REGIONAL HEALTH PROPERTIES, INC - Quarter Report: 2013 September (Form 10-Q)

September 30, 2013

September 30, 2012

Cumulative number of facilities

Cumulative number of operational beds

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



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

For the quarterly period ended September 30, 2013



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

For the transition period from to

Commission File Number 001-33135

AdCare Health Systems, Inc.

(Exact name of registrant as specified in its charter)



Ohio		31-1332119
(State or other jurisdiction of incorporation)		(I.R.S. Employer Identification Number)

1145 Hembree Road, Roswell, GA 30076

(Address of principal executive offices)

(678) 869-5116

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

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

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



Large accelerated filer o		Accelerated filer o

Non-accelerated filer o		Smaller reporting company x
(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of October 31, 2013: 15,767,645 shares of common stock with no par value were outstanding.

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AdCare Health Systems, Inc.

Form 10-Q

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		Page Number
Part I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)	4
	Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012	4
	Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and 2012 (unaudited)	5
	Consolidated Statement of Stockholders' Equity for the nine months ended September 30, 2013 (unaudited)	6
	Consolidated Statements of Cash Flow for the nine months ended September 30, 2013 and 2012 (unaudited)	7
	Notes to Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	49
Item 4.	Controls and Procedures	49

Part II.	OTHER INFORMATION

Item 1.	Legal Proceedings	51
Item 1A.	Risk Factors	51
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 3.	Defaults upon Senior Securities	52
Item 4.	Mine Safety Disclosures	52
Item 5.	Other Information	52
Item 6.	Exhibits	52

Signatures		58

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Forward-Looking Statements

This Quarterly Report on Form 10-Q (this "Quarterly Report") and certain information incorporated herein by reference contain forward-looking statements and information within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This information includes assumptions made by, and information currently available to management, including statements regarding future economic performance and financial condition, liquidity and capital resources, and management’s plans and objectives. In addition, certain statements included in this Quarterly Report and the Company’s future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and written statements made by us or with our approval, which are not statements of historical fact, are forward-looking statements. Words such as “may,” “could,” “should,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “seeks,” “plan,” “project,” “continue,” “predict,” “will,” “should,” and other words or expressions of similar meaning are intended by us to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements are found at various places throughout this Quarterly Report. These statements are based on the Company’s current expectations about future events or results and information that is currently available to us, involve assumptions, risks, and uncertainties, and speak only as of the date on which such statements are made.

All forward-looking statements are subject to the risks and uncertainties inherent in predicting the future. The Company’s actual results may differ materially from those projected, stated or implied in these forward-looking statements as a result of many factors, including the Company’s critical accounting policies and risks and uncertainties related to, but not limited to, overall industry environment, regulatory delays, negative clinical results, and the Company’s financial condition. These and other risks and uncertainties are described in more detail in the Company’s most recent Annual Report on Form 10-K, as well as other reports that the Company files with the SEC.

Forward-looking statements speak only as of the date they are made and should not be relied upon as representing the Company’s views as of any subsequent date. The Company undertakes no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur, except as required by applicable laws, and you are urged to review and consider disclosures that the Company makes in this Quarterly Report and other reports that the Company files with the SEC that discuss factors germane to the Company’s business.

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Part I. Financial Information

Item 1. Financial Statements

ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in 000’s)



	September 30, 2013			December 31, 2012
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	12,724		$	15,937
Restricted cash and investments	3,473			1,742
Accounts receivable, net of allowance of $5,372 and $3,729	24,305			26,037
Prepaid expenses and other	1,519			489
Assets of disposal group held for sale	400			6,159
Total current assets	42,421			50,364

Restricted cash and investments	11,361			7,215
Property and equipment, net	149,676			151,064
Intangible assets - bed licenses	2,471			2,471
Intangible assets - lease rights, net	5,446			6,844
Goodwill	5,023			5,023
Lease deposits	1,694			1,720
Deferred loan costs, net	4,877			6,137
Other assets	22			3,611
Total assets	$	222,991		$	234,449

