARE:
Basic-
Continuing operations	$	0.18		$	0.63		$	0.27		$	0.70		$	1.22
Discontinued operations		—			(0.02	)		0.13			0.25			0.32
Net per common share	$	0.18		$	0.61		$	0.40		$	0.95		$	1.54
Diluted-
Continuing operations	$	0.18		$	0.62		$	0.26		$	0.67		$	1.17
Discontinued operations		(0.01	)		(0.02	)		0.13			0.25			0.31
Net per common share	$	0.17		$	0.60		$	0.39		$	0.92		$	1.48
CASH DIVIDENDS DECLARED PER COMMON SHARE	$	0.22		$	0.215		$	0.15			—			—
WEIGHTED AVERAGE COMMON SHARES:
Basic		5,744			5,732			5,678			5,693			5,870
Diluted		5,906			5,854			5,797			5,887			6,127
	December 31,
	2011			2010			2009			2008			2007
	(in thousands)
Balance Sheet Data
Working capital	$	15,435		$	16,228		$	12,334		$	10,885		$	15,677
Total assets	$	116,744		$	105,596		$	105,451		$	107,339		$	110,090
Long-term debt and capitalized lease obligations, including current portion	$	29,899		$	24,401		$	24,829		$	32,410		$	34,455
Preferred Stock – Series C (including unamortized premium)	$	4,918		$	4,918		$	6,192		$	7,891		$	9,590
Total Shareholders’ Equity of Advocat Inc.	$	21,315		$	22,205		$	19,693		$	17,551		$	12,744
Total Shareholders’ Equity	$	22,969		$	22,205		$	19,693		$	17,551		$	12,744

19

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

Overview

Advocat Inc. provides long-term care services to nursing center patients in eight states, primarily in the Southeast and Southwest United States. Our centers provide a range of health care services to their patients. In addition to the nursing, personal care and social services usually provided in long-term care centers, we offer a variety of comprehensive rehabilitation services as well as nutritional support services.

As of December 31, 2011, our continuing operations consist of 47 nursing centers with 5,445 licensed nursing beds. As of December 31, 2011, our continuing operations included nine owned nursing centers and 38 leased nursing centers.

Divestitures.

Effective March 31, 2010, we terminated operations of four nursing centers in Florida under a lease that, as amended, would have expired in August 2010. The operating margins of the four facilities subject to this lease did not meet our goals. Effective March 31, 2010, we transitioned operations at these leased facilities, and we have reclassified the operations of these facilities as discontinued operations and current assets in the accompanying consolidated financial statements.

The Centers for Medicare and Medicaid Services (“CMS”) issued regulations that became effective October 1, 2009 that prohibit us from billing Medicare Part B for certain enteral nutrition, urological, ostomy and tracheostomy supplies, and these services are now provided by third parties. The revenue and cost of goods sold for providing these services prior to October 2009 have been reclassified as discontinued operations.

The net assets of discontinued operations presented in property and equipment on our balance sheet represent real estate related to an assisted living center in North Carolina closed in April 2006. Based on an evaluation of the estimated realizable value of the land, we recorded an impairment charge of $0.4 million to reduce the carrying value of the land during 2010. We are continuing our efforts to sell this land.

Basis of Financial Statements. Our patient revenues consist of the fees charged for the care of patients in the nursing centers we own and lease. Our operating expenses include the costs, other than lease, depreciation and amortization expenses, incurred in the operation of the nursing centers we own and lease. Our general and administrative expenses consist of the costs of the corporate office and regional support functions. Our interest, depreciation and amortization expenses include all such expenses across the range of our operations.

20

Selected Financial and Operating Data

The following table summarizes the Advocat statements of continuing operations for the years ended December 31, 2011, 2010 and 2009, and sets forth this data as a percentage of revenues for the same years.

	Year Ended December 31,
	(Dollars in thousands)
	2011					2010					2009
Revenues:
Patient revenues, net	$	314,715		100.0	%	$	290,130		100.0	%	$	276,979		100.0	%
Expenses:
Operating		243,929		77.5			229,081		79.0			219,567		79.3
Lease		22,939		7.3			22,600		7.8			21,791		7.8
Professional liability		10,962		3.5			5,364		1.8			8,228		3.0
General & administrative		25,589		8.1			19,680		6.8			17,926		6.5
Depreciation and amortization		6,592		2.1			5,825		2.0			5,446		1.9
Asset impairment		344		0.1			—		—			—		—
		310,355		98.6			282,550		97.4			272,958		98.5
Operating income		4,360		1.4			7,580		2.6			4,021		1.5
Other income (expense):
Foreign currency transaction gain		—		—			—		—			191		0.1
Other income		—		—			—		—			549		0.2
Interest income		11		—			2		—			161		—
Interest expense		(2,366	)	(0.8	)		(1,634	)	(0.6	)		(1,877	)	(0.7	)
Debt retirement costs		(112	)	—			(127	)	—			—		—
		(2,467	)	(0.8	)		(1,759	)	(0.6	)		(976	)	(0.4	)
Income from continuing operations before income taxes		1,893		0.6			5,821		2.0			3,045		1.1
Provision for income taxes		(509	)	(0.2	)		(1,858	)	(0.6	)		(1,165	)	(0.4	)
Net income from continuing operations	$	1,384		0.4	%	$	3,963		1.4	%	$	1,880		0.7	%

The following table presents data about the facilities we operated as part of our continuing operations as of the dates:

	December 31,
	2011		2010		2009
Licensed Nursing Center Beds:
Owned		936		936		936
Leased		4,509		4,428		4,848
Total		5,445		5,364		5,784
Facilities:
Owned		9		9		9
Leased		38		37		41
Total		47		46		50

Critical Accounting Policies and Judgments

A “critical accounting policy” is one which is both important to the understanding of our financial condition and results of operations and requires management’s most difficult, subjective or complex judgments often of the need to make estimates about the effect of matters that are inherently uncertain. Actual results could differ from those estimates and cause our reported net income to vary significantly from period to period. Our accounting policies that fit this definition include the following:

Revenues

Patient Revenues

The fees we charge patients in our nursing centers are recorded on an accrual basis. These rates are contractually adjusted with respect to individuals receiving benefits under federal and state-funded programs and other third-party payors. Our net revenues are derived substantially from Medicare, Medicaid and other government programs (approximately 83.9%, 84.1% and 85.0% for 2011, 2010, and 2009, respectively). Medicare intermediaries make retroactive adjustments based on changes in allowed claims. In addition, certain of the states in which we operate require complicated detailed cost reports which are subject to review and adjustments. In the opinion of management, adequate provision has been made for adjustments that

21

may result from such reviews. Retroactive adjustments, if any, are recorded when objectively determinable, generally within three years of the close of a reimbursement year depending upon the timing of appeals and third-party settlement reviews or audits.

Allowance for Doubtful Accounts

We evaluate the collectability of our accounts receivable by reviewing current aging summaries of accounts receivable, historical collections data and other factors. As a percentage of revenue, our provision for doubtful accounts was approximately 0.7% for 2011, 2010 and 2009. Historical bad debts have generally resulted from uncollectible private pay balances, some uncollectible coinsurance and deductibles and other factors. Receivables that are deemed to be uncollectible are written off.

Professional Liability and Other Self-Insurance Reserves

Accrual for Professional and General Liability Claims-

For claims made after March 9, 2001, we have purchased professional liability insurance coverage for our nursing centers that, based on historical claims experience, is likely to be substantially less than the amount required to satisfy claims that were incurred. We have essentially exhausted all of our general and professional liability insurance coverage for claims first asserted prior to July 1, 2011.

Currently, our nursing centers are covered by one of two professional liability insurance policies. Our nursing centers in Arkansas, Kentucky, Tennessee, and two centers in West Virginia are covered by an insurance policy with coverage limits of $250,000 per medical incident and total annual aggregate policy limits of $750,000. This policy provides the only commercially affordable insurance coverage available for claims made during this period against these nursing centers. Our nursing centers in Alabama, Florida, Ohio, Texas and our new center in West Virginia are covered by an insurance policy with coverage limits of $1.0 million per medical incident, subject to a deductible of $0.5 million per claim, with a total annual aggregate policy limit of $15.0 million and a sublimit per center of $3.0 million.

Because our actual liability for existing and anticipated professional liability and general liability claims will exceed our limited insurance coverage, we have recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $19.4 million as of December 31, 2011, including $3.1 million for settlements that are expected to be paid in 2012, estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, and estimates of related legal costs incurred and expected to be incurred. All losses are projected on an undiscounted basis.

Semi-annually we retain the Actuarial Division of Willis of Tennessee, Inc. (“Willis”), a third-party actuarial firm, to provide its estimate of the accrual for incurred general and professional liability claims. The actuary, Willis, primarily uses historical data regarding the frequency and cost of our past claims over a multi-year period and information regarding our number of occupied beds to develop its estimates of our ultimate professional liability cost for current periods. The actuary estimates our professional liability accrual for past periods by using currently-known information to adjust the initial reserve that was created for that period.

On a quarterly basis, we obtain reports of asserted claims and lawsuits from our insurers and a third party claims administrator. These reports contain information relevant to the liability actually incurred to date with that claim as well as the third-party administrator’s estimate of the anticipated total cost of the claim. This information is reviewed by us quarterly and provided to the actuary semi-annually. We use this information to determine the timing of claims reporting and the development of reserves, and compare the information obtained to our previously recorded estimates of liability. Based on the actual claim information obtained, the semi-annual estimates received from the actuary and on estimates regarding the number and cost of additional claims anticipated in the future, the reserve estimate for a particular period may be revised upward or downward on a quarterly basis. Final determination of our actual liability for claims incurred in any given period is a process that takes years.

The Company’s cash expenditures for self-insured professional liability costs were $8.0 million, $5.1 million and $4.8 million for the years ended December 31, 2011, 2010 and 2009, respectively.

Although we retain a third-party actuarial firm to assist us, professional and general liability claims are inherently uncertain, and the liability associated with anticipated claims is very difficult to estimate. Professional liability cases have a long cycle from the date of an incident to the date a case is resolved, and final determination of our actual liability for claims incurred in any given period is a process that takes years. As a result, our actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given quarter.

22

Professional liability costs are material to our financial position, and changes in estimates, as well as differences between estimates and the ultimate amount of loss, may cause a material fluctuation in our reported results of operations. Our professional liability expense was $11.0 million, $5.4 million and $8.2 million for the years ended December 31, 2011, 2010 and 2009, respectively. These amounts are material in relation to our reported net income from continuing operations for the related periods of $1.4 million, $4.0 million and $1.9 million, respectively. The total liability recorded at December 31, 2011, was $19.4 million, compared to current assets of $45.3 million and total assets of $116.7 million.

Accrual for Other Self-Insured Claims-

With respect to workers’ compensation insurance, substantially all of our employees became covered under either an indemnity insurance plan or state-sponsored programs in May 1997. We are completely self-insured for workers’ compensation exposures prior to May 1997. We have been and remain a non-subscriber to the Texas workers’ compensation system and are, therefore, completely self-insured for employee injuries with respect to our Texas operations. From June 30, 2003 until June 30, 2007, our workers’ compensation insurance programs provided coverage for claims incurred with premium adjustments depending on incurred losses. For the period from July 1, 2008 through June 30, 2011, we are covered by a prefunded deductible policy. Under this policy, we are self-insured for the first $500,000 per claim, subject to an aggregate maximum of $3,000,000. We fund a loss fund account with the insurer to pay for claims below the deductible. We account for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred.

We are self-insured for health insurance benefits for certain employees and dependents for amounts up to $175,000 per individual annually. We provide reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate, based on known claims and estimates of unknown claims based on historical information. The differences between actual settlements and reserves are included in expense in the period finalized. Our reserves for health insurance benefits can fluctuate materially from one year to the next depending on the number of significant health issues of our covered employees and their dependants.

Asset Impairment

We evaluate our property, equipment and other long-lived assets on a quarterly basis to determine if facts and circumstances suggest that the assets may be impaired or that the estimated depreciable life of the asset may need to be changed for significant physical changes in the property, or significant adverse changes in general economic conditions, and significant deteriorations of the underlying cash flows or fair values of the property. The need to recognize impairment is based on estimated future cash flows from a property compared to the carrying value of that property. If recognition of impairment is necessary, it is measured as the amount by which the carrying amount of the property exceeds the fair value of the property. We have few assets recorded at fair value and those fair value assets are the result of our asset impairment analysis described below. Our asset impairment analysis is consistent with the fair value measurements described in the accounting guidance for “Fair Value Measurements and Disclosures.”

On July 29, 2011, the Centers for Medicare & Medicaid Services (“CMS”) issued its final rule for skilled nursing facilities effective October 1, 2011, reducing Medicare reimbursement rates for skilled nursing facilities by 11.1% and also making changes to rehabilitation therapy regulations. This final rule will have a negative effect on our revenue and costs in Medicare’s fiscal year ending September 30, 2012 as compared to Medicare’s fiscal year ended September 30, 2011. As a result of this negative impact, we determined that the carrying value of the long-lived assets of one of our leased nursing centers exceeded the fair value. As a result, we recorded a fixed asset impairment charge during 2011 of $0.3 million to reduce the carrying value of these assets.

In 2010, we recorded an impairment of approximately $0.4 million related to land held as discontinued operations. No impairment of long lived assets was recognized in 2009. If our estimates or assumptions with respect to a property change in the future, we may be required to record additional impairment charges for our assets.

Business Combinations

For business combination transactions, we recognize and measure the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree as well as the goodwill acquired or gain recognized in a bargain purchase, and we make certain valuations to determine the fair value of assets acquired and the liabilities assumed. These valuations are subject to retroactive adjustment during the twelve month period subsequent to the acquisition date. Such valuations require us to make significant estimates, judgments and assumptions, including projections of future events and operating performance.

23

Stock-Based Compensation

We recognize compensation cost for all share-based payments granted after January 1, 2006 on a straight-line basis over the vesting period. We calculated the recognized and unrecognized stock-based compensation using the Black-Scholes-Merton option valuation method, which requires us to use certain key assumptions to develop the fair value estimates. These key assumptions include expected volatility, risk-free interest rate, expected dividends and expected term. During the years ended December 31, 2011, 2010 and 2009, we recorded charges of approximately $0.5 million, $0.6 million and $0.7 million in stock-based compensation, respectively. Stock-based compensation expense is a non-cash expense and such amounts are included as a component of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees.

Income Taxes

We determine deferred tax assets and liabilities based upon differences between financial reporting and tax bases of assets and liabilities and measure them using the enacted tax laws that will be in effect when the differences are expected to reverse. We maintain a valuation allowance of approximately $0.9 million to reduce the deferred tax assets to amounts we believe can be realized in accordance with generally accepted accounting principles. In future periods, we will continue to assess the need for and adequacy of the remaining valuation allowance. We follow the relevant guidance found in the FASB codification, accounting for uncertainty in income taxes. The guidance provides information and procedures for financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns.

Contractual Obligations and Commercial Commitments

We have certain contractual obligations of continuing operations as of December 31, 2011, summarized by the period in which payment is due, as follows (dollar amounts in thousands):

Contractual Obligations	Total		Less than 1 year		1 to 3 Years		3 to 5 Years		After 5 Years
Long-term debt obligations (1)	$	38,074	$	3,295	$	6,223	$	28,556	$	—
Settlement obligations (2)	$	3,170	$	3,170	$	—	$	—	$	—
Executive severance (3)	$	1,923	$	1,923	$	—	$	—	$	—
Series C Preferred Stock (4)	$	4,918	$	4,918	$	—	$	—	$	—
Elimination of Preferred Stock Conversion feature (5)	$	4,636	$	687	$	1,374	$	1,374	$	1,201
Operating leases	$	563,859	$	23,119	$	47,880	$	50,189	$	442,671
Required capital expenditures under operating leases (6)	$	19,415	$	285	$	569	$	569	$	17,992
Total	$	635,995	$	37,397	$	56,046	$	80,688	$	461,864

(1) Long-term debt obligations include scheduled future payments of principal and interest of long-term debt and amounts outstanding on our capital lease obligations.

(2) Settlement obligations relate to professional liability cases that will be paid within the next twelve months. The professional liabilities are included in our current portion of self-insurance reserves.

(3) Executive severance includes separation payments to former executives that will be paid within the next twelve months. The separation payments are included in our accrued payroll and employee benefits.

(4) Series C Preferred Stock equals the redemption value at the preferred shareholder’s earliest redemption date.

(5) Payments to Omega for the elimination of the preferred stock conversion feature in connection with restructuring the preferred stock and master lease agreements. Monthly payments of approximately $57,000 will be made through the end of the initial lease period that ends in September 2018.

(6) Includes annual expenditure requirements under operating leases.

We have employment agreements with certain members of management that provide for the payment to these members of amounts up to 1 times their annual salary in the event of a termination without cause, a constructive discharge (as defined), or upon a change of control of the Company (as defined). The maximum contingent liability under these agreements is approximately $1.1 million as of December 31, 2011. The terms of such agreements are from one to three years and automatically renew for one year if not terminated by us or the employee. In addition, upon the occurrence of any triggering event, those certain members of management may elect to require that we purchase equity awards granted to them for a purchase price equal to the difference in the fair market value of our common stock at the date of termination versus the stated equity award exercise price. Based on the closing price of our stock on December 31, 2011, the maximum contingent liability for the repurchase of the equity grants is approximately $41,000. No amounts have been accrued for these contingent liabilities.

24

Payor Sources

We classify our revenues from patients into four major categories: Medicaid, Medicare, Managed care, and private pay and other. Medicaid revenues are composed of the traditional Medicaid program established to provide benefits to those in need of financial assistance in the securing of medical services. Medicare revenues include revenues received under both Part A and Part B of the Medicare program. Managed care revenues include payments for patients who are insured by a third-party entity, typically called a Health Maintenance Organization, often referred to as an HMO plan, or are Medicare beneficiaries who assign their Medicare benefits to a Managed Care replacement plan often referred to as Medicare replacement products. The private pay and other revenues are composed primarily of individuals or parties who directly pay for their services. Included in the private pay and other are patients who are hospice beneficiaries as well as the recipients of Veterans Administration benefits. Veterans Administration payments are made pursuant to renewable contracts negotiated with these payors.

The following table sets forth net patient revenues related to our continuing operations by payor source for the periods presented (dollar amounts in thousands):

	Year Ended December 31,
	2011				2010				2009
Medicaid	$	155,481	49.4	%	$	155,035	53.4	%	$	149,987	54.2	%
Medicare		108,687	34.5			88,920	30.7			85,433	30.8
Managed care		12,710	4.0			8,619	3.0			7,412	2.7
Private Pay and other		37,837	12.1			37,556	12.9			34,147	12.3
Total	$	314,715	100.0	%	$	290,130	100.0	%	$	276,979	100.0	%

The following table sets forth average daily skilled nursing census by payor source for our continuing operations for the periods presented:

	Year Ended December 31,
	2011				2010				2009
Medicaid		2,793	67.5	%		2,886	68.8	%		2,854	69.6	%
Medicare		593	14.3			544	13.0			534	13.0
Managed care		82	2.0			59	1.4			51	1.2
Private Pay and other		673	16.2			704	16.8			661	16.2
Total		4,141	100.0	%		4,193	100.0	%		4,100	100.0	%

Consistent with the nursing center industry in general, changes in the mix of a nursing center’s patient population among Medicaid, Medicare, Managed care and private pay can significantly affect the profitability of the center’s operations.

25

Results of Operations

As discussed in the overview at the beginning of Management’s Discussion and Analysis of Financial Condition and Results of Operations, we have completed certain divestitures, acquisitions and entered a new lease agreement. We have reclassified our Consolidated Financial Statements to present certain divestitures as discontinued operations for all periods presented.

(in thousands)	Year Ended December 31,
	2011			2010			Change			%
PATIENT REVENUES, net	$	314,715		$	290,130		$	24,585			8.5	%
EXPENSES:
Operating		243,929			229,081			14,848			6.5
Lease		22,939			22,600			339			1.5
Professional liability		10,962			5,364			5,598			104.4
General and administrative		25,589			19,680			5,909			30.0
Depreciation and amortization		6,592			5,825			767			13.2
Asset impairment		344			—			344			100.0
Total expenses		310,355			282,550			27,805			9.8
OPERATING INCOME		4,360			7,580			(3,220	)		(42.5	)
OTHER INCOME (EXPENSE):
Interest income		11			2			9			450.0
Interest expense		(2,366	)		(1,634	)		(732	)		(44.8	)
Debt retirement costs		(112	)		(127	)		15			11.8
		(2,467	)		(1,759	)		(708	)		40.3
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		1,893			5,821			(3,928	)		(67.5	)
PROVISION FOR INCOME TAXES		(509	)		(1,858	)		(1,349	)		(72.6	)
NET INCOME FROM CONTINUING OPERATIONS	$	1,384		$	3,963		$	(2,579	)		(65.1	)%
(in thousands)	Year Ended December 31,
	2010			2009			Change			%
PATIENT REVENUES, net	$	290,130		$	276,979		$	13,151			4.7	%
EXPENSES:
Operating		229,081			219,567			9,514			4.3
Lease		22,600			21,791			809			3.7
Professional liability		5,364			8,228			(2,864	)		(34.8	)
General and administrative		19,680			17,926			1,754			9.8
Depreciation and amortization		5,825			5,446			379			7.0
Total expenses		282,550			272,958			9,592			3.5
OPERATING INCOME		7,580			4,021			3,559			88.5
OTHER INCOME (EXPENSE):
Foreign currency transaction gain		—			191			(191	)		(100.0	)
Other income		—			549			(549	)		(100.0	)
Interest income		2			161			(159	)		(98.8	)
Interest expense		(1,634	)		(1,877	)		243			12.9
Debt retirement costs		(127	)		—			(127	)		(100.0	)
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		(1,759	)		(976	)		(783	)		(80.2	)
PROVISION FOR INCOME TAXES		5,821			3,045			2,776			91.2
NET INCOME FROM CONTINUING OPERATIONS		(1,858	)		(1,165	)		(693	)		(59.5	)
	$	3,963		$	1,880		$	2,083			110.8	%

26

Year Ended December 31, 2011 Compared with Year Ended December 31, 2010

Patient Revenues

Patient revenues increased to $314.7 million in 2011 from $290.1 million in 2010, an increase of $24.6 million, or 8.5%.

The following table summarizes key revenue and census statistics for continuing operations for each period:

	Year Ended December 31
	2011			2010
Skilled nursing occupancy		77.2	%		78.1	%
As a percent of total census:
Medicare census		14.3	%		13.0	%
Managed care census		2.0	%		1.4	%
As a percent of total revenues:
Medicare revenues		34.5	%		30.7	%
Medicaid revenues		49.4	%		53.4	%
Managed care revenues		4.0	%		3.0	%
Average rate per day:
Medicare	$	451.76		$	403.67
Medicaid	$	152.25		$	146.84
Managed care	$	403.25		$	386.08

The average Medicare rate per patient day for 2011 increased 11.9% compared to 2010, resulting in a net increase in revenue of $10.4 million. This increase is primarily attributable to the investments we have made to improve our skilled care offerings and rate changes enacted by CMS. On October 1, 2010, CMS implemented RUG IV in connection with the MDS 3.0 patient assessment tool. RUG IV expanded RUG categories to 66 from 53 under RUG III. Also on October 1, 2010, CMS implemented a Medicare rate increase of 1.7% for the annual SNF market basket adjustment. The combined effect of these rate changes, together with changes in patient acuity levels, increased revenue by $12.0 million in the first nine months of 2011. Partially offsetting these increases was a rate decrease of 11.1% effective October 1, 2011, resulting in a net increase of $10.4 million for 2011.

An increase in Medicare census contributed approximately $7.2 million to the total revenue increase. Medicare average daily census increased 9.0% to 593 in 2011 from 544 in 2010. We experienced an increase of $2.1 million in revenue delivery to our Medicare B patients in 2011 compared to 2010.

Medicaid rates and census contributed approximately $0.5 million of the total revenue increase. The average Medicaid rate per patient day for 2011 increased 3.7% compared to 2010, resulting in an increase in revenue of $5.5 million. This average rate per day for Medicaid patients is the result of rate increases in certain states, partially funded by increased provider taxes, and increasing patient acuity levels. Medicaid average daily census was 3.2% lower in 2011, decreasing revenue by $5.0 million in 2011. The decrease in Medicaid census reflects our focus on improving our skilled mix.

Managed care rates and census contributed approximately $3.8 million of the total revenue increase, primarily due to an increase in managed care average daily census of 39%.

Operating expense

Operating expense increased to $243.9 million in 2011 from $229.1 million in 2010, an increase of $14.8 million, or 6.5%. The increase in operating expense is primarily attributable to cost increases associated with our increased revenue as well as investment in our operating initiatives focused on improving our skilled mix and occupancy. As a result of the significant increase in revenues, operating expense decreased to 77.5% of revenue in 2011, compared to 79.0% of revenue in 2010.

The largest component of operating expenses is wages, which increased to $152.5 million in 2011 from $142.0 million in 2010, an increase of $10.5 million, or 7.4%. The increase in wages was primarily due to labor costs associated with the 11.9% increase in Medicare and managed care patients, competitive labor markets in most of the areas in which we operate and regular merit and inflationary raises for personnel (increase of approximately 3.7% for the year). In accordance with our strategic initiatives to increase our high acuity patient care capabilities and grow our skilled mix and occupancy, we have added additional registered nurses and therapists to attract and serve the needs of these patients, including approximately $4.2 million in therapy staffing costs, $2.1 million in nursing center staffing costs to improve our ability to market and care for high acuity patients and $0.7 million for increased wages that resulted from the transition to the new MDS 3.0 patient assessment tool in our facilities.

27

Provider taxes increased approximately $0.6 million in 2011, primarily due to increases in tax rates and higher census in certain states in which we operate.

Workers compensation insurance expense increased approximately $0.8 million in 2011 compared to 2010. The increase is the result of better claims experience in 2010 compared to 2011.

Employee health insurance costs were approximately $1.4 million lower in 2011 compared to 2010, a decrease of 19.9%. The Company is self-insured for the first $175,000 in claims per employee each year, and we experienced a lower level of claims costs during 2011. Employee health insurance costs can vary significantly from year to year, and we continually evaluate the provisions of these plans.

The remaining increases in operating expense are primarily due to the effects of the increase in patient census.

Lease expense

Lease expense increased to $22.9 million in 2011 from $22.6 million in 2010. The primary reason for the increase in lease expense was rent for lessor funded property renovations.

Professional liability

Professional liability expense was $11.0 million in 2011 compared to $5.4 million in 2010, an increase of $5.6 million. We were engaged in 38 professional liability lawsuits as of December 31, 2011, compared to 32 as of December 31, 2010. Our cash expenditures for professional liability costs of continuing operations were $8.0 million and $5.1 million for 2011 and 2010, respectively. Professional liability expense and cash expenditures fluctuate from year to year based respectively on the results of our third-party professional liability actuarial studies and on the costs incurred in defending and settling existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.

General and administrative expense

General and administrative expenses were approximately $25.6 million in 2011 compared to $19.7 million in 2010, an increase of $5.9 million, or 30%. Costs of our strategic initiatives accounted for approximately $3.3 million, including compensation costs related to new positions of approximately $2.3 million, and cost increases totaling $1.0 million related to the continued implementation of electronic medical records, increased travel costs of $0.3 million, consulting services and hiring and relocation costs. Performance-based incentive expense was $0.4 million higher in 2011. We also experienced an increase of approximately $1.0 million in severance costs and $0.6 million increase in legal costs during 2011.

Depreciation and amortization

Depreciation and amortization expense was approximately $6.6 million in 2011 and $5.8 million in 2010. The increase in 2011 is primarily due to depreciation and amortization expenses related to capital expenditures for additions to property and equipment, including equipment related to our EMR initiative.

Asset impairment

During 2011, we determined that the carrying value of the long-lived assets of one of our leased nursing centers exceeded the fair value of such assets. As a result, we recorded a fixed asset impairment charge of $0.3 million to reduce the carrying value of these assets.

Interest expense

Interest expense increased to $2.4 million in 2011 compared to $1.6 million in 2010. As discussed further in “Capital Resources” the increase in interest expense is due to the change in interest rates on our Mortgage Loan to a fixed rate of 7.07% from 4.01% and the additional $2.4 million in borrowings for capital improvements at our owned homes.

28

Income from continuing operations before income taxes; income from continuing operations per common share

As a result of the above, continuing operations reported income before income taxes of $1.9 million and $5.8 million in 2011 and 2010, respectively. The provision for income taxes was $0.5 million in 2011, an effective rate of 26.9% and $1.9 million in 2010, an effective rate of 31.9%. The basic and diluted income per common share from continuing operations were both $0.18 in 2011 compared to $0.63 and $0.62, respectively, in 2010.

Year Ended December 31, 2010 Compared with Year Ended December 31, 2009

Patient Revenues

Patient revenues increased to $290.1 million in 2010 from $277.0 million in 2009, an increase of $13.1 million, or 4.7%.

The following table summarizes key revenue and census statistics for continuing operations for each period:

	Year Ended December 31
	2010			2009
Skilled nursing occupancy		78.1	%		76.6	%
As a percent of total census:
Medicare census		13.0	%		13.0	%
Managed care census		1.4	%		1.2	%
As a percent of total revenues:
Medicare revenues		30.7	%		30.8	%
Medicaid revenues		53.4	%		54.2	%
Managed care revenues		3.0	%		2.7	%
Average rate per day:
Medicare	$	403.67		$	397.74
Medicaid	$	146.84		$	143.65
Managed care	$	386.08		$	378.85

The average Medicare rate per patient day for 2010 increased 1.5% compared to 2009, resulting in a net increase in revenue of $1.2 million. On October 1, 2010, CMS implemented RUG IV in connection with the MDS 3.0 patient assessment tool, RUG IV expanded RUG categories to 66 from 53 under RUG III. Also on October 1, 2010, CMS implemented a Medicare rate increase of 1.7% for the annual SNF market basket adjustment. The combined effect of these rate changes, together with changes in patient acuity levels, increased revenue by $2.7 million in the fourth quarter of 2010. Partially offsetting these increases was a 1.1% rate decrease implemented by CMS on October 1, 2009. That decrease was the net effect of a 3.3% forecast error correction related to the implementation of RUG III in 2006, partially offset by a 2.2% market basket adjustment. The effect of this 1.1% rate decrease and changes in patient acuity levels was to reduce revenue in the first nine months of 2010 by $1.5 million.

An increase in Medicare census contributed approximately $1.4 million to the total revenue increase. Medicare average daily census increased 1.9% to 544 in 2010 from 534 in 2009. We experienced an increase of $1.2 million in revenue delivery to our Medicare B patients in 2010 compared to 2009.

Medicaid rates and census contributed approximately $4.9 million of the total revenue increase. The average Medicaid rate per patient day for 2010 increased 2.2% compared to 2009, resulting in a net increase in revenue of $3.4 million. This average rate per day for Medicaid patients is the result of rate increases in certain states, partially funded by increased provider taxes, and increasing patient acuity levels. Taking higher provider taxes into consideration, the net increase in average rate per day for Medicaid patients was 1.8%.

Managed care rates and census contributed approximately $1.2 million of the total revenue increase. The average managed care rate per patient day for 2010 increased 1.9% compared to 2009 and managed care average daily census increased 15.7%. Private and hospice payors contributed a combined $3.5 million to the increase as a result of higher rates and average daily census among those payor types.

29

Operating expense

Operating expense increased to $229.1 million in 2010 from $219.6 million in 2009, an increase of $9.5 million, or 4.3%. This increase is primarily attributable to cost increases related to wages and other costs discussed below. Operating expense decreased to 79.0% of revenue in 2010, compared to 79.3% of revenue in 2009.

The largest component of operating expenses is wages, which increased to $142.0 million in 2010 from $134.2 million in 2009, an increase of $7.8 million, or 5.8%. The increase in wages was primarily due to labor costs associated with the 2.3% increase in average daily census levels, the 3.1% increase in Medicare and managed care patients, competitive labor markets in most of the areas in which we operate and regular merit and inflationary raises for personnel (increase of approximately 2.0% for the year). We made several additions to staffing as part of our plan to increase occupancy and skilled mix, which included approximately $1.7 million in therapy staffing cost to support the needs of our higher skilled census, $0.3 million in nursing center staffing costs to improve our ability to market to and care for high acuity patients and $0.6 million for increased wages that resulted from the transition to the new MDS 3.0 patient assessment tool in all our facilities.

Provider taxes increased approximately $0.6 million in 2010, primarily due to increases in tax rates and higher census in certain states in which we operate.

Payroll taxes were reduced during 2010 by approximately $0.4 million as a result of payroll tax credits we received under the Hiring Incentives to Restore Employment (HIRE) Act, enacted in March 2010. These credits eliminated a portion of payroll taxes on wages of employees hired during 2010 who met certain requirements. The credits ended effective December 31, 2010.

Employee health insurance costs were approximately $0.6 million lower in 2010 compared to 2009, a decrease of 7.6%. The Company is self-insured for the first $175,000 in claims per employee each year, and we experienced a lower level of claims costs during 2010. Employee health insurance costs can vary significantly from year to year, and we evaluate the provisions of these plans annually.

Workers compensation insurance expense decreased approximately $0.5 million in 2010 compared to 2009. The decrease is the result of better claims experience in 2010 compared to 2009.

The remaining increases in operating expense are primarily due to the effects of the increase in patient census.

Lease expense

Lease expense increased to $22.6 million in 2010 from $21.8 million in 2009. The primary reason for the increase in lease expense was rent for the Brentwood Terrace replacement center completed in August 2009 as well as rent increases for lessor funded property renovations.

Professional liability

Professional liability expense was $5.4 million in 2010 compared to $8.2 million in 2009, a decrease of $2.8 million. We were engaged in 32 professional liability lawsuits as of December 31, 2010, compared to 33 as of December 31, 2009. Our cash expenditures for professional liability costs of continuing operations were $5.1 million and $4.8 million for 2010 and 2009, respectively. Professional liability expense and cash expenditures fluctuate from year to year based respectively on the results of our third-party professional liability actuarial studies and on the costs incurred in defending and settling existing claims.

General and administrative expense

General and administrative expenses were approximately $19.7 million in 2010 compared to $17.9 million in 2009, an increase of $1.8 million, or 9.8%. As a percentage of revenue, general and administrative expense increased to 6.8% in 2010 from 6.5% in 2009. We experienced higher compensation costs of $0.3 million as a result of new staff positions and average wage increases of 1.6%. Performance-based incentive expense was $0.8 million higher in 2010. We experienced increased general and administrative costs of $0.4 million related to the implementation of electronic medical records systems in 20 facilities during the last half of 2010. In 2010, we incurred $0.4 million in non-recurring general and administrative expense comprised of charges for severance and hiring costs related to new positions.

Depreciation and amortization

Depreciation and amortization expense was approximately $5.8 million in 2010 and $5.4 million in 2009. The increase in 2010 is primarily due to depreciation and amortization expenses related to capital expenditures for additions to property and equipment.

30

Foreign currency transaction gain

A foreign currency transaction gain of $0.2 million was recorded in 2009. This gain resulted from foreign currency translation of a note receivable from the sale of our Canadian operations in 2004. The balance due on this note was collected in June 2009. There was no foreign currency gain or loss in 2010.

Other income

Other income in 2009 of $549,000 is a non-cash gain that resulted from the settlement of pre-acquisition cost report obligations related to one of the centers we acquired in Texas in 2007. We had previously recorded a contingent liability related to cost report assessments and the other income results from the settlement of this liability with CMS for less than the amount accrued.

Interest expense

Interest expense decreased to $1.6 million in 2010 compared to $1.9 million in 2009. The reduction in expense is primarily due to principal payments made on our debt.