LIABILITIES AND EQUITY

Current liabilities:
Current portion of notes payable and other debt	$	21,634		$	6,941
Revolving credit facilities and lines of credit	3,111			1,498
Current portion of convertible debt, net of discount	13,803			10,948
Accounts payable	23,054			19,503
Accrued expenses	13,799			13,730
Liabilities of disposal group held for sale	93			3,662
Total current liabilities	75,494			56,282

Notes payable and other debt, net of current portion:
Senior debt	101,316			112,160
Bonds, net of discounts	12,940			16,088
Revolving credit facilities	6,167			7,706
Convertible debt	7,500			12,009
Other debt	231			864
Derivative liability	929			3,630
Other liabilities	1,516			1,394
Deferred tax liability	77			104
Total liabilities	206,170			210,237

Commitments and contingency (Note 16)

Preferred stock, no par value; 1,000 shares authorized; 450 shares issued and outstanding	9,159			9,159

Stockholders’ equity:
Common stock and additional paid-in capital, no par value; 29,000 shares authorized; 15,319 and 14,659 issued and outstanding	45,280			41,644
Accumulated deficit	(36,151		)	(25,753		)
Total stockholders’ equity	9,129			15,891
Noncontrolling interest in subsidiaries	(1,467		)	(838		)
Total equity	7,662			15,053
Total liabilities and equity	$	222,991		$	234,449

See accompanying notes to unaudited consolidated financial statements

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ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in 000’s, except per share data)

(Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenues:
Patient care revenues	$	55,344		$	52,633		$	166,986		$	140,522
Management revenues	521			588			1,529			1,637
Total revenues	55,865			53,221			168,515			142,159

Expenses:
Cost of services (exclusive of facility rent, depreciation and amortization)	46,102			44,475			141,219			115,645
General and administrative expense	4,583			3,957			14,017			12,204
Audit committee investigation expense	302			—			2,284			—
Facility rent expense	1,761			1,775			5,256			5,278
Depreciation and amortization	1,888			1,760			5,558			4,730
Salary retirement and continuation costs	5			38			154			38
Total expenses	54,641			52,005			168,488			137,895

Income from Operations	1,224			1,216			27			4,264

Other Income (Expense):
Interest expense, net	(3,462		)	(3,695		)	(10,253		)	(9,475		)
Acquisition costs, net of gains	(33		)	(342		)	(607		)	(1,160		)
Derivative gain (loss)	1,989			(2,105		)	2,178			(1,342		)
(Loss) gain on extinguishment of debt	(6		)	500			(33		)	500
(Loss) gain on disposal of assets	(6		)	—			(10		)	2
Other income (expense)	15			(229		)	15			(258		)
Total other expense, net	(1,503		)	(5,871		)	(8,710		)	(11,733		)

Loss from Continuing Operations Before Income Taxes	(279		)	(4,655		)	(8,683		)	(7,469		)
Income tax benefit (expense)	54			(111		)	(24		)	(132		)
Loss from Continuing Operations	(225		)	(4,766		)	(8,707		)	(7,601		)

(Loss) Income from Discontinued Operations, Net of Tax	(188		)	126			(1,402		)	203
Net Loss	(413		)	(4,640		)	(10,109		)	(7,398		)

Net Loss Attributable to Noncontrolling Interests	195			134			629			420
Net Loss Attributable to AdCare Health Systems, Inc.	(218		)	(4,506		)	(9,480		)	(6,978		)

Preferred stock dividend	(306		)	—			(918		)	—
Net Loss Attributable to AdCare Health Systems, Inc. Common Stockholders	$	(524	)	$	(4,506	)	$	(10,398	)	$	(6,978	)

Net (loss) income per Common Share attributable to AdCare Health Systems, Inc.
Common Stockholders -
Basic:
Continuing Operations	$	(0.02	)	$	(0.32	)	$	(0.61	)	$	(0.51	)
Discontinued Operations	(0.01		)	0.01			(0.09		)	0.01
	$	(0.03	)	$	(0.31	)	$	(0.70	)	$	(0.50	)

Diluted:
Continuing Operations	$	(0.02	)	$	(0.32	)	$	(0.61	)	$	(0.51	)
Discontinued Operations	(0.01		)	0.01			(0.09		)	0.01
	$	(0.03	)	$	(0.31	)	$	(0.70	)	$	(0.50	)

Weighted Average Common Shares Outstanding:
Basic	14,962			14,498			14,805			13,825
Diluted	14,962			14,498			14,805			13,825

See accompanying notes to unaudited consolidated financial statements

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ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Amounts in 000’s)

(Unaudited)



	Common Stock Shares	Common Stock and Additional Paid-in Capital		Accumulated Deficit			Noncontrolling Interests			Total
Balances, December 31, 2012	14,659	$	41,644	$	(25,753	)	$	(838	)	$	15,053

Stock-based compensation expense	—	737		—			—			737

Exercises of options and warrants	38	67		—			—			67

Issuance of stock for converted debt	622	2,823		—			—			2,823

Preferred stock dividend	—	—		(918		)	—			(918		)

Nonemployee warrants for services	—	9		—			—			9

Net loss	—	—		(9,480		)	(629		)	(10,109		)
Balances, September 30, 2013	15,319	$	45,280	$	(36,151	)	$	(1,467	)	$	7,662

See accompanying notes to unaudited consolidated financial statements

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ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in 000’s)

(Unaudited)



	Nine Months Ended September 30,
	2013			2012
Cash flows from operating activities:
Net loss	$	(10,109	)	$	(7,398	)
Loss (Income) from discontinued operations, net of tax	1,402			(203		)
Loss from continuing operations	(8,707		)	(7,601		)
Adjustments to reconcile net loss from continuing operations to net cash provided by (used in) operating activities:
Depreciation and amortization	5,558			4,730
Warrants issued for services	9			2
Stock-based compensation expense	737			639
Lease expense in excess of cash	121			419
Amortization of deferred financing costs	1,727			1,585
Amortization of debt discounts	501			646
Derivative (gain) loss	(2,178		)	1,342
Loss (gain) on debt extinguishment	33			(500		)
Deferred tax expense	(27		)	(12		)
Loss (gain) on disposal of assets	10			(2		)
Provision for bad debts	3,374			2,286
Changes in certain assets and liabilities, net of acquisitions:
Accounts receivable	(2,693		)	(10,739		)
Prepaid expenses and other	(997		)	(106		)
Other assets	580			93
Accounts payable and accrued expenses	4,335			9,891
Net cash provided by operating activities - continuing operations	2,383			2,673
Net cash provided by operating activities - discontinued operations	213			797
Net cash provided by operating activities	2,596			3,470

Cash flows from investing activities:
Proceeds from sale of property and equipment	—			3
Change in restricted cash and investments and escrow deposits for acquisitions	(5,998		)	(1,820		)
Acquisitions	—			(52,482		)
Proceeds from notes receivable	3,240			—
Purchase of property and equipment	(3,285		)	(2,666		)
Net cash used in investing activities - continuing operations	(6,043		)	(56,965		)
Net cash provided by (used in) investing activities - discontinued operations	1,580			(293		)
Net cash used in investing activities	(4,463		)	(57,258		)

Cash flows from financing activities:
Proceeds from debt	7,372			58,788
Proceeds from convertible debt	—			2,500
Repayment on notes payable	(5,387		)	(7,819		)
Change in lines of credit	74			1,787
Debt issuance costs	(407		)	(2,763		)
Exercise of warrants and options	67			137
Proceeds from stock issuances, net	—			3,837
Dividends paid on preferred stock	(918		)	—
Net cash flows provided by financing activities - continuing operations	801			56,467
Net cash flows used in financing activities - discontinued operations	(2,147		)	(170		)
Net cash flows (used in) provided by financing activities	(1,346		)	56,297
Net Change in Cash	(3,213		)	2,509
Cash, Beginning	15,937			7,364
Cash decrease due to deconsolidation of variable interest entities	—			(180		)
Cash, Ending	$	12,724		$	9,693