Income from continuing operations before income taxes; income from continuing operations per common share

As a result of the above, continuing operations reported income before income taxes of $5.8 million and $3.0 million in 2010 and 2009, respectively. The provision for income taxes was $1.9 million in 2010, an effective rate of 31.9% and $1.2 million in 2009, an effective rate of 38.3%. The basic and diluted income per common share from continuing operations were $0.63 and $0.62, respectively, in 2010 compared to $0.27 and $0.26, respectively, in 2009.

Liquidity and Capital Resources

Liquidity

Our primary source of liquidity is the net cash flow provided by the operating activities of our facilities. We believe that these internally generated cash flows will be adequate to service existing debt obligations, fund required capital expenditures as well as provide cash flows for investing opportunities. In determining priorities for our cash flow, we evaluate alternatives available to us and select the ones that we believe will most benefit us over the long term. Options for our cash include, but are not limited to, capital improvements, dividends, purchase of additional shares of our common stock, acquisitions, payment of existing debt obligations, preferred stock redemptions as well as initiatives to improve nursing center performance. We review these potential uses and align them to our cash flows with a goal of achieving long term success. We plan to invest in business initiatives and development that will increase our operating expenses for the next one to two years as part of our plan to improve our high acuity offerings.

Net cash provided by operating activities of continuing operations totaled $9.4 million, $9.3 million and $10.3 million in 2011, 2010 and 2009, respectively. Operating activities of discontinued operations provided cash of $0.6 million, $0.7 million and $2.1 million in 2011, 2010 and 2009, respectively.

Investing activities of continuing operations used cash of $14.4 million, $6.4 million and $9.0 million in 2011, 2010 and 2009, respectively. These amounts primarily represent cash used for purchases of property, plant and equipment. We have used between $6.4 million and $13.4 million for capital expenditures of continuing operations in each of the three calendar years ended December 31, 2011. The $13.4 million in purchases of property and equipment during 2011 includes $5.8 million in assets added by the entity constructing the West Virginia nursing center that we are consolidating. We borrowed $2.4 million in our March 2011 mortgage refinancing to fund capital improvements at the four owned nursing centers that secure the mortgage loan, and have classified the unused portion of these funds as restricted cash. These uses of cash were partially offset by collections on a note receivable of $4.2 million in 2009. The $6.9 million in “payment for construction in progress – leased center” in 2009 relates to the replacement nursing center that was constructed in Texas with lease financing. During the third quarter 2009, the center was completed and the sale and leaseback of the Brentwood Terrace nursing center was deemed to have occurred.

Financing activities of continuing operations provided cash of $2.2 million in 2011 and used cash of $3.4 million and $2.2 million in 2010 and 2009 respectively. Net cash provided in 2011 primarily resulted from payment and refinancing of existing mortgage obligations of $20.6 million and paying $0.8 million in financing costs in connection with the new mortgage loan under which we borrowed $23.0 million, including approximately $2.4 million to fund capital improvements at our owned centers. We also paid the remaining $3.5 million outstanding on our revolving line of credit during 2011. Financing activities in 2011 also reflect debt of $5.2 million that was added by the entity that owns the West Virginia nursing center that we are consolidating as well as the proceeds of a

31

$1.3 million sale and leaseback transaction for certain equipment purchased for the implementation of EMR in our nursing centers. Cash used in 2010 and 2009 primarily resulted from payment of existing debt obligations of $4.3 million and $7.6 million, respectively. Net cash used in 2010 was impacted by the payment of $0.5 million in financing costs in connection with the new revolving credit facility under which we borrowed $3.5 million. Financing activities reflect $1.3 million, $1.2 million and $0.6 million in common stock dividends in 2011, 2010 and 2009, respectively. The $6.9 million in “construction allowance receipts – leased center” in 2009, relate to the replacement nursing center that was constructed in Texas with lease financing. During the third quarter 2009, the center was completed and the sale and leaseback of the Brentwood Terrace nursing center was deemed to have occurred.

Our cash expenditures related to professional liability claims were $8.0 million, $5.1 million and $4.8 million in 2011, 2010 and 2009, respectively. Although we work diligently to limit the cash required to settle and defend professional liability claims, a significant judgment entered against us in one or more legal actions could have a material adverse impact on our cash flows and could result in our being unable to meet all of our cash needs as they become due.

Electronic Medical Records

In 2010, we began implementation of EMR in all of our facilities, and we completed this implementation in 2011. Our investment in EMR is providing operational improvements through automation of record keeping and improvement in clinical records quality. Through December 31, 2011, we have capitalized $3.5 million related to our EMR initiative and expensed $1.7 million for training costs. During 2011, we capitalized $1.7 million related to the EMR initiative and expensed $1.1 million in training costs. Total EMR project costs were approximately $110,000 per nursing center.

Dividends

On February 29, 2012, the Board of Directors declared a quarterly dividend on common shares of $0.055 per share. While the Board of Directors intends to pay quarterly dividends, the Board will make the determination of the amount of future cash dividends, if any, to be declared and paid based on, among other things, the Company’s financial condition, funds from operations, the level of its capital expenditures and its future business prospects and opportunities.

Redeemable Preferred Stock

At December 31, 2011, we have outstanding 5,000 shares of Series C Redeemable Preferred Stock (“Preferred Stock”) that has a stated value of approximately $4.9 million which pays an annual dividend rate of 7% of its stated value. Dividends on the Preferred Stock are paid quarterly in cash. The Preferred Stock was issued to Omega in 2006 and is not convertible, but has been redeemable at its stated value at Omega’s option since September 30, 2010, and since September 30, 2007, has been redeemable at its stated value at our option. Redemption under our option or Omega’s is subject to certain limitations. We believe we have adequate resources to redeem the Preferred Stock if Omega were to elect to redeem it.

Professional Liability

For claims made after March 9, 2001, we have purchased professional liability insurance coverage for our nursing centers that, based on historical claims experience, is likely to be substantially less than the amount required to satisfy claims that were incurred. We have essentially exhausted all of our general and professional liability insurance coverage for claims first asserted prior to July 1, 2011.

Currently, our nursing centers are covered by one of two professional liability insurance policies. Our nursing centers in Arkansas, Kentucky, Tennessee, and two centers in West Virginia are covered by an insurance policy with coverage limits of $250,000 per medical incident and total annual aggregate policy limits of $750,000. This policy provides the only commercially affordable insurance coverage available for claims made during this period against these nursing centers. Our nursing centers in Alabama, Florida, Ohio, Texas and our new center in West Virginia are covered by an insurance policy with coverage limits of $1.0 million per medical incident, subject to a deductible of $0.5 million per claim, with a total annual aggregate policy limit of $15.0 million and a sublimit per center of $3.0 million.

As of December 31, 2011, we have recorded total liabilities for reported and settled professional liability claims and estimates for incurred but unreported claims of $19.4 million, including $3.1 million for settlements that are expected to be paid in 2012. Our calculation of this estimated liability is based on an assumption that the Company will not incur a multi-million dollar judgment with respect to any asserted claim; however, a significant judgment could be entered against us in one or more of these legal actions, and such a judgment could have a material adverse impact on our financial position and cash flows.

32

Capital Resources

As of December 31, 2011, we had $29.9 million of outstanding long term debt and capital lease obligations. The $29.9 million total includes $1.9 million in capital lease obligations and $5.2 million in a notes payable for the nursing center that was recently constructed in West Virginia. The balance of the long term debt is comprised of $22.7 million owed on our mortgage loan.

On March 1, 2011, we entered into an agreement with a syndicate of banks that provides a credit facility to refinance our mortgage loan and extend the maturity of our existing revolving credit facility. Under the terms of the new agreement, the syndicate of banks provided mortgage debt (“Mortgage Loan”) of $23 million with a five year maturity and extended the maturity of our $15 million revolving credit facility (“revolver”) from March 2013 to March 2016. The proceeds of the new mortgage loan were used to retire our existing mortgage loan, pay transaction costs and fund capital improvements at our owned homes. The Mortgage Loan has a term of five years, with principal and interest payable monthly based on a 25 year amortization. Interest is based on LIBOR plus 4.5%, but is fixed at 7.07% based on the interest rate swap transaction described below. The new mortgage loan is secured by four owned nursing centers, related equipment and a lien on the accounts receivable of these centers.

The March 1, 2011 refinancing transaction extended the maturity of our existing $15 million revolving credit facility and amended the interest rate terms. We originally entered into this revolver in March 2010, replacing an existing revolving credit facility. As part of the March 2010 agreement, we used $3.5 million in proceeds from the facility to retire an existing bank term loan and pay certain transaction costs. The March 2010 revolver originally had an interest rate of LIBOR (with a floor of 3.0%) plus 3.5% and was to expire in March 2013. The March 1, 2011 refinancing extended the maturity of the revolver to March 2016, removed the 3.0% floor on LIBOR and changed the LIBOR margin on loans from 3.5% to 4.5%.

The revolver is secured by accounts receivable and is subject to limits on the maximum amount of loans that can be outstanding under the revolver based on borrowing base restrictions. As of December 31, 2011, we have no borrowings outstanding under the revolving credit facility. Annual fees for letters of credit issued under this revolver are 3.00% of the amount outstanding. We have a letter of credit of $4.6 million to serve as a security deposit for our leases. Considering the balance of eligible accounts receivable at December 31, 2011, the letter of credit, the amounts outstanding under the revolving credit facility and the maximum loan amount of $15.0 million, the balance available for borrowing under the revolving credit facility is approximately $10.4 million. Eligible accounts receivable are calculated as defined and consider 80% of certain net receivables while excluding receivables from private pay patients, those pending approval by Medicaid and receivables greater than 90 days. The Mortgage Loan and the Revolver are cross-collateralized.

Our lending agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. We are in compliance with all such covenants at December 31, 2011.

Our calculated compliance with financial covenants is presented below:

	Requirement		Level at December 31,  2011
Minimum fixed charge coverage ratio	³	1.05:1.00		1.21:1.00
Minimum adjusted EBITDA	³	$10.0 million	$	16.3 million
EBITDAR (mortgaged facilities)	³	$ 3.3 million	$	5.3 million

We have consolidated $5.2 million in debt that was added by the entity that owns the West Virginia nursing center. The borrower is subject to covenants concerning total liabilities to tangible net worth as well as current assets compared to current liabilities. The borrower is in compliance with all such covenants at December 31, 2011. The borrower’s liabilities do not provide creditors with recourse to the general assets of the Company.

As part of the debt agreements entered into in March 2011, we entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The interest rate swap agreement has the same effective date, maturity date and notional amounts as the Mortgage Loan. The interest rate swap agreement requires us to make fixed rate payments to the bank calculated on the applicable notional amount at an annual fixed rate of 7.07% while the bank is obligated to make payments to us based on LIBOR on the same notional amounts. We entered into the interest rate swap agreement to mitigate the variable interest rate risk on our outstanding mortgage borrowings.

33

Capitalized Lease Obligations

During 2011 and 2010, we entered into a series of lease agreements to finance the purchase of certain equipment primarily for the implementation of EMR in our nursing centers. We determined the leases were capital in nature and recorded both assets and capitalized lease obligations of $0.5 million and $0.4 million during 2011 and 2010, respectively. These lease agreements provide three year terms.

In October 2011, we completed a sale and leaseback transaction for certain equipment purchased in the implementation of EMR in our nursing centers. The lease transaction, involving $1.2 million in assets we purchased during 2010 and 2011, is capital in nature, and we recorded the cash from the sale and the capitalized lease obligation under the financing during the fourth quarter of 2011. The lease agreement provides a three year term.

Lease Agreement – West Virginia Nursing Center

On December 28, 2011, we completed construction of Rose Terrace, our third health care center in West Virginia. The state of the art 90-bed skilled nursing center is located in Culloden, West Virginia, along the Huntington-Charleston corridor, and offers 24-hour skilled nursing care designed to meet the care needs of both short and long term nursing patients. The center utilizes a Certificate of Need we initially obtained in the June 2009 acquisition of certain assets of a skilled nursing center in Milton, West Virginia. The facility is expected to obtain its Medicare and Medicaid certifications in the first quarter of 2012. We operate this nursing center under a lease with an initial lease term that expires December 2031 and renewal options through December 2041. The lease agreement grants us the right to purchase the center beginning in December 2012 and continuing through December 2016 for a purchase price ranging from 110% to 120% of the total project cost.

Texas Nursing Center

In August 2009, we completed the construction of a 119 bed skilled nursing center, Brentwood Terrace, located in Paris, Texas, replacing an existing 102 bed nursing center leased from Omega. The replacement center was financed with funding from Omega under a long term operating lease with renewal options through 2035. Annual rent was $0.8 million for the year ended December 31, 2011 and is based on a calculation of 10.25% of the total cost of the replacement center. The Brentwood Terrace nursing center lease provides for annual increases in lease payments equal to the increase in the Consumer Price Index, not to exceed 2.5%.

Nursing Center Renovations

During 2005, we began an initiative to complete strategic renovations of certain facilities to improve occupancy, quality of care and profitability. We developed a plan to begin with those facilities with the greatest potential for benefit, and began the renovation program during the third quarter of 2005. As of December 31, 2011, we have completed renovations at fifteen facilities. In January 2012, we completed two additional projects, one a $1.7 million major renovation project and the other a $0.4 million project to add therapy space and functionality to a nursing center we renovated in 2010. We currently have two other projects in process that we expect to complete in early 2012 and we are developing plans for additional renovation projects.

A total of $24.7 million has been spent on these renovation programs to date, with $17.2 million financed through Omega, $6.1 million financed with internally generated cash, and $1.4 million financed with long-term debt.

For the fifteen facilities with renovations completed as of the beginning of the fourth quarter 2011 compared to the last twelve months prior to the commencement of renovation, average occupancy increased from 69.8% to 77.1% and Medicare average daily census increased from a total of 177 to 225 in the fourth quarter of 2011.

Change in Executive Officers

William R. Council, III resigned as Chief Executive Officer and Director of the Company effective September 30, 2011. In connection with his resignation, we entered into a separation agreement with Mr. Council effective September 30, 2011 for the severance under the terms of his employment agreement. We also entered into a six month consulting agreement with Mr. Council effective October 1, 2011, to facilitate the transition of management. Pursuant to the consulting agreement, Mr. Council will receive $36,800 per month through March 2012. Our cash expenditures related to the separation and consulting agreements will be approximately $0.3 million in the fourth quarter of 2011 and $1.6 million in the first quarter of 2012.

34

On November 4, 2011, we promoted Kelly Gill to Chief Executive Officer of Advocat and appointed him to the Board of Directors. In connection with his promotion, we entered into an amendment with Mr. Gill to his employment agreement. The amendment provides that Mr. Gill is the Chief Executive Officer and increases his base salary to $450,000.

In December 2011, L. Glynn Riddle, Jr., our Chief Financial Officer, notified us that he intends to resign effective March 31, 2012. In connection with his resignation, we entered into a retention agreement with Mr. Riddle to facilitate the orderly transition to Mr. Riddle’s successor. Our cash expenditures related to the retention agreement will be approximately $0.3 million in 2012.

On December 20, 2011, we appointed Sam Daniel as executive vice president, effective January 1, 2012. In connection with the appointment of Mr. Daniel, we entered into an employment agreement with Mr. Daniel which provides that Mr. Daniel is initially executive vice president and will replace Mr. Riddle as Chief Financial Officer following Mr. Riddle’s resignation. Mr. Daniel’s initial base salary will be $250,000.

Receivables

Our operations could be adversely affected if we experience significant delays in reimbursement from Medicare, Medicaid and other third-party revenue sources. Our 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 our 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 us in the processing of our invoices, could adversely affect our liquidity and results of operations.

Accounts receivable attributable to patient services of continuing operations totaled $29.2 million at December 31, 2011, compared to $26.7 million at December 31, 2010, representing approximately 34 days revenue in accounts receivable in both years. The increase in accounts receivable is the result of increased revenue in 2011.

The allowance for bad debt was $2.9 million and $2.8 million at December 31, 2011 and 2010, respectively. We continually evaluate the adequacy of our bad debt reserves based on patient mix trends, aging of older balances, payment terms and delays with regard to third-party payors, collateral and deposit resources, as well as other factors. We continue to evaluate and implement additional procedures to strengthen our collection efforts and reduce the incidence of uncollectible accounts.

Inflation

Based on contract pricing for food and other supplies and recent market conditions, we expect cost increases in 2012 to be relatively the same or slightly lower than the increases in 2011. We expect salary and wage increases for our skilled health care providers to continue to be higher than average salary and wage increases, as is common in the health care industry.

Off-Balance Sheet Arrangements

We have a letter of credit outstanding of approximately $4.6 million as of December 31, 2011, which serves as a security deposit for our nursing center lease with Omega. The letter of credit was issued under our revolving credit facility. Our accounts receivable serve as the collateral for this revolving credit facility. We incurred approximately $0.1 million and $0.2 million in fees related to the outstanding letter of credit during the years ended December 31, 2011 and 2010, respectively.

Recent Accounting Guidance

In June 2011, the FASB issued updated guidance in the form of a FASB Accounting Standards Update on “Comprehensive Income – Presentation of Comprehensive Income,” to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The update eliminates the option to present the components of other comprehensive income as part of the statement of equity. We will adopt this guidance effective January 1, 2012 and will apply it retrospectively. We believe there will be no significant impact to our consolidated financial statements.

In July 2011, the FASB issued updated guidance in the form of a FASB Accounting Standards Update on “Health Care Entities: Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities.” This guidance impacts health care entities that recognize significant amounts of patient service revenue at the time the services are rendered even though they do not assess the patient’s ability to pay. This updated guidance requires an

35

impacted health care entity to present its provision for doubtful accounts as a deduction from revenue, similar to contractual discounts. Accordingly, patient service revenue for entities subject to this updated guidance will be required to be reported net of both contractual discounts and provision for doubtful accounts. The updated guidance also requires certain qualitative disclosures about the entity’s policy for recognizing revenue and bad debt expense for patient service transactions. The guidance is effective for us starting January 1, 2012. As further discussed in Note 2 of the consolidated financial statements, we do not believe we are an impacted entity so adoption will not impact our consolidated financial statements.

Forward-Looking Statements

The foregoing discussion and analysis provides information deemed by management to be relevant to an assessment and understanding of our consolidated results of operations and financial condition. This discussion and analysis should be read in conjunction with our consolidated financial statements included herein. Certain statements made by or on behalf of us, 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. Actual results could differ materially from those contemplated by the forward-looking statements made herein. In addition to any assumptions and other factors referred to specifically in connection with such statements, other factors, many of which are beyond our ability to control or predict, could cause our actual results to differ materially from the results expressed or implied in any forward-looking statements including, but not limited to, our ability to successfully license and operate the new nursing center in West Virginia, our ability to increase census at our renovated facilities, changes in governmental reimbursement, including the impact of the CMS final rule that has resulted in a reduction in Medicare reimbursement as of October 2011 and our ability to mitigate the impact of the reduction, government regulation, the impact of the recently adopted federal health care reform or any future health care reform, any increases in the cost of borrowing under our credit agreements, our ability to comply with covenants contained in those credit agreements, the outcome of professional liability lawsuits and claims, our ability to control ultimate professional liability costs, the accuracy of our estimate of our anticipated professional liability expense, the impact of future licensing surveys, the outcome of proceedings alleging violations of laws and regulations governing quality of care or violations of other laws and regulations applicable to our business, costs and impacts associated with the implementation of our electronic medical records plan, the costs of investing in our business initiatives and development, our ability to control costs, changes to our valuation of deferred tax assets, changes in occupancy rates in our facilities, changing economic and competitive conditions, changes in anticipated revenue and cost growth, changes in the anticipated results of operations, the effect of changes in accounting policies 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 “Part I. Item 1A. Risk Factors” for a discussion of various risk factors of the Company and that are inherent in the health care industry. Given these risks and uncertainties, we can give no assurances that these forward-looking statements will, in fact, transpire and, therefore, caution investors not to place undue reliance on them. These assumptions may not materialize to the extent assumed, and risks and uncertainties may cause actual results to be different from anticipated results. These risks and uncertainties also may result in changes to the Company’s business plans and prospects. Such cautionary statements identify important factors that could cause our actual results to materially differ from those projected in forward-looking statements. In addition, we disclaim any intent or obligation to update these forward-looking statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The chief market risk factor affecting our financial condition and operating results is interest rate risk. As of December 31, 2011, we had outstanding borrowings of approximately $22.7 million that were subject to variable interest rates. In connection with our March 2011 financing agreement, we entered into an interest rate swap with respect to the mortgage loan to mitigate the floating interest rate risk of such borrowing. Therefore, we have no outstanding borrowings subject to variable interest rate risk after the March 1, 2011 refinancing transaction.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Audited financial statements are contained on pages F-1 through F-33 of this Annual Report on Form 10-K and are incorporated herein by reference. Audited supplemental schedule data is contained on pages S-1 through S-2 of this Annual Report on Form 10-K and is incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

36

ITEM 9A. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

Advocat, with the participation of our principal executive and financial officers, has evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of December 31, 2011. Based on this evaluation, the principal executive and financial officers have determined that such disclosure controls and procedures are effective to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms.

Management’s Report on Internal Control over Financial Reporting

We are responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). We assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. We have concluded that, as of December 31, 2011, our internal control over financial reporting is effective based on these criteria.

Changes in Internal Control over Financial Reporting

There has been no change (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal control over financial reporting that has occurred during our fiscal quarter ended December 31, 2011, that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.

Our management does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefit of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

ITEM 9B. OTHER INFORMATION

None.

37

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information concerning our Directors, Executive Officers and Corporate Governance is incorporated herein by reference to our definitive proxy statement for our 2012 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

ITEM 11. EXECUTIVE COMPENSATION

Information concerning Executive Compensation is incorporated herein by reference to our definitive proxy statement for our 2012 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS

Information concerning Security Ownership of Certain Beneficial Owners and Management is incorporated herein by reference to our definitive proxy statement for our 2012 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information concerning Certain Relationships and Related Transactions is incorporated herein by reference to our definitive proxy statement for our 2012 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information concerning the fees and services provided by our principal accountant is incorporated herein by reference to our definitive proxy statement for our 2012 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

38

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

The Financial statements and schedule for us and our subsidiaries required to be included in Part II, Item 8 are listed below.

	Form 10-K Pages
Financial Statements
Report of Independent Registered Public Accounting Firm	F-1
Consolidated Balance Sheets as of December 31, 2011 and 2010	F-2
Consolidated Statements of Income for the Years Ended December 31, 2011, 2010 and 2009	F-3
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2011, 2010 and 2009	F-4
Consolidated Statements of Shareholders’ Equity for the Years Ended December  31, 2011, 2010 and 2009	F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2011, 2010 and 2009	F-6
Notes to Consolidated Financial Statements as of December 31, 2011, 2010 and 2009	F-8 to F-33
Financial Statement Schedule
Schedule II – Valuation and Qualifying Accounts	S-1 to S-2

Exhibits

The exhibits filed as part of this Report on Form 10-K are listed in the Exhibit Index immediately following the financial statement pages.

39

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

/s/ Wallace E. Olson

Wallace E. Olson

Chairman of the Board

March 7, 2012

/s/ Kelly J. Gill

Kelly J. Gill

President and Chief Executive Officer

(Principal Executive Officer)

March 7, 2012

/s/ L. Glynn Riddle, Jr.

L. Glynn Riddle, Jr.

Executive Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

March 7, 2012

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/ Wallace E. Olson	/s/ Robert Z. Hensley
Wallace E. Olson	Robert Z. Hensley
Chairman of the Board and Director	Director
March 7, 2012	March 7, 2012
/s/ Chad A. McCurdy	/s/ William C. O’Neil. Jr.
Chad A. McCurdy	William C. O’Neil, Jr.
Vice Chairman of the Board and Director	Director
March 7, 2012	March 7, 2012
/s/ Kelly J. Gill	/s/ Richard M. Brame
Kelly J. Gill	Richard M. Brame
President and Chief Executive Officer	Director
Director	March 7, 2012
March 7, 2012

40

ADVOCAT INC. AND SUBSIDIARIES

Consolidated Financial Statements

For the Years Ended December 31, 2011, 2010 and 2009

Together with Report of Independent Registered Public Accounting Firm

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm	F-1
Consolidated Balance Sheets	F-2
Consolidated Statements of Income	F-3
Consolidated Statements of Comprehensive Income	F-4
Consolidated Statements of Shareholders’ Equity	F-5
Consolidated Statements of Cash Flows	F-6
Notes to Consolidated Financial Statements	F-8
Schedule II – Valuation and Qualifying Accounts	S-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

Advocat Inc.

Brentwood, Tennessee

We have audited the accompanying consolidated balance sheets of Advocat Inc. as of December 31, 2011 and 2010 and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Advocat Inc. at December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ BDO USA, LLP

Nashville, Tennessee

March 7, 2012

F - 1

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2011 AND 2010

ASSETS	2011			2010
CURRENT ASSETS:
Cash and cash equivalents	$	6,692,000		$	8,862,000
Receivables, less allowance for doubtful accounts of $2,882,000 and $2,822,000, respectively		26,342,000			23,801,000
Other receivables		1,739,000			424,000
Prepaid expenses and other current assets		3,448,000			4,102,000
Income tax refundable		1,058,000			1,439,000
Deferred income taxes		6,041,000			4,207,000
Total current assets		45,320,000			42,835,000
PROPERTY AND EQUIPMENT, at cost		93,351,000			78,690,000
Less accumulated depreciation		(47,326,000	)		(41,563,000	)
Discontinued operations, net		1,053,000			1,053,000
Property and equipment, net (variable interest entity restricted – 2011: $7,298,000; 2010: $0)		47,078,000			38,180,000
OTHER ASSETS:
Deferred income taxes		10,352,000			12,408,000
Deferred financing and other costs, net		1,318,000			834,000
Other assets		3,680,000			2,319,000
Acquired leasehold interest, net		8,996,000			9,380,000
Total other assets		24,346,000			24,941,000
	$	116,744,000		$	105,956,000

LIABILITIES AND SHAREHOLDERS’ EQUITY	2011			2010
CURRENT LIABILITIES:
Current portion of long-term debt and capitalized lease obligations (variable interest entity nonrecourse – 2011: $173,000; 2010: $0)	$	1,131,000		$	582,000
Trade accounts payable		3,928,000			3,120,000
Accrued expenses:
Payroll and employee benefits		13,589,000			11,047,000
Current portion of self-insurance reserves		8,470,000			7,379,000
Other current liabilities		2,767,000			4,479,000
Total current liabilities		29,885,000			26,607,000
NONCURRENT LIABILITIES:
Long-term debt and capitalized lease obligations, less current portion (variable interest entity nonrecourse – 2011: $5,067,000; 2010: $0)		28,768,000			23,819,000
Self-insurance liabilities, less current portion		12,049,000			11,659,000
Other noncurrent liabilities		18,155,000			16,748,000
Total noncurrent liabilities		58,972,000			52,226,000
COMMITMENTS AND CONTINGENCIES
SERIES C REDEEMABLE PREFERRED STOCK, $.10 par value, 5,000 shares authorized, issued and outstanding, stated value of $4,918,000		4,918,000			4,918,000
SHAREHOLDERS’ EQUITY:
Series A preferred stock, authorized 200,000 shares, $.10 par value, none issued and outstanding		—			—
Common stock, authorized 20,000,000 shares, $.01 par value, 6,061,000 and 5,976,000 shares issued, 5,829,000 and 5,744,000 shares outstanding, respectively		61,000			60,000
Treasury stock at cost, 232,000 shares of common stock		(2,500,000	)		(2,500,000	)
Paid-in capital		18,219,000			17,896,000
Retained earnings		6,480,000			6,749,000
Accumulated other comprehensive loss		(945,000	)		—
Total shareholders’ equity of Advocat Inc.		21,315,000			22,205,000
Non-controlling interests		1,654,000			—
Total shareholders’ equity		22,969,000			22,205,000
	$	116,744,000		$	105,956,000

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

F - 2

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

	Year Ended December 31,
	2011			2010			2009
REVENUES:
Patient revenues, net	$	314,715,000		$	290,130,000		$	276,979,000
EXPENSES:
Operating		243,929,000			229,081,000			219,567,000
Lease		22,939,000			22,600,000			21,791,000
Professional liability		10,962,000			5,364,000			8,228,000
General and administrative		25,589,000			19,680,000			17,926,000
Depreciation and amortization		6,592,000			5,825,000			5,446,000
Asset impairment		344,000			—			—
		310,355,000			282,550,000			272,958,000
OPERATING INCOME		4,360,000			7,580,000			4,021,000
OTHER INCOME (EXPENSE):
Foreign currency transaction gain		—			—			191,000
Other income		—			—			549,000
Interest income		11,000			2,000			161,000
Interest expense		(2,366,000	)		(1,634,000	)		(1,877,000	)
Debt retirement costs		(112,000	)		(127,000	)		—
		(2,467,000	)		(1,759,000	)		(976,000	)
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		1,893,000			5,821,000			3,045,000
PROVISION FOR INCOME TAXES		(509,000	)		(1,858,000	)		(1,165,000	)
NET INCOME FROM CONTINUING OPERATIONS		1,384,000			3,963,000			1,880,000
NET INCOME FROM DISCONTINUED OPERATIONS:
Operating income (loss), net of tax (benefit) provision of $(6,000), $177,000 and $449,000, respectively		(17,000	)		344,000			721,000
Disposal and impairment, net of tax benefit of $217,000		—			(458,000	)		—
DISCONTINUED OPERATIONS		(17,000	)		(114,000	)		721,000
NET INCOME		1,367,000			3,849,000			2,601,000
PREFERRED STOCK DIVIDENDS		(344,000	)		(344,000	)		(344,000	)
NET INCOME FOR COMMON STOCK	$	1,023,000		$	3,505,000		$	2,257,000
NET INCOME PER COMMON SHARE:
Per common share – basic
Continuing operations	$	0.18		$	0.63		$	0.27
Discontinued operations		—			(0.02	)		0.13
	$	0.18		$	0.61		$	0.40
Per common share – diluted
Continuing operations	$	0.18		$	0.62		$	0.26
Discontinued operations		(0.01	)		(0.02	)		0.13
	$	0.17		$	0.60		$	0.39
COMMON STOCK DIVIDENDS DECLARED PER SHARE OF COMMON STOCK	$	0.22		$	0.215		$	0.15
WEIGHTED AVERAGE COMMON SHARES:
Basic		5,774,000			5,732,000			5,678,000
Diluted		5,906,000			5,854,000			5,797,000

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

F - 3

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

	Year Ended December 31,
	2011			2010		2009
NET INCOME	$	1,367,000		$	3,849,000	$	2,601,000
OTHER COMPREHENSIVE INCOME:
Change in fair value of cash flow hedge		(1,524,000	)		—		—
Income tax benefit		579,000			—		—
		(945,000	)		—		—
COMPREHENSIVE INCOME	$	422,000		$	3,849,000	$	2,601,000

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

F - 4

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

	Common Stock				Treasury Stock					Paid-in			Retained			Accumulated Other Comprehensive			Total Shareholders’ Equity of			Non- Controlling		Total Shareholders’
	Shares Issued		Amount		Shares		Amount			Capital			Earnings			Loss			Advocat Inc.			Interests		Equity
BALANCE, DECEMBER 31, 2008		5,903,000	$	59,000		232,000	$	(2,500,000	)	$	16,903,000		$	3,089,000			—			—			—	$	17,551,000
Net Income		—		—		—		—			—			2,601,000			—			—			—		2,601,000
Preferred stock dividends		—		—		—		—			—			(344,000	)		—			—			—		(344,000	)
Common stock dividends declared		—		—		—		—			6,000			(859,000	)		—			—			—		(853,000	)
Exercise of stock options		46,000		—		—		—			(76,000	)		—			—			—			—		(76,000	)
Purchase of restricted share units		—		—		—		—			76,000			—			—			—			—		76,000
Tax impact of equity grant exercises		—		—		—		—			118,000			—			—			—			—		118,000
Stock based compensation		—		—		—		—			620,000			—			—			—			—		620,000
BALANCE, DECEMBER 31, 2009		5,949,000		59,000		232,000		(2,500,000	)		17,647,000			4,487,000			—			—			—		19,693,000
Net Income		—		—		—		—			—			3,849,000			—			—			—		3,849,000
Preferred stock dividends		—		—		—		—			—			(344,000	)		—			—			—		(344,000	)
Common stock dividends declared		—		—		—		—			9,000			(1,243,000	)		—			—			—		(1,234,000	)
Exercise of stock options		27,000		1,000		—		—			(51,000	)		—			—			—			—		(50,000	)
Purchase of restricted share units		—		—		—		—			29,000			—			—			—			—		29,000
Tax impact of equity grant exercises		—		—		—		—			(90,000	)		—			—			—			—		(90,000	)
Stock based compensation		—		—		—		—			352,000			—			—			—			—		352,000
BALANCE, DECEMBER 31, 2010		5,976,000		60,000		232,000		(2,500,000	)		17,896,000			6,749,000			—			22,205,000			—		22,205,000
Net Income		—		—		—		—			—			1,367,000			—			1,367,000			—		1,367,000
Preferred stock dividends		—		—		—		—			—			(344,000	)		—			(344,000	)		—		(344,000	)
Common stock dividends declared		—		—		—		—			21,000			(1,292,000	)		—			(1,271,000	)		—		(1,271,000	)
Issuance/redemption of equity grants, net		85,000		1,000		—		—			39,000			—			—			40,000			—		40,000
Interest rate cash flow hedge		—		—		—		—			—			—			(945,000	)		(945,000	)		—		(945,000	)
Tax impact of equity grant exercises		—		—		—		—			(162,000	)		—			—			(162,000	)		—		(162,000	)
Consolidation of non-controlling interests of variable interest entity		—		—		—		—			—			—			—			—			1,654,000		1,654,000
Stock based compensation		—		—		—		—			425,000			—			—			425,000			—		425,000
BALANCE, DECEMBER 31, 2011		6,061,000	$	61,000		232,000	$	(2,500,000	)	$	18,219,000		$	6,480,000		$	(945,000	)	$	21,315,000		$	1,654,000	$	22,969,000

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

F - 5

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2011			2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,367,000		$	3,849,000		$	2,601,000
Discontinued operations		(17,000	)		(114,000	)		721,000
Net income from continuing operations		1,384,000			3,963,000			1,880,000
Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:
Depreciation and amortization		6,592,000			5,825,000			5,446,000
Provision for doubtful accounts		2,330,000			2,127,000			1,965,000
Deferred income tax provision (benefit)		801,000			2,041,000			(528,000	)
Provision for (benefit from) self-insured professional liability, net of cash payments		1,767,000			(754,000	)		2,774,000
Stock-based compensation		537,000			597,000			689,000
Amortization of deferred balances		160,000			213,000			382,000
Provision for leases in excess of cash payments		320,000			782,000			1,254,000
Payment from lessor for leasehold improvement		—			120,000			771,000
Non-cash gain on settlement of contingent liability		—			—			(549,000	)
Foreign currency transaction gain		—			—			(191,000	)
Debt retirement costs		79,000			127,000			—
Non-cash interest income		—			—			(41,000	)
Non-cash interest accretion		176,000			—			—
Asset impairment		344,000			—			—
Changes in other assets and liabilities affecting operating activities:
Receivables, net		(6,507,000	)		(3,787,000	)		(4,200,000	)
Prepaid expenses and other assets		(140,000	)		(1,817,000	)		621,000
Trade accounts payable and accrued expenses		1,589,000			(94,000	)		(4,000	)
Net cash provided by continuing operations		9,432,000			9,343,000			10,269,000
Discontinued operations		609,000			713,000			2,109,000
Net cash provided by operating activities		10,041,000			10,056,000			12,378,000

(Continued)

F - 6

ADVOCAT INC. SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Continued)

	Year Ended December 31,
	2011			2010			2009
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	$	(13,357,000	)	$	(6,363,000	)	$	(6,372,000	)
Payment for construction in progress – leased facility		—			—			(6,891,000	)
Notes receivable collected		—			—			4,184,000
Increase in restricted cash		(1,029,000	)		—			—
Deposits and other deferred balances		(31,000	)		—			59,000
Net cash used in continuing operations		(14,417,000	)		(6,363,000	)		(9,020,000	)
Discontinued operations		—			(45,000	)		(187,000	)
Net cash used in investing activities		(14,417,000	)		(6,408,000	)		(9,207,000	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt obligations		(24,583,000	)		(4,278,000	)		(7,581,000	)
Proceeds from issuance of debt		29,554,000			3,463,000			—
Financing costs		(797,000	)		(511,000	)		(42,000	)
Payment of common stock dividends		(1,272,000	)		(1,203,000	)		(573,000	)
Payment of preferred stock dividends		(344,000	)		(344,000	)		(344,000	)
Non-controlling interest equity investment		3,000			—			—
Construction allowance receipts – leased facility		—			—			6,891,000
Payment for preferred stock restructuring		(546,000	)		(528,000	)		(512,000	)
Issuance of restricted share units		190,000			57,000			76,000
Net settlement of exercised stock options		1,000			(51,000	)		(75,000	)
Net cash provided by (used in) financing activities		2,206,000			(3,395,000	)		(2,160,000	)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(2,170,000	)		253,000			1,011,000
CASH AND CASH EQUIVALENTS, beginning of period		8,862,000			8,609,000			7,598,000
CASH AND CASH EQUIVALENTS, end of period	$	6,692,000		$	8,862,000		$	8,609,000
SUPPLEMENTAL INFORMATION:
Cash payments of interest, net of amounts capitalized	$	1,875,000		$	1,353,000		$	1,512,000
Cash payments of income taxes, net of refunds	$	627,000		$	617,000		$	1,413,000

NON-CASH TRANSACTIONS:

As discussed in Note 6 the Company entered into capitalized lease agreements and recorded $527,000 and $387,000 in 2011 and 2010, respectively, in fixed assets and capital lease obligations. These non-cash transactions have been excluded from the consolidated statements of cash flows. As discussed in Note 11, the Company was deemed to have control and was considered owner of the Brentwood Terrace replacement facility during the construction period. Upon completion of construction of the replacement facility during the third quarter 2009, a sale and leaseback of the facility was deemed to have occurred and the Company removed both the facility asset and the long term liability from its consolidated balance sheet, resulting in non cash reductions of property and long term liability of $7.7 million.