Supplemental disclosure of cash flow information:
Cash paid during the year for interest	$	7,984		$	9,632
Conversions of debt and other liabilities to equity	$	2,331		$	—
Acquisitions in exchange for debt and equity instruments	$	—		$	7,800
Warrants issued for financing costs	$	9		$	641
Restricted stock issued for financing costs	$	—		$	175

See accompanying notes to unaudited consolidated financial statements

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ADCARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

For the Three and Nine Months Ended September 30, 2013 and 2012

NOTE 1. DESCRIPTION OF BUSINESS

AdCare Health Systems, Inc. (“AdCare”) and its controlled subsidiaries (collectively with AdCare, the “Company” or “we”), owns and operates skilled nursing and assisted living facilities in the states of Alabama, Arkansas, Georgia, Missouri, North Carolina, Ohio, Oklahoma and South Carolina. The Company, through wholly owned separate operating subsidiaries, as of September 30, 2013, operates 47 facilities comprised of 43 skilled nursing facilities, three assisted living facilities and one independent living/senior housing facility totaling approximately 4,800 beds. The Company’s facilities provide a range of health care services to their patients and residents including, but not limited to, skilled nursing and assisted living services, social services, various therapy services, and other rehabilitative and healthcare services for both long-term residents and short-stay patients. As of September 30, 2013, of the total 47 facilities, the Company owned and operated 26 facilities, leased and operated nine facilities, managed 11 facilities for third parties and had one consolidated variable interest entity (a "VIE"). As part of the Company’s strategy to focus on the growth of skilled nursing facilities, the Company decided in the fourth quarter of 2011 to exit the home health business; therefore, this business is reported as discontinued operations (see Note 11 — Discontinued Operations). The Company sold the assets of the home health business in 2012. Additionally, in the fourth quarter of 2012, the Company entered into an agreement to sell six assisted living facilities located in Ohio and executed a sublease arrangement to exit the skilled nursing business in Jeffersonville, Georgia. The six Ohio assisted living facilities and the Jeffersonville, Georgia skilled nursing facility had an aggregate of 313 units in service. These seven facilities are also reported as discontinued operations (see Note 11 — Discontinued Operations). The Company sold the assets of four of the six Ohio assisted living facilities in December 2012, one in February 2013, and one in May 2013. On June 12, 2013, the Company executed two sublease arrangements effective as of June 30, 2013 to exit the skilled nursing business in Tybee Island, Georgia. The two skilled nursing facilities had an aggregate of 135 units in service. These two facilities are also reported as discontinued operations (see Note 11 — Discontinued Operations).

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Article 8 of Regulations S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Changes to GAAP are established by the Financial Accounting Standards Board (“FASB”) in the form of Accounting Standards Updates (“ASUs”) to the FASB’s Accounting Standards Codification (“ASC”). In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results of operations for the periods presented have been included. Operating results for the three and nine months ended September 30, 2013 and 2012, are not necessarily indicative of the results that may be expected for the fiscal year. The balance sheet at December 31, 2012, has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.

You should read these consolidated financial statements together with the historical consolidated financial statements of the Company for the year ended December 31, 2012 included in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on July 8, 2013.

The Company operates in one business segment. These statements include the accounts of AdCare Health Systems, Inc. and its controlled subsidiaries. Controlled subsidiaries include AdCare’s majority owned subsidiaries and one VIE in which AdCare has control as primary beneficiary. All inter-company accounts and transactions were eliminated in the consolidation.

NOTE 2. SIGNIFICANT ACCOUNTING POLICIES

See Note 1 to our Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, for a description of all significant accounting policies.

Reclassifications

Certain items previously reported in the consolidated financial statement captions have been reclassified to conform to the current financial statement presentation with no effect on the Company’s consolidated financial position or results of

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operations. These reclassifications did not affect total assets, total liabilities, or stockholders’ equity. These reclassifications in the December 31, 2012 Consolidated Balance Sheets included separating "Bonds, net of discounts" within "Notes payable and other debt" within the "Total liabilities" to define the Company’s debt instruments in further detail. Reclassifications were made to September 30, 2012 Consolidated Statements of Operations to reflect the same facilities in discontinued operations for both periods presented.

Use of Estimates

The preparation of financial statements in conformity with GAAP 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 revenue and expenses during the reporting period. Actual results could differ from those estimates.

Patient Care Receivables and Revenues

Patient care accounts receivable and revenues for the Company are recorded in the month in which the services are provided.

The Company provides services to certain patients under contractual arrangements with third-party payors, primarily under Federal Medicare and state Medicaid programs. Amounts paid under these contractual arrangements are subject to review and final determination by the appropriate government authority or its agent. In the opinion of management, adequate provision was made in the consolidated financial statements for any adjustments resulting from the respective government authorities’ review.

For residents under reimbursement arrangements with third-party payors, including Medicaid, Medicare and private insurers, revenue is recorded based on contractually agreed-upon amounts on a per patient, daily basis.

Potentially uncollectible patient accounts are provided for on the allowance method based upon management’s evaluation of outstanding accounts receivable at period-end and historical experience. Uncollected accounts that are written off are charged against the allowance. As of September 30, 2013 and December 31, 2012, management recorded an allowance for uncollectible accounts of $5.4 million and $3.7 million, respectively.

Management Fee Receivables and Revenues

Management fee receivables and revenue are recorded in the month that services are provided. As of September 30, 2013 and December 31, 2012, there was no allowance for uncollectible management fee receivables.

Fair Value Measurements and Financial Instruments

Accounting guidance establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are defined as follows:

Level 1 — Quoted market prices in active markets for identical assets or liabilities

Level 2 — Other observable market-based inputs or unobservable inputs that are corroborated by market data

Level 3 — Significant unobservable inputs

The respective carrying value of certain financial instruments of the Company approximates their fair value. These instruments include cash and cash equivalents, restricted cash and investments, accounts receivable, notes receivable, notes payable and other debt, and accounts payable. Fair values were assumed to approximate carrying values for these financial instruments since they are short-term in nature and their carrying amounts approximate fair values, they are receivable or payable on demand, or the interest rates earned and/or paid approximate current market rates.

Recent Accounting Pronouncements

The Company considers the applicability and impact of all ASUs. For the three months ended September 30, 2013 and through the date of this Quarterly Report, all ASUs issued, effective and not yet effective, were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial position and results of operations.

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NOTE 3. EARNINGS PER SHARE

Basic earnings per common share is computed using the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is computed using the weighted-average number of common and dilutive common equivalent shares from stock options, warrants and convertible promissory notes using the treasury stock method. For all periods presented, diluted net loss per share is the same as basic net loss per share, as the inclusion of equivalent shares from outstanding common stock options, warrants and convertible promissory notes would be anti-dilutive.



	Three Months Ended September 30,
	2013							2012
(Amounts in 000’s, except per share data)	Income (loss)			Shares	Per Share			Income (loss)			Shares	Per Share
Continuing Operations:
Loss from continuing operations	$	(225	)					$	(4,766	)
Net loss attributable to noncontrolling interests	195							134
Basic loss from continuing operations	$	(30	)	14,962	$	—		$	(4,632	)	14,498	$	(0.32	)
Preferred stock dividend	(306		)	14,962	$	(0.02	)	—			—	$	—
Effect of dilutive securities: Stock options, warrants outstanding and convertible debt (a)
Diluted loss from continuing operations	$	(336	)	14,962	$	(0.02	)	$	(4,632	)	14,498	$	(0.32	)

Discontinued Operations:
Basic (loss) income from discontinued operations	(188		)	14,962	$	(0.01	)	126			14,498	$	0.01
Diluted (loss) income from discontinued operations	(188		)	14,962	$	(0.01	)	126			14,498	$	0.01

Net Loss Attributable to AdCare:
Basic loss	(524		)	14,962	$	(0.03	)	(4,506		)	14,498	$	(0.31	)
Diluted loss	(524		)	14,962	$	(0.03	)	(4,506		)	14,498	$	(0.31	)