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

F - 7

ADVOCAT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2011, 2010 AND 2009

1. COMPANY AND ORGANIZATION

Advocat Inc. (together with its subsidiaries, “Advocat” or the “Company”) provides long-term care services to nursing center patients in eight states, primarily in the Southeast and Southwest United States. The Company’s centers provide a range of health care services to their patients. In addition to the nursing, personal care and social services usually provided in long-term care centers, the Company offers a variety of comprehensive rehabilitation services as well as nutritional support services.

As of December 31, 2011, the Company’s continuing operations consist of 47 nursing centers with 5,445 licensed nursing beds. The Company owns 9 and leases 38 of its nursing centers. The Company’s continuing operations include centers in Alabama, Arkansas, Florida, Kentucky, Ohio, Tennessee, Texas and West Virginia.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation

The consolidated financial statements include the operations and accounts of Advocat and its subsidiaries, all wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation. Any variable interest entities (“VIEs”) in which the Company has an interest are consolidated when the Company identifies that it is the primary beneficiary. The Company has one variable interest entity and it relates to a nursing center in West Virginia further described in Note 3.

The Company is managed as one reporting unit for internal purposes and for managing the enterprise. Therefore, management has concluded that the Company is operated as a single reportable segment, as defined in The Financial Accounting Standards Board’s (“FASB”) guidance on “Segment Reporting.”

Revenues

Patient Revenues

The fees charged by the Company to patients in its nursing centers are recorded on an accrual basis. These rates are contractually adjusted with respect to individuals receiving benefits under federal and state-funded programs and other third-party payors. Rates under federal and state-funded programs are determined prospectively for each facility and may be based on the acuity of the care and services provided. These rates may be based on facility’s actual costs subject to program ceilings and other limitations or on established rates based on acuity and services provided as determined by the federal and state-funded programs. Amounts earned under federal and state programs with respect to nursing home patients are subject to review by the third-party payors which may result in retroactive adjustments. In the opinion of management, adequate provision has been made for any adjustments that may result from such reviews. Retroactive adjustments, if any, are recorded when objectively determinable, generally within three years of the close of a reimbursement year depending upon the timing of appeals and third-party settlement reviews or audits. During the years ended December 31, 2011, 2010 and 2009, the Company recorded $663,000, $(2,000) and $109,000 of net favorable (unfavorable) estimated settlements from federal and state programs for periods prior to the beginning of fiscal 2011, 2010 and 2009, respectively.

F - 8

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 generally resulted from uncollectible private balances, some uncollectible coinsurance and deductibles and other factors. Receivables that are deemed to be uncollectible are written off. The allowance for doubtful accounts balance is assessed on a quarterly basis, with changes in estimated losses being recorded in the Consolidated Statements of Income in the period identified.

The Company includes the provision for doubtful accounts in operating expenses in its Consolidated Statements of Income. The provisions for doubtful accounts of continuing operations were $2,330,000, $2,127,000 and $1,965,000 for 2011, 2010 and 2009, respectively. The provision for doubtful accounts of continuing operations was 0.7% of net revenue during 2011, 2010, and 2009.

Lease Expense

As of December 31, 2011, the Company operates 38 nursing centers under operating leases, including 36 owned or financed by Omega Healthcare Investors, Inc. (together with its subsidiaries, “Omega”) and two owned by other parties. The Company’s operating leases generally require the Company to pay stated rent, subject to increases based on changes in the Consumer Price Index, a minimum percentage increase, or increases in the net revenues of the leased properties. The Company’s Omega leases require the Company to pay certain scheduled rent increases. Such scheduled rent increases are recorded as additional lease expense on a straight-line basis recognized over the term of the related leases.

See Notes 3, 8 and 11 for a discussion regarding the Company’s Master Lease with Omega, the termination of leases for certain facilities and the addition of certain leased facilities.

Classification of Expenses

The Company classifies all expenses (except lease, interest, depreciation and amortization expenses) that are associated with its corporate and regional management support functions as general and administrative expenses. All other expenses (except lease, professional liability, interest, depreciation and amortization expenses) incurred by the Company at the facility level are classified as operating expenses.

Property and Equipment

Property and equipment are recorded at cost with depreciation being provided over the shorter of the remaining lease term (where applicable) or the assets’ estimated useful lives on the straight-line basis as follows:

Buildings and improvements	-	5 to 40 years
Leasehold improvements	-	2 to 10 years
Furniture, fixtures and equipment	-	2 to 15 years

Interest incurred during construction periods is capitalized as part of the building cost. Maintenance and repairs are expensed as incurred, and major betterments and improvements are capitalized. Property and equipment obtained through purchase acquisitions are stated at their estimated fair value determined on the respective dates of acquisition.

In accordance with FASB guidance on “Property, Plant and Equipment,” specifically the discussion around the accounting for the impairment or disposal of long-lived assets, the Company routinely evaluates the recoverability of the carrying value of its long-lived assets, including when significant adverse changes in the general economic conditions and significant deteriorations of the underlying cash flows or fair values of the property indicate that the carrying amount of the property may not be recoverable. The need to recognize impairment is based on estimated future undiscounted cash flows from a property compared to the carrying value of that property.

F - 9

On July 29, 2011, the Centers for Medicare & Medicaid Services (“CMS”) issued its final rule for skilled nursing facilities effective October 1, 2011, reducing Medicare reimbursement rates for skilled nursing facilities by 11.1% and also making changes to rehabilitation therapy regulations. This final rule will have a negative effect on the Company’s revenue and costs in Medicare’s fiscal year ending September 30, 2012 as compared to Medicare’s fiscal year ended September 30, 2011. As a result of this negative impact, an interim impairment analysis was conducted in 2011, and the Company determined that the carrying value of the long-lived assets of one of its leased nursing centers exceeded the fair value. As a result, the Company recorded a fixed asset impairment charge during 2011 of $344,000 to reduce the carrying value of these assets.

In the fourth quarter of 2010, the Company recorded an impairment of approximately $402,000 related to land held as discontinued operations. The Company’s impairment charge was corroborated by local market data. No impairment of long lived assets was recognized in 2009.

Cash and Cash Equivalents

Cash and cash equivalents include cash on deposit with banks and all highly liquid investments with original maturities of three months or less when purchased.

Deferred Financing and Other Costs

The Company records deferred financing and lease costs for expenditures related to entering into or amending debt and lease agreements. These expenditures include lenders and attorneys fees. Financing costs are amortized using the effective interest method over the term of the related debt. The amortization is reflected as interest expense in the accompanying consolidated statements of income. Deferred lease costs are amortized on a straight-line basis over the term of the related leases. See Note 6 for further discussion.

Acquired Leasehold Interest

The Company has recorded an acquired leasehold interest intangible asset related to an acquisition completed during 2007. The intangible asset is accounted for in accordance with the FASB’s guidance on goodwill and other intangible assets, and is amortized on a straight-line basis over the remaining life of the acquired lease, including renewal periods, the original period of which is approximately 28 years from the date of acquisition. The lease terms for the seven centers this intangible relates to provide for an initial term and renewal periods at the Company’s option through May 31, 2035. As the renewal periods of the acquired leased facilities are solely based on the Company’s option, it is expected that costs (if any) to renew the lease through its current amortization period would be nominal and the decision to continue to lease the acquired facilities lies solely within the Company’s intent to continue to operate the seven facilities. Any renewal costs would be included in deferred lease costs and amortized over the renewal period. Amortization expense of approximately $384,000 related to this intangible asset was recorded during each of the years ended December 31, 2011, 2010 and 2009, respectively.

The carrying value of the acquired leasehold interest intangible and the accumulated amortization are as follows:

	December 31
	2011			2010
Intangible	$	10,652,000		$	10,652,000
Accumulated Amortization		(1,656,000	)		(1,272,000	)
Net Intangible	$	8,996,000		$	9,380,000

The Company evaluates the recoverability of the carrying value of the acquired leasehold intangible in accordance with the FASB’s guidance on accounting for the impairment or disposal of long-lived assets. Included in this evaluation is whether significant adverse changes in general economic conditions, and significant deteriorations of the underlying cash flows or fair values of the intangible asset, indicate that the carrying amount of the intangible asset may not be recoverable. The need to recognize an impairment charge is based on estimated future undiscounted cash flows from the asset compared to the carrying value of that asset. If recognition of an impairment charge is necessary, it is measured as the amount by which the carrying amount of the intangible asset exceeds the fair value of the intangible asset.

F - 10

The expected amortization expense for the acquired leasehold interest intangible asset is as follows:

2012	$	384,000
2013		384,000
2014		384,000
2015		384,000
2016		384,000
Thereafter		7,076,000
	$	8,996,000

Self Insurance

Self-insurance liabilities primarily represent the accrual for self insured risks associated with general and professional liability claims, employee health insurance and workers’ compensation. The Company’s health insurance liability 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 liability relates primarily to periods of self insurance prior to May 1997 and consists of an estimate of the future costs to be incurred for the known claims.

Final determination of the Company’s actual liability for incurred general and professional liability claims is a process that takes years. The Company evaluates the adequacy of this liability on a quarterly basis and engages a third-party actuarial firm to conduct an analysis semi-annually in the second and fourth quarters. The semi-annual actuarial analysis is prepared by the Actuarial Division of Willis of Tennessee, Inc. (“Willis”) based on data furnished as of May 31 and November 30 each year.

On a quarterly basis, the Company obtains reports of asserted claims and lawsuits incurred. These reports, which are provided by the Company’s insurers and a third party claims administrator, contain information relevant to the actual expense already incurred with each claim as well as the third-party administrator’s estimate of the anticipated total cost of the claim. This information is reviewed by the Company quarterly and provided to the actuary semi-annually. The actuary also considers historical data regarding the frequency and cost of the Company’s claims over a multi-year period and information regarding the Company’s number of occupied beds to develop estimates of the Company’s ultimate professional liability cost for current periods. The actuary estimates the Company’s professional liability accrual for past periods by using currently-known information to adjust the initial liability that was created for that period. Based on the actual claim information obtained, the semi-annual estimates received from Willis and on estimates regarding the number and cost of additional claims anticipated in the future, the Company records its estimate of professional liability expense as of the end of each quarter. This expense is revised upward or downward on a quarterly basis.

All losses are projected on an undiscounted basis. The self-insurance liabilities include estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, actual liabilities related to settlements, including settlements to be paid over time, and estimates of related legal costs incurred and expected to be incurred.

One of the key assumptions in the actuarial analysis is that historical losses provide an accurate forecast of future losses. Changes in legislation such as tort reform, changes in our financial condition, changes in our risk management practices and other factors may affect the severity and frequency of claims incurred in future periods as compared to historical claims.

Another key assumption is the limit of claims to a maximum of $4.5 million. The actuary has selected this limit based on the Company’s historical data. While most of the Company’s claims have been for amounts less than the $4.5 million, there have been claims at higher amounts, and there may be claims above this level in the future. The facts and circumstances of each claim vary significantly, and the amount of ultimate liability for an individual claim may vary due to many factors, including whether the case can be settled by agreement, the quality of legal representation, the individual jurisdiction in which

F - 11

the claim is pending, and the views of the particular judge or jury deciding the case. To date, the Company has not experienced an uninsured loss in excess of this limit. In the event that the Company believes it has incurred a loss in excess of this limit, an adjustment to the liabilities determined by the actuary would be necessary.

Although the Company retains Willis to assist management in estimating the appropriate accrual for these claims, professional liability claims are inherently uncertain, and the liability associated with anticipated claims is very difficult to estimate. As a result, the Company’s actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given quarter. Each change in the amount of this accrual will directly affect the Company’s reported earnings and financial position for the period in which the change in accrual is made.

Income Taxes

The Company follows the FASB’s guidance on Accounting for Income Taxes, which requires an asset and liability approach for financial accounting and reporting of income taxes. Under this method, deferred tax assets and liabilities are determined based upon differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax laws that will be in effect when the differences are expected to reverse. The Company assesses the need for a valuation allowance to reduce the deferred tax assets by the amount that is believed is more likely than not to not be utilized through the turnaround of existing temporary differences, future earnings, or a combination thereof, including certain net operating loss carryforwards we do not expect to realize due to change in ownership limitations. The Company follows the guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns evaluating the need to recognize or derecognize uncertain tax positions. See Note 10 for additional information related to the provision for income taxes.

Disclosure of Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, receivables, trade accounts payable and accrued expenses approximate fair value because of the short-term nature of these accounts. The Company’s self-insurance liabilities are reported on an undiscounted basis as the timing of estimated settlements cannot be determined.

The Company follows the FASB’s guidance on Fair Value Measurements and Disclosures which provides rules for using fair value to measure assets and liabilities as well as a fair value hierarchy that prioritizes the information used to develop the measurements. It applies whenever other guidance requires (or permits) assets or liabilities to be measured at fair value and gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements).

A summary of the fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels is described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

The Company has not elected to expand the use of fair value measurements for assets and liabilities. As such, its long-term debt obligations, receivables and trade accounts payable are still reported at their carrying values. It is noted that the assessment of carrying value compared to fair value for impairment analysis, as discussed in Note 2 “Property and Equipment,” follow these fair value principles and hierarchy.

F - 12

As further discussed in Note 6, in conjunction with the debt agreements entered into in March 2011, the Company entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The applicable guidance requires companies to recognize all derivative instruments as either assets or liabilities at fair value in a company’s balance sheets.

As the Company’s interest rate swap, a cash flow hedge, is not traded on a market exchange, the fair value is determined using a valuation model based on a discounted cash flow analysis. This analysis reflects the contractual terms of the interest rate swap agreement and uses observable market-based inputs, including estimated future LIBOR interest rates. The fair value of the Company’s interest rate swap is the net difference in the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates and are observable inputs available to a market participant. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.

Net Income per Common Share

The Company follows the FASB’s guidance on Earnings Per Share for the financial reporting of net income per common share. Basic earnings per common share excludes dilution and restricted shares and is computed by dividing income available to common shareholders by the weighted-average number of common shares, excluding restricted shares, outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or otherwise resulted in the issuance of common stock that then shared in the earnings of the Company. See Note 9 for additional disclosures about the Company’s Net Income per Common Share.

Stock-Based Compensation

The Company follows the FASB’s guidance on Stock Compensation to account for share-based payments granted to employees and recorded non-cash stock-based compensation expense of $537,000, $597,000 and $689,000 during the years ended December 31, 2011, 2010 and 2009, respectively. Such amounts are included as components of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. See Note 8 for additional disclosures about the Company’s stock-based compensation plans.

Accumulated Other Comprehensive Income

Accumulated other comprehensive income consists of other comprehensive income (loss). Comprehensive income (loss) is a more inclusive financial reporting method that includes disclosure of financial information that historically has not been recognized in the calculation of net income. The Company has chosen to present the components of other comprehensive income in a separate statement of Comprehensive income. Currently, the Company’s other comprehensive income (loss) consists of a deferred loss on the Company’s interest rate swap transaction accounted for as a cash flow hedge.

Recent Accounting Guidance

In June 2011, the FASB issued updated guidance in the form of a FASB Accounting Standards Update on “Comprehensive Income - Presentation of Comprehensive Income,” to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two

F - 13

separate but consecutive statements. The update eliminates the option to present the components of other comprehensive income as part of the statement of equity. The Company will adopt this guidance effective January 1, 2012 and will apply it retrospectively. The Company currently believes there will be no significant impact on its consolidated financial statements.

In July 2011, the FASB issued updated guidance in the form of a FASB Accounting Standards Update on “Health Care Entities: Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities.” This guidance impacts health care entities that recognize significant amounts of patient service revenue at the time the services are rendered even though they do not assess the patient’s ability to pay. This updated guidance requires an impacted health care entity to present its provision for doubtful accounts as a deduction from revenue, similar to contractual discounts. Accordingly, patient service revenue for entities subject to this updated guidance will be required to be reported net of both contractual discounts and provision for doubtful accounts. The updated guidance also requires certain qualitative disclosures about the entity’s policy for recognizing revenue and bad debt expense for patient service transactions. The guidance is effective for the Company starting January 1, 2012. Based on the Company’s assessment of its admission procedures, the Company does not believe that it is an impacted health care entity under this guidance since it assesses each patient’s ability or the patient’s payor source’s ability to pay. As a result of this assessment, the Company will continue to record bad debt expense as a component of operating expense, and adoption will not have an impact on the Company’s consolidated financial statements.

Reclassifications

As discussed in Note 7, the consolidated financial statements of the Company have been reclassified to reflect as discontinued operations certain divestitures and lease terminations. Certain amounts in the 2010 and 2009 Consolidated Financial Statements have been reclassified to conform to the presentation of 2011.

3. ACQUISITIONS

West Virginia Facility

On December 28, 2011, the Company completed construction of Rose Terrace Health and Rehabilitation Center (“Rose Terrace”), its third health care center in West Virginia. The state of the art 90-bed skilled nursing center is located in Culloden, West Virginia, along the Huntington-Charleston corridor, and offers 24-hour skilled nursing care designed to meet the care needs of both short and long term nursing patients. The Rose Terrace nursing center utilizes a Certificate of Need the Company obtained in June 2009, when the Company completed the acquisition of certain assets of a skilled nursing center in West Virginia. The facility is expected to obtain its Medicare and Medicaid certifications in the first quarter of 2012.

The Company has a lease agreement with the real estate developer that constructed, furnished, and equipped Rose Terrace that provides an initial lease term of 20 years and the option to renew the lease for two additional five-year periods. The agreement provides the Company the right to purchase the center beginning at the end of the first year of the initial term of the lease and continuing through the fifth year for a purchase price ranging from 110% to 120% of the total project cost.

The Company has no equity interest in the entity that constructed the new facility and does not guarantee any debt obligations of the entity. The owners of the facility have provided guarantees of the debt of the entity and, based on those guarantees, the entity is considered to be a variable interest entity (“VIE”).

F - 14

The Company owns the underlying Certificate of Need that is required for operation as a skilled nursing center. During 2011, the Company determined it is the primary beneficiary of the VIE based primarily on the ownership of the Certificate of Need, the fixed price purchase option described above, its ability to direct the activities that most significantly impact the economic performance of the VIE and the right to receive potentially significant benefits from the VIE.

The following table summarizes the accounts and amounts included in the Company’s Consolidated Balance Sheet that are associated with the real estate developer’s interests in the VIE. These assets can be used only to settle obligations of the VIE and none of these liabilities provide creditors with recourse to the general assets of the Company.

	December 31, 2011
Land	$	787,000
Building and improvements		5,938,000
Furniture, fixtures and equipment		573,000
Other assets		46,000
	$	7,344,000
Current liabilities	$	450,000
Notes payable		5,240,000
Non-controlling interests equity		1,654,000
	$	7,344,000

Gain on Settlement of acquisition liability

During 2009, the Company recorded a gain of $549,000 in other income as a result of an agreement with CMS to settle cost report obligations related to the 2007 acquisition of leasehold interests in certain nursing centers. The cost report obligations sought by CMS totaled approximately $1,180,000 and related to Medicare reimbursement for 1997 and earlier periods for one of the acquired facilities. During 2008, the Company recorded a liability of $1,022,000 for its estimate of its ultimate liability for this assessment and defense costs and the gain resulted from payments of the settlements and legal fees being less than the amounts previously accrued.

4. RECEIVABLES

Receivables, before the allowance for doubtful accounts, consist of the following components:

	December 31,
	2011		2010
Medicare	$	11,296,000	$	10,603,000
Medicaid and other non-federal government programs		10,695,000		9,758,000
Other patient and resident receivables		7,233,000		6,262,000
	$	29,224,000	$	26,623,000
Other receivables and advances	$	1,739,000	$	424,000

The other receivables and advances balance at December 31, 2011 is composed of $1,335,000 related to renovation projects funded by Omega. See Note 11 for additional discussion of these receivables and leased facility construction projects.

The Company provides credit for a substantial portion of its revenues and continually monitors the credit-worthiness and collectability from its patients, including proper documentation of third-party coverage. The Company is subject to accounting losses from uncollectible receivables in excess of its reserves.

Substantially all receivables are pledged as collateral on the Company’s debt obligations.

F - 15

5. PROPERTY AND EQUIPMENT

Property and equipment, at cost, consists of the following:

	December 31,
	2011		2010
Land	$	2,706,000	$	1,919,000
Buildings and leasehold improvements		63,108,000		54,032,000
Furniture, fixtures and equipment		27,537,000		22,739,000
	$	93,351,000	$	78,690,000

As discussed further in Note 6, the property and equipment of certain skilled nursing centers are pledged as collateral for mortgage debt obligations. In addition, the Company has assets recorded as capital leased assets purchased through capitalized lease obligations. The Company capitalizes leasehold improvements which will revert back to the lessor of the property at the expiration or termination of the lease, and depreciates these improvements over the shorter of the remaining lease term or the assets’ estimated useful lives.

As discussed further in Note 3, the Company has consolidated the assets and liabilities of a real estate developers interest in a center the Company leases.

6. LONG-TERM DEBT, INTEREST RATE SWAP AND CAPITALIZED LEASE OBLIGATIONS

Long-term debt consists of the following:

	December 31,
	2011			2010
Mortgage loan with a syndicate of banks; issued in March 2011; payable monthly, interest at 4.5% above LIBOR but fixed at 7.07% based on the interest rate swap described below.	$	22,715,000		$	—
Mortgage loan payable to a commercial finance company; issued in August 2006; refinanced in March 2011 as described below; payable monthly, interest at 3.75% above LIBOR (4.01% at December 31, 2010).		—			20,551,000
Revolving credit facility borrowings payable to a bank; entered into in March 2010; amended in March 2011 as described below; secured by receivables of the Company; interest at 4.5% above LIBOR (6.5% at December 31, 2010).		—			3,463,000
Commercial loan of consolidated VIE, payable by VIE landlord to a bank; issued in January 2011; payable monthly, fixed interest rate of 5.3%.		5,240,000			—
		27,955,000			24,014,000
Less current portion		(576,000	)		(442,000	)
	$	27,379,000		$	23,572,000

As of December 31, 2011, the Company’s weighted average interest rate on long-term debt, including the impact of the interest rate swap, was approximately 6.74%.

On March 1, 2011, the Company entered into an agreement with a syndicate of banks to refinance the Company’s mortgage loan scheduled to mature in August 2011 and extend the Company’s revolving credit facility. Under the terms of the new agreement, the syndicate of banks provided mortgage debt (“Mortgage Loan”) of $23 million with a five year maturity and extended the maturity of the Company’s $15 million revolving credit facility (“revolver”) from March 2013 to March 2016. The proceeds of these new loans were used to retire the Company’s mortgage loan and provided funding for capital

F - 16

improvements at the Company’s owned homes. The Mortgage Loan has a term of five years, with principal and interest payable monthly based on a 25 year amortization. Interest is based on LIBOR plus 4.5% but is fixed at 7.07% based on the interest rate swap described below. The new mortgage loan is secured by four owned nursing centers, related equipment and a lien on the accounts receivable of these facilities. The Mortgage Loan and the revolver are cross-collateralized.

The March 2011 debt agreement extended the maturity of the Company’s $15 million revolving credit facility (“revolver”) entered into in March 2010 with a member of the bank syndicate to March 2016. The extension also removes the 3.0% floor on LIBOR and changes the LIBOR spread to 4.5%. The March 2010 agreement replaced the Company’s previous revolving credit facility which was to expire in August 2010. As part of the March 2010 agreement, the Company used $3,463,000 in proceeds from the facility to retire the Company’s existing term loan and pay certain transaction costs. The March 2010 revolver had an interest rate of LIBOR (with a floor of 3.0%) plus 3.5% and was to expire in March 2013.

In connection with the Company’s 2011 and 2010 financing agreements the Company recognized the following debt retirement costs related to the write off of deferred financing on the existing financing agreements and recorded new deferred loan costs related the new financing agreements as follows:

	2011		2010
Write-off of deferred financing costs	$	112,000	$	127,000
Deferred financing costs capitalized	$	776,000	$	432,000

Under both agreements, the revolver is secured by accounts receivable and is subject to limits on the maximum amount of loans that can be outstanding under the revolver based on borrowing base restrictions. As of December 31, 2011, the Company had no borrowings outstanding under the revolving credit facility. Annual fees for letters of credit issued under this revolver are 3.00% of the amount outstanding. The Company has a letter of credit of $4,551,000 to serve as a security deposit for the Company’s leases. Considering the balance of eligible accounts receivable at December 31, 2011, the letter of credit, the amounts outstanding under the revolving credit facility and the maximum loan amount of $15,000,000, the balance available for borrowing under the revolving credit facility is $10,449,000.

Scheduled principal payments of long-term debt are as follows:

2012	$	576,000
2013		608,000
2014		645,000
2015		686,000
2016		25,440,000
Thereafter		—
Total	$	27,955,000

The Company’s debt agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. The Company is in compliance with all such covenants at December 31, 2011. The Company has consolidated $5,240,000 in debt that was added by the entity that owns the West Virginia nursing center. The borrower is subject to covenants concerning total liabilities to tangible net worth as well as current assets compared to current liabilities. The borrower is in compliance with all such covenants at December 31, 2011. The borrower’s liabilities do not provide creditors with recourse to the general assets of the Company.

Interest Rate Swap Cash Flow Hedge

As part of the debt agreements entered into in March 2011, the Company entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The interest rate swap agreement has the same effective date, maturity date and notional amounts as the Mortgage Loan. The interest rate swap agreement requires the Company to make fixed rate payments to the bank calculated on the applicable notional amount at an annual fixed rate of 7.07% while the bank is obligated to make payments to the Company based on LIBOR on the same notional amounts. The Company entered into the interest rate swap agreement to mitigate the variable interest rate risk on its outstanding mortgage

F - 17

borrowings. The applicable guidance requires companies to recognize all derivative instruments as either assets or liabilities at fair value in a company’s balance sheets. In accordance with this guidance, the Company designated its interest rate swap as a cash flow hedge and the earnings component of the hedge, net of taxes, is reflected as a component of other comprehensive income.

The Company assesses the effectiveness of its interest rate swap on a quarterly basis and at December 31, 2011, the Company determined that the interest rate swap was effective. The interest rate swap valuation model indicated a net liability of $1,524,000 at December 31, 2011. The fair value of the interest rate swap is included in “other noncurrent liabilities” on the Company’s consolidated balance sheet. The balance of accumulated other comprehensive loss at December 31, 2011, is $945,000 and reflects the liability related to the interest rate swap, net of the income tax benefit of $579,000. As the Company’s interest rate swap is not traded on a market exchange, the fair value is determined using a valuation model based on a discounted cash flow analysis. This analysis reflects the contractual terms of the interest rate swap agreement and uses observable market-based inputs, including estimated future LIBOR interest rates. The fair value of the Company’s interest rate swap is the net difference in the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates and are observable inputs available to a market participant. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy, in accordance with the FASB’s guidance on Fair Value Measurements and Disclosures.

Capitalized Lease Obligations

During 2011 and 2010, the Company entered into a series of lease agreements to finance the purchase of certain equipment primarily for the implementation of Electronic Medical Records (“EMR”) in its nursing centers. The Company determined the leases were capital in nature and recorded both assets and capitalized lease obligations of $527,000 and $387,000 during 2011 and 2010, respectively. These lease agreements provide three year terms.

In October 2011, the Company completed a sale and leaseback transaction for certain equipment purchased in the implementation of EMR in its nursing centers. The lease transaction, involving $1,219,000 in assets purchased by the Company during 2010 and 2011, is capital in nature, and the Company recorded the cash from the sale and the capitalized lease obligation under the financing during the fourth quarter of 2011. The lease agreement provides a three year term.

Scheduled payments of the capitalized lease obligations are as follows:

2012	$	812,000
2013		784,000
2014		491,000
Total		2,087,000
Amounts related to interest		(142,000	)
Principal payments on capitalized lease obligation	$	1,945,000

7. DISCONTINUED OPERATIONS

Effective March 31, 2010, the Company terminated operations of four nursing centers in Florida under a lease that, as amended, would have expired in August 2010 and transitioned operations at these leased facilities to a new operator. The operating margins of the four facilities subject to this lease did not meet the Company’s long-term goals. These four homes contributed revenues of $6,852,000 and $25,053,000 and net income of $169,000 and $541,000 in the years ended December 31, 2010 and 2009, respectively. Included in the loss on disposal and impairment is a loss of $273,000 ($185,000 net of tax) on lease termination primarily related to severance, legal and other costs incurred to facilitate the transition as well as the transfer of inventory. While the results of discontinued operations reflect the direct expense related to the Florida regional office which has been closed, they do not reflect any allocation of corporate general and administrative expense or any allocation of corporate interest expense.

F - 18

CMS issued regulations that became effective October 1, 2009, that prohibited the Company from billing Medicare Part B for certain services. These services produced revenues of $974,000 and net income of $204,000 during the year ended December 31, 2009.

The Company owns land related to a North Carolina assisted living facility it closed in April 2006. The net assets of discontinued operations presented in property and equipment on the accompanying consolidated balance sheet represent the real estate related to this assisted living facility. The Company is continuing its efforts to sell this land. Based on an evaluation of the current fair value of the property, the Company determined the carrying value exceeded the fair value. As a result, the Company recorded an impairment charge of $402,000 ($273,000 net of tax) to reduce the carrying value of the land during 2010.

The Company has classified the operations and the real estate described above as discontinued operations for all periods presented in the Company’s Consolidated Financial Statements.

8. SHAREHOLDERS’ EQUITY, STOCK PLANS AND PREFERRED STOCK

Shareholders’ Rights Plan

On August 14, 2009, the Company’s Board of Directors amended its current Amended and Restated Rights Agreement (the “Rights Agreement”) which was originally adopted in 1995. The amendment changes the definition of “Acquiring Person” to be such person that acquires 20% or more of the shares of Common Stock of the Company up from the 15% that previously defined an acquiring person. On August 1, 2008, another amendment was approved which provided for an increase of the exercise price of the rights under the Rights Agreement (the “Rights”) to $50 from $15 and for the extension of the expiration date of the Rights to August 2, 2018.

In addition, the amendment includes a share exchange feature that provides the Company’s Board of Directors the option of exchanging, in whole or in part, each Right, other than those of the hostile acquiring holder, for one share of the Company’s common stock. This provision is intended to avoid requiring Rights holders to pay cash to exercise their Rights and to alleviate the uncertainty as to whether holders will exercise their Rights. The Plan is designed to protect the Company’s shareholders from unfair or coercive takeover tactics. The rights may be exercised only upon the occurrence of certain triggering events, including the acquisition of, or a tender offer for, 20% or more of the Company’s common stock without the Company’s prior approval.

Stock-Based Compensation Plans

The Company follows the FASB’s guidance on Stock Compensation to account for share-based payments granted to employees and non-employee directors.

Overview of Plans

The Company adopted the 1994 Incentive and Nonqualified Stock Option Plan for Key Personnel (the “Key Personnel Plan”) and the 1994 Nonqualified Stock Option Plan for the Directors (the “Director Plan”). Under both plans, the option exercise price equals the stock’s closing market price on the day prior to the grant date. The maximum term of any option granted pursuant to either the Key Personnel Plan or to the Director Plan is ten years. In accordance with their terms, the Key Personnel Plan and the Director Plan expired in May 2004 and no further grants can be made under these plans. No options remain outstanding under these plans at December 31, 2011.

In December 2005, the Compensation Committee of the Board of Directors adopted the 2005 Long-Term Incentive Plan (“2005 Plan”). The 2005 Plan allows the Company to issue stock options and other share and cash based awards. Under the 2005 Plan, 700,000 shares of the Company’s common stock have been reserved for issuance upon exercise of equity awards granted thereunder. All grants under this plan expire 10 years from the date the grants were authorized by the Board of Directors.

F - 19

In June 2008, the Company adopted the Advocat Inc. 2008 Stock Purchase Plan for Key Personnel (“Stock Purchase Plan”). The Stock Purchase Plan provides for the granting of rights to purchase shares of the Company’s common stock to directors and officers and 150,000 shares of the Company’s common stock has been reserved for issuance under the Stock Purchase Plan. The Stock Purchase Plan allows participants to elect to utilize a specified portion of base salary, annual cash bonus, or director compensation to purchase restricted shares or restricted share units (“RSU’s”) at 85% of the fair market value of a share of the Company’s common stock on the date of purchase. The restriction period under the Stock Purchase Plan is generally two years from the date of purchase and during which the shares will have the rights to receive dividends, however, the restricted share certificates will not be delivered to the shareholder and the shares cannot be sold, assigned or disposed of during the restriction period. No grants can be made under the Stock Purchase Plan after April 25, 2018.

In April 2010, the Compensation Committee of the Board of Directors adopted the 2010 Long-Term Incentive Plan (“2010 Plan”), followed by approval by the Company’s shareholders in June 2010. The 2010 Plan allows the Company to issue stock appreciation rights, stock options and other share and cash based awards. Under the 2010 Plan, 380,000 shares of the Company’s common stock have been reserved for issuance upon exercise of equity awards granted under the 2010 Plan.

Equity Grants and Valuations

During 2011, 2010 and 2009, the Compensation Committee of the Board of Directors approved the grant of Stock Only Stock Appreciation Rights (“SOSARs”) at the market price of the Company’s common stock on the grant date. The SOSARs vest one-third on the first, second and third anniversaries of the grant date. The SOSARs are valued and recorded in the same manner as stock options, and will be settled with issuance of new stock for the difference between the market price on the date of exercise and the exercise price.