	Nine Months Ended September 30,
	2013							2012
(Amounts in 000’s, except per share data)	Income (loss)			Shares	Per Share			Income (loss)			Shares	Per Share
Continuing Operations:
Loss from continuing operations	$	(8,707	)					$	(7,601	)
Net loss attributable to noncontrolling interests	629							420
Basic loss from continuing operations	$	(8,078	)	14,805	$	(0.55	)	$	(7,181	)	13,825	$	(0.51	)
Preferred stock dividend	(918		)	14,805	$	(0.06	)	—			—	$	—
Effect of dilutive securities: Stock options, warrants outstanding and convertible debt (a)
Diluted loss from continuing operations	$	(8,996	)	14,805	$	(0.61	)	$	(7,181	)	13,825	$	(0.51	)

Discontinued Operations:
Basic (loss) income from discontinued operations	(1,402		)	14,805	$	(0.09	)	203			13,825	$	0.01
Diluted (loss) income from discontinued operations	(1,402		)	14,805	$	(0.09	)	203			13,825	$	0.01

Net Loss Attributable to AdCare:
Basic loss	(10,398		)	14,805	$	(0.70	)	(6,978		)	13,825	$	(0.50	)
Diluted loss	(10,398		)	14,805	$	(0.70	)	(6,978		)	13,825	$	(0.50	)

(a) Securities outstanding that were excluded from the computation, prior to the use of the treasury stock method, because they would have been anti-dilutive are as follows:

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(Amounts in 000’s)	September 30, 2013	December 31, 2012
Outstanding Stock Options	1,357	1,351
Outstanding Warrants - employee	1,876	1,806
Outstanding Warrants - nonemployee	1,904	1,961
Convertible Debt shares issuable(a)	6,406	7,140
Total anti-dilutive securities	11,543	12,258

(a) The number of shares issuable upon conversion of convertible promissory notes reflected in the tables above is 120% of the aggregate principal amount of the convertible promissory notes divided by the current conversion price, which is the number of shares required to be reserved for issuance by the Company under the applicable registration rights agreement.

NOTE 4. LIQUIDITY AND PROFITABILITY

For the nine months ended and as of September 30, 2013, we had a net loss of $10.1 million and negative working capital of $33.1 million. At September 30, 2013, we had $12.7 million in cash and cash equivalents and $166.7 million in indebtedness, including current maturities and discontinued operations, of which $38.5 million is current debt (including the Company’s outstanding subordinated convertible promissory notes with a principal amount in the aggregate of $4.5 million and $9.3 million that mature in March 2014 and August 2014, respectively). Our ability to

achieve profitable operations is dependent on continued growth in revenue and controlling costs.

We anticipate that scheduled debt service (excluding approximately $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively, that the Company believes will be refinanced on a longer term basis but including principal, interest, collateral and capital improvement fund or other escrow deposits) will total approximately $33.4 million and cash outlays for acquisition costs, maintenance capital expenditures, dividends on our Series A Preferred Stock and income taxes will total approximately $5.3 million for the 12 months ending September 30, 2014. We routinely have ongoing discussions with existing and potential new lenders to refinance current debt on a longer term basis and, in recent periods, have refinanced shorter term acquisition debt, including seller notes, with traditional longer term mortgage notes, some of which have been executed under government guaranteed lending programs. Although we anticipate the conversion to common stock of the Company’s outstanding subordinated convertible promissory notes with a principal amount in the aggregate of $7.7 million that mature in August 2014, which excludes subordinated convertible promissory notes with a principal amount in the aggregate of $1.7 million that were converted into shares of common stock of the Company in October 2013 (see Note 18 - Subsequent Events), we believe that our anticipated cash flow and funding sources would allow us to pay these notes in cash. These promissory notes are convertible at the option of the holder into shares of common stock of the Company at $3.73 per share. The closing price of the common stock exceeded $3.79 per share from January 1, 2013 through November 6, 2013. We have been successful in recent years in raising new equity capital and in October 2013 the Company issued 500,000 shares of Series A Preferred Stock at $25.00 per share receiving proceeds of approximately $11.2 million after deducting underwriting discounts and other offering-related expenses (see Note 18 - Subsequent Events). As discussed further below, if we are unable to refinance the $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively, then the Company may be required to restructure its outstanding indebtedness, implement further cost reduction initiatives, sell assets, as well as delay, modify, or abandon its expansion plans due to our limited liquidity in such an event.

Based on existing cash balances, anticipated cash flows for the 12 months ending September 30, 2014, the anticipated refinancing of the $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively, and the net proceeds from the issuance of 500,000 shares of Series A Preferred Stock in October 2013, we believe there will be sufficient funds for our operations, scheduled debt service, and capital expenditures at least through the next 12 months. On a longer term basis, we have approximately $65.9 million of debt payments and maturities due between 2015 and 2017, excluding subordinated convertible promissory notes which are convertible into shares of common stock. We believe our long-term liquidity needs will be satisfied by these same sources, as well as borrowings as required to refinance indebtedness.

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currently have limited borrowing availability under our existing revolving credit facilities. If the Company is unable to improve operating results or refinance current debt (including the $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively), then the Company may be required to restructure its outstanding indebtedness, implement further cost reduction initiatives, sell assets, as well as delay, modify, or abandon its expansion plans.

NOTE 5. RESTRICTED CASH AND INVESTMENTS

The following table sets forth the Company’s various restricted cash, escrow deposits and investments:



(Amounts in 000’s)	September 30, 2013		December 31, 2012
Defeased bonds escrow	$	3,145	$	—
HUD escrow deposits	65		279
Principal and interest escrow	—		106
Lender's collection account	105		—
Collateral certificates of deposit	158		1,357
Total current portion	3,473		1,742

HUD reserve replacement	362		372
Reserves for capital improvements	1,613		1,602
Restricted investments for other debt obligations	9,386		5,241
Total noncurrent portion	11,361		7,215

Total restricted cash and investments	$	14,834	$	8,957

NOTE 6. PROPERTY AND EQUIPMENT

The following table sets forth the Company’s property and equipment:



(Amounts in 000’s)	Estimated Useful Lives (Years)	September 30, 2013		December 31, 2012
Buildings and improvements	5-40	$	139,707	$	137,842
Equipment	2-10	11,645		10,448
Land	—	8,469		8,469
Computer related	2-10	2,884		2,670
Construction in process	—	713		510
		163,418		159,939
Less: Accumulated depreciation and amortization expense		13,742		8,875
Property and equipment, net		$	149,676	$	151,064

Depreciation and amortization expense was approximately $1.9 million and $5.6 million for the three and nine months ended September 30, 2013, respectively, and $1.8 million and $4.7 million for the three and nine months ended September 30, 2012, respectively.

During the quarter ended March 31, 2012, the Company recognized a $0.4 million impairment charge to write down the carrying value of an office building located in Rogers, Arkansas. The office building was acquired in 2011. The purchase price allocation for that acquisition was deemed to be final as of December 31, 2011. Subsequent to December 31, 2011, it was determined that the acquired office building would not be utilized and the building was not in use as of March 31, 2012. The impairment charge represents a change in fair value from value recognized in the purchase price allocation. The impairment charge is classified as depreciation expense in the consolidated statement of operations.

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NOTE 7. INTANGIBLE ASSETS AND GOODWILL

There have been no impairment adjustments to goodwill during the three and nine months ended September 30, 2013. The Company recognized an impairment loss of $0.7 million related to two facilities in Tybee Island, Georgia during the nine months ended September 30, 2013 (see Note 11 — Discontinued Operations).