During 2011, the Compensation Committee of the Board of Directors approved grants of shares of restricted common stock to certain employees and members of the Board of Directors. The restricted shares vest one-third on the first, second and third anniversaries of the grant date. Unvested shares may not be sold or transferred. During the vesting period, dividends accrue on the restricted shares, but are paid in additional shares of common stock upon vesting, subject to the vesting provisions of the underlying restricted shares. The restricted shares are entitled to the same voting rights as other common shares. Upon vesting, all restrictions are removed.

The Company recorded non-cash stock-based compensation expense for equity grants and RSU’s issued under the Plans of $537,000, $597,000 and $689,000 during the years ended December 31, 2011, 2010, and 2009, respectively. Such amounts are included as components of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. As of December 31, 2011, there was $327,000 in unrecognized compensation costs related to stock-based compensation to be recognized over the applicable remaining vesting periods. The Company estimated the total recognized and unrecognized compensation using the Black-Scholes-Merton equity grant valuation model.

The table below shows the weighted average assumptions the Company used to develop the fair value estimates under its option valuation model:

	Year Ended December 31,
	2011	2010	2009
Expected volatility (range)	59% - 60%	62% - 89%	95% - 111%
Risk free interest rate (range)	1.02% - 1.30%	2.21% - 3.28%	2.02% - 2.40%
Expected dividends	3.93%	3.22%	—
Weighted average expected term (years)	6.0	6.0	6.0

In computing the fair value estimates using the Black-Scholes-Merton valuation model, the Company took into consideration the exercise price of the equity grants and the market price of the Company’s stock on the date of grant. The Company used an expected volatility that equals the historical volatility over the most recent period equal to the expected life of the equity grants. The risk free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. The Company used the expected dividend yield at the date of grant, reflecting the level of annual cash dividends currently being paid on its common stock.

F - 20

In computing the fair value of these equity grants, the Company estimated the equity grants expected term based on the average of the vesting term and the original contractual terms of the grants, consistent with the Securities and Exchange Commission’s interpretive guidance often referred to as the “Simplified Method.” The Company continues to use the Simplified Method since the Company’s exercise history is not representative of the expected term of the equity granted in 2011. The Company’s recent exercise history is primarily from options granted in 2005 that were vested at grant date and were significantly in-the-money due to an increase in stock price during the period between grant date and formal approval by shareholders, and from older options granted several years ago that had fully vested.

The table below describes the resulting weighted average grant date fair values calculated as well as the intrinsic value of options exercised under the Company’s equity awards during each of the following years:

	Year Ended December 31,
	2011		2010		2009
Weighted Average grant date fair value	$	2.19	$	2.61	$	1.91
Total Intrinsic Value of Exercises	$	87,000	$	192,000	$	320,000

The following table summarizes information regarding stock options and SOSAR grants outstanding as of December 31, 2011:

Range of Exercise Prices	Weighted Average Exercise Prices		Grants Outstanding		Intrinsic Value-grants Outstanding		Grants Exercisable		Intrinsic Value-grants Exercisable
$10.40 to $11.59	$	11.17		117,000		—		117,000		—
$2.37 to $6.21	$	5.10		334,000		175,000		186,000		113,000
				451,000				303,000

As of December 31, 2011, the outstanding equity grants have a weighted average remaining life of 6.65 years and those outstanding equity grants that are exercisable have a weighted average remaining life of 5.62 years. During the year ended December 31, 2011 approximately 18,000 stock option and SOSAR grants were exercised under these plans. All but 13,600 of the equity grants exercised were net settled and those 13,600 contributed $68,000 in proceeds.

Summarized activity of the equity compensation plans is presented below:

	Shares			Weighted Average Exercise Price
Outstanding, December 31, 2010		610,000		$	6.59
Granted		50,000			5.60
Exercised		(18,000	)		.87
Expired or cancelled		(191,000	)		6.65
Outstanding, December 31, 2011		451,000		$	6.68
Exercisable, December 31, 2011		303,000		$	7.38

F - 21

	Restricted Shares			Weighted Average Grant Date Fair Value
Outstanding, December 31, 2010		—			—
Granted		50,000		$	6.63
Dividend Equivalents		1,000			6.33
Vested		(6,000	)		6.80
Cancelled		(4,000	)		6.76
Outstanding December 31, 2011		41,000		$	6.57

Summarized activity of the Restricted Share Units for the Stock Purchase Plan is as follows:

	Restricted Share Units			Weighted Average Grant Date Fair Value
Outstanding, December 31, 2010		38,000		$	3.41
Granted		43,000			6.80
Dividend Equivalents		2,000			6.36
Vested		(30,000	)		2.73
Cancelled		—			—
Outstanding December 31, 2011		53,000		$	6.68

Series A Preferred Stock

The Company is authorized to issue up to 200,000 shares of Series A Preferred Stock. The Company’s Board of Directors is authorized to establish the terms and rights of each series, including the voting powers, designations, preferences, and other special rights, qualifications, limitations, or restrictions thereof.

Series B and Series C Redeemable Preferred Stock

As part of the consideration paid to Omega for restructuring the terms of the Omega Master Lease in November 2000, the Company issued to Omega 393,658 shares of the Company’s Series B Redeemable Convertible Preferred Stock (“Series B Preferred Stock”) with a stated value of $3,300,000 and an annual dividend rate of 7% of the stated value. In October 2006, the Company and Omega entered into a Restructuring Stock Issuance and Subscription Agreement (“Restructuring Agreement”) to restructure the Series B Preferred Stock, eliminating the option of Omega to convert the Series B Preferred Stock into shares of Advocat common stock.

At the time of the Restructuring Agreement, the Series B Preferred Stock had a recorded value (including accrued dividends) of approximately $4,918,000 and was convertible into approximately 792,000 shares of common stock. The Company issued 5,000 shares of a new Series C Redeemable Preferred Stock (“Series C Preferred Stock”) to Omega in exchange for the 393,658 shares of Series B Preferred Stock held by Omega. The new Series C Preferred Stock has a stated value of approximately $4,918,000 and an annual dividend rate of 7% of its stated value payable quarterly in cash. The Series C Preferred Stock is not convertible, but has been redeemable at its stated value at Omega’s option since September 30, 2010, and since September 30, 2007, has been redeemable at its stated value at the Company’s option. Redemption under the Company’s or Omega’s option is subject to certain limitations.

In connection with the termination of the conversion feature, the Company agreed to pay Omega an additional $687,000 per year under the Lease Amendment. The additional annual rental payments of $687,000 were discounted over the twelve year term of the renewal to arrive at a net present value of $6,701,000, the preferred stock premium. The Company recorded the fair value of the elimination of the conversion feature as a reduction in Paid In Capital with an offsetting increase to record a premium on the Series C Preferred Stock. As a result, the Series C Preferred Stock was initially recorded at a total value of $11,619,000, equal to the stated value of the Series B Preferred Stock, $4,918,000, plus the value of the conversion feature, $6,701,000. As the related cash payments were made, the preferred stock premium was reduced and interest expense was recorded.

F - 22

The Series C Preferred Stock shares have preference in liquidation but do not have voting rights. The total redemption value is equal to the stated value plus any accrued but unpaid dividends. The liquidation preference value is equal to the redemption value. The following table reflects activity in the Series C Preferred Stock:

Series C Preferred Stock

	2011		2010			2009
Balance at the beginning of the period	$	4,918,000	$	6,192,000		$	7,891,000
Amortization of preferred stock premium		—		(1,274,000	)		(1,699,000	)
Balance at the end of the period	$	4,918,000	$	4,918,000		$	6,192,000

9. NET INCOME (LOSS) PER COMMON SHARE

Information with respect to the calculation of basic and diluted net income (loss) per common share is presented below:

	2011			2010			2009
Basic net income per common share
Net income from continuing operations	$	1,384,000		$	3,963,000		$	1,880,000
Preferred stock dividends		(344,000	)		(344,000	)		(344,000	)
Net income from continuing operations for common stock		1,040,000			3,619,000			1,536,000
Discontinued operations:
Operating income (loss), net of taxes		(17,000	)		344,000			721,000
Loss on disposal and impairment, net of taxes		—			(458,000	)		—
Income (loss) from discontinued operations		(17,000	)		(114,000	)		721,000
Net income for common stock	$	1,023,000		$	3,505,000		$	2,257,000
Basic weighted average common shares outstanding		5,774,000			5,732,000			5,678,000
Basic net income per common share:
Net income from continuing operations	$	0.18		$	0.63		$	0.27
Income (loss) from discontinued operations		—			(0.02	)		0.13
Basic net income per common share	$	0.18		$	0.61		$	0.40

	2011			2010			2009
Diluted net income per common share
Net income from continuing operations for common stock
	$	1,040,000		$	3,619,000		$	1,536,000
Discontinued operations:
Operating income, net of taxes		(17,000	)		344,000			721,000
Loss on disposal and impairment, net of taxes		—			(458,000	)		—
Income (loss) from discontinued operations operations		(17,000	)		(114,000	)		721,000
Net income for common stock	$	1,023,000		$	3,505,000		$	2,257,000
Basic weighted average common shares outstanding		5,774,000			5,732,000			5,678,000
Incremental shares from assumed exercise of options, SoSARs and Restricted Stock Units		132,000			122,000			119,000
Diluted weighted average common shares outstanding		5,906,000			5,854,000			5,797,000
Diluted net income per common share
Net income from continuing operations	$	0.18		$	0.62		$	0.26
Net income (loss) from discontinued operations operations		(0.01	)		(0.02	)		0.13
Diluted net income per common share	$	0.17		$	0.60		$	0.39

F - 23

The dilutive effects of the Company’s stock options and Restricted Share Units are included in the computation of diluted income per common share during the periods they are considered dilutive.

The following table reflects the weighted average outstanding SOSARs and Options that were excluded from the computation of diluted earnings per share, as they would have been anti-dilutive:

	2011		2010		2009
SOSARs/Options Excluded		202,000		323,000		228,000

10. INCOME TAXES

The provision (benefit) for income taxes of continuing operations is composed of the following components:

	Year Ended December 31,
	2011		2010			2009
Current provision :
Federal	$	73,000	$	(139,000	)	$	1,543,000
State		225,000		(44,000	)		150,000
		298,000		(183,000	)		1,693,000
Deferred provision (benefit):
Federal		199,000		1,851,000			(544,000	)
State		12,000		190,000			16,000
		211,000		2,041,000			(528,000	)
Provision for income taxes of continuing operations	$	509,000	$	1,858,000		$	1,165,000

A reconciliation of taxes computed at statutory income tax rates on income from continuing operations is as follows:

	Year Ended December 31,
	2011			2010			2009
Provision for federal income taxes at statutory rates	$	644,000		$	1,979,000		$	1,035,000
Provision for state income taxes, net of federal benefit		149,000			97,000			221,000
Resolution with tax authorities		(79,000	)		—			—
Valuation allowance changes affecting the provision for income taxes		(8,000	)		(2,000	)		(76,000	)
Employment tax credits		(1,000,000	)		(580,000	)		(600,000	)
Nondeductible expenses		437,000			357,000			516,000
Stock based compensation expense		410,000			—			—
Other		(44,000	)		7,000			69,000
Provision for income taxes of continuing operations	$	509,000		$	1,858,000		$	1,165,000

F - 24

The net deferred tax assets and liabilities, at the respective income tax rates, are as follows:

		$10,352,000			$10,352,000
	December 31,
	2011			2010
Current deferred assets:
Credit carryforwards	$	1,288,000		$	580,000
Allowance for doubtful accounts		1,066,000			953,000
Accrued liabilities		4,961,000			3,813,000
		7,315,000			5,346,000
Less valuation allowance		(298,000	)		(196,000	)
		7,017,000			5,150,000
Current deferred liabilities:
Prepaid expenses		(976,000	)		(943,000	)
	$	6,041,000		$	4,207,000

		$10,352,000			$10,352,000
	December 31,
	2011			2010
Noncurrent deferred assets:
Net operating loss and other carryforwards	$	1,720,000		$	2,050,000
Deferred lease costs		416,000			471,000
Depreciation		(2,589,000	)		(872,000	)
Tax goodwill and intangibles		(469,000	)		(158,000	)
Stock-based compensation		1,242,000			1,847,000
Accrued rent		4,582,000			4,394,000
Impairment of long-lived assets		656,000			513,000
Interest rate swap		579,000			—
Noncurrent self-insurance liabilities		4,785,000			4,843,000
		10,922,000			13,088,000
Less valuation allowance		(570,000	)		(680,000	)
	$	10,352,000		$	12,408,000

In 2011, 2010, and 2009, the Company recorded a deferred tax benefit to reverse approximately $8,000, $2,000 and $76,000, respectively, of the valuation allowance on deferred tax assets. The decreases in valuation allowance were based on the Company’s assessment of the realization of certain individual tax assets. The Company continues to maintain a valuation allowance of approximately $868,000 to reduce the deferred tax assets by the amount management believes is more likely than not to not be utilized through the turnaround of existing temporary differences, future earnings, or a combination thereof. In future periods, the Company will continue to assess the need for and adequacy of the remaining valuation allowance.

At December 31, 2011, the Company had $9,194,000 of net operating losses, which expire at various dates beginning in 2019 and continue through 2021. The use of these loss carryforwards is limited by change in ownership provisions of the Federal tax code to a maximum of approximately $4,328,000. In 2005, the Company reduced the deferred tax asset and the corresponding valuation allowances for net operating loss deductions permanently lost as a result of the change in ownership provisions.

Stock-based compensation increases the Company’s effective tax rate to the extent that stock-based compensation expense recorded in the Company’s financial statements is non-deductible for tax purposes. This primarily occurs for equity grants that have a higher grant date fair value than the income tax deduction the Company receives upon exercise.

During 2011, the Company recorded an estimated $400,000 in employment tax credits under the Hiring Incentives to Restore

Employment (HIRE) Act which provided a one-time tax credit. In addition, under the Work Opportunity Tax Credit program the Company recorded $600,000, $580,000 and $600,000 in Work Opportunity Tax Credits during 2011, 2010 and 2009, respectively.

F - 25

The Company follows the FASB’s guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns evaluating the need to recognize or unrecognize uncertain tax positions. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

	2011		2010		2009
Balance at the beginning of the period	$	84,000	$	76,000	$	70,000
Changes in tax positions for prior years		2,000		8,000		6,000
Balance at the end of the period	$	86,000	$	84,000	$	76,000

The unrecognized tax benefits are accrued in “other current liabilities.” The net change in the amount of unrecognized tax benefits during the years ended December 31, 2011, 2010 and 2009 was related primarily to the adjustment of the estimated liability. None of the current unrecognized tax benefits are expected to impact the Company’s effective tax rates.

The Company has chosen to classify interest and penalties as a component separate from income tax expense in its consolidated statements of income. The tax years 2008 through 2010 remain open to examination by major taxing jurisdictions in which the Company operates. During 2010, the Internal Revenue Service (“IRS”) commenced an examination of the Company’s U.S. income tax returns for the years 2008 and 2009. The examination for both years was completed during 2011 and the Company recognized a combined income tax benefit of $79,000 as a result of the examination.

11. COMMITMENTS AND CONTINGENCIES

Lease Commitments

The Company is committed under long-term operating leases with various expiration dates and varying renewal options. Minimum annual rentals, including renewal option periods (exclusive of taxes, insurance, and maintenance costs) under these leases beginning January 1, 2012, are as follows:

2012	$	23,119,000
2013		23,677,000
2014		24,203,000
2015		24,786,000
2016		25,402,000
Thereafter		442,672,000
	$	563,859,000

Under lease agreements with Omega and others, the Company’s lease payments are subject to periodic annual escalations as described below and in Note 2. Total lease expense for continuing operations was $22,939,000, $22,600,000 and $21,791,000 for 2011, 2010 and 2009, respectively. The accrued liability related to straight line rent was $11,537,000 and $11,216,000 at December 31, 2011 and 2010, respectively, and is included in “Other noncurrent liabilities” on the accompanying consolidated balance sheets.

Omega Leases

General Terms

The Company leases 36 nursing centers from Omega under the Master Lease. On October 20, 2006, the Company and Omega entered into a Third Amendment to Consolidated Amended and Restated Master Lease (“Lease Amendment”) to extend the term of its facilities leased from Omega. The Lease amendment extended the term to September 30, 2018 and provided a renewal option of an additional twelve years. Consistent with prior terms, the lease provides for annual increases in lease payments equal to the lesser of two times the increase in the consumer price index or 3 percent. Under generally accepted accounting principles, the Company is required to report these scheduled rent increases on a straight line basis over the 12 year term of the renewal period. These scheduled increases had no effect on cash rent payments at the start of the lease term and only result in additional cash outlay as the annual increases take effect each year.

F - 26

The Master Lease requires the Company to fund annual capital expenditures related to the leased facilities at an amount currently equal to $412 per licensed bed. These amounts are subject to adjustment for increases in the Consumer Price Index. The Company is in compliance with the capital expenditure requirements. Total required capital expenditures during the remaining lease term and renewal options are $19,257,000. These capital expenditures are being depreciated on a straight-line basis over the shorter of the asset life or the appropriate lease term.

Upon expiration of the Master Lease or in the event of a default under the Master Lease, the Company is required to transfer all of the leasehold improvements, equipment, furniture and fixtures of the leased facilities to Omega. The assets to be transferred to Omega are being depreciated on a straight-line basis over the shorter of the remaining lease term or estimated useful life, and will be fully depreciated upon the expiration of the lease. All of the equipment, inventory and other related assets of the facilities leased pursuant to the Master Lease have been pledged as security under the Master Lease. In addition, the Company has a letter of credit of $4,551,000 as a security deposit for the Company’s leases with Omega, as described in Note 6.

Brentwood Terrace

In August 2009, the Company completed the construction of a 119 bed skilled nursing facility, Brentwood Terrace, located in Paris, Texas, replacing an existing 102 bed facility leased from Omega. The new facility was financed with funding from Omega and is leased from Omega under a long term operating lease with renewal options through 2035. Annual rent was $789,000 initially, equal to 10.25% of $7,702,000, the total cost of the replacement facility, and is subject to the annual escalation provisions described above.

The Company was deemed to have control of the construction project and was considered the owner during the construction period as a result of its involvement in construction and the terms of the lease. In accordance with the accounting guidance surrounding lessee involvement in asset construction, the Company recorded the amounts incurred for facility construction as an asset, and amounts reimbursed by Omega were recorded as a long term liability. Upon completion of construction of the replacement facility during the third quarter 2009, a sale and leaseback of the facility was deemed to have occurred and the Company removed both the facility asset and the long term liability from its consolidated balance sheet. There was no resulting gain or loss on the deemed sale and leaseback transaction and the Company will have no continuing involvement with the property except for its operating lease described above.

Texas Leased Nursing Centers

Effective August 11, 2007, the Company acquired the leases and leasehold interests of seven facilities which are leased from a subsidiary of Omega. In connection with this acquisition, the Company amended the Master Lease to include these seven facilities. The substantive terms of the lease of these centers, including payment provisions and lease period including renewal options were not changed by the amendment. The lease terms for the seven facilities provide for an initial term and renewal periods at the Company’s option through May 31, 2035. The lease provides for annual increases in lease payments equal to the increase in the consumer price index, not to exceed 2.5%.

Renovation Funding

In April 2011, we entered into an amendment to the Master lease with Omega under which Omega agreed to provide an additional $5,000,000 million to fund renovations to four nursing centers located in Arkansas, Kentucky, Ohio and Texas that are leased from Omega. The annual base rent related to these facilities will be increased to reflect the amount of capital improvements to the respective facilities as the related expenditures are made. The increase is based on a rate of 10.25% per year of the amount financed under this amendment. This arrangement is similar to amendments entered into in 2009, 2006 and 2005 that provided financing totaling $15,000,000 million that was used to fund renovations at twelve nursing centers leased from Omega. In addition to the twelve leased center renovations, in January 2012 the Company held two open houses for leased center projects, one a $1,656,000 major renovation project and the other a $404,000 project to add therapy space and functionality to a nursing center the Company renovated in 2010. The Company currently has two other projects in process, one involving a leased building and the other involving an owned building that it expects to complete in early 2012. The Company is developing plans for additional renovation projects.

F - 27

The Company completed an expansion to one of its facilities by making use of fifteen licensed beds it acquired in 2005. This expansion project was funded by Omega with the renovation funding previously described. This project increased capacity and footprint compared to the Company’s previous lessor funded facility projects which included renovations of existing facilities, but did not increase capacity. Accordingly, the costs incurred to expand the facility are recorded as a leasehold improvement asset with the amounts reimbursed by Omega for this project included as a long term liability. The capitalized leasehold improvements and lessor reimbursed costs will be amortized over the initial lease term ending in September 2018. The leasehold improvement asset and accumulated amortization are as follows:

	December 31
	2011			2010
Leasehold improvement	$	921,000		$	921,000
Accumulated Amortization		(210,000	)		(105,000	)
Net Intangible	$	711,000		$	816,000

Insurance Matters

Professional Liability and Other Liability Insurance-

For claims made after March 9, 2001, the Company has purchased professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. The Company has essentially exhausted all general and professional liability insurance available for claims asserted prior to July 1, 2011.

Effective June 1, 2010, the Company’s nursing centers are covered by one of two professional liability insurance policies. The Company’s nursing centers in Arkansas, Kentucky, Tennessee, and two centers in West Virginia are currently covered by an insurance policy with coverage limits of $250,000 per medical incident and total annual aggregate policy limits of $750,000. This policy provides the only commercially affordable insurance coverage available for claims made during this period against these nursing centers. The Company’s nursing centers in Alabama, Florida, Ohio, Texas and its new center in West Virginia are currently covered by an insurance policy with coverage limits of $1,000,000 per medical incident, subject to a deductible of $495,000 per claim, with a total annual aggregate policy limit of $15,000,000 and a sublimit per center of $3,000,000.

Estimated Self-Insured Professional Liability Claims-

Because the Company anticipates that its actual liability for existing and anticipated claims will exceed the Company’s professional liability insurance coverage, the Company has recorded total liabilities for professional liability and other claims of $19,357,000 as of December 31, 2011. This accrual includes estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, actual liabilities related to settlements, including settlements to be paid over time, and estimates of legal costs related to these claims. All losses are projected on an undiscounted basis. Amounts are added to the accrual for estimates of anticipated liability for claims incurred during each period, and amounts are deducted from the accrual for settlements paid on existing claims during each period.

Final determination of the Company’s actual liability for claims incurred in any given period is a process that takes years. The Company evaluates the adequacy of this liability on a quarterly basis and engages a third-party actuarial firm to conduct an analysis semi-annually in the second and fourth quarters. The semi-annual actuarial analysis is prepared by the Actuarial Division of Willis of Tennessee, Inc. (“Willis”) based on data furnished as of May 31 and November 30 each year.

The Company’s liability for professional liability claims is assessed and adjusted quarterly based on numerous factors, including claims actually reported, lawsuits filed, lawsuits resolved, the results of the semi-annual actuary reports, changes in the Company’s occupied beds and relevant claim development data. The Company records any revisions in estimates and differences between actual settlements and reserves, with changes in estimated losses being recorded in the consolidated statements of operations in the period identified. Any increase in the accrual decreases income in the period and any reduction in the accrual increases income during the period.

F - 28

Although the Company retains Willis to assist management in estimating the appropriate accrual for these claims, professional liability claims are inherently uncertain and the liability associated with anticipated claims is very difficult to estimate. As a result, the Company’s actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given period. Each change in the amount of this accrual will directly affect the Company’s reported earnings and financial position for the period in which the change in accrual is made.

Prior to 2010, the Company obtained quarterly third-party actuarial analyses to evaluate the liability for self insured risk. Beginning in the first quarter of 2010, the Company changed the frequency of these reviews from quarterly to semi-annually. Professional liability cases have a long cycle from the date of an incident to the date a case is resolved, and the Company believes that a semi-annual evaluation is appropriate.

The Company’s cash expenditures for self-insured professional liability costs of continuing operations were $8,014,000, $5,145,000 and $4,824,000 for the years ending December 31, 2011, 2010 and 2009, respectively.

Adoption of New Accounting Pronouncements - Self-Insured Professional Liability Claims-

In August 2010, the FASB issued updated guidance in the form of a FASB Accounting Standards Update on “Presentation of Insurance Claims and Related Insurance Recoveries” to clarify that a health care entity should not net insurance recoveries against a related professional liability claim and that the amount of the claim liability should be determined without consideration of insurance recoveries. The update is intended to improve accounting guidance by eliminating an existing industry exception and reduce diversity in practice by removing the ability to offset insurance recoveries against liabilities. The Company adopted this guidance effective January 1, 2011 and, as a result, reclassified amounts representing estimated insurance recoveries previously recorded as offsets to the related liability to an asset. Those amounts totaled $750,000 and $438,000 at December 31, 2011 and 2010, respectively.

Other Insurance-

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. 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. From June 30, 2003 until June 30, 2007, the Company’s workers’ compensation insurance programs provided coverage for claims incurred with premium adjustments depending on incurred losses. For the period from July 1, 2008 through June 30, 2012, the Company is covered by a prefunded deductible policy. Under this policy, the Company is self-insured for the first $500,000 per claim, subject to an aggregate maximum of $3,000,000. The Company funds a loss fund account with the insurer to pay for claims below the deductible. The Company accounts for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred. The liability for workers compensation claims is $309,000 at December 31, 2011. The Company has a non-current receivable for workers’ compensation policy’s covering previous years of $830,000 as of December 31, 2011. The non-current receivable is a function of payments paid to the Company’s insurance carrier in excess of the estimated level of claims expected to be incurred.

As of December 31, 2011, the Company is self-insured for health insurance benefits for certain employees and dependents for amounts up to $175,000 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 $853,000 at December 31, 2011. The differences between actual settlements and liabilities are included in expense in the period finalized.

F - 29

Employment Agreements

Current employment agreements-

The Company has employment agreements with certain members of management that provide for the payment to these members of amounts up to 1.0 times their annual salary in the event of a termination without cause, a constructive discharge (as defined in each employee agreement), or upon a change in control of the Company (as defined in each employee agreement). The maximum contingent liability under these agreements is $1,101,000 as of December 31, 2011. 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. In addition, upon the occurrence of any triggering event, these certain members of management may elect to require the Company to purchase equity awards 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 equity award exercise price. Based on the closing price of the Company’s common stock on December 31, 2011, the maximum contingent liability for the repurchase of the equity grants is approximately $41,000. No amounts have been accrued for these contingent liabilities for members of management the Company currently employ. As discussed below, the Company has accrued and will accrue costs under the terms of such agreements for members of management who are no longer employed by the Company or are resigning from their positions with the Company.

Changes in executive officers-

In September 2011, the Company announced the resignation of its Chief Executive Officer, William R. Council, III. The Company recorded $1,258,000 in severance and other expenses in the third quarter of 2011 related to Mr. Council’s departure in accordance with his employment agreement, most of which will be paid on March 31, 2012. The Company and Mr. Council also entered into a six month consulting agreement effective October 1, 2011 to facilitate the transition of management. Under the consulting agreement, Mr. Council receives $36,800 per month through March 2012.

On November 4, 2011, the Company promoted Kelly Gill to Chief Executive Officer of Advocat and appointed him to the Board of Directors. In connection with his promotion, the Company entered into an amendment to his employment agreement. The amendment provides that Mr. Gill is the Chief Executive Officer and increases his base salary to $450,000.

In December 2011, L. Glynn Riddle, Jr., the Company’s Chief Financial Officer, notified the Company that he intends to resign effective March 31, 2012. In connection with his resignation, the Company and Mr. Riddle entered into a retention agreement to facilitate the orderly transition to Mr. Riddle’s successor. The Company will record $246,000 in retention and other expenses in the first quarter of 2012 related to Mr. Riddle’s departure.

On December 20, 2011, the Company appointed Sam Daniel as executive vice president, effective January 1, 2012. In connection with the appointment of Mr. Daniel, the Company entered into an employment agreement which provides that Mr. Daniel is initially executive vice president and will replace Mr. Riddle as Chief Financial Officer following Mr. Riddle’s resignation. Mr. Daniel’s initial base salary will be $250,000.

Health Care Industry and Legal Proceedings

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. Over the last several years, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse statutes and regulations as well as laws and regulations governing quality of care issues in the skilled nursing profession in general. Violations of these laws and regulations could result in exclusion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations is subject to ongoing government review and interpretation, as well as regulatory actions which may be unknown or unasserted at this time. The Company is involved in regulatory actions of this type from time to time.

F - 30

All of the Company’s nursing centers must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing homes are subject to certificate of need laws, which require the Company to obtain government approval for the construction of new nursing homes or the addition of new licensed beds to existing homes. The Company’s nursing centers must comply with detailed statutory and regulatory requirements on an ongoing basis in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid certification are similar and relate to quality and adequacy of personnel, quality of medical care, record keeping, dietary services, resident rights, and the physical condition of the facility and the adequacy of the equipment used therein. Each facility is subject to periodic inspections, known as “surveys” by health care regulators, to determine compliance with all applicable licensure and certification standards. Such requirements are both subjective and subject to change. If the survey concludes that there are deficiencies in compliance, the facility is subject to various sanctions, including but not limited to monetary fines and penalties, increased staffing requirements, suspension of new admissions, non-payment for new admissions and loss of licensure or certification. Generally, however, once a facility receives written notice of any compliance deficiencies, it may submit a written plan of correction and is given a reasonable opportunity to make mutually agreeable measures to correct the deficiencies. There can be no assurance that, in the future, the Company will be able to maintain such licenses and certifications for its facilities or that the Company will not be required to expend significant sums in order to comply with regulatory requirements. Recently, the Company has experienced an increase in the severity of survey citations and the size of monetary penalties, consistent with industry trends.

As of December 31, 2011, the Company is engaged in 38 professional liability lawsuits. Four lawsuits are currently scheduled for trial or mediation during the next ten months, and it is expected that additional cases will be set for trial. The ultimate results of any of the Company’s professional liability claims and disputes cannot be predicted. The Company has limited, and sometimes no, professional liability insurance with regard to most of these claims. A significant judgment entered against the Company in one or more of these legal actions could have a material adverse impact on the Company’s financial position and cash flows.

In January 2009, a purported class action complaint was filed in the Circuit Court of Garland County, Arkansas against the Company and certain of its subsidiaries and Garland Nursing & Rehabilitation Center (the “Facility”). The complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Facility over the past five years. The lawsuit remains in its early stages and has not yet been certified by the court as a class action. The Company intends to defend the lawsuit vigorously.

The Company cannot currently predict with certainty the ultimate impact of any of the above cases on the Company’s financial condition, cash flows or results of operations. In the course of the Company’s business, it is periodically involved in governmental investigations, regulatory and administrative proceedings and lawsuits relating to its compliance with regulations and laws governing its operations, including reimbursement laws, fraud and abuse laws, elderly abuse laws, and state and federal false claims acts and laws governing quality of care issues. A finding of non-compliance with any of these governing laws or regulations in any such lawsuit, regulatory proceeding or investigation could subject it to fines, penalties and damages being excluded from the Medicare or Medicaid programs and could also have a material adverse impact on its financial condition, cash flows or results of operations.

Reimbursement

The Company is unable to predict what, if any, reform proposals or reimbursement limitations will be implemented in the future, or the effect such changes would have on its operations. For the year ended December 31, 2011, the Company derived 34.5% and 49.4% of its total patient and resident revenues related to continuing operations from the Medicare and Medicaid programs, respectively.

The Company will attempt to increase revenues from non-governmental sources to the extent capital is available to do so, if at all. However, private payors, including managed care payors, are increasingly demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments, which can result in significant losses to health care providers if patients require expensive treatment not adequately covered by the capitated rate.

F - 31

12. QUARTERLY FINANCIAL INFORMATION (Unaudited)

Selected quarterly financial information for each of the quarters in the years ended December 31, 2011 and 2010 is as follows:

	Quarter
2011	First			Second			Third			Fourth
Net revenues	$	77,130,000		$	79,172,000		$	80,644,000		$	77,769,000
Professional liability expense (1)		1,691,000			1,081,000			4,610,000			3,580,000
Net income (loss) from continuing operations		446,000			2,939,000			(873,000	)		(1,128,000	)
Loss from discontinued operations		(8,000	)		(2,000	)		—			(7,000	)
Net income (loss) for common stock	$	352,000		$	2,851,000		$	(959,000	)	$	(1,221,000	)
Basic net income per common share:
Net income (loss) from continuing operations	$	0.06		$	0.49		$	(0.17	)	$	(0.21	)
Loss from discontinued operations		—			—			—			—
Net income (loss) per common share	$	0.06		$	0.49		$	(0.17	)	$	(0.21	)
Diluted net income per common share:
Net income (loss) from continuing operations	$	0.06		$	0.48		$	(0.17	)	$	(0.21	)
Loss from discontinued operations		—			—			—			—
Net income (loss) per common share	$	0.06		$	0.48		$	(0.17	)	$	(0.21	)

⁽¹⁾  The Company’s quarterly results are significantly affected by the amounts recorded for professional liability expense, as discussed further in Note 11. The amount of expense recorded for professional liability in each quarter of 2011 is set forth in the table above.

F - 32

	Quarter
2010	First		Second			Third			Fourth
Net revenues	$	70,152,000	$	71,492,000		$	72,996,000		$	75,490,000
Professional liability expense (1)		1,414,000		997,000			1,684,000			1,269,000
Net income from continuing operations		707,000		987,000			229,000			2,040,000
Income (loss) from discontinued operations(2)		201,000		(10,000	)		(9,000	)		(296,000	)
Net income for common stock	$	822,000	$	891,000		$	134,000		$	1,658,000
Basic net income per common share:
Net income from continuing operations	$	0.11	$	0.16		$	0.02		$	0.34
Income (loss) from discontinued operations		0.03		—			—			(0.05	)
Net income (loss) per common share	$	0.14	$	0.16		$	0.02		$	0.29
Diluted net income per common share:
Net income from continuing operations	$	0.11	$	0.15		$	0.02		$	0.34
Income (loss) from discontinued operations		0.03		—			—			(0.05	)
Net income (loss) per common share	$	0.14	$	0.15		$	0.02		$	0.29

⁽¹⁾  The Company’s quarterly results are significantly affected by the amounts recorded for professional liability expense, as discussed further in Note 11. The amount of expense recorded for professional liability in each quarter of 2010 is set forth in the table above.

⁽²⁾  The loss from discontinued operations in the fourth quarter was the result of an impairment charge of $273,000 net of tax to reduce the carrying value of land held for sale in discontinued operations.

F - 33

ADVOCAT INC.

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

OF CONTINUING OPERATIONS

(in thousands)

Column A	Column B				Column C				Column D			Column E
			Additions						Deductions
Description	Balance at Beginning of Period		Charged to Costs and Expenses		Charged to Other Accounts		Other		(Write-offs) net of Recoveries			Balance at End of Period
Year ended December 31, 2011:
Allowance for doubtful accounts	$	2,822	$	2,330	$	—	$	—	$	(2,270	)	$	2,882
Year ended December 31, 2010:
Allowance for doubtful accounts	$	2,566	$	2,127	$	—	$	—	$	(1,871	)	$	2,822
Year ended December 31, 2009:
Allowance for doubtful accounts	$	2,839	$	1,965	$	12	$	—	$	(2,250	)	$	2,566

S-1

ADVOCAT INC.

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

(in thousands)

Column A	Column B				Column C						Column D			Column E
			Additions								Deductions
Description	Balance at Beginning of Period		Charged to Costs and Expenses		Charged to Other Accounts (2)			Other			Payments			Balance at End of Period
Year ended December 31, 2011:
Professional Liability Reserve	$	17,251	$	10,155	$	(35	)	$	—		$	(8,014	)(1)	$	19,357
Workers Compensation Reserve	$	346	$	1,323	$	—		$	(257	)	$	(1,103	)	$	309
Health Insurance Reserve	$	1,003	$	7,247	$	—		$	—		$	(7,397	)	$	853
Year ended December 31, 2010:
Professional Liability Reserve	$	18,502	$	4,391	$	(497	)	$	—		$	(5,145	)(1)	$	17,251
Workers Compensation Reserve	$	472	$	872	$	—		$	509		$	(1,507	)	$	346
Health Insurance Reserve	$	1,121	$	8,931	$	—		$	—		$	(9,049	)	$	1,003
Year ended December 31, 2009:
Professional Liability Reserve	$	14,959	$	7,598	$	769		$	—		$	(4,824	)(1)	$	18,502
Workers Compensation Reserve	$	492	$	1,689	$	—		$	—		$	(1,709	)	$	472
Health Insurance Reserve	$	1,230	$	9,944	$	—		$	—		$	(10,053	)	$	1,121

⁽¹⁾  Payments include amounts paid for claims settled during the period as well as payments made under structured arrangements for claims settled in earlier periods.

⁽²⁾  As discussed in Note 7 of the Consolidated Financial Statements, the Company has presented the results of certain divestiture and lease termination transactions as discontinued operations. The amounts charged to Other Accounts represent the amounts charged to discontinued operations.

S-2

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	Certificate of Designation of Registrant (incorporated by reference to Exhibit 3.5 to the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2006).
3.3	Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement No. 33-76150 on Form S-1).
3.4	Bylaw Amendment adopted November 5, 2007 (incorporated by reference to Exhibit 3.4 to the Company’s annual report on Form 10-K for the year ended December 31, 2007).
3.5	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).
3.6	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	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).
4.3	Amendment No. 1 to the Amended and Restated Rights Agreement, dated March 19, 2005, by and between Advocat Inc. and SunTrust Bank, as Rights Agent (incorporated by reference to Exhibit 2 to Form 8-A/A filed on March 24, 2005).
4.4	Second Amendment to the Amended and Restated Rights Agreement, dated August 15, 2008, by and between Advocat Inc. and ComputerShare Trust Company, N.A., as successor to SunTrust Bank (incorporated by reference to Exhibit 3 to Form 8-A/A filed on August 18, 2008).
4.5	Third Amendment to Amended and Restated Rights Agreement, dated August 14, 2009, between Advocat, Inc. and Computershare Trust Company, N.A, as successor to SunTrust Bank, (incorporated by reference to Exhibit 4 to the Company’s Registration Statement on Form 8-A/A filed on August 14, 2009).
*10.1	Master Agreement and Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.6 to the Company’s Registration Statement No. 33-76150 on Form S-1).
10.2	Form of Director Indemnification Agreement (incorporated by reference to Exhibit 10.8 to the Company’s Registration Statement No. 33-76150 on Form S-1).
10.3	Advocat Inc. Guaranty in favor of Omega Healthcare Investors, Inc. dated May 10, 1994 (incorporated by reference to Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1994).
10.4	Settlement and Restructuring Agreement dated as of October 1, 2000 among Registrant, Diversicare Leasing Corp., Sterling Health Care Management, Inc., Diversicare Management Services Co., Advocat Finance, Inc., Omega Healthcare Investors, Inc. and Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.83 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
10.5	Consolidated Amended and Restated Master Lease dated November 8, 2000, effective October 1, 2000, between Sterling Acquisition Corp. (as Lessor) and Diversicare Leasing Corp. (as Lessee) (incorporated by reference to Exhibit 10.84 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000).

Exhibit Number	Description of Exhibits
10.6	Management Agreement effective October 1, 2000, between Diversicare Leasing Corp. and Diversicare Management Services Co. (incorporated by reference to Exhibit 10.85 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
10.7	Amended and Restated Security Agreement dated as of November 8, 2000 between Diversicare Leasing Corp and Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.86 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
10.8	Security Agreement dated as of November 8, 2000 between Sterling Health Care Management, Inc. and Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.87 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
10.9	Guaranty given as of November 8, 2000 by Registrant, Advocat Finance, Inc., Diversicare Management Services Co., in favor of Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.88 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
10.10	First Amendment to Consolidated Amended and Restated Master lease dated September 30, 2001 by and between Sterling Acquisition Corp and Diversicare Leasing Corporation. (incorporated by reference to Exhibit 10.126 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001).
10.11	Purchase and Sale Agreement dated as of 4th day of November, 2004, by and between McKesson Medical-Surgical Minnesota Supply Inc. a Minnesota corporation, Advocat Distribution Services, Inc., a Tennessee corporation and Diversicare Management Services, Inc. (incorporated by reference to Exhibit 10.121 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).
10.12	Second Amendment to Consolidated Amended and Restated Master Lease dated as of June 15, 2005 by and between Sterling Acquisition Corp. and Diversicare Leasing Corporation (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005).
*10.13	Amended and Restated Employment Agreement dated as of March 31, 2006, by and among Advocat Inc., a Delaware corporation, and William R. Council, III (incorporated by reference to Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2006).
*10.14	Employment Agreement dated as of March 31, 2006, by and among Advocat Inc., a Delaware corporation, and L. Glynn Riddle. (incorporated by reference to Exhibit 10.3 to the Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2006).
10.15	Restructuring Stock Issuance and Subscription Agreement dated as of October 20, 2006 between Advocat Inc. and Omega Healthcare Investors, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K filed October 24, 2006).
10.16	Third Amendment to Consolidated Amended and Restated Master Lease executed as of October 20, 2006, to be effective as of October 1, 2006 by and between Sterling Acquisition Corp. and Diversicare Leasing Corporation (incorporated by reference to Exhibit 10.2 to the Company’s current report on Form 8-K filed October 24, 2006).
10.17	Subordinated Promissory Note in the amount of $2,533,614.53 issued to Omega HealthCare Investors Inc. dated as of October 1, 2006 (incorporated by reference to Exhibit 10.3 to the Company’s current report on Form 8-K filed October 24, 2006).
10.18	Fourth Amendment to Consolidated Amended and Restated Master Lease executed and delivered as of April 1, 2007 by and between Sterling Acquisition Corp., a Kentucky corporation, and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2007).

Exhibit Number	Description of Exhibits
10.19	Operations Transfer Agreement effective as of July 20, 2007, by and among certain subsidiaries of the Company, and Senior Management Services of America North Texas, Inc., a Texas corporation, Senior Management Services of Estates at Fort Worth, Inc., a Texas corporation, Senior Management Services of Doctors at Dallas, Inc., a Texas corporation, Senior Management Services of Humble, Inc., a Texas corporation, Senior Management Services of Katy, Inc., a Texas corporation, Senior Management Services of Treemont, Inc., a Texas corporation, Senior Management Services of Heritage Oaks at Ballinger, Inc., a Texas corporation, and Senior Management Services of Normandy at San Antonio, Inc., a Texas corporation (incorporated by reference to Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2007).
10.20	Loan and Security Agreement made as of August 10, 2007, between Diversicare Leasing Corp., a Tennessee corporation, and Bridge Associates LLC, as trustee for the SMSA Creditors’ Trust, a Texas trust. (Incorporated by reference to Exhibit 10.2 to the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2007).
10.21	Fifth Amendment to Consolidated Amended and Restated Master Lease dated as of August 10, 2007 by and between Sterling Acquisition Corp., a Kentucky corporation and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.7 to the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2007).
10.22	Sixth Amendment to Consolidated Amended and Restated Master Lease dated as of March 14, 2008 by and between Sterling Acquisition Corp., a Kentucky corporation and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2008).
10.23	Seventh Amendment to Consolidated Amended and Restated Master Lease dated as of October 24, 2008 by and between Sterling Acquisition Corp., a Kentucky corporation and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2008).
*10.24	Advocat Inc. 2005 Long-Term Incentive Plan (incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement on Schedule 14A filed on April 20, 2006).
*10.25	First Amendment to the Advocat Inc. 2005 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.63 to the Company’s annual report on Form 10-K for the year ended December 31, 2008).
10.26	Ninth Amendment to Consolidated Amended and Restated Master Lease dated as of May 5, 2009 by and between Sterling Acquisition Corp., a Kentucky corporation and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended June 30, 2009).
10.27	Tenth Amendment to Consolidated Amended and Restated Master Lease dated as of September 8, 2009 by and between Sterling Acquisition Corp., a Kentucky corporation and Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1 to the Company’s quarterly report on Form 10-Q for the quarter ended September 30, 2009).
*10.28	Employment Agreement effective April 5, 2010, by and among Advocat Inc., a Delaware corporation, and Kelly Gill (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010).
10.29	Lease Agreement dated as of July 14, 2010 by and between Diversicare Rose Terrace, LLC, a subsidiary of the registrant and A.B.E., LLC. (incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010).
10.30	$15 million revolving credit facility dated March 17, 2010 between the registrant and The Privatebank and Trust Company. (incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010)

Exhibit Number	Description of Exhibits
10.31	Eleventh Amendment to the Amended and Restated Master Lease (“Master Lease”) between the Company and Sterling Acquisition Corp., an affiliate of Omega Healthcare Investors, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
10.32	Amended and Restated Revolving Loan and Security Agreement, dated as of February 28, 2011, is by and among Diversicare Management Services Co., a Tennessee corporation, and those certain other entities set forth, The PrivateBank and Trust Company, an Illinois banking corporation in its individual capacity, and the other financial institutions parties thereto, and The PrivateBank and Trust Company, an Illinois banking corporation in its capacity as administrative agent for the Lenders. (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
10.33	Amended and Restated Guaranty dated as of February 28, 2011, by Advocat Inc., to and for the benefit of The PrivateBank and Trust Company. (incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
10.34	Term Loan and Security Agreement dated as of February 28, 2011, is by and among the subsidiaries of the Company, The PrivateBank and Trust Company, an Illinois banking corporation in its individual capacity and the other financial institutions parties thereto, and The PrivateBank and Trust Company, an Illinois banking corporation in its capacity as administrative agent for the Lenders. (incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
10.35	Guaranty dated as of February 28, 2011, by Advocat Inc., a Delaware corporation to and for the benefit of The PrivateBank and Trust Company. (incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
10.36	Swap Agreement between the Company and The PrivateBank and Trust Company dated as of March 1, 2011. (incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
*10.37	Employment Agreement effective June 28, 2010, by and among Advocat Inc., a Delaware corporation, and William David Houghton. (incorporated by reference to Exhibit 10.7 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
*10.38	Amendment No. 1 effective March 9, 2011 to Employment Agreement by and among Advocat Inc., a Delaware corporation, and William David Houghton. (incorporated by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
*10.39	Separation Agreement dated September 27, 2011 between William R. Council, III and Advocat Inc. (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011)
*10.40	Consulting Agreement dated October 1, 2011 between William R. Council, III and Advocat Inc. (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011)
*10.41	Amendment to Employment Agreement effective November 4, 2011 between Kelly Gill and Advocat Inc.
*10.42	Retention Agreement dated December 20, 2011 between L. Glynn Riddle and Advocat Inc.
*10.43	Employment Agreement effective January 1, 2012 between Sam Daniel and Advocat Inc.
*10.44	Separation Agreement dated February 8, 2012 between W. David Houghton and Advocat Inc.
21	Subsidiaries of the Registrant.
23.1	Consent of BDO USA, LLP.

Exhibit Number	Description of Exhibits
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a).
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a).
32	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b).

* Indicates management contract or compensatory plan or arrangement.

EX-10.41

EXHIBIT 10.41

AMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT

This amendment is made effective as of November 4, 2011 by and between Advocat Inc., a Delaware corporation (the “Company”), and Kelly Gill (the “Executive”).

WHEREAS, The Company and the Executive are parties to that certain employment agreement dated April 10, 2010 (the “Employment Agreement”).

WHEREAS, The Company wishes to name Executive the Chief Executive Officer of the Company and the Executive has agreed to serve in such position.

WHEREAS, the parties have agreed to amend the Employment Agreement to reflect the change in position as set forth herein.

NOW THEREFORE, The parties agree as follows:

1. Section II of the Employment Agreement is hereby amended and restated as follows:

SECTION II

POSITION AND RESPONSIBILITIES

During the Period of Employment, the Executive agrees to serve as Chief Executive Officer of the Company and to be responsible for the typical management responsibilities expected of an officer holding such positions and such other responsibilities as may be assigned to Executive from time to time by the Board of Directors of the Company.

2. Section III B of the Employment Agreement is hereby amended and restated as follows:

B. Duties

During the Period of Employment, the Executive shall devote all of his business time, attention and skill to the business and affairs of the Company and its subsidiaries. The Executive will perform faithfully the duties which may be assigned to him from time to time by the Board of Directors.

3. Section IV A of the Employment Agreement is hereby amended and restated as follows:

A. Compensation

For all services rendered by the Executive in any capacity during the Period of Employment, the Executive shall be compensated as follows:

Base Salary

The Company shall pay the Executive a base salary (“Base Salary”) as follows: four hundred fifty thousand dollars ($450,000.00) per annum, effective October 1, 2011.

Base Salary shall be payable according to the customary payroll practices of the Company but in no event less frequently than once each month. The base salary shall be reviewed annually and shall be subject to increase according to the policies and practices adopted by the Company from time to time.

4. Except as otherwise provided herein, the Employment Agreement continues in full force and effect.

IN WITNESS WHEREOF, the undersigned have executed this amendment as of the date first above written.

ADVOCAT INC.
By:	/s/ Richard M. Brame
	Richard M. Brame
Title:	Chairman of Compensation Committee
EXECUTIVE:
/s/ Kelly Gill
Kelly Gill

EX-10.42

EXHIBIT 10.42

RETENTION BONUS AGREEMENT

THIS RETENTION BONUS AGREEMENT is made and entered into as of December 20, 2011, by and between ADVOCAT INC., a Delaware corporation (hereinafter, the “Company”), and L. Glynn Riddle, Jr. (“Riddle”).

WHEREAS, Riddle is employed by the Company pursuant to that certain employment agreement dated March 31, 2006 (the “Employment Agreement”) pursuant to which Riddle is the Chief Financial Officer of the Company and is considered by the Company to be critical to its on-going business operations; and

WHEREAS, the Company understands that Riddle desires to resign his position with the Company and has stated that he intends to resign his position and employment with the Company on or before December 31, 2011

WHEREAS, pursuant to the Employment Agreement between Riddle and the Company, upon Riddle’s voluntary termination, he would be entitled to his unpaid Base Salary and the Company would have no further obligation to him; and

WHEREAS, the Company is presently in the process of replacing its Chief Financial Officer (“CFO”), and dealing with the end of the year audit and other issues and desires Riddle stay through the audit period in order to have a better transition; and

WHEREAS, subject to Riddle’s continued satisfactory job performance, the Company is willing to enter into this agreement to induce Riddle to remain with the Company in order to assist the Company with its 2011 fiscal year audit, preparation and filing of its Form 10-K for the year ended December 31, 2011 and ongoing operations during the period while the Company engages in a search for a replacement CFO and Riddle is willing to remain employed by the Company during such time on the terms provided herein;

NOW, THEREFORE, in consideration of the mutual promises, covenants and agreements made herein, the receipt and sufficiency of which are hereby acknowledged, the parties, intending to be legally bound hereby, agree as follows:

1. Retention. The Company hereby retains Riddle in the position of Chief Financial Officer and Riddle hereby accepts said retention by the Company on the terms and conditions specified herein.

2. Term. The term of this Agreement shall commence on the date hereof and, unless earlier terminated in accordance with the provisions set forth herein below, shall expire on March 31, 2012 (the “Retention Period”). Notwithstanding anything to the contrary in this Section 2, the provisions of Section 9 will survive the expiration or earlier termination of this Agreement.

3. Duties of Riddle. Riddle shall continue to perform the duties of CFO and those duties which are assigned to him by the Board of Directors or Chief Executive Officer of the Company through the Retention Period. Riddle agrees to devote his full time, attention and skill to his duties hereunder throughout the Retention Period and to be in a position to sign the certifications required to be filed with the Form 10-K. In connection herewith, the Company agrees to ensure that Riddle remains connected and has access to all information of the Company required to enable Riddle to be in a position to sign the certifications.

4. Compensation.

(a) As compensation for the duties and services performed by Riddle, the Company will continue Riddle’s annual base salary as provided in the Employment Agreement as such may be increased in the ordinary course by the Board of Directors, subject to federal and state withholding allowances and in accordance with the Company’s standard payroll practices.

(b) The Company acknowledges that Riddle will be entitled to his full bonus for the 2011 fiscal year and that such bonus shall be paid at the same time the other officers of the Company are paid their bonuses, but in any event, on or before March 15, 2012.

(c) Upon the filing of the Company’s annual report on Form 10-K, with the CFO certifications signed by Riddle, the Company will pay Riddle a bonus of Fifty Thousand Dollars ($50,000).

(d) In addition, the Company acknowledges that Riddle is performing his job for the benefit of the Company at a time when he has expressed a desire to resign. Thus, the Company agrees that, in addition to, and without limitation of, any other compensation contemplated hereby, the Company will continue to pay Riddle his annual base salary pursuant to the Company’s regular payroll periods, through December 31, 2012, if Riddle continues to work through the end of the Retention Period, and fulfills his other obligations under this agreement.

5. Options, SARs and Restricted Stock. As a further inducement for Riddle to remain through the Retention Period, one hundred percent (100%) of all unvested options, SOSARs, and restricted stock granted to Riddle under the Company’s 1994 Non-Qualified Stock Option Plan, 2005 Long Term Incentive Plan, or 2010 Long Term Incentive Plan or any other equity plan shall be deemed vested as of the last day of the Retention Period, if Riddle continues to work through the end of the Retention Period, and fulfills his other obligations under this agreement. The Company shall cause the options and SOSARs vested prior to the end of the Retention Period pursuant to the terms of the agreements under which they were granted and those vested pursuant to this Section 5 to remain exercisable until December 31, 2012 or such shorter period that does not constitute an extension under Treasury Regulation Section 1.409A-1(b)(5)(v)(C)(1). All Restricted Stock that vests prior to the end of the Retention Period and those shares that vest as a result of this Section 5 shall be promptly issued to Riddle at the end of the Retention Period.

6. Restricted Stock Units. All of the restricted share units in the account of Riddle under the 2008 Stock Purchase Plan For Key Personnel (“2008 Stock Plan”), shall be deemed vested as of the last day of the Retention Period, if Riddle continues to work through the end of the Retention Period, and fulfills his other obligations under this agreement. The delivery to Riddle by the Company of unrestricted shares of common stock of the Company equal to the number of restricted shares units held by Riddle under the 2008 Stock Plan adjusted for dividends through the Delayed Payment Date (defined below), rounded down to the nearest whole share, shall be made six months from the end of the Retention Period (the “Delayed Payment Date”) and the Company will make a payment to Riddle in amount representing the value of any remaining fractional restricted share units held by Riddle using the value per share as determined under Section 2(p) of the 2008 Stock Plan.

7. Benefits. Riddle shall also be entitled to participate in all benefit plans and programs through the Retention Period that are available to Riddle as of the date of this Agreement, provided such are continued after the date hereof. If Riddle elects to continue COBRA benefits at the end of the Retention Period, each month through December 31, 2012, the Company shall reimburse Riddle for the cost of group health and dental insurance premiums under COBRA, subject to any required withholding. In addition, should Riddle elect to continue any disability insurance or life insurance under the Company’s plans, the Company shall reimburse Riddle through December 31, 2012, for the cost of such disability insurance premiums, and life insurance premiums, subject to any required withholding. Note that the Company shall not continue EIRP payments to Riddle following the end of the Retention Period. Any reimbursements under this Section 7 shall be made to Riddle on a monthly basis, but in all events before the end of the limited period described in Treasury Regulation Section 1.409A-1(b)(9)(v)(E).

8. Termination.

(a) The Company shall have the right at any time, by written notice to Riddle to terminate this Agreement if one of the following events occurs:

(i) a Termination for Cause as defined in the Employment Agreement; or

(ii) Riddle’s disability as defined in Section 10 below; or

(iii) Riddle’s death.

Notwithstanding the above, it is the intent of the Company at all times to comply with the Americans With Disabilities Act, the Family and Medical Leave Act and any other applicable federal and state employment laws. This Agreement shall be terminable without cause by Riddle upon two (2) weeks written notice to the Company. In the case of termination under this Section 8 (a), all obligations of the parties under this Agreement shall cease, except for the Company’s obligations under Sections 4, 5, and 7 herein through the date of Riddle’s separation, to the extent earned and vested as of the date of Riddle’s separation, and Riddle’s obligations under Section 9 hereof. In addition, notwithstanding the above, if, prior to the end of the Retention Period, the Company should terminate Riddle’s employment due to a Without Cause Termination or Riddle should terminate his employment due to a Constructive Discharge, each as defined in the Employment Agreement or his employment shall be terminated by Riddle’s death or disability, Riddle shall be entitled to the compensation provided in the Employment Agreement instead of the provisions of this Agreement.

(b) This Agreement shall be terminable by Riddle upon thirty (30) days written notice to the Company, if the Company breaches any material terms of this Agreement and provided such breach has not been cured by the Company within such thirty (30) day period after notice by Riddle. In the case of termination under this Section 8(b), such termination shall be deemed a Constructive Discharge and Riddle shall be entitled to the compensation provided in the Employment Agreement in lieu of any payment that would otherwise have been due under this Agreement.

9. Confidential Information. In consideration of the covenants of the Company contained herein, Riddle agrees that the provisions of Section IX of the Employment Agreement will remain in full force and effect during and after the Retention Period and that for purposes of Section IX of the Employment Agreement Riddle will be deemed to have submitted his voluntary resignation at the end of the Retention Period. Provided Riddle maintains the confidentiality of Company information, the Company acknowledges that it will consent to Riddle’s employment as chief financial officer, or other financial position with a company operating in the nursing home industry.

10. Section 409A Compliance.

(a) This Agreement and any payments or benefits provided pursuant to the Employment Agreement shall be interpreted, operated and administered in a manner intended to avoid the imposition of additional taxes under Section 409A of the Code. Further, the parties acknowledge and agree that the form and timing of the payments and benefits to be provided pursuant to this Agreement are intended comply with Section 409A of the Code or to be exempt from, or to comply with, one or more exceptions to the requirements of Section 409A of the Code. Notwithstanding any provision of this Agreement to the contrary, the Company, its affiliates, subsidiaries, successors, and each of their respective officers, directors, employees and representatives, neither represent nor warrant the tax treatment under any federal, state, local, or foreign laws or regulations thereunder (individually and collectively referred to as the “Tax Laws”) of any payment or benefits contemplated by this Agreement including, but not limited to, when and to what extent such payments or benefits may be subject to tax, penalties and interest under the Tax Laws.

(b) If and to the extent required to comply with Section 409A, no payment or benefit required to be paid under this Agreement on account of termination of Riddle’s employment shall be made unless and until Riddle incurs a “separation from service” within the meaning of Section 409A.

(c) Notwithstanding the applicable provisions of this Agreement entered into pursuant thereto regarding the timing of payments in order for the Plan to comply with Section 409A, to the extent any such payment is subject to the provisions of Section 409A, the following special rules shall apply to any payment due under this Agreement as a result of such separation from service: (a) to the extent Riddle is a “Specified Employee” (as defined under Section 409A at the time of Separation from Service and to the extent such applicable provisions of Section 409A of the Code and the regulations thereunder require a delay of such payment for a six-month period after the date of such Riddle’s Separation from Service, no such payment shall be made prior to the earlier of (i) the death of Riddle or (ii) the date that is six months after the date of Riddle’s separation from service, and (b) any delayed payment shall be paid to Riddle, as otherwise provided in this Agreement, promptly after the end of the applicable six-month delay.

(d) Disability shall mean a medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than twelve months, where such impairment causes Riddle to be unable to perform the duties under this Agreement or any substantially similar position of employment.

11. Assignments; Successors and Assigns. The rights and obligations of Riddle hereunder are not assignable or delegable and any prohibited assignment or delegation will be null and void. The Company may assign and delegate this Agreement to a successor in interest to the Company’s business. Any such assignment shall expressly include the obligations herein and shall not relieve the Company of same. The provisions hereof shall inure to the benefit of and be binding upon the permitted successors and assigns of the parties hereto.

12. Governing Law/Arbitration. This Agreement shall be interpreted under, subject to and governed by the substantive laws of the State of Tennessee without giving effect to provisions thereof regarding conflict of laws, and all questions concerning its validity, construction, and administration shall be determined in accordance thereby.

13. Counterparts. This Agreement may be executed simultaneously in any number of counterparts, each of which will be deemed an original but all of which will together constitute one and same instrument.

14. Invalidity. The invalidity or unenforceability of any provision of this Agreement shall not affect any other provision hereof, and this Agreement shall be construed in all respects as if such invalid or unenforceable provision was omitted. Furthermore, in lieu of such illegal, invalid, or unenforceable provision there shall be added automatically as a part of this Agreement a provision as similar in terms to such illegal, invalid, or unenforceable provision as may be possible and be legal, valid and enforceable.

15. Exclusiveness. This Agreement and the Employment Agreement constitute the entire understanding and agreement between the parties with respect to the retention by the Company of Riddle and supersedes any and all other agreements, oral or written, between the parties. Except as otherwise provided herein, the Employment Agreement continues in full force and effect.

16. Modification. This Agreement may not be modified or amended except in writing signed by the parties. No term or condition of this Agreement will be deemed to have been waived except in writing by the party charged with waiver. A waiver shall operate only as to the specific term or condition waived and will not constitute a waiver for the future or act on anything other than that which is specifically waived.

17. Notices. All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been made when delivered or mailed first-class postage prepaid by registered mail, return receipt requested, or when delivered if by hand, overnight delivery service or confirmed facsimile transmission, to the following:

(a) If to the Company, at 1621 Galleria Boulevard, Brentwood, TN 37027, Attention: CEO, or at such other address as may have been furnished to Riddle by the Company in writing; or

(b) If to Riddle, at the address stated below, or such other address as may have been furnished to the Company by Riddle in writing.

18. Consolidation, Merger or Sale of Assets. Nothing in this Agreement shall preclude the Company from consolidating or merging in to or with, or transferring all or substantially all of its assets to, another corporation which assumes this Agreement and all obligations and undertaking of the Company hereunder. No such consolidation, merger or transfer shall affect the rights of Riddle or the obligations of the Company hereunder.

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written.

“COMPANY”
ADVOCAT INC.
By:	/s/ Kelly Gill
Title:	President & CEO

“RIDDLE”

/s/ L. Glynn Riddle, Jr.

L. Glynn Riddle, Jr.

Riddle’s Principal Address:

1203 Signature Court

Franklin, Tennessee 37064

EX-10.43

EXHIBIT 10.43

EMPLOYMENT AGREEMENT

This Agreement made effective as of January 1, 2012 by and between Advocat Inc., a Delaware corporation (the “Company”), and Sam Daniel (the “Executive”).

In consideration of the mutual covenants contained in this Agreement, the parties hereby agree as follows:

SECTION I

EMPLOYMENT

The Company agrees to employ the Executive and the Executive agrees to be employed by the Company for the Period of Employment as provided in Section III.A. below and upon the terms and conditions provided in the Agreement.

SECTION II

POSITION AND RESPONSIBILITIES

From the Effective Date of this Agreement until the earlier of April 1, 2012 or the date that Glynn Riddle is no longer the Chief Financial Officer of the Company; the Executive agrees to serve as Executive Vice President. Effective upon the resignation of Mr. Riddle as the Chief Financial Officer of the Company, the Executive agrees to serve as Chief Financial Officer of the Company and to be responsible for the typical management responsibilities expected of an officer holding such positions and such other responsibilities as may be assigned to Executive from time to time by the Board of Directors of the Company.

SECTION III

TERMS AND DUTIES

A. Period of Employment

The period of Executive’s employment under this Agreement will commence as of the date hereof and shall continue through March 31, 2013, subject to extension or termination as provided in this Agreement (“Period of Employment”). On March 31 of each year beginning March 31, 2013, the period of Executive’s employment shall be extended for additional one (1) year periods, unless either party gives notice thirty (30) days in advance of the expiration of the then current period of employment of such party’s intent not to extend the Period of Employment.

B. Duties

During the Period of Employment, the Executive shall devote all of his business time, attention and skill to the business and affairs of the Company and its subsidiaries. The Executive will perform faithfully the duties which may be assigned to him from time to time by the Board of Directors.

SECTION IV

COMPENSATION AND BENEFITS

A. Compensation

For all services rendered by the Executive in any capacity during the Period of Employment, the Executive shall be compensated as follows:

1. Base Salary

The Company shall pay the Executive a base salary (“Base Salary”) as follows: Two Hundred Fifty Thousand Dollars ($250,000) per annum.

Base Salary shall be payable according to the customary payroll practices of the Company but in no event less frequently than once each month. The base salary shall be reviewed annually and shall be subject to increase according to the policies and practices adopted by the Company from time to time.

B. Annual Incentive Awards

The Company will pay the Executive annual incentive compensation awards as may be granted by the Board or a Compensation Committee to the Executive under any executive bonus or incentive plan in effect from time to time. In all events, any such incentive bonuses or payments will be made on or before March 15 following the Executive’s taxable year in which such award is no longer subject to a substantial risk of forfeiture as defined by Treasury Regulation Section 1.409A-1(d).

C. Additional Benefits

The Executive will be entitled to participate in all compensation or employee benefit plans or programs and receive all benefits and perquisites for which any salaried employees are eligible under any existing or future plan or program established by the Company for salaried employees. The Executive will participate to the extent permissible under the terms and provisions of such plans or programs in accordance with program provisions. These may include group hospitalization, health, dental care, life or other insurance, tax qualified pension, car allowance, savings, thrift and profit sharing plans, termination pay programs, sick leave plans, travel or accident insurance, disability insurance, and contingent compensation plans including capital accumulation programs, Restricted Stock programs, stock purchase programs and stock option plans. Nothing in this Agreement will preclude the Company from amending or terminating any of the plans or programs applicable to salaried or senior executives as long as such amendment or termination is applicable to all salaried employees or senior executives. The Executive will be entitled to an annual four-week paid vacation.

SECTION V

BUSINESS EXPENSES

The Company will reimburse the Executive for all reasonable travel and other expenses incurred by the Executive in connection with the performance of his duties and obligations under this Agreement.

SECTION VI

DISABILITY

A. In the event of disability of the Executive during the Period of Employment, the Company will continue to pay the Executive according to the compensation provisions of this Agreement during the period of his disability, until such time as Executive’s long term disability insurance benefits are available. Once the Executive’s long term disability insurance benefits are available, the Company’s obligation to continue paying compensation shall cease unless the disability ends. In the event the Executive is disabled for a continuous period of six (6) months after the Executive first becomes disabled, the Company may terminate the employment of the Executive. In this case, the Company’s obligation to make payments under this Agreement shall cease as of the date of termination, except for earned but unpaid Base Salary and Incentive Compensation Awards which will be paid on a pro-rated basis for the year in which the disability occurred. In the event of such termination, all unvested stock options held by Executive shall be deemed fully vested on the date of such termination.

B. During the period the Executive is receiving payments of either regular compensation or disability insurance described in this Agreement and as long as he is physically and mentally able to do so, the Executive will furnish information and assistance to the Company and from time to time will make himself available to the Company to undertake assignments consistent with his prior position with the Company and his physical and mental health. If the Company fails to make a payment or provide a benefit required as part of the Agreement, the Executive’s obligation to fulfill information and assistance will end.

SECTION VII

DEATH

In the event of the death of the Executive during the Period of Employment, the Company’s obligation to make payments under this Agreement shall cease as of the date of death, except for earned but unpaid Base Salary and Incentive Compensation Awards which will be paid on a pro-rated basis for that year. The Executive’s designated beneficiary will be entitled to receive the proceeds of any life or other insurance or other death benefit programs provided in this Agreement.

SECTION VIII

EFFECT OF TERMINATION OF EMPLOYMENT

A. If the Executive’s employment terminates after March 31, 2012 due to either a Without Cause Termination or a Constructive Discharge, as defined later in this Agreement, the Company will pay the Executive in a lump sum an amount equal to 100% of his Base Salary as in effect at the time of the termination upon such Termination or Constructive Discharge, and subject to Section XII, will be paid at the time of termination of employment. Earned but unpaid Base Salary and Incentive Compensation Awards will be paid in a lump sum upon such Termination or Constructive Discharge. The benefits and perquisites described in this Agreement as in effect at the date of termination of employment will be continued for twelve (12) months. If the Executive’s employment terminates due to either a Without Cause Termination or a Constructive Discharge, or pursuant to Section XI, all stock options, SOSARs, restricted stock or other equity grants granted to the Executive under the Company’s 2010 Long-Term Incentive Plan or other stock option program or plan (the “Plan”) shall be deemed vested, and the Company shall cause any options or SOSARs to remain exercisable until the earlier of (i) the latest date upon which the option or SOSAR could have expired by its original terms under any circumstances or the tenth anniversary of the original date of grant of such option or SOSAR or (ii) the later of the fifteenth (15^th) day of the third (3^rd) month following the date on which the Options would have expired or December 31 of the calendar year in which the Option would have expired.

B. If the Executive’s employment terminates due to a Termination for Cause, earned but unpaid Base Salary will be paid on a pro-rated basis for the year in which the termination occurs. No other payments will be made or benefits provided by the Company.

C. Upon termination of the Executive’s employment for any reason prior to March 31, 2012 or at any time for reasons other than due to death, disability, or pursuant to Paragraph A of this Section or Section XI, the Period of Employment and the Company’s obligation to make payments under this Agreement will cease as of the date of the termination except as expressly defined in this Agreement.

D. For this Agreement, the following terms have the following meanings:

1. “Termination for Cause” means termination of the Executive’s employment by the Company’s Board of Directors acting in good faith by the Company by written notice to the Executive specifying the event relied upon for such termination, due to the Executive’s serious, willful misconduct with respect to his duties under this Agreement, including but not limited to conviction for a felony or perpetration of a common law fraud, which has resulted or is likely to result in material economic damage to the Company.

2. “Constructive Discharge” means termination of the Executive’s employment by the Executive as a result of any of the following: a material diminution of base salary of Executive; a material diminution in the Executive’s authority, duties or responsibilities; a material diminution in the budget over which the Executive retains authority; a material change in geographic location at which the Executive must perform the services; or any other action or inaction that constitutes a material breach of the terms of this Agreement. Provided, however, that such condition shall not constitute a reason for Constructive Discharge unless the Executive provides written notice of such condition within sixty (60) days of its occurrence and provides the Company with thirty (30) days to remedy the condition. Further, any termination of employment by the Executive must occur within one hundred twenty (120) days from the initial existence of the condition giving rise to the Constructive Discharge.

3. “Without Cause Termination” means termination of the Executive’s employment by the Company (a) other than due to death, disability, Termination for Cause or pursuant to Section XI; or (b) upon expiration of the Period of Employment as a result of the giving of notice by the Company of its intent not to extend the Period of Employment as provided in Section III.A.

SECTION IX

OTHER DUTIES OF THE EXECUTIVE DURING AND AFTER THE PERIOD OF EMPLOYMENT

A. The Executive will, with reasonable notice during or after the Period of Employment, furnish information as may be in his possession and cooperate with the Company as may reasonably be requested in connection with any claims or legal actions in which the Company is or may become a party.

B. The Executive recognizes and acknowledges that all information pertaining to the affairs, business, clients, customers or other relationships of the Company, as hereinafter defined, is confidential and is a unique and valuable asset of the Company. Access to and knowledge of this information are essential to the performance of the Executive’s duties under this Agreement. The Executive will not during the Period of Employment or after except to the extent reasonably necessary in performance of the duties under this Agreement, give to any person, firm, association, corporation or governmental agency any information concerning the affairs, business, clients, customers or other relationships of the Company except as required by law. The Executive will not make use of this type of information for his own purposes or for the benefit of any person or organization other than the Company. The Executive will also use his best efforts to prevent the disclosure of this information by others. All records, memoranda, etc. relating to the business of the Company whether made by the Executive or otherwise coming into his possession are confidential and will remain the property of the Company.

C. During the Period of Employment and for a twelve (12) month period thereafter, the Executive will not use his status with the Company to obtain loans, goods or services from another organization on terms that would not be available to him in the absence of his relationship to the Company. During the Period of Employment and for a twelve (12) month period following termination of the Period of Employment, other than termination due to a Without Cause Termination, a Constructive Discharge or termination pursuant to Section XI: the Executive will not make any statements or perform any acts intended to advance the interest of any existing or prospective competitors of the Company in any way that will injure the interest of the Company; the Executive without prior express written approval by the Board of Directors of the Company will not directly or indirectly own or hold any proprietary interest in or be employed by or receive compensation from any party engaged in the same or any similar business in the same geographic areas the Company does business; and the Executive without express prior written approval from the Board of Directors, will not solicit any members of the then current clients of the Company or discuss with any employee of the Company information or operation of any business intended to compete with the Company. For the purposes of the Agreement, proprietary interest means legal or equitable ownership, whether through stock holdings or otherwise, of a debt or equity interest (including options, warrants, rights and convertible interests) in a business firm or entity, or ownership of more than 5% of any class of equity interest in a publicly-held company. The Executive acknowledges that the covenants contained herein are reasonable as to geographic and temporal scope. For a twelve (12) month period after termination of the Period of Employment for any reason, the Executive will not directly or indirectly hire any employee of the Company or solicit or encourage any such employee to leave the employ of the Company.

D. The Executive acknowledges that his breach or threatened or attempted breach of any provision of Section IX would cause irreparable harm to the Company not compensable in monetary damages and that the Company shall be entitled, in addition to all other applicable remedies, to a temporary and permanent injunction and a decree for specific performance of the terms of Section IX without being required to prove damages or furnish any bond or other security.

E. The Executive shall not be bound by the provisions of Section IX in the event of the default by the Company in its obligations under this Agreement which are to be performed upon or after termination of this Agreement.

SECTION X

INDEMNIFICATION, LITIGATION

The Company will indemnify the Executive to the fullest extent permitted by the laws of the state of incorporation in effect at that time, or certificate of incorporation and by-laws of the Company whichever affords the greater protection to the Executive. The Executive will be entitled to any insurance proceeds related to any award, or any fees or expenses incurred in connection with any action, suit or proceeding to which he may be made a party by reason of being a director or officer of the Company.

SECTION XI

CHANGE IN CONTROL

In the event there is a Change in Control of the ownership of the Company and within the six (6) month period following such event, the Executive elects to resign upon written notice to the Company, the Company shall pay to the Executive on such resignation in a lump sum an amount equal to 100% of his Base Salary as in effect at the time of such resignation, and subject to Section XII, will be paid at the time of termination of employment. In addition, earned but unpaid Base Salary and Incentive Compensation Awards will be paid on a pro-rated basis for the year in which resignation occurs. Any stock options granted to the Executive prior to termination pursuant to the Plan, but subject to vesting restrictions, will be fully vested upon a Change in Control whether or not the Executive resigns. The benefits and perquisites described in this Agreement as in effect at the date of termination of employment will also be continued for twelve (12) months from the effective date of termination pursuant to Change of Control.

A “Change in Control” shall be deemed to have occurred if (i) a tender offer shall be made and consummated for the ownership of more than 50% of the outstanding voting securities of the Company, (ii) the Company shall be merged or consolidated with another corporation and as a result of such merger or consolidation less than 75% of the outstanding voting securities of the surviving or resulting corporation shall be owned in the aggregate by the former shareholders of the Company, as the same shall have existed immediately prior to such merger or consolidation, (iii) the Company shall sell all or substantially all of its assets to another corporation which is not a wholly-owned subsidiary, (iv) a person, within the meaning of Section 3(a)(9) or of Section 13(d)(3) (as in effect on the date hereof) of the Securities and Exchange Act of 1934 (“Exchange Act”), shall acquire more than 50% of the outstanding voting securities of the Company (whether directly, indirectly, beneficially or of record) ) or (v) the individuals who, as of the date hereof, constitute the Board of the Company (the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company’s shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person or group other than the Board. For purposes hereof, ownership of voting securities shall take into account and shall include ownership as determined by applying the provisions of Rule 13d-3(d)(1)(i) (as in effect on the date hereof) pursuant to the Exchange Act.

SECTION XII

CODE SECTION 409A COMPLIANCE

A. This Agreement and any payments or benefits provided hereunder shall be interpreted, operated and administered in a manner intended to avoid the imposition of additional taxes under Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). Further, the parties acknowledge and agree that the form and timing of the payments and benefits to be provided pursuant to this Agreement are intended comply with Section 409A of the Code or to be exempt from, or to comply with, one or more exceptions to the requirements of Section 409A of the Code. Notwithstanding any provision of this Agreement to the contrary, the Company, its affiliates, subsidiaries, successors, and each of their respective officers, directors, employees and representatives, neither represent nor warrant the tax treatment under any federal, state, local, or foreign laws or regulations thereunder (individually and collectively referred to as the “Tax Laws”) of any payment or benefits contemplated by this Agreement including, but not limited to, when and to what extent such payments or benefits may be subject to tax, penalties and interest under the Tax Laws.

B. If and to the extent required to comply with Section 409A of the Code, no payment or benefit required to be paid under this Agreement on account of termination of the Executive’s employment shall be made unless and until the Executive incurs a “separation from service” within the meaning of Section 409A of the Code.

C. Delayed Payments.

1. Notwithstanding any other payment schedule provided herein or any provision herein regarding the timing of payments in this Agreement to the contrary, if, and only if, the Executive is deemed on the date of termination of employment to be a “specified employee” within the meaning of that term under Section 409A(a)(2)(B) of the Code, then the terms of this Section XII.C. shall apply as required by Section 409A of the Code so as to avoid the imposition of additional tax under Section 409A of the Code. Any payment that is considered deferred compensation under Section 409A of the Code payable on account of a “separation from service” shall be made on the date which is the earlier of (a) the expiration of the six (6) month period measured from the date of such “separation from service” of Executive or (b) the date of Executive’s death (the “Delay Period”) to the extent required under Section 409A of the Code. Upon the expiration of the Delay Period, all payments delayed pursuant to the immediately preceding sentence (whether they otherwise would have been payable in a single sum or in installments in the absence of such delay) shall be paid to Executive in a lump sum by the Company at the end of the Delay Period, and all remaining payments due under this Agreement shall be paid or provided in accordance with the normal payment dates specified for them herein; and

2. To the extent that any benefits to be provided during the Delay Period are considered deferred compensation under Section 409A of the Code provided on account of a “separation from service,” and such benefits are not otherwise exempt from Section 409A of the Code, Executive shall pay the cost of such benefits during the Delay Period, and the Company shall reimburse Executive, to the extent that such costs otherwise would have been paid by the Company or to the extent that such benefits otherwise would have been provided by the Company at no cost to Executive, the Company’s share of the cost of such benefits upon expiration of the Delay Period, and any remaining benefits shall be reimbursed or provided by the Company in accordance with the procedures specified herein.

D. Disability shall mean a medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than twelve months, where such impairment causes the Executive to be unable to perform the duties under this Agreement or any substantially similar position of employment.

E. The Executive and the Company shall cooperate to determine the application of Section 409A of the Code to the provisions of this Agreement. If the Executive and the Company are unable to agree on the application of Section 409A of the Code within ten (10) business days after the Executive’s separation from service with the Company, then the application of Section 409A of the Code to any provision of this Agreement in dispute shall be determined by an accounting firm of recognized national standing acceptable to the Executive and the Company. The accounting firm shall be instructed to use every reasonable effort to make its determination within ten (10) business days after it is retained. The parties will cooperate fully with the accounting firm. The costs and expenses for the services of the accounting firm shall be borne equally by the Executive and the Company.

SECTION XIII

WITHHOLDING TAXES

The Company may directly or indirectly withhold from any payments under this Agreement all federal, state, city or other taxes that shall be required pursuant to any law or governmental regulation.

SECTION XIV

EFFECTIVE PRIOR AGREEMENTS

This Agreement contains the entire understanding between the Company and the Executive with respect to the subject matter and supersedes any prior employment or severance agreements between the Company and its affiliates, and the Executive.

SECTION XV

CONSOLIDATION, MERGER OR SALE OF ASSETS

Nothing in this Agreement shall preclude the Company from consolidating or merging into or with, or transferring all or substantially all of its assets to, another corporation which assumes this Agreement and all obligations and undertakings of the Company hereunder. Upon such a Consolidation, Merger or Sale of Assets, the term “the Company” as used will mean the other corporation and this Agreement shall continue in full force and effect. This Section XV is not intended to modify or limit the rights of the Executive hereunder, including without limitation, the rights of Executive under Section XI.

SECTION XVI

MODIFICATION

This Agreement may not be modified or amended except in writing signed by the parties. No term or condition of this Agreement will be deemed to have been waived except in writing by the party charged with waiver. A waiver shall operate only as to the specific term or condition waived and will not constitute a waiver for the future or act on anything other than that which is specifically waived.

SECTION XVII

GOVERNING LAW; ARBITRATION

This Agreement has been executed and delivered in the State of Tennessee and its validity, interpretation, performance and enforcement shall be governed by the laws of that state.

Any dispute among the parties hereto shall be settled by arbitration in Nashville, Tennessee, in accordance with the rules then obtaining of the American Arbitration Association and judgment upon the award rendered may be entered in any court having jurisdiction thereof.

SECTION XVIII

NOTICES

All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been made when delivered or mailed first-class postage prepaid by registered mail, return receipt requested, or if delivered by hand, overnight delivery service or confirmed facsimile transmission, to the following:

(a) If to the Company, at 1621 Galleria Boulevard, Brentwood, TN 37027-2926, Attention: President or Chief Executive Officer, or at such other address as may have been furnished to the Executive by the Company in writing; or

(b) If to the Executive, at 528 Grand Oaks Dr., Brentwood, TN 37027, or such other address as may have been furnished to the Company by the Executive in writing.

SECTION XIX

BINDING AGREEMENT

This Agreement shall be binding on the parties’ successors, heirs and assigns.

IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date first above written.

ADVOCAT INC.
By:	/s/ Kelly Gill
	Kelly Gill
Title:	President and Chief Executive Officer
EXECUTIVE:
/s/ Sam Daniel
Sam Daniel

EX-10.44

EXHIBIT 10.44

SEPARATION AGREEMENT

This Separation Agreement (“Agreement”) is made and entered as of February 8, 2012, by and among Advocat Inc., a Delaware corporation (the “Company”), and William David Houghton (hereinafter “Employee”).

WITNESSETH:

WHEREAS, Employee has been employed by Company as Chief Information Officer; and

WHEREAS, Company and Employee have agreed to mutually terminate their employment relationship;

NOW, THEREFORE, in consideration of the mutual promises contained herein and other good and valuable consideration, the receipt of which is hereby acknowledged, the parties agree to the following terms and conditions governing the termination of Employee’s employment from Company:

1. Last Day of Employment and Termination of Employment Agreement. Employee’s last day of employment with Company shall be February 3, 2012 (“Date of Termination”). Employee and the Company acknowledge and agree that both parties are subject to a certain Employment Agreement dated June 28, 2010, as amended March 9, 2011 (the “Employment Agreement”) and that in consideration of the payments and other consideration set forth herein, the Employment Agreement shall terminate effective as of the date set forth above and, as of the effective date, the Employment Agreement shall be void and have no further effect, except that the provisions of Section IX and X shall survive the termination and shall be enforceable as written. The provisions of paragraphs 2 through 8 of this Agreement shall supercede and replace the provisions of Sections VIII and XI of the Employment Agreement in their entirety. The mutual termination of Employee’s employment with the Company is a “Without Cause Termination” as that term is defined in the Employment Agreement.

2. Severance Payment. All earned but unpaid Base Salary and Incentive Compensation Awards and accrued, but unused, vacation time shall be paid on the Date of Termination. The Parties agree that the earned but unpaid Incentive Compensation Award for 2011 is $72,900.00 (less normal withholdings). In addition, the Company agrees to pay to Employee a lump sum amount of $200,000 upon the Date of Termination which payment will be less normal withholding.

3. COBRA Continuation Coverage. Employee has been covered under a group medical or health benefits plan while employed by Company. Employee shall have a right to continue such coverage in accord with the provisions of COBRA. Employee may exercise the option of continuing such coverage consistent with, for the duration allowed by, and under the conditions imposed under applicable federal and state laws. If Employee elects to continue COBRA benefits, Company will pay the cost of such health insurance benefits for twelve months after the Date of Termination. Thereafter, Employee will bear the expense of such benefits. Company shall provide Employee with a standard “COBRA” letter providing further details concerning Employee’s health insurance continuation rights.

4. Disability and Life Insurance Coverage. Each month for a period of twelve months following the Date of Termination, the Company shall reimburse Employee for the cost of disability and/or life insurance premiums, subject to any required withholding, provided that Employee has furnished to the Company evidence, as reasonable required by the Company, of his payment of disability and/or life insurance premiums.

5. Stock Options. Employee’s outstanding stock options and stock appreciation rights (“SARs”) shall be deemed vested and shall remain exercisable until December 31, 2012. Upon the written request of Employee within 30 days of the Date of Termination, the Company shall purchase from Employee all of such options and SARs for an amount equal to the difference between the fair market value of a share of the Company’s common stock on the Date of Termination and the per share exercise price of such option or SAR. All restrictions on Employee’s Restricted Stock shall terminate as of the Date of Termination and Employee shall receive unrestricted shares of Stock, including all dividends paid on such Restricted Stock through the Date of Termination.

6. Restricted Share Units. On the date which is the six months from the Date of Termination (the “Delayed Payment Date”), the Company shall deliver to Employee unrestricted shares of common stock of the Company equal to the number of Restricted Shares Units held by Employee under the 2008 Stock Purchase Plan For Key Personnel (“2008 Stock Plan”), adjusted for dividends through the Delayed Payment Date, rounded down to the nearest whole share, and will make a payment to Employee in amount representing the value of any remaining fractional Restricted Share Units held by Employee using the value per share as determined under Section 2(p) of the 2008 Stock Plan.

7. Transfer of Employee 401(k) Accounts. If requested in writing by Employee, Company shall, as and to the extent permitted by applicable law, transfer Employee’s 401(k) plan to an account designated by Employee. Notwithstanding the foregoing, no unvested amounts shall be transferred to Employee.

8. EIRP Payment. The Company shall pay Employee an amount equal to the Company’s matching contributions to the EIRP for four quarters, payable in one lump sum of $12,000 less normal withholdings.

9. Confidentiality. Employee hereby agrees that the terms of this Agreement shall remain STRICTLY CONFIDENTIAL and that Employee shall not disclose the benefits Employee has received, or will receive, from Company pursuant to the terms of this Agreement to any other person including, without limitation, any future, current, or former employee of, or applicant for employment with, Company, but excluding Employee’s immediate family, and legal and tax advisors, if any, unless compelled to do so by judicial or administrative process. The foregoing representation is a material term and condition of this Agreement.

10. Governing Law and Venue. This Agreement supersedes any prior agreements between the parties except as noted herein and constitutes and contains the entire agreement and understanding between the parties and may not be modified except by a writing signed by both parties. This Agreement shall be interpreted under the laws of the State of Tennessee. The parties hereto submit to the jurisdiction of any federal or state court of competent jurisdiction sitting in the State of Tennessee over any suit, action or proceeding arising out of or relating to this Agreement.

11. Entire Agreement. This Agreement contains the entire understanding between the parties concerning the subject matter hereof and it may be amended or modified only by another writing executed by both parties. There have been no offers or inducements with respect to the execution of this Agreement by Employee except as set forth herein.

12. Cooperation, Mutual Respect, No Disparagement. The parties agree that certain matters which Employee was involved in during his period of employment may necessitate Employee’s cooperation in the future. Employee agrees to cooperate with all reasonable requests of Company for such assistance in the future provided that the Company may not make any such requests after one (1) year from the effective date of this Agreement. Each party agrees to mutually respect the other and to refrain from making any disparaging comments about the other or disparaging the business of the other.

13. No Admission. Each party acknowledges that this document does not constitute an admission by the other party of any unlawful act or of any violation of any statute, regulation or other provision of statutory, regulatory or common law.

14. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto, their heirs, estates, successors and assigns, their affiliates, employees, directors, officers, shareholders, and agents. The provisions of this Agreement are severable. If any provision is held to be invalid or unenforceable, it shall not affect the validity or enforceability of any other provision.

15. Notices. Any notice or communication required or permitted to be given hereunder shall be deemed to have been properly given when received, addressed as follows (or to such other addresses as the parties may specify by due notice to the others):

Company:

Advocat Inc.

1621 Galleria Boulevard

Brentwood, TN 37027-2926

Employee:

David Houghton

440 Tinnan Avenue

Franklin, TN 37067

16. Counterpart Copies. This Agreement may be executed in one or more counterparts, all of which will be considered one and the same.

17. Legal Fees and Costs. In the event any party hereto elects to incur legal expenses to enforce or interpret any provision of this Agreement, the prevailing party will be entitled to recover such legal expenses, including without limitation, attorney’s fees, costs and necessary disbursements, in addition to any other relief to which such party shall be entitled.

ADVOCAT INC
By:	/s/ David Hickman
Title:	VP, HR
EMPLOYEE:
/s/ William David Houghton
William David Houghton

EX-21

Exhibit 21

Subsidiaries

Advocat Ancillary Services, Inc.

Advocat Distribution Services, Inc.

Advocat Finance, Inc.

Diversicare Afton Oaks, LLC

Diversicare Assisted Living Services, Inc.

Diversicare Assisted Living Services NC, LLC

Diversicare Assisted Living Services NC I, LLC

Diversicare Assisted Living Services NC II, LLC

Diversicare Ballinger, LLC

Diversicare Briarcliff, LLC

Diversicare Chisolm, LLC

Diversicare Clinton, LLC

Diversicare Doctors, LLC

Diversicare Estates, LLC

Diversicare Hartford, LLC

Diversicare Hillcrest, LLC

Diversicare Humble, LLC

Diversicare Katy, LLC

Diversicare Lampasas, LLC

Diversicare Leasing Corp.

Diversicare Management Services Co.

Diversicare Normandy Terrace, LLC

Diversicare Paris, LLC

Diversicare Pharmacy Holdings, LLC

Diversicare Pinedale, LLC

Diversicare Rose Terrace, LLC

Diversicare Texas I, LLC

Diversicare Therapy Services, LLC

Diversicare Treemont, LLC

Diversicare Windsor House, LLC

Diversicare Yorktown, LLC

Senior Care Cedar Hills, LLC

Senior Care Florida Leasing, LLC

Senior Care Golfcrest, LLC

Senior Care Golfview, LLC

Senior Care Southern Pines, LLC

Sterling Health Care Management, Inc.

EX-23.1

EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Advocat Inc.

Brentwood, Tennessee

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File Numbers 333-134905, 333-151565 and 333-167630) of Advocat Inc. of our report dated March 7, 2012, relating to the consolidated financial statements and financial statement schedule which appears in this Form 10-K.

/s/ BDO USA, LLP

Nashville, Tennessee

March 7, 2012

42

EX-31.1

Exhibit 31.1

CERTIFICATIONS PURSUANT TO SECTION 302 OF

THE SARBANES-OXLEY ACT OF 2002

(i) CERTIFICATION

I, Kelly J. Gill, certify that:

1. I have reviewed this annual report on Form 10-K of Advocat Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 7, 2012

/s/ Kelly J. Gill

Kelly J. Gill

Chief Executive Officer

43

EX-31.2

Exhibit 31.2

CERTIFICATIONS PURSUANT TO

SECTION 302 OF

THE SARBANES-OXLEY ACT OF 2002

(ii) CERTIFICATION

I, L. Glynn Riddle, Jr., certify that:

1. I have reviewed this annual report on Form 10-K of Advocat Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 7, 2012

/s/ L. Glynn Riddle, Jr.

L. Glynn Riddle, Jr.

Chief Financial Officer

44

EX-32

EXHIBIT 32

CERTIFICATION OF ANNUAL REPORT ON FORM 10-K

OF ADVOCAT INC.

FOR THE YEAR ENDED DECEMBER 31, 2011

The undersigned hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the undersigned’s best knowledge and belief, the Annual Report on Form 10-K for Advocat Inc. (the “Company”) for the period ending December 31, 2011 as filed with the Securities and Exchange Commission on the date hereof (the “Report”):

(a) fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(b) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

This Certification is executed as of March 7, 2012.

/s/ Kelly J. Gill

Kelly J. Gill

Chief Executive Officer

/s/ L. Glynn Riddle, Jr.

L. Glynn Riddle, Jr.

Chief Financial Officer

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

45

XML

Company and Organization

12 Months Ended

Dec. 31, 2011

Company and Organization [Abstract]

COMPANY AND ORGANIZATION

1. COMPANY AND ORGANIZATION

Advocat Inc. (together with its subsidiaries, “Advocat” or the “Company”) provides long-term care services to nursing center patients in eight states, primarily in the Southeast and Southwest United States. The Company’s centers provide a range of health care services to their patients. In addition to the nursing, personal care and social services usually provided in long-term care centers, the Company offers a variety of comprehensive rehabilitation services as well as nutritional support services.

As of December 31, 2011, the Company’s continuing operations consist of 47 nursing centers with 5,445 licensed nursing beds. The Company owns 9 and leases 38 of its nursing centers. The Company’s continuing operations include centers in Alabama, Arkansas, Florida, Kentucky, Ohio, Tennessee, Texas and West Virginia.

XML

Consolidated Statements of Cash Flows (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$ 1,367,000	$ 3,849,000	$ 2,601,000
Discontinued operations	(17,000)	(114,000)	721,000
Net income from continuing operations	1,384,000	3,963,000	1,880,000
Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:
Depreciation and amortization	6,592,000	5,825,000	5,446,000
Provision for doubtful accounts	2,330,000	2,127,000	1,965,000
Deferred income tax provision (benefit)	801,000	2,041,000	(528,000)
Provision for (benefit from) self-insured professional liability, net of cash payments	1,767,000	(754,000)	2,774,000
Stock-based compensation	537,000	597,000	689,000
Amortization of deferred balances	160,000	213,000	382,000
Provision for leases in excess of cash payments	320,000	782,000	1,254,000
Payment from lessor for leasehold improvement		120,000	771,000
Non-cash gain on settlement of contingent liability			(549,000)
Foreign currency transaction gain			(191,000)
Debt retirement costs	79,000	127,000
Non-cash interest income			(41,000)
Non-cash interest accretion	176,000
Asset impairment	344,000
Changes in other assets and liabilities affecting operating activities:
Receivables, net	(6,507,000)	(3,787,000)	(4,200,000)
Prepaid expenses and other assets	(140,000)	(1,817,000)	621,000
Trade accounts payable and accrued expenses	1,589,000	(94,000)	(4,000)
Net cash provided by continuing operations	9,432,000	9,343,000	10,269,000
Discontinued operations	609,000	713,000	2,109,000
Net cash provided by operating activities	10,041,000	10,056,000	12,378,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(13,357,000)	(6,363,000)	(6,372,000)
Payment for construction in progress - leased facility			(6,891,000)
Notes receivable collected			4,184,000
Increase in restricted cash	(1,029,000)
Deposits and other deferred balances	(31,000)		59,000
Net cash used in continuing operations	(14,417,000)	(6,363,000)	(9,020,000)
Discontinued operations		(45,000)	(187,000)
Net cash used in investing activities	(14,417,000)	(6,408,000)	(9,207,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt obligations	(24,583,000)	(4,278,000)	(7,581,000)
Proceeds from issuance of debt	29,554,000	3,463,000
Financing costs	(797,000)	(511,000)	(42,000)
Payment of common stock dividends	(1,272,000)	(1,203,000)	(573,000)
Payment of preferred stock dividends	(344,000)	(344,000)	(344,000)
Non-controlling interest equity investment	3,000
Construction allowance receipts - leased facility			6,891,000
Payment for preferred stock restructuring	(546,000)	(528,000)	(512,000)
Issuance of restricted share units	190,000	57,000	76,000
Net settlement of exercised stock options	1,000	(51,000)	(75,000)
Net cash provided by (used in) financing activities	2,206,000	(3,395,000)	(2,160,000)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	(2,170,000)	253,000	1,011,000
CASH AND CASH EQUIVALENTS, beginning of period	8,862,000	8,609,000	7,598,000
CASH AND CASH EQUIVALENTS, end of period	6,692,000	8,862,000	8,609,000
SUPPLEMENTAL INFORMATION:
Cash payments of interest, net of amounts capitalized	1,875,000	1,353,000	1,512,000
Cash payments of income taxes, net of refunds	627,000	617,000	1,413,000
NON-CASH TRANSACTIONS:
Capital Lease Obligations Incurred	478,000	387,000
Non cash reductions of property and long term liability			$ 7,700,000

XML

Consolidated Balance Sheets (USD $)	Dec. 31, 2011	Dec. 31, 2010
CURRENT ASSETS:
Cash and cash equivalents	$ 6,692,000	$ 8,862,000
Receivables, less allowance for doubtful accounts of $2,882,000 and $2,822,000, respectively	26,342,000	23,801,000
Other receivables	1,739,000	424,000
Prepaid expenses and other current assets	3,448,000	4,102,000
Income tax refundable	1,058,000	1,439,000
Deferred income taxes	6,041,000	4,207,000
Total current assets	45,320,000	42,835,000
PROPERTY AND EQUIPMENT, at cost	93,351,000	78,690,000
Less accumulated depreciation	(47,326,000)	(41,563,000)
Discontinued operations, net	1,053,000	1,053,000
Property and equipment, net (variable interest entity restricted - 2011: $7,298,000; 2010: $0)	47,078,000	38,180,000
OTHER ASSETS:
Deferred income taxes	10,352,000	12,408,000
Deferred financing and other costs, net	1,318,000	834,000
Other assets	3,680,000	2,319,000
Acquired leasehold interest, net	8,996,000	9,380,000
Total other assets	24,346,000	24,941,000
Total assets	116,744,000	105,956,000
LIABILITIES AND SHAREHOLDERS' EQUITY
Current portion of long-term debt and capitalized lease obligations (variable interest entity nonrecourse - 2011: $173,000; 2010: $0)	1,131,000	582,000
Trade accounts payable	3,928,000	3,120,000
Accrued expenses:
Payroll and employee benefits	13,589,000	11,047,000
Current portion of self-insurance reserves	8,470,000	7,379,000
Other current liabilities	2,767,000	4,479,000
Total current liabilities	29,885,000	26,607,000
NONCURRENT LIABILITIES:
Long-term debt and capitalized lease obligations, less current portion (variable interest entity nonrecourse - 2011: $5,067,000; 2010: $0)	28,768,000	23,819,000
Self-insurance liabilities, less current portion	12,049,000	11,659,000
Other noncurrent liabilities	18,155,000	16,748,000
Total noncurrent liabilities	58,972,000	52,226,000
COMMITMENTS AND CONTINGENCIES
SERIES C REDEEMABLE PREFERRED STOCK, $.10 par value, 5,000 shares authorized, issued and outstanding, stated value of $4,918,000	4,918,000	4,918,000
SHAREHOLDERS' EQUITY:
Series A preferred stock, authorized 200,000 shares, $.10 par value, none issued and outstanding
Common stock, authorized 20,000,000 shares, $.01 par value, 6,061,000 and 5,976,000 shares issued, 5,829,000 and 5,744,000 shares outstanding, respectively	61,000	60,000
Treasury stock at cost, 232,000 shares of common stock	(2,500,000)	(2,500,000)
Paid-in capital	18,219,000	17,896,000
Retained earnings	6,480,000	6,749,000
Accumulated other comprehensive loss	(945,000)	0
Total shareholders' equity of Advocat Inc.	21,315,000	22,205,000
Non-controlling interests	1,654,000	0
Total shareholders' equity	22,969,000	22,205,000
Total Liabilities and shareholder's equity	$ 116,744,000	$ 105,956,000

XML

Consolidated Statements of Comprehensive Income (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Consolidated Statements of Comprehensive Income [Abstract]
NET INCOME	$ 1,367,000	$ 3,849,000	$ 2,601,000
OTHER COMPREHENSIVE INCOME:
Change in fair value of cash flow hedge	(1,524,000)
Income tax benefit	579,000
Total other comprehensive income	(945,000)
COMPREHENSIVE INCOME	$ 422,000	$ 3,849,000	$ 2,601,000

XML

Consolidated Statements of Shareholders' Equity (USD $)	Total	Common Stock	Non- Controlling Interests	Treasury Stock	Paid-in Capital	Retained Earnings	Accumulated Other Comprehensive Loss	Total Shareholders' Equity of Advocat Inc.
Balance at Dec. 31, 2008	$ 17,551,000	$ 59,000	$ 0	$ (2,500,000)	$ 16,903,000	$ 3,089,000	$ 0	$ 0
Balance, shares at Dec. 31, 2008		5,903,000		232,000
Net Income	2,601,000					2,601,000
Preferred stock dividends	(344,000)					(344,000)
Common stock dividends declared	(853,000)				6,000	(859,000)
Exercise of stock options	(76,000)				(76,000)
Exercise of stock options, shares		46,000
Purchase of restricted share units	76,000				76,000
Tax impact of equity grant exercises	118,000				118,000
Stock based compensation	620,000				620,000
Balance at Dec. 31, 2009	19,693,000	59,000	0	(2,500,000)	17,647,000	4,487,000	0	0
Balance, shares at Dec. 31, 2009		5,949,000		232,000
Net Income	3,849,000					3,849,000
Preferred stock dividends	(344,000)					(344,000)
Common stock dividends declared	(1,234,000)				9,000	(1,243,000)
Exercise of stock options	(50,000)	1,000			(51,000)
Exercise of stock options, shares		27,000
Purchase of restricted share units	29,000				29,000
Tax impact of equity grant exercises	(90,000)				(90,000)
Stock based compensation	352,000				352,000
Balance at Dec. 31, 2010	22,205,000	60,000	0	(2,500,000)	17,896,000	6,749,000	0	22,205,000
Balance, shares at Dec. 31, 2010		5,976,000		232,000
Net Income	1,367,000					1,367,000		1,367,000
Preferred stock dividends	(344,000)					(344,000)		(344,000)
Common stock dividends declared	(1,271,000)				21,000	(1,292,000)		(1,271,000)
Issuance/redemption of equity grants, net	40,000	1,000			39,000			40,000
Issuance/redemption of equity grants, net, shares		85,000
Interest rate cash flow hedge	(945,000)						(945,000)	(945,000)
Tax impact of equity grant exercises	(162,000)				(162,000)			(162,000)
Consolidation of non-controlling interests of variable interest entity	1,654,000		1,654,000
Stock based compensation	425,000				425,000			425,000
Balance at Dec. 31, 2011	$ 22,969,000	$ 61,000	$ 1,654,000	$ (2,500,000)	$ 18,219,000	$ 6,480,000	$ (945,000)	$ 21,315,000
Balance, shares at Dec. 31, 2011		6,061,000		232,000

XML

Consolidated Balance Sheets (Parenthetical) (USD $)	Dec. 31, 2011	Dec. 31, 2010
Consolidated Balance Sheets [Abstract]
Allowance for doubtful accounts receivable	$ 2,882,000	$ 2,822,000
Property and equipment, variable interest entity restricted	7,298,000	0
Current portion of long-term debt and capitalized lease obligations, variable interest entity nonrecourse	173,000	0
Long-term debt and capitalized lease obligations, variable interest entity nonrecourse	$ 5,067,000	$ 0
Redeemable preferred stock, par value	$ 0.10	$ 0.10
Redeemable preferred stock, shares authorized	5,000	5,000
Redeemable preferred stock, shares issued	5,000	5,000
Redeemable preferred stock, shares outstanding	5,000	5,000
Preferred stock, par value	$ 0.10	$ 0.10
Preferred stock, shares authorized	200,000	200,000
Preferred stock, shares issued
Preferred stock, shares outstanding
Common stock, par value	$ 0.01	$ 0.01
Common stock, shares authorized	20,000,000	20,000,000
Common stock, shares issued	6,061,000	5,976,000
Common stock, shares outstanding	5,829,000	5,744,000
Treasury stock, shares	232,000	232,000

XML

Net Income (Loss) Per Common Share

12 Months Ended

Dec. 31, 2011

Net Income (Loss) Per Common Share [Abstract]

NET INCOME (LOSS) PER COMMON SHARE

9. NET INCOME (LOSS) PER COMMON SHARE

Information with respect to the calculation of basic and diluted net income (loss) per common share is presented below:

	2011			2010			2009
Basic net income per common share
Net income from continuing operations	$	1,384,000		$	3,963,000		$	1,880,000
Preferred stock dividends		(344,000	)		(344,000	)		(344,000	)
Net income from continuing operations for common stock		1,040,000			3,619,000			1,536,000
Discontinued operations:
Operating income (loss), net of taxes		(17,000	)		344,000			721,000
Loss on disposal and impairment, net of taxes		—			(458,000	)		—
Income (loss) from discontinued operations		(17,000	)		(114,000	)		721,000
Net income for common stock	$	1,023,000		$	3,505,000		$	2,257,000
Basic weighted average common shares outstanding		5,774,000			5,732,000			5,678,000
Basic net income per common share:
Net income from continuing operations	$	0.18		$	0.63		$	0.27
Income (loss) from discontinued operations		—			(0.02	)		0.13
Basic net income per common share	$	0.18		$	0.61		$	0.40

	2011			2010			2009
Diluted net income per common share
Net income from continuing operations for common stock
	$	1,040,000		$	3,619,000		$	1,536,000
Discontinued operations:
Operating income, net of taxes		(17,000	)		344,000			721,000
Loss on disposal and impairment, net of taxes		—			(458,000	)		—
Income (loss) from discontinued operations operations		(17,000	)		(114,000	)		721,000
Net income for common stock	$	1,023,000		$	3,505,000		$	2,257,000
Basic weighted average common shares outstanding		5,774,000			5,732,000			5,678,000
Incremental shares from assumed exercise of options, SoSARs and Restricted Stock Units		132,000			122,000			119,000
Diluted weighted average common shares outstanding		5,906,000			5,854,000			5,797,000
Diluted net income per common share
Net income from continuing operations	$	0.18		$	0.62		$	0.26
Net income (loss) from discontinued operations operations		(0.01	)		(0.02	)		0.13
Diluted net income per common share	$	0.17		$	0.60		$	0.39

The dilutive effects of the Company’s stock options and Restricted Share Units are included in the computation of diluted income per common share during the periods they are considered dilutive.

The following table reflects the weighted average outstanding SOSARs and Options that were excluded from the computation of diluted earnings per share, as they would have been anti-dilutive:

	2011		2010		2009
SOSARs/Options Excluded		202,000		323,000		228,000

XML

Document and Entity Information (USD $)	12 Months Ended
	Dec. 31, 2011	Feb. 17, 2012	Jun. 30, 2011
Document and Entity Information [Abstract]
Entity Registrant Name	ADVOCAT INC
Entity Central Index Key	0000919956
Document Type	10-K
Document Period End Date	Dec. 31, 2011
Amendment Flag	false
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	FY
Current Fiscal Year End Date	--12-31
Entity Well-known Seasoned Issuer	No
Entity Voluntary Filers	No
Entity Current Reporting Status	Yes
Entity Filer Category	Smaller Reporting Company
Entity Public Float			$ 17,238,000
Entity Common Stock, Shares Outstanding		5,824,774

XML

Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes [Abstract]

INCOME TAXES

10. INCOME TAXES

The provision (benefit) for income taxes of continuing operations is composed of the following components:

	Year Ended December 31,
	2011		2010			2009
Current provision :
Federal	$	73,000	$	(139,000	)	$	1,543,000
State		225,000		(44,000	)		150,000
		298,000		(183,000	)		1,693,000
Deferred provision (benefit):
Federal		199,000		1,851,000			(544,000	)
State		12,000		190,000			16,000
		211,000		2,041,000			(528,000	)
Provision for income taxes of continuing operations	$	509,000	$	1,858,000		$	1,165,000

A reconciliation of taxes computed at statutory income tax rates on income from continuing operations is as follows:

	Year Ended December 31,
	2011			2010			2009
Provision for federal income taxes at statutory rates	$	644,000		$	1,979,000		$	1,035,000
Provision for state income taxes, net of federal benefit		149,000			97,000			221,000
Resolution with tax authorities		(79,000	)		—			—
Valuation allowance changes affecting the provision for income taxes		(8,000	)		(2,000	)		(76,000	)
Employment tax credits		(1,000,000	)		(580,000	)		(600,000	)
Nondeductible expenses		437,000			357,000			516,000
Stock based compensation expense		410,000			—			—
Other		(44,000	)		7,000			69,000
Provision for income taxes of continuing operations	$	509,000		$	1,858,000		$	1,165,000

The net deferred tax assets and liabilities, at the respective income tax rates, are as follows:

		$10,352,000			$10,352,000
	December 31,
	2011			2010
Current deferred assets:
Credit carryforwards	$	1,288,000		$	580,000
Allowance for doubtful accounts		1,066,000			953,000
Accrued liabilities		4,961,000			3,813,000
		7,315,000			5,346,000
Less valuation allowance		(298,000	)		(196,000	)
		7,017,000			5,150,000
Current deferred liabilities:
Prepaid expenses		(976,000	)		(943,000	)
	$	6,041,000		$	4,207,000

		$10,352,000			$10,352,000
	December 31,
	2011			2010
Noncurrent deferred assets:
Net operating loss and other carryforwards	$	1,720,000		$	2,050,000
Deferred lease costs		416,000			471,000
Depreciation		(2,589,000	)		(872,000	)
Tax goodwill and intangibles		(469,000	)		(158,000	)
Stock-based compensation		1,242,000			1,847,000
Accrued rent		4,582,000			4,394,000
Impairment of long-lived assets		656,000			513,000
Interest rate swap		579,000			—
Noncurrent self-insurance liabilities		4,785,000			4,843,000
		10,922,000			13,088,000
Less valuation allowance		(570,000	)		(680,000	)
	$	10,352,000		$	12,408,000

In 2011, 2010, and 2009, the Company recorded a deferred tax benefit to reverse approximately $8,000, $2,000 and $76,000, respectively, of the valuation allowance on deferred tax assets. The decreases in valuation allowance were based on the Company’s assessment of the realization of certain individual tax assets. The Company continues to maintain a valuation allowance of approximately $868,000 to reduce the deferred tax assets by the amount management believes is more likely than not to not be utilized through the turnaround of existing temporary differences, future earnings, or a combination thereof. In future periods, the Company will continue to assess the need for and adequacy of the remaining valuation allowance.

At December 31, 2011, the Company had $9,194,000 of net operating losses, which expire at various dates beginning in 2019 and continue through 2021. The use of these loss carryforwards is limited by change in ownership provisions of the Federal tax code to a maximum of approximately $4,328,000. In 2005, the Company reduced the deferred tax asset and the corresponding valuation allowances for net operating loss deductions permanently lost as a result of the change in ownership provisions.

Stock-based compensation increases the Company’s effective tax rate to the extent that stock-based compensation expense recorded in the Company’s financial statements is non-deductible for tax purposes. This primarily occurs for equity grants that have a higher grant date fair value than the income tax deduction the Company receives upon exercise.

During 2011, the Company recorded an estimated $400,000 in employment tax credits under the Hiring Incentives to Restore

Employment (HIRE) Act which provided a one-time tax credit. In addition, under the Work Opportunity Tax Credit program the Company recorded $600,000, $580,000 and $600,000 in Work Opportunity Tax Credits during 2011, 2010 and 2009, respectively.

The Company follows the FASB’s guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns evaluating the need to recognize or unrecognize uncertain tax positions. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

	2011		2010		2009
Balance at the beginning of the period	$	84,000	$	76,000	$	70,000
Changes in tax positions for prior years		2,000		8,000		6,000
Balance at the end of the period	$	86,000	$	84,000	$	76,000

The unrecognized tax benefits are accrued in “other current liabilities.” The net change in the amount of unrecognized tax benefits during the years ended December 31, 2011, 2010 and 2009 was related primarily to the adjustment of the estimated liability. None of the current unrecognized tax benefits are expected to impact the Company’s effective tax rates.

The Company has chosen to classify interest and penalties as a component separate from income tax expense in its consolidated statements of income. The tax years 2008 through 2010 remain open to examination by major taxing jurisdictions in which the Company operates. During 2010, the Internal Revenue Service (“IRS”) commenced an examination of the Company’s U.S. income tax returns for the years 2008 and 2009. The examination for both years was completed during 2011 and the Company recognized a combined income tax benefit of $79,000 as a result of the examination.

XML

Consolidated Statements of Income (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
REVENUES:
Patient revenues, net	$ 314,715,000	$ 290,130,000	$ 276,979,000
EXPENSES:
Operating	243,929,000	229,081,000	219,567,000
Lease	22,939,000	22,600,000	21,791,000
Professional liability	10,962,000	5,364,000	8,228,000
General and administrative	25,589,000	19,680,000	17,926,000
Depreciation and amortization	6,592,000	5,825,000	5,446,000
Asset impairment	344,000
Total expenses	310,355,000	282,550,000	272,958,000
OPERATING INCOME	4,360,000	7,580,000	4,021,000
OTHER INCOME (EXPENSE):
Foreign currency transaction gain			191,000
Other income			549,000
Interest income	11,000	2,000	161,000
Interest expense	(2,366,000)	(1,634,000)	(1,877,000)
Debt retirement costs	(112,000)	(127,000)
Total other income (expense)	(2,467,000)	(1,759,000)	(976,000)
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	1,893,000	5,821,000	3,045,000
PROVISION FOR INCOME TAXES	(509,000)	(1,858,000)	(1,165,000)
NET INCOME FROM CONTINUING OPERATIONS	1,384,000	3,963,000	1,880,000
NET INCOME FROM DISCONTINUED OPERATIONS:
Operating income (loss), net of tax (benefit) provision of $(6,000), $177,000 and $449,000, respectively	(17,000)	344,000	721,000
Disposal and impairment, net of tax benefit of $217,000		(458,000)
DISCONTINUED OPERATIONS	(17,000)	(114,000)	721,000
NET INCOME	1,367,000	3,849,000	2,601,000
Preferred stock dividends	(344,000)	(344,000)	(344,000)
NET INCOME FOR COMMON STOCK	$ 1,023,000	$ 3,505,000	$ 2,257,000
Per common share - basic
Continuing operations	$ 0.18	$ 0.63	$ 0.27
Discontinued operations		$ (0.02)	$ 0.13
Total per common share - basic	$ 0.18	$ 0.61	$ 0.40
Per common share - diluted
Continuing operations	$ 0.18	$ 0.62	$ 0.26
Discontinued operations	$ (0.01)	$ (0.02)	$ 0.13
Total per common share - diluted	$ 0.17	$ 0.60	$ 0.39
COMMON STOCK DIVIDENDS DECLARED PER SHARE OF COMMON STOCK	$ 0.22	$ 0.215	$ 0.15
WEIGHTED AVERAGE COMMON SHARES:
Basic	5,774,000	5,732,000	5,678,000
Diluted	5,906,000	5,854,000	5,797,000

XML

Receivables

12 Months Ended

Dec. 31, 2011

Receivables [Abstract]

RECEIVABLES

4. RECEIVABLES

Receivables, before the allowance for doubtful accounts, consist of the following components:

	December 31,
	2011		2010
Medicare	$	11,296,000	$	10,603,000
Medicaid and other non-federal government programs		10,695,000		9,758,000
Other patient and resident receivables		7,233,000		6,262,000
	$	29,224,000	$	26,623,000
Other receivables and advances	$	1,739,000	$	424,000

The other receivables and advances balance at December 31, 2011 is composed of $1,335,000 related to renovation projects funded by Omega. See Note 11 for additional discussion of these receivables and leased facility construction projects.

The Company provides credit for a substantial portion of its revenues and continually monitors the credit-worthiness and collectability from its patients, including proper documentation of third-party coverage. The Company is subject to accounting losses from uncollectible receivables in excess of its reserves.

Substantially all receivables are pledged as collateral on the Company’s debt obligations.

XML

Acquisitions

12 Months Ended

Dec. 31, 2011

Acquisitions [Abstract]

ACQUISITIONS

3. ACQUISITIONS

West Virginia Facility

On December 28, 2011, the Company completed construction of Rose Terrace Health and Rehabilitation Center (“Rose Terrace”), its third health care center in West Virginia. The state of the art 90-bed skilled nursing center is located in Culloden, West Virginia, along the Huntington-Charleston corridor, and offers 24-hour skilled nursing care designed to meet the care needs of both short and long term nursing patients. The Rose Terrace nursing center utilizes a Certificate of Need the Company obtained in June 2009, when the Company completed the acquisition of certain assets of a skilled nursing center in West Virginia. The facility is expected to obtain its Medicare and Medicaid certifications in the first quarter of 2012.

The Company has a lease agreement with the real estate developer that constructed, furnished, and equipped Rose Terrace that provides an initial lease term of 20 years and the option to renew the lease for two additional five-year periods. The agreement provides the Company the right to purchase the center beginning at the end of the first year of the initial term of the lease and continuing through the fifth year for a purchase price ranging from 110% to 120% of the total project cost.

The Company has no equity interest in the entity that constructed the new facility and does not guarantee any debt obligations of the entity. The owners of the facility have provided guarantees of the debt of the entity and, based on those guarantees, the entity is considered to be a variable interest entity (“VIE”). The Company owns the underlying Certificate of Need that is required for operation as a skilled nursing center. During 2011, the Company determined it is the primary beneficiary of the VIE based primarily on the ownership of the Certificate of Need, the fixed price purchase option described above, its ability to direct the activities that most significantly impact the economic performance of the VIE and the right to receive potentially significant benefits from the VIE.

The following table summarizes the accounts and amounts included in the Company’s Consolidated Balance Sheet that are associated with the real estate developer’s interests in the VIE. These assets can be used only to settle obligations of the VIE and none of these liabilities provide creditors with recourse to the general assets of the Company.

	December 31, 2011
Land	$	787,000
Building and improvements		5,938,000
Furniture, fixtures and equipment		573,000
Other assets		46,000
	$	7,344,000
Current liabilities	$	450,000
Notes payable		5,240,000
Non-controlling interests equity		1,654,000
	$	7,344,000

Gain on Settlement of acquisition liability

During 2009, the Company recorded a gain of $549,000 in other income as a result of an agreement with CMS to settle cost report obligations related to the 2007 acquisition of leasehold interests in certain nursing centers. The cost report obligations sought by CMS totaled approximately $1,180,000 and related to Medicare reimbursement for 1997 and earlier periods for one of the acquired facilities. During 2008, the Company recorded a liability of $1,022,000 for its estimate of its ultimate liability for this assessment and defense costs and the gain resulted from payments of the settlements and legal fees being less than the amounts previously accrued.

XML

Commitments and Contingencies

12 Months Ended

Dec. 31, 2011

Commitments and Contingencies [Abstract]

COMMITMENTS AND CONTINGENCIES

11. COMMITMENTS AND CONTINGENCIES

Lease Commitments

The Company is committed under long-term operating leases with various expiration dates and varying renewal options. Minimum annual rentals, including renewal option periods (exclusive of taxes, insurance, and maintenance costs) under these leases beginning January 1, 2012, are as follows:

2012	$	23,119,000
2013		23,677,000
2014		24,203,000
2015		24,786,000
2016		25,402,000
Thereafter		442,672,000
	$	563,859,000

Under lease agreements with Omega and others, the Company’s lease payments are subject to periodic annual escalations as described below and in Note 2. Total lease expense for continuing operations was $22,939,000, $22,600,000 and $21,791,000 for 2011, 2010 and 2009, respectively. The accrued liability related to straight line rent was $11,537,000 and $11,216,000 at December 31, 2011 and 2010, respectively, and is included in “Other noncurrent liabilities” on the accompanying consolidated balance sheets.

Omega Leases

General Terms

The Company leases 36 nursing centers from Omega under the Master Lease. On October 20, 2006, the Company and Omega entered into a Third Amendment to Consolidated Amended and Restated Master Lease (“Lease Amendment”) to extend the term of its facilities leased from Omega. The Lease amendment extended the term to September 30, 2018 and provided a renewal option of an additional twelve years. Consistent with prior terms, the lease provides for annual increases in lease payments equal to the lesser of two times the increase in the consumer price index or 3 percent. Under generally accepted accounting principles, the Company is required to report these scheduled rent increases on a straight line basis over the 12 year term of the renewal period. These scheduled increases had no effect on cash rent payments at the start of the lease term and only result in additional cash outlay as the annual increases take effect each year.

The Master Lease requires the Company to fund annual capital expenditures related to the leased facilities at an amount currently equal to $412 per licensed bed. These amounts are subject to adjustment for increases in the Consumer Price Index. The Company is in compliance with the capital expenditure requirements. Total required capital expenditures during the remaining lease term and renewal options are $19,257,000. These capital expenditures are being depreciated on a straight-line basis over the shorter of the asset life or the appropriate lease term.

Upon expiration of the Master Lease or in the event of a default under the Master Lease, the Company is required to transfer all of the leasehold improvements, equipment, furniture and fixtures of the leased facilities to Omega. The assets to be transferred to Omega are being depreciated on a straight-line basis over the shorter of the remaining lease term or estimated useful life, and will be fully depreciated upon the expiration of the lease. All of the equipment, inventory and other related assets of the facilities leased pursuant to the Master Lease have been pledged as security under the Master Lease. In addition, the Company has a letter of credit of $4,551,000 as a security deposit for the Company’s leases with Omega, as described in Note 6.

Brentwood Terrace

In August 2009, the Company completed the construction of a 119 bed skilled nursing facility, Brentwood Terrace, located in Paris, Texas, replacing an existing 102 bed facility leased from Omega. The new facility was financed with funding from Omega and is leased from Omega under a long term operating lease with renewal options through 2035. Annual rent was $789,000 initially, equal to 10.25% of $7,702,000, the total cost of the replacement facility, and is subject to the annual escalation provisions described above.

The Company was deemed to have control of the construction project and was considered the owner during the construction period as a result of its involvement in construction and the terms of the lease. In accordance with the accounting guidance surrounding lessee involvement in asset construction, the Company recorded the amounts incurred for facility construction as an asset, and amounts reimbursed by Omega were recorded as a long term liability. Upon completion of construction of the replacement facility during the third quarter 2009, a sale and leaseback of the facility was deemed to have occurred and the Company removed both the facility asset and the long term liability from its consolidated balance sheet. There was no resulting gain or loss on the deemed sale and leaseback transaction and the Company will have no continuing involvement with the property except for its operating lease described above.

Texas Leased Nursing Centers

Effective August 11, 2007, the Company acquired the leases and leasehold interests of seven facilities which are leased from a subsidiary of Omega. In connection with this acquisition, the Company amended the Master Lease to include these seven facilities. The substantive terms of the lease of these centers, including payment provisions and lease period including renewal options were not changed by the amendment. The lease terms for the seven facilities provide for an initial term and renewal periods at the Company’s option through May 31, 2035. The lease provides for annual increases in lease payments equal to the increase in the consumer price index, not to exceed 2.5%.

Renovation Funding

In April 2011, we entered into an amendment to the Master lease with Omega under which Omega agreed to provide an additional $5,000,000 million to fund renovations to four nursing centers located in Arkansas, Kentucky, Ohio and Texas that are leased from Omega. The annual base rent related to these facilities will be increased to reflect the amount of capital improvements to the respective facilities as the related expenditures are made. The increase is based on a rate of 10.25% per year of the amount financed under this amendment. This arrangement is similar to amendments entered into in 2009, 2006 and 2005 that provided financing totaling $15,000,000 million that was used to fund renovations at twelve nursing centers leased from Omega. In addition to the twelve leased center renovations, in January 2012 the Company held two open houses for leased center projects, one a $1,656,000 major renovation project and the other a $404,000 project to add therapy space and functionality to a nursing center the Company renovated in 2010. The Company currently has two other projects in process, one involving a leased building and the other involving an owned building that it expects to complete in early 2012. The Company is developing plans for additional renovation projects.

The Company completed an expansion to one of its facilities by making use of fifteen licensed beds it acquired in 2005. This expansion project was funded by Omega with the renovation funding previously described. This project increased capacity and footprint compared to the Company’s previous lessor funded facility projects which included renovations of existing facilities, but did not increase capacity. Accordingly, the costs incurred to expand the facility are recorded as a leasehold improvement asset with the amounts reimbursed by Omega for this project included as a long term liability. The capitalized leasehold improvements and lessor reimbursed costs will be amortized over the initial lease term ending in September 2018. The leasehold improvement asset and accumulated amortization are as follows:

	December 31
	2011			2010
Leasehold improvement	$	921,000		$	921,000
Accumulated Amortization		(210,000	)		(105,000	)
Net Intangible	$	711,000		$	816,000

Insurance Matters

Professional Liability and Other Liability Insurance-

For claims made after March 9, 2001, the Company has purchased professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. The Company has essentially exhausted all general and professional liability insurance available for claims asserted prior to July 1, 2011.

Effective June 1, 2010, the Company’s nursing centers are covered by one of two professional liability insurance policies. The Company’s nursing centers in Arkansas, Kentucky, Tennessee, and two centers in West Virginia are currently covered by an insurance policy with coverage limits of $250,000 per medical incident and total annual aggregate policy limits of $750,000. This policy provides the only commercially affordable insurance coverage available for claims made during this period against these nursing centers. The Company’s nursing centers in Alabama, Florida, Ohio, Texas and its new center in West Virginia are currently covered by an insurance policy with coverage limits of $1,000,000 per medical incident, subject to a deductible of $495,000 per claim, with a total annual aggregate policy limit of $15,000,000 and a sublimit per center of $3,000,000.

Estimated Self-Insured Professional Liability Claims-

Because the Company anticipates that its actual liability for existing and anticipated claims will exceed the Company’s professional liability insurance coverage, the Company has recorded total liabilities for professional liability and other claims of $19,357,000 as of December 31, 2011. This accrual includes estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, actual liabilities related to settlements, including settlements to be paid over time, and estimates of legal costs related to these claims. All losses are projected on an undiscounted basis. Amounts are added to the accrual for estimates of anticipated liability for claims incurred during each period, and amounts are deducted from the accrual for settlements paid on existing claims during each period.

Final determination of the Company’s actual liability for claims incurred in any given period is a process that takes years. The Company evaluates the adequacy of this liability on a quarterly basis and engages a third-party actuarial firm to conduct an analysis semi-annually in the second and fourth quarters. The semi-annual actuarial analysis is prepared by the Actuarial Division of Willis of Tennessee, Inc. (“Willis”) based on data furnished as of May 31 and November 30 each year.

The Company’s liability for professional liability claims is assessed and adjusted quarterly based on numerous factors, including claims actually reported, lawsuits filed, lawsuits resolved, the results of the semi-annual actuary reports, changes in the Company’s occupied beds and relevant claim development data. The Company records any revisions in estimates and differences between actual settlements and reserves, with changes in estimated losses being recorded in the consolidated statements of operations in the period identified. Any increase in the accrual decreases income in the period and any reduction in the accrual increases income during the period.

Although the Company retains Willis to assist management in estimating the appropriate accrual for these claims, professional liability claims are inherently uncertain and the liability associated with anticipated claims is very difficult to estimate. As a result, the Company’s actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given period. Each change in the amount of this accrual will directly affect the Company’s reported earnings and financial position for the period in which the change in accrual is made.

Prior to 2010, the Company obtained quarterly third-party actuarial analyses to evaluate the liability for self insured risk. Beginning in the first quarter of 2010, the Company changed the frequency of these reviews from quarterly to semi-annually. Professional liability cases have a long cycle from the date of an incident to the date a case is resolved, and the Company believes that a semi-annual evaluation is appropriate.

The Company’s cash expenditures for self-insured professional liability costs of continuing operations were $8,014,000, $5,145,000 and $4,824,000 for the years ending December 31, 2011, 2010 and 2009, respectively.

Adoption of New Accounting Pronouncements - Self-Insured Professional Liability Claims-

In August 2010, the FASB issued updated guidance in the form of a FASB Accounting Standards Update on “Presentation of Insurance Claims and Related Insurance Recoveries” to clarify that a health care entity should not net insurance recoveries against a related professional liability claim and that the amount of the claim liability should be determined without consideration of insurance recoveries. The update is intended to improve accounting guidance by eliminating an existing industry exception and reduce diversity in practice by removing the ability to offset insurance recoveries against liabilities. The Company adopted this guidance effective January 1, 2011 and, as a result, reclassified amounts representing estimated insurance recoveries previously recorded as offsets to the related liability to an asset. Those amounts totaled $750,000 and $438,000 at December 31, 2011 and 2010, respectively.

Other Insurance-

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. 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. From June 30, 2003 until June 30, 2007, the Company’s workers’ compensation insurance programs provided coverage for claims incurred with premium adjustments depending on incurred losses. For the period from July 1, 2008 through June 30, 2012, the Company is covered by a prefunded deductible policy. Under this policy, the Company is self-insured for the first $500,000 per claim, subject to an aggregate maximum of $3,000,000. The Company funds a loss fund account with the insurer to pay for claims below the deductible. The Company accounts for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred. The liability for workers compensation claims is $309,000 at December 31, 2011. The Company has a non-current receivable for workers’ compensation policy’s covering previous years of $830,000 as of December 31, 2011. The non-current receivable is a function of payments paid to the Company’s insurance carrier in excess of the estimated level of claims expected to be incurred.

As of December 31, 2011, the Company is self-insured for health insurance benefits for certain employees and dependents for amounts up to $175,000 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 $853,000 at December 31, 2011. The differences between actual settlements and liabilities are included in expense in the period finalized.

Employment Agreements

Current employment agreements-

The Company has employment agreements with certain members of management that provide for the payment to these members of amounts up to 1.0 times their annual salary in the event of a termination without cause, a constructive discharge (as defined in each employee agreement), or upon a change in control of the Company (as defined in each employee agreement). The maximum contingent liability under these agreements is $1,101,000 as of December 31, 2011. 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. In addition, upon the occurrence of any triggering event, these certain members of management may elect to require the Company to purchase equity awards 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 equity award exercise price. Based on the closing price of the Company’s common stock on December 31, 2011, the maximum contingent liability for the repurchase of the equity grants is approximately $41,000. No amounts have been accrued for these contingent liabilities for members of management the Company currently employ. As discussed below, the Company has accrued and will accrue costs under the terms of such agreements for members of management who are no longer employed by the Company or are resigning from their positions with the Company.

Changes in executive officers-

In September 2011, the Company announced the resignation of its Chief Executive Officer, William R. Council, III. The Company recorded $1,258,000 in severance and other expenses in the third quarter of 2011 related to Mr. Council’s departure in accordance with his employment agreement, most of which will be paid on March 31, 2012. The Company and Mr. Council also entered into a six month consulting agreement effective October 1, 2011 to facilitate the transition of management. Under the consulting agreement, Mr. Council receives $36,800 per month through March 2012.

On November 4, 2011, the Company promoted Kelly Gill to Chief Executive Officer of Advocat and appointed him to the Board of Directors. In connection with his promotion, the Company entered into an amendment to his employment agreement. The amendment provides that Mr. Gill is the Chief Executive Officer and increases his base salary to $450,000.

In December 2011, L. Glynn Riddle, Jr., the Company’s Chief Financial Officer, notified the Company that he intends to resign effective March 31, 2012. In connection with his resignation, the Company and Mr. Riddle entered into a retention agreement to facilitate the orderly transition to Mr. Riddle’s successor. The Company will record $246,000 in retention and other expenses in the first quarter of 2012 related to Mr. Riddle’s departure.

On December 20, 2011, the Company appointed Sam Daniel as executive vice president, effective January 1, 2012. In connection with the appointment of Mr. Daniel, the Company entered into an employment agreement which provides that Mr. Daniel is initially executive vice president and will replace Mr. Riddle as Chief Financial Officer following Mr. Riddle’s resignation. Mr. Daniel’s initial base salary will be $250,000.

Health Care Industry and Legal Proceedings

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. Over the last several years, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of fraud and abuse statutes and regulations as well as laws and regulations governing quality of care issues in the skilled nursing profession in general. Violations of these laws and regulations could result in exclusion from government health care programs together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations is subject to ongoing government review and interpretation, as well as regulatory actions which may be unknown or unasserted at this time. The Company is involved in regulatory actions of this type from time to time.

All of the Company’s nursing centers must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing homes are subject to certificate of need laws, which require the Company to obtain government approval for the construction of new nursing homes or the addition of new licensed beds to existing homes. The Company’s nursing centers must comply with detailed statutory and regulatory requirements on an ongoing basis in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid certification are similar and relate to quality and adequacy of personnel, quality of medical care, record keeping, dietary services, resident rights, and the physical condition of the facility and the adequacy of the equipment used therein. Each facility is subject to periodic inspections, known as “surveys” by health care regulators, to determine compliance with all applicable licensure and certification standards. Such requirements are both subjective and subject to change. If the survey concludes that there are deficiencies in compliance, the facility is subject to various sanctions, including but not limited to monetary fines and penalties, increased staffing requirements, suspension of new admissions, non-payment for new admissions and loss of licensure or certification. Generally, however, once a facility receives written notice of any compliance deficiencies, it may submit a written plan of correction and is given a reasonable opportunity to make mutually agreeable measures to correct the deficiencies. There can be no assurance that, in the future, the Company will be able to maintain such licenses and certifications for its facilities or that the Company will not be required to expend significant sums in order to comply with regulatory requirements. Recently, the Company has experienced an increase in the severity of survey citations and the size of monetary penalties, consistent with industry trends.

As of December 31, 2011, the Company is engaged in 38 professional liability lawsuits. Four lawsuits are currently scheduled for trial or mediation during the next ten months, and it is expected that additional cases will be set for trial. The ultimate results of any of the Company’s professional liability claims and disputes cannot be predicted. The Company has limited, and sometimes no, professional liability insurance with regard to most of these claims. A significant judgment entered against the Company in one or more of these legal actions could have a material adverse impact on the Company’s financial position and cash flows.

In January 2009, a purported class action complaint was filed in the Circuit Court of Garland County, Arkansas against the Company and certain of its subsidiaries and Garland Nursing & Rehabilitation Center (the “Facility”). The complaint alleges that the defendants breached their statutory and contractual obligations to the patients of the Facility over the past five years. The lawsuit remains in its early stages and has not yet been certified by the court as a class action. The Company intends to defend the lawsuit vigorously.

The Company cannot currently predict with certainty the ultimate impact of any of the above cases on the Company’s financial condition, cash flows or results of operations. In the course of the Company’s business, it is periodically involved in governmental investigations, regulatory and administrative proceedings and lawsuits relating to its compliance with regulations and laws governing its operations, including reimbursement laws, fraud and abuse laws, elderly abuse laws, and state and federal false claims acts and laws governing quality of care issues. A finding of non-compliance with any of these governing laws or regulations in any such lawsuit, regulatory proceeding or investigation could subject it to fines, penalties and damages being excluded from the Medicare or Medicaid programs and could also have a material adverse impact on its financial condition, cash flows or results of operations.

Reimbursement

The Company is unable to predict what, if any, reform proposals or reimbursement limitations will be implemented in the future, or the effect such changes would have on its operations. For the year ended December 31, 2011, the Company derived 34.5% and 49.4% of its total patient and resident revenues related to continuing operations from the Medicare and Medicaid programs, respectively.

The Company will attempt to increase revenues from non-governmental sources to the extent capital is available to do so, if at all. However, private payors, including managed care payors, are increasingly demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments, which can result in significant losses to health care providers if patients require expensive treatment not adequately covered by the capitated rate.

XML

Discontinued Operations

12 Months Ended

Dec. 31, 2011

Discontinued Operations [Abstract]

DISCONTINUED OPERATIONS

7. DISCONTINUED OPERATIONS

Effective March 31, 2010, the Company terminated operations of four nursing centers in Florida under a lease that, as amended, would have expired in August 2010 and transitioned operations at these leased facilities to a new operator. The operating margins of the four facilities subject to this lease did not meet the Company’s long-term goals. These four homes contributed revenues of $6,852,000 and $25,053,000 and net income of $169,000 and $541,000 in the years ended December 31, 2010 and 2009, respectively. Included in the loss on disposal and impairment is a loss of $273,000 ($185,000 net of tax) on lease termination primarily related to severance, legal and other costs incurred to facilitate the transition as well as the transfer of inventory. While the results of discontinued operations reflect the direct expense related to the Florida regional office which has been closed, they do not reflect any allocation of corporate general and administrative expense or any allocation of corporate interest expense.

CMS issued regulations that became effective October 1, 2009, that prohibited the Company from billing Medicare Part B for certain services. These services produced revenues of $974,000 and net income of $204,000 during the year ended December 31, 2009.

The Company owns land related to a North Carolina assisted living facility it closed in April 2006. The net assets of discontinued operations presented in property and equipment on the accompanying consolidated balance sheet represent the real estate related to this assisted living facility. The Company is continuing its efforts to sell this land. Based on an evaluation of the current fair value of the property, the Company determined the carrying value exceeded the fair value. As a result, the Company recorded an impairment charge of $402,000 ($273,000 net of tax) to reduce the carrying value of the land during 2010.

The Company has classified the operations and the real estate described above as discontinued operations for all periods presented in the Company’s Consolidated Financial Statements.

XML

Property and Equipment

12 Months Ended

Dec. 31, 2011

Property and Equipment [Abstract]

PROPERTY AND EQUIPMENT

5. PROPERTY AND EQUIPMENT

Property and equipment, at cost, consists of the following:

	December 31,
	2011		2010
Land	$	2,706,000	$	1,919,000
Buildings and leasehold improvements		63,108,000		54,032,000
Furniture, fixtures and equipment		27,537,000		22,739,000
	$	93,351,000	$	78,690,000

As discussed further in Note 6, the property and equipment of certain skilled nursing centers are pledged as collateral for mortgage debt obligations. In addition, the Company has assets recorded as capital leased assets purchased through capitalized lease obligations. The Company capitalizes leasehold improvements which will revert back to the lessor of the property at the expiration or termination of the lease, and depreciates these improvements over the shorter of the remaining lease term or the assets’ estimated useful lives.

As discussed further in Note 3, the Company has consolidated the assets and liabilities of a real estate developers interest in a center the Company leases.

XML

Long-Term Debt, Interest Rate Swap and Capitalized Lease Obligations

12 Months Ended

Dec. 31, 2011

Long-Term Debt, Interest Rate Swap and Capitalized Lease Obligations [Abstract]

LONG-TERM DEBT, INTEREST RATE SWAP AND CAPITALIZED LEASE OBLIGATIONS

6. LONG-TERM DEBT, INTEREST RATE SWAP AND CAPITALIZED LEASE OBLIGATIONS

Long-term debt consists of the following:

	December 31,
	2011			2010
Mortgage loan with a syndicate of banks; issued in March 2011; payable monthly, interest at 4.5% above LIBOR but fixed at 7.07% based on the interest rate swap described below.	$	22,715,000		$	—
Mortgage loan payable to a commercial finance company; issued in August 2006; refinanced in March 2011 as described below; payable monthly, interest at 3.75% above LIBOR (4.01% at December 31, 2010).		—			20,551,000
Revolving credit facility borrowings payable to a bank; entered into in March 2010; amended in March 2011 as described below; secured by receivables of the Company; interest at 4.5% above LIBOR (6.5% at December 31, 2010).		—			3,463,000
Commercial loan of consolidated VIE, payable by VIE landlord to a bank; issued in January 2011; payable monthly, fixed interest rate of 5.3%.		5,240,000			—
		27,955,000			24,014,000
Less current portion		(576,000	)		(442,000	)
	$	27,379,000		$	23,572,000

As of December 31, 2011, the Company’s weighted average interest rate on long-term debt, including the impact of the interest rate swap, was approximately 6.74%.

On March 1, 2011, the Company entered into an agreement with a syndicate of banks to refinance the Company’s mortgage loan scheduled to mature in August 2011 and extend the Company’s revolving credit facility. Under the terms of the new agreement, the syndicate of banks provided mortgage debt (“Mortgage Loan”) of $23 million with a five year maturity and extended the maturity of the Company’s $15 million revolving credit facility (“revolver”) from March 2013 to March 2016. The proceeds of these new loans were used to retire the Company’s mortgage loan and provided funding for capital improvements at the Company’s owned homes. The Mortgage Loan has a term of five years, with principal and interest payable monthly based on a 25 year amortization. Interest is based on LIBOR plus 4.5% but is fixed at 7.07% based on the interest rate swap described below. The new mortgage loan is secured by four owned nursing centers, related equipment and a lien on the accounts receivable of these facilities. The Mortgage Loan and the revolver are cross-collateralized.

The March 2011 debt agreement extended the maturity of the Company’s $15 million revolving credit facility (“revolver”) entered into in March 2010 with a member of the bank syndicate to March 2016. The extension also removes the 3.0% floor on LIBOR and changes the LIBOR spread to 4.5%. The March 2010 agreement replaced the Company’s previous revolving credit facility which was to expire in August 2010. As part of the March 2010 agreement, the Company used $3,463,000 in proceeds from the facility to retire the Company’s existing term loan and pay certain transaction costs. The March 2010 revolver had an interest rate of LIBOR (with a floor of 3.0%) plus 3.5% and was to expire in March 2013.

In connection with the Company’s 2011 and 2010 financing agreements the Company recognized the following debt retirement costs related to the write off of deferred financing on the existing financing agreements and recorded new deferred loan costs related the new financing agreements as follows:

	2011		2010
Write-off of deferred financing costs	$	112,000	$	127,000
Deferred financing costs capitalized	$	776,000	$	432,000

Under both agreements, the revolver is secured by accounts receivable and is subject to limits on the maximum amount of loans that can be outstanding under the revolver based on borrowing base restrictions. As of December 31, 2011, the Company had no borrowings outstanding under the revolving credit facility. Annual fees for letters of credit issued under this revolver are 3.00% of the amount outstanding. The Company has a letter of credit of $4,551,000 to serve as a security deposit for the Company’s leases. Considering the balance of eligible accounts receivable at December 31, 2011, the letter of credit, the amounts outstanding under the revolving credit facility and the maximum loan amount of $15,000,000, the balance available for borrowing under the revolving credit facility is $10,449,000.

Scheduled principal payments of long-term debt are as follows:

2012	$	576,000
2013		608,000
2014		645,000
2015		686,000
2016		25,440,000
Thereafter		—
Total	$	27,955,000

The Company’s debt agreements contain various financial covenants, the most restrictive of which relate to minimum cash deposits, cash flow and debt service coverage ratios. The Company is in compliance with all such covenants at December 31, 2011. The Company has consolidated $5,240,000 in debt that was added by the entity that owns the West Virginia nursing center. The borrower is subject to covenants concerning total liabilities to tangible net worth as well as current assets compared to current liabilities. The borrower is in compliance with all such covenants at December 31, 2011. The borrower’s liabilities do not provide creditors with recourse to the general assets of the Company.

Interest Rate Swap Cash Flow Hedge

As part of the debt agreements entered into in March 2011, the Company entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The interest rate swap agreement has the same effective date, maturity date and notional amounts as the Mortgage Loan. The interest rate swap agreement requires the Company to make fixed rate payments to the bank calculated on the applicable notional amount at an annual fixed rate of 7.07% while the bank is obligated to make payments to the Company based on LIBOR on the same notional amounts. The Company entered into the interest rate swap agreement to mitigate the variable interest rate risk on its outstanding mortgage borrowings. The applicable guidance requires companies to recognize all derivative instruments as either assets or liabilities at fair value in a company’s balance sheets. In accordance with this guidance, the Company designated its interest rate swap as a cash flow hedge and the earnings component of the hedge, net of taxes, is reflected as a component of other comprehensive income.

The Company assesses the effectiveness of its interest rate swap on a quarterly basis and at December 31, 2011, the Company determined that the interest rate swap was effective. The interest rate swap valuation model indicated a net liability of $1,524,000 at December 31, 2011. The fair value of the interest rate swap is included in “other noncurrent liabilities” on the Company’s consolidated balance sheet. The balance of accumulated other comprehensive loss at December 31, 2011, is $945,000 and reflects the liability related to the interest rate swap, net of the income tax benefit of $579,000. As the Company’s interest rate swap is not traded on a market exchange, the fair value is determined using a valuation model based on a discounted cash flow analysis. This analysis reflects the contractual terms of the interest rate swap agreement and uses observable market-based inputs, including estimated future LIBOR interest rates. The fair value of the Company’s interest rate swap is the net difference in the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates and are observable inputs available to a market participant. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy, in accordance with the FASB’s guidance on Fair Value Measurements and Disclosures.

Capitalized Lease Obligations

During 2011 and 2010, the Company entered into a series of lease agreements to finance the purchase of certain equipment primarily for the implementation of Electronic Medical Records (“EMR”) in its nursing centers. The Company determined the leases were capital in nature and recorded both assets and capitalized lease obligations of $527,000 and $387,000 during 2011 and 2010, respectively. These lease agreements provide three year terms.

In October 2011, the Company completed a sale and leaseback transaction for certain equipment purchased in the implementation of EMR in its nursing centers. The lease transaction, involving $1,219,000 in assets purchased by the Company during 2010 and 2011, is capital in nature, and the Company recorded the cash from the sale and the capitalized lease obligation under the financing during the fourth quarter of 2011. The lease agreement provides a three year term.

Scheduled payments of the capitalized lease obligations are as follows:

2012	$	812,000
2013		784,000
2014		491,000
Total		2,087,000
Amounts related to interest		(142,000	)
Principal payments on capitalized lease obligation	$	1,945,000

XML

Shareholders' Equity, Stock Plans and Preferred Stock

12 Months Ended

Dec. 31, 2011

Shareholders' Equity, Stock Plans and Preferred Stock [Abstract]

SHAREHOLDERS' EQUITY, STOCK PLANS AND PREFERRED STOCK

8. SHAREHOLDERS’ EQUITY, STOCK PLANS AND PREFERRED STOCK

Shareholders’ Rights Plan

On August 14, 2009, the Company’s Board of Directors amended its current Amended and Restated Rights Agreement (the “Rights Agreement”) which was originally adopted in 1995. The amendment changes the definition of “Acquiring Person” to be such person that acquires 20% or more of the shares of Common Stock of the Company up from the 15% that previously defined an acquiring person. On August 1, 2008, another amendment was approved which provided for an increase of the exercise price of the rights under the Rights Agreement (the “Rights”) to $50 from $15 and for the extension of the expiration date of the Rights to August 2, 2018.

In addition, the amendment includes a share exchange feature that provides the Company’s Board of Directors the option of exchanging, in whole or in part, each Right, other than those of the hostile acquiring holder, for one share of the Company’s common stock. This provision is intended to avoid requiring Rights holders to pay cash to exercise their Rights and to alleviate the uncertainty as to whether holders will exercise their Rights. The Plan is designed to protect the Company’s shareholders from unfair or coercive takeover tactics. The rights may be exercised only upon the occurrence of certain triggering events, including the acquisition of, or a tender offer for, 20% or more of the Company’s common stock without the Company’s prior approval.

Stock-Based Compensation Plans

The Company follows the FASB’s guidance on Stock Compensation to account for share-based payments granted to employees and non-employee directors.

Overview of Plans

The Company adopted the 1994 Incentive and Nonqualified Stock Option Plan for Key Personnel (the “Key Personnel Plan”) and the 1994 Nonqualified Stock Option Plan for the Directors (the “Director Plan”). Under both plans, the option exercise price equals the stock’s closing market price on the day prior to the grant date. The maximum term of any option granted pursuant to either the Key Personnel Plan or to the Director Plan is ten years. In accordance with their terms, the Key Personnel Plan and the Director Plan expired in May 2004 and no further grants can be made under these plans. No options remain outstanding under these plans at December 31, 2011.

In December 2005, the Compensation Committee of the Board of Directors adopted the 2005 Long-Term Incentive Plan (“2005 Plan”). The 2005 Plan allows the Company to issue stock options and other share and cash based awards. Under the 2005 Plan, 700,000 shares of the Company’s common stock have been reserved for issuance upon exercise of equity awards granted thereunder. All grants under this plan expire 10 years from the date the grants were authorized by the Board of Directors.

In June 2008, the Company adopted the Advocat Inc. 2008 Stock Purchase Plan for Key Personnel (“Stock Purchase Plan”). The Stock Purchase Plan provides for the granting of rights to purchase shares of the Company’s common stock to directors and officers and 150,000 shares of the Company’s common stock has been reserved for issuance under the Stock Purchase Plan. The Stock Purchase Plan allows participants to elect to utilize a specified portion of base salary, annual cash bonus, or director compensation to purchase restricted shares or restricted share units (“RSU’s”) at 85% of the fair market value of a share of the Company’s common stock on the date of purchase. The restriction period under the Stock Purchase Plan is generally two years from the date of purchase and during which the shares will have the rights to receive dividends, however, the restricted share certificates will not be delivered to the shareholder and the shares cannot be sold, assigned or disposed of during the restriction period. No grants can be made under the Stock Purchase Plan after April 25, 2018.

In April 2010, the Compensation Committee of the Board of Directors adopted the 2010 Long-Term Incentive Plan (“2010 Plan”), followed by approval by the Company’s shareholders in June 2010. The 2010 Plan allows the Company to issue stock appreciation rights, stock options and other share and cash based awards. Under the 2010 Plan, 380,000 shares of the Company’s common stock have been reserved for issuance upon exercise of equity awards granted under the 2010 Plan.

Equity Grants and Valuations

During 2011, 2010 and 2009, the Compensation Committee of the Board of Directors approved the grant of Stock Only Stock Appreciation Rights (“SOSARs”) at the market price of the Company’s common stock on the grant date. The SOSARs vest one-third on the first, second and third anniversaries of the grant date. The SOSARs are valued and recorded in the same manner as stock options, and will be settled with issuance of new stock for the difference between the market price on the date of exercise and the exercise price.

During 2011, the Compensation Committee of the Board of Directors approved grants of shares of restricted common stock to certain employees and members of the Board of Directors. The restricted shares vest one-third on the first, second and third anniversaries of the grant date. Unvested shares may not be sold or transferred. During the vesting period, dividends accrue on the restricted shares, but are paid in additional shares of common stock upon vesting, subject to the vesting provisions of the underlying restricted shares. The restricted shares are entitled to the same voting rights as other common shares. Upon vesting, all restrictions are removed.

The Company recorded non-cash stock-based compensation expense for equity grants and RSU’s issued under the Plans of $537,000, $597,000 and $689,000 during the years ended December 31, 2011, 2010, and 2009, respectively. Such amounts are included as components of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. As of December 31, 2011, there was $327,000 in unrecognized compensation costs related to stock-based compensation to be recognized over the applicable remaining vesting periods. The Company estimated the total recognized and unrecognized compensation using the Black-Scholes-Merton equity grant valuation model.

The table below shows the weighted average assumptions the Company used to develop the fair value estimates under its option valuation model:

	Year Ended December 31,
	2011	2010	2009
Expected volatility (range)	59% - 60%	62% - 89%	95% - 111%
Risk free interest rate (range)	1.02% - 1.30%	2.21% - 3.28%	2.02% - 2.40%
Expected dividends	3.93%	3.22%	—
Weighted average expected term (years)	6.0	6.0	6.0

In computing the fair value estimates using the Black-Scholes-Merton valuation model, the Company took into consideration the exercise price of the equity grants and the market price of the Company’s stock on the date of grant. The Company used an expected volatility that equals the historical volatility over the most recent period equal to the expected life of the equity grants. The risk free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. The Company used the expected dividend yield at the date of grant, reflecting the level of annual cash dividends currently being paid on its common stock.

In computing the fair value of these equity grants, the Company estimated the equity grants expected term based on the average of the vesting term and the original contractual terms of the grants, consistent with the Securities and Exchange Commission’s interpretive guidance often referred to as the “Simplified Method.” The Company continues to use the Simplified Method since the Company’s exercise history is not representative of the expected term of the equity granted in 2011. The Company’s recent exercise history is primarily from options granted in 2005 that were vested at grant date and were significantly in-the-money due to an increase in stock price during the period between grant date and formal approval by shareholders, and from older options granted several years ago that had fully vested.

The table below describes the resulting weighted average grant date fair values calculated as well as the intrinsic value of options exercised under the Company’s equity awards during each of the following years:

	Year Ended December 31,
	2011		2010		2009
Weighted Average grant date fair value	$	2.19	$	2.61	$	1.91
Total Intrinsic Value of Exercises	$	87,000	$	192,000	$	320,000

The following table summarizes information regarding stock options and SOSAR grants outstanding as of December 31, 2011:

Range of Exercise Prices	Weighted Average Exercise Prices		Grants Outstanding		Intrinsic Value-grants Outstanding		Grants Exercisable		Intrinsic Value-grants Exercisable
$10.40 to $11.59	$	11.17		117,000		—		117,000		—
$2.37 to $6.21	$	5.10		334,000		175,000		186,000		113,000
				451,000				303,000

As of December 31, 2011, the outstanding equity grants have a weighted average remaining life of 6.65 years and those outstanding equity grants that are exercisable have a weighted average remaining life of 5.62 years. During the year ended December 31, 2011 approximately 18,000 stock option and SOSAR grants were exercised under these plans. All but 13,600 of the equity grants exercised were net settled and those 13,600 contributed $68,000 in proceeds.

Summarized activity of the equity compensation plans is presented below:

	Shares			Weighted Average Exercise Price
Outstanding, December 31, 2010		610,000		$	6.59
Granted		50,000			5.60
Exercised		(18,000	)		.87
Expired or cancelled		(191,000	)		6.65
Outstanding, December 31, 2011		451,000		$	6.68
Exercisable, December 31, 2011		303,000		$	7.38

	Restricted Shares			Weighted Average Grant Date Fair Value
Outstanding, December 31, 2010		—			—
Granted		50,000		$	6.63
Dividend Equivalents		1,000			6.33
Vested		(6,000	)		6.80
Cancelled		(4,000	)		6.76
Outstanding December 31, 2011		41,000		$	6.57

Summarized activity of the Restricted Share Units for the Stock Purchase Plan is as follows:

	Restricted Share Units			Weighted Average Grant Date Fair Value
Outstanding, December 31, 2010		38,000		$	3.41
Granted		43,000			6.80
Dividend Equivalents		2,000			6.36
Vested		(30,000	)		2.73
Cancelled		—			—
Outstanding December 31, 2011		53,000		$	6.68

Series A Preferred Stock

The Company is authorized to issue up to 200,000 shares of Series A Preferred Stock. The Company’s Board of Directors is authorized to establish the terms and rights of each series, including the voting powers, designations, preferences, and other special rights, qualifications, limitations, or restrictions thereof.

Series B and Series C Redeemable Preferred Stock

As part of the consideration paid to Omega for restructuring the terms of the Omega Master Lease in November 2000, the Company issued to Omega 393,658 shares of the Company’s Series B Redeemable Convertible Preferred Stock (“Series B Preferred Stock”) with a stated value of $3,300,000 and an annual dividend rate of 7% of the stated value. In October 2006, the Company and Omega entered into a Restructuring Stock Issuance and Subscription Agreement (“Restructuring Agreement”) to restructure the Series B Preferred Stock, eliminating the option of Omega to convert the Series B Preferred Stock into shares of Advocat common stock.

At the time of the Restructuring Agreement, the Series B Preferred Stock had a recorded value (including accrued dividends) of approximately $4,918,000 and was convertible into approximately 792,000 shares of common stock. The Company issued 5,000 shares of a new Series C Redeemable Preferred Stock (“Series C Preferred Stock”) to Omega in exchange for the 393,658 shares of Series B Preferred Stock held by Omega. The new Series C Preferred Stock has a stated value of approximately $4,918,000 and an annual dividend rate of 7% of its stated value payable quarterly in cash. The Series C Preferred Stock is not convertible, but has been redeemable at its stated value at Omega’s option since September 30, 2010, and since September 30, 2007, has been redeemable at its stated value at the Company’s option. Redemption under the Company’s or Omega’s option is subject to certain limitations.

In connection with the termination of the conversion feature, the Company agreed to pay Omega an additional $687,000 per year under the Lease Amendment. The additional annual rental payments of $687,000 were discounted over the twelve year term of the renewal to arrive at a net present value of $6,701,000, the preferred stock premium. The Company recorded the fair value of the elimination of the conversion feature as a reduction in Paid In Capital with an offsetting increase to record a premium on the Series C Preferred Stock. As a result, the Series C Preferred Stock was initially recorded at a total value of $11,619,000, equal to the stated value of the Series B Preferred Stock, $4,918,000, plus the value of the conversion feature, $6,701,000. As the related cash payments were made, the preferred stock premium was reduced and interest expense was recorded.

The Series C Preferred Stock shares have preference in liquidation but do not have voting rights. The total redemption value is equal to the stated value plus any accrued but unpaid dividends. The liquidation preference value is equal to the redemption value. The following table reflects activity in the Series C Preferred Stock:

Series C Preferred Stock

	2011		2010			2009
Balance at the beginning of the period	$	4,918,000	$	6,192,000		$	7,891,000
Amortization of preferred stock premium		—		(1,274,000	)		(1,699,000	)
Balance at the end of the period	$	4,918,000	$	4,918,000		$	6,192,000

XML

Valuation and Qualifying Accounts

12 Months Ended

Dec. 31, 2011

Valuation and Qualifying Accounts [Abstract]

VALUATION AND QUALIFYING ACCOUNTS

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

OF CONTINUING OPERATIONS

(in thousands)

Column A	Column B				Column C				Column D			Column E
			Additions						Deductions
Description	Balance at Beginning of Period		Charged to Costs and Expenses		Charged to Other Accounts		Other		(Write-offs) net of Recoveries			Balance at End of Period
Year ended December 31, 2011:
Allowance for doubtful accounts	$	2,822	$	2,330	$	—	$	—	$	(2,270	)	$	2,882
Year ended December 31, 2010:
Allowance for doubtful accounts	$	2,566	$	2,127	$	—	$	—	$	(1,871	)	$	2,822
Year ended December 31, 2009:
Allowance for doubtful accounts	$	2,839	$	1,965	$	12	$	—	$	(2,250	)	$	2,566

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

(in thousands)

Column A	Column B				Column C						Column D			Column E
			Additions								Deductions
Description	Balance at Beginning of Period		Charged to Costs and Expenses		Charged to Other Accounts (2)			Other			Payments			Balance at End of Period
Year ended December 31, 2011:
Professional Liability Reserve	$	17,251	$	10,155	$	(35	)	$	—		$	(8,014	)(1)	$	19,357
Workers Compensation Reserve	$	346	$	1,323	$	—		$	(257	)	$	(1,103	)	$	309
Health Insurance Reserve	$	1,003	$	7,247	$	—		$	—		$	(7,397	)	$	853
Year ended December 31, 2010:
Professional Liability Reserve	$	18,502	$	4,391	$	(497	)	$	—		$	(5,145	)(1 )	$	17,251
Workers Compensation Reserve	$	472	$	872	$	—		$	509		$	(1,507	)	$	346
Health Insurance Reserve	$	1,121	$	8,931	$	—		$	—		$	(9,049	)	$	1,003
Year ended December 31, 2009:
Professional Liability Reserve	$	14,959	$	7,598	$	769		$	—		$	(4,824	)(1 )	$	18,502
Workers Compensation Reserve	$	492	$	1,689	$	—		$	—		$	(1,709	)	$	472
Health Insurance Reserve	$	1,230	$	9,944	$	—		$	—		$	(10,053	)	$	1,121

⁽¹⁾  Payments include amounts paid for claims settled during the period as well as payments made under structured arrangements for claims settled in earlier periods.

⁽²⁾  As discussed in Note 7 of the Consolidated Financial Statements, the Company has presented the results of certain divestiture and lease termination transactions as discontinued operations. The amounts charged to Other Accounts represent the amounts charged to discontinued operations.

XML

Consolidated Statements of Income (Parenthetical) (USD $)	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Consolidated Statements of Income [Abstract]
Tax effect on operating income	$ (6,000)	$ 177,000	$ 449,000
Tax effect on disposal and impairment		$ 217,000

XML

Summary of Significant Accounting policies

12 Months Ended

Dec. 31, 2011

Summary of Significant Accounting policies [Abstract]

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation

The consolidated financial statements include the operations and accounts of Advocat and its subsidiaries, all wholly-owned. All significant intercompany accounts and transactions have been eliminated in consolidation. Any variable interest entities (“VIEs”) in which the Company has an interest are consolidated when the Company identifies that it is the primary beneficiary. The Company has one variable interest entity and it relates to a nursing center in West Virginia further described in Note 3.

The Company is managed as one reporting unit for internal purposes and for managing the enterprise. Therefore, management has concluded that the Company is operated as a single reportable segment, as defined in The Financial Accounting Standards Board’s (“FASB”) guidance on “Segment Reporting.”

Revenues

Patient Revenues

The fees charged by the Company to patients in its nursing centers are recorded on an accrual basis. These rates are contractually adjusted with respect to individuals receiving benefits under federal and state-funded programs and other third-party payors. Rates under federal and state-funded programs are determined prospectively for each facility and may be based on the acuity of the care and services provided. These rates may be based on facility’s actual costs subject to program ceilings and other limitations or on established rates based on acuity and services provided as determined by the federal and state-funded programs. Amounts earned under federal and state programs with respect to nursing home patients are subject to review by the third-party payors which may result in retroactive adjustments. In the opinion of management, adequate provision has been made for any adjustments that may result from such reviews. Retroactive adjustments, if any, are recorded when objectively determinable, generally within three years of the close of a reimbursement year depending upon the timing of appeals and third-party settlement reviews or audits. During the years ended December 31, 2011, 2010 and 2009, the Company recorded $663,000, $(2,000) and $109,000 of net favorable (unfavorable) estimated settlements from federal and state programs for periods prior to the beginning of fiscal 2011, 2010 and 2009, respectively.

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 generally resulted from uncollectible private balances, some uncollectible coinsurance and deductibles and other factors. Receivables that are deemed to be uncollectible are written off. The allowance for doubtful accounts balance is assessed on a quarterly basis, with changes in estimated losses being recorded in the Consolidated Statements of Income in the period identified.

The Company includes the provision for doubtful accounts in operating expenses in its Consolidated Statements of Income. The provisions for doubtful accounts of continuing operations were $2,330,000, $2,127,000 and $1,965,000 for 2011, 2010 and 2009, respectively. The provision for doubtful accounts of continuing operations was 0.7% of net revenue during 2011, 2010, and 2009.

Lease Expense

As of December 31, 2011, the Company operates 38 nursing centers under operating leases, including 36 owned or financed by Omega Healthcare Investors, Inc. (together with its subsidiaries, “Omega”) and two owned by other parties. The Company’s operating leases generally require the Company to pay stated rent, subject to increases based on changes in the Consumer Price Index, a minimum percentage increase, or increases in the net revenues of the leased properties. The Company’s Omega leases require the Company to pay certain scheduled rent increases. Such scheduled rent increases are recorded as additional lease expense on a straight-line basis recognized over the term of the related leases.

See Notes 3, 8 and 11 for a discussion regarding the Company’s Master Lease with Omega, the termination of leases for certain facilities and the addition of certain leased facilities.

Classification of Expenses

The Company classifies all expenses (except lease, interest, depreciation and amortization expenses) that are associated with its corporate and regional management support functions as general and administrative expenses. All other expenses (except lease, professional liability, interest, depreciation and amortization expenses) incurred by the Company at the facility level are classified as operating expenses.

Property and Equipment

Property and equipment are recorded at cost with depreciation being provided over the shorter of the remaining lease term (where applicable) or the assets’ estimated useful lives on the straight-line basis as follows:

Buildings and improvements	-	5 to 40 years
Leasehold improvements	-	2 to 10 years
Furniture, fixtures and equipment	-	2 to 15 years

Interest incurred during construction periods is capitalized as part of the building cost. Maintenance and repairs are expensed as incurred, and major betterments and improvements are capitalized. Property and equipment obtained through purchase acquisitions are stated at their estimated fair value determined on the respective dates of acquisition.

In accordance with FASB guidance on “Property, Plant and Equipment,” specifically the discussion around the accounting for the impairment or disposal of long-lived assets, the Company routinely evaluates the recoverability of the carrying value of its long-lived assets, including when significant adverse changes in the general economic conditions and significant deteriorations of the underlying cash flows or fair values of the property indicate that the carrying amount of the property may not be recoverable. The need to recognize impairment is based on estimated future undiscounted cash flows from a property compared to the carrying value of that property.

On July 29, 2011, the Centers for Medicare & Medicaid Services (“CMS”) issued its final rule for skilled nursing facilities effective October 1, 2011, reducing Medicare reimbursement rates for skilled nursing facilities by 11.1% and also making changes to rehabilitation therapy regulations. This final rule will have a negative effect on the Company’s revenue and costs in Medicare’s fiscal year ending September 30, 2012 as compared to Medicare’s fiscal year ended September 30, 2011. As a result of this negative impact, an interim impairment analysis was conducted in 2011, and the Company determined that the carrying value of the long-lived assets of one of its leased nursing centers exceeded the fair value. As a result, the Company recorded a fixed asset impairment charge during 2011 of $344,000 to reduce the carrying value of these assets.

In the fourth quarter of 2010, the Company recorded an impairment of approximately $402,000 related to land held as discontinued operations. The Company’s impairment charge was corroborated by local market data. No impairment of long lived assets was recognized in 2009.

Cash and Cash Equivalents

Cash and cash equivalents include cash on deposit with banks and all highly liquid investments with original maturities of three months or less when purchased.

Deferred Financing and Other Costs

The Company records deferred financing and lease costs for expenditures related to entering into or amending debt and lease agreements. These expenditures include lenders and attorneys fees. Financing costs are amortized using the effective interest method over the term of the related debt. The amortization is reflected as interest expense in the accompanying consolidated statements of income. Deferred lease costs are amortized on a straight-line basis over the term of the related leases. See Note 6 for further discussion.

Acquired Leasehold Interest

The Company has recorded an acquired leasehold interest intangible asset related to an acquisition completed during 2007. The intangible asset is accounted for in accordance with the FASB’s guidance on goodwill and other intangible assets, and is amortized on a straight-line basis over the remaining life of the acquired lease, including renewal periods, the original period of which is approximately 28 years from the date of acquisition. The lease terms for the seven centers this intangible relates to provide for an initial term and renewal periods at the Company’s option through May 31, 2035. As the renewal periods of the acquired leased facilities are solely based on the Company’s option, it is expected that costs (if any) to renew the lease through its current amortization period would be nominal and the decision to continue to lease the acquired facilities lies solely within the Company’s intent to continue to operate the seven facilities. Any renewal costs would be included in deferred lease costs and amortized over the renewal period. Amortization expense of approximately $384,000 related to this intangible asset was recorded during each of the years ended December 31, 2011, 2010 and 2009, respectively.

The carrying value of the acquired leasehold interest intangible and the accumulated amortization are as follows:

	December 31
	2011			2010
Intangible	$	10,652,000		$	10,652,000
Accumulated Amortization		(1,656,000	)		(1,272,000	)
Net Intangible	$	8,996,000		$	9,380,000

The Company evaluates the recoverability of the carrying value of the acquired leasehold intangible in accordance with the FASB’s guidance on accounting for the impairment or disposal of long-lived assets. Included in this evaluation is whether significant adverse changes in general economic conditions, and significant deteriorations of the underlying cash flows or fair values of the intangible asset, indicate that the carrying amount of the intangible asset may not be recoverable. The need to recognize an impairment charge is based on estimated future undiscounted cash flows from the asset compared to the carrying value of that asset. If recognition of an impairment charge is necessary, it is measured as the amount by which the carrying amount of the intangible asset exceeds the fair value of the intangible asset.

The expected amortization expense for the acquired leasehold interest intangible asset is as follows:

2012	$	384,000
2013		384,000
2014		384,000
2015		384,000
2016		384,000
Thereafter		7,076,000
	$	8,996,000

Self Insurance

Self-insurance liabilities primarily represent the accrual for self insured risks associated with general and professional liability claims, employee health insurance and workers’ compensation. The Company’s health insurance liability 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 liability relates primarily to periods of self insurance prior to May 1997 and consists of an estimate of the future costs to be incurred for the known claims.

Final determination of the Company’s actual liability for incurred general and professional liability claims is a process that takes years. The Company evaluates the adequacy of this liability on a quarterly basis and engages a third-party actuarial firm to conduct an analysis semi-annually in the second and fourth quarters. The semi-annual actuarial analysis is prepared by the Actuarial Division of Willis of Tennessee, Inc. (“Willis”) based on data furnished as of May 31 and November 30 each year.

On a quarterly basis, the Company obtains reports of asserted claims and lawsuits incurred. These reports, which are provided by the Company’s insurers and a third party claims administrator, contain information relevant to the actual expense already incurred with each claim as well as the third-party administrator’s estimate of the anticipated total cost of the claim. This information is reviewed by the Company quarterly and provided to the actuary semi-annually. The actuary also considers historical data regarding the frequency and cost of the Company’s claims over a multi-year period and information regarding the Company’s number of occupied beds to develop estimates of the Company’s ultimate professional liability cost for current periods. The actuary estimates the Company’s professional liability accrual for past periods by using currently-known information to adjust the initial liability that was created for that period. Based on the actual claim information obtained, the semi-annual estimates received from Willis and on estimates regarding the number and cost of additional claims anticipated in the future, the Company records its estimate of professional liability expense as of the end of each quarter. This expense is revised upward or downward on a quarterly basis.

All losses are projected on an undiscounted basis. The self-insurance liabilities include estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, actual liabilities related to settlements, including settlements to be paid over time, and estimates of related legal costs incurred and expected to be incurred.

One of the key assumptions in the actuarial analysis is that historical losses provide an accurate forecast of future losses. Changes in legislation such as tort reform, changes in our financial condition, changes in our risk management practices and other factors may affect the severity and frequency of claims incurred in future periods as compared to historical claims.

Another key assumption is the limit of claims to a maximum of $4.5 million. The actuary has selected this limit based on the Company’s historical data. While most of the Company’s claims have been for amounts less than the $4.5 million, there have been claims at higher amounts, and there may be claims above this level in the future. The facts and circumstances of each claim vary significantly, and the amount of ultimate liability for an individual claim may vary due to many factors, including whether the case can be settled by agreement, the quality of legal representation, the individual jurisdiction in which the claim is pending, and the views of the particular judge or jury deciding the case. To date, the Company has not experienced an uninsured loss in excess of this limit. In the event that the Company believes it has incurred a loss in excess of this limit, an adjustment to the liabilities determined by the actuary would be necessary.

Although the Company retains Willis to assist management in estimating the appropriate accrual for these claims, professional liability claims are inherently uncertain, and the liability associated with anticipated claims is very difficult to estimate. As a result, the Company’s actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given quarter. Each change in the amount of this accrual will directly affect the Company’s reported earnings and financial position for the period in which the change in accrual is made.

Income Taxes

The Company follows the FASB’s guidance on Accounting for Income Taxes, which requires an asset and liability approach for financial accounting and reporting of income taxes. Under this method, deferred tax assets and liabilities are determined based upon differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax laws that will be in effect when the differences are expected to reverse. The Company assesses the need for a valuation allowance to reduce the deferred tax assets by the amount that is believed is more likely than not to not be utilized through the turnaround of existing temporary differences, future earnings, or a combination thereof, including certain net operating loss carryforwards we do not expect to realize due to change in ownership limitations. The Company follows the guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns evaluating the need to recognize or derecognize uncertain tax positions. See Note 10 for additional information related to the provision for income taxes.

Disclosure of Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, receivables, trade accounts payable and accrued expenses approximate fair value because of the short-term nature of these accounts. The Company’s self-insurance liabilities are reported on an undiscounted basis as the timing of estimated settlements cannot be determined.

The Company follows the FASB’s guidance on Fair Value Measurements and Disclosures which provides rules for using fair value to measure assets and liabilities as well as a fair value hierarchy that prioritizes the information used to develop the measurements. It applies whenever other guidance requires (or permits) assets or liabilities to be measured at fair value and gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements).

A summary of the fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels is described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

The Company has not elected to expand the use of fair value measurements for assets and liabilities. As such, its long-term debt obligations, receivables and trade accounts payable are still reported at their carrying values. It is noted that the assessment of carrying value compared to fair value for impairment analysis, as discussed in Note 2 “Property and Equipment,” follow these fair value principles and hierarchy.

As further discussed in Note 6, in conjunction with the debt agreements entered into in March 2011, the Company entered into an interest rate swap agreement with a member of the bank syndicate as the counterparty. The applicable guidance requires companies to recognize all derivative instruments as either assets or liabilities at fair value in a company’s balance sheets.

As the Company’s interest rate swap, a cash flow hedge, is not traded on a market exchange, the fair value is determined using a valuation model based on a discounted cash flow analysis. This analysis reflects the contractual terms of the interest rate swap agreement and uses observable market-based inputs, including estimated future LIBOR interest rates. The fair value of the Company’s interest rate swap is the net difference in the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates and are observable inputs available to a market participant. The interest rate swap valuation is classified in Level 2 of the fair value hierarchy.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.

Net Income per Common Share

The Company follows the FASB’s guidance on Earnings Per Share for the financial reporting of net income per common share. Basic earnings per common share excludes dilution and restricted shares and is computed by dividing income available to common shareholders by the weighted-average number of common shares, excluding restricted shares, outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or otherwise resulted in the issuance of common stock that then shared in the earnings of the Company. See Note 9 for additional disclosures about the Company’s Net Income per Common Share.

Stock-Based Compensation

The Company follows the FASB’s guidance on Stock Compensation to account for share-based payments granted to employees and recorded non-cash stock-based compensation expense of $537,000, $597,000 and $689,000 during the years ended December 31, 2011, 2010 and 2009, respectively. Such amounts are included as components of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. See Note 8 for additional disclosures about the Company’s stock-based compensation plans.

Accumulated Other Comprehensive Income

Accumulated other comprehensive income consists of other comprehensive income (loss). Comprehensive income (loss) is a more inclusive financial reporting method that includes disclosure of financial information that historically has not been recognized in the calculation of net income. The Company has chosen to present the components of other comprehensive income in a separate statement of Comprehensive income. Currently, the Company’s other comprehensive income (loss) consists of a deferred loss on the Company’s interest rate swap transaction accounted for as a cash flow hedge.

Recent Accounting Guidance

In June 2011, the FASB issued updated guidance in the form of a FASB Accounting Standards Update on “Comprehensive Income - Presentation of Comprehensive Income,” to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The update eliminates the option to present the components of other comprehensive income as part of the statement of equity. The Company will adopt this guidance effective January 1, 2012 and will apply it retrospectively. The Company currently believes there will be no significant impact on its consolidated financial statements.

In July 2011, the FASB issued updated guidance in the form of a FASB Accounting Standards Update on “Health Care Entities: Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities.” This guidance impacts health care entities that recognize significant amounts of patient service revenue at the time the services are rendered even though they do not assess the patient’s ability to pay. This updated guidance requires an impacted health care entity to present its provision for doubtful accounts as a deduction from revenue, similar to contractual discounts. Accordingly, patient service revenue for entities subject to this updated guidance will be required to be reported net of both contractual discounts and provision for doubtful accounts. The updated guidance also requires certain qualitative disclosures about the entity’s policy for recognizing revenue and bad debt expense for patient service transactions. The guidance is effective for the Company starting January 1, 2012. Based on the Company’s assessment of its admission procedures, the Company does not believe that it is an impacted health care entity under this guidance since it assesses each patient’s ability or the patient’s payor source’s ability to pay. As a result of this assessment, the Company will continue to record bad debt expense as a component of operating expense, and adoption will not have an impact on the Company’s consolidated financial statements.

Reclassifications

As discussed in Note 7, the consolidated financial statements of the Company have been reclassified to reflect as discontinued operations certain divestitures and lease terminations. Certain amounts in the 2010 and 2009 Consolidated Financial Statements have been reclassified to conform to the presentation of 2011.

XML

Quarterly Financial Information (Unaudited)

12 Months Ended

Dec. 31, 2011

Quarterly Financial Information (Unaudited) [Abstract]

QUARTERLY FINANCIAL INFORMATION (Unaudited)

12. QUARTERLY FINANCIAL INFORMATION (Unaudited)

Selected quarterly financial information for each of the quarters in the years ended December 31, 2011 and 2010 is as follows:

	Quarter
2011	First			Second			Third			Fourth
Net revenues	$	77,130,000		$	79,172,000		$	80,644,000		$	77,769,000
Professional liability expense (1)		1,691,000			1,081,000			4,610,000			3,580,000
Net income (loss) from continuing operations		446,000			2,939,000			(873,000	)		(1,128,000	)
Loss from discontinued operations		(8,000	)		(2,000	)		—			(7,000	)
Net income (loss) for common stock	$	352,000		$	2,851,000		$	(959,000	)	$	(1,221,000	)
Basic net income per common share:
Net income (loss) from continuing operations	$	0.06		$	0.49		$	(0.17	)	$	(0.21	)
Loss from discontinued operations		—			—			—			—
Net income (loss) per common share	$	0.06		$	0.49		$	(0.17	)	$	(0.21	)
Diluted net income per common share:
Net income (loss) from continuing operations	$	0.06		$	0.48		$	(0.17	)	$	(0.21	)
Loss from discontinued operations		—			—			—			—
Net income (loss) per common share	$	0.06		$	0.48		$	(0.17	)	$	(0.21	)

⁽¹⁾  The Company’s quarterly results are significantly affected by the amounts recorded for professional liability expense, as discussed further in Note 11. The amount of expense recorded for professional liability in each quarter of 2011 is set forth in the table above.

	Quarter
2010	First		Second			Third			Fourth
Net revenues	$	70,152,000	$	71,492,000		$	72,996,000		$	75,490,000
Professional liability expense (1)		1,414,000		997,000			1,684,000			1,269,000
Net income from continuing operations		707,000		987,000			229,000			2,040,000
Income (loss) from discontinued operations ( 2 )		201,000		(10,000	)		(9,000	)		(296,000	)
Net income for common stock	$	822,000	$	891,000		$	134,000		$	1,658,000
Basic net income per common share:
Net income from continuing operations	$	0.11	$	0.16		$	0.02		$	0.34
Income (loss) from discontinued operations		0.03		—			—			(0.05	)
Net income (loss) per common share	$	0.14	$	0.16		$	0.02		$	0.29
Diluted net income per common share:
Net income from continuing operations	$	0.11	$	0.15		$	0.02		$	0.34
Income (loss) from discontinued operations		0.03		—			—			(0.05	)
Net income (loss) per common share	$	0.14	$	0.15		$	0.02		$	0.29

⁽¹⁾  The Company’s quarterly results are significantly affected by the amounts recorded for professional liability expense, as discussed further in Note 11. The amount of expense recorded for professional liability in each quarter of 2010 is set forth in the table above.

⁽²⁾  The loss from discontinued operations in the fourth quarter was the result of an impairment charge of $273,000 net of tax to reduce the carrying value of land held for sale in discontinued operations.