Intangible assets consist of the following:



(Amounts in 000’s)	Bed Licenses (included in property and equipment)			Bed Licenses - Separable		Lease Rights			Total
Balances, December 31, 2012
Gross	$	38,478		$	2,471	$	9,545		$	50,494
Accumulated amortization	(1,438		)	—		(2,701		)	(4,139		)
Net carrying amount	$	37,040		$	2,471	$	6,844		$	46,355

Acquisitions	—			—		—			—
Disposals	—			—		—			—
Impairment losses	—			—		(721		)	(721		)
Amortization expense	(932		)	—		(677		)	(1,609		)

Balances, September 30, 2013
Gross	38,478			2,471		9,545			50,494
Impairment losses	—			—		(721		)	(721		)
Accumulated amortization	(2,370		)	—		(3,378		)	(5,748		)
Net carrying amount	$	36,108		$	2,471	$	5,446		$	44,025

Amortization expense for bed licenses included in property and equipment was approximately $0.3 million and $0.9 million for the three and nine months ended September 30, 2013, respectively, and $0.3 million and $0.7 million for the three and nine months ended September 30, 2012, respectively. Amortization expense for lease rights was approximately $0.2 million and $0.7 million for the three and nine months ended September 30, 2013, respectively, and $0.3 million and $0.8 million for the three and nine months ended September 30, 2012, respectively. For the nine months ended September 30, 2013, the Company recognized an impairment loss of $0.7 million related to two facilities in Tybee Island, Georgia (see Note 11 — Discontinued Operations).

Expected amortization expense for all definite lived intangibles for each of the years ended December 31 is as follows:



(Amounts in 000’s)	Bed Licenses		Lease Rights
2013 (a)	$	320	$	225
2014	1,283		844
2015	1,283		719
2016	1,283		719
2017	1,283		719
Thereafter	30,656		2,220
Total expected amortization expense	$	36,108	$	5,446

(a) Estimated amortization expense for the year ending December 31, 2013 includes only amortization to be recorded after September 30, 2013.

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The following table summarizes the carrying amount of goodwill at September 30, 2013 as compared with December 31, 2012:



	(Amounts in 000’s)
Balances, December 31, 2012
Gross	$	5,023
Accumulated impairment losses	—
Total	$	5,023

Goodwill acquired in acquisitions	—
Disposed in sale of business, net	—
Impairment losses	—

Balances, September 30, 2013
Gross	$	5,023
Accumulated impairment losses	—
Total	$	5,023

The Company does not amortize goodwill or indefinite lived intangibles, which consist of separable bed licenses.

NOTE 8. ACCRUED EXPENSES

Accrued expenses consist of the following:



(Amounts in 000’s)	September 30, 2013		December 31, 2012
Accrued payroll related	$	4,338	$	5,626
Accrued employee benefits	4,932		3,790
Real estate and other taxes	1,670		1,245
Other accrued expenses	2,859		3,069
Total accrued expenses	$	13,799	$	13,730

NOTE 9. NOTES PAYABLE AND OTHER DEBT

Notes payable and other debt consist of the following:



(Amounts in 000’s)	September 30, 2013		December 31, 2012
Senior debt - guaranteed by HUD (a)	$	4,093	$	9,699
Senior debt - guaranteed by USDA	27,914		28,370
Senior debt - guaranteed by SBA	6,013		6,189
Senior debt - bonds, net of discount (b)	16,123		16,265
Senior debt - other mortgage indebtedness	78,361		75,188
Revolving credit facilities and lines of credit	9,278		9,204
Convertible debt issued in 2010, net of discount	9,344		10,948
Convertible debt issued in 2011	4,459		4,509
Convertible debt issued in 2012	7,500		7,500
Other debt	3,617		4,004
Total	$	166,702	$	171,876
Less: current portion	38,548		19,387
Less: portion included in liabilities of disposal group held for sale	—		3,662
Notes payable and other debt, net of current portion	$	128,154	$	148,827

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(a) The senior debt - guaranteed by the U.S. Department of Housing and Urban Development (“HUD”) includes $3.6 million related to the Vandalia HUD mortgage note classified as liabilities of disposal group held for sale at December 31, 2012, that was assumed by the buyer of the Hearth & Home of Vandalia assisted living facility that the Company sold in a transaction that closed in May 2013.

(b) The senior debt - bonds, net of discount includes $3.1 million related to the outstanding bonds that were assumed by the Company upon its acquisition of the Quail Creek skilled nursing facility in July 2012, which, pursuant to the applicable loan agreement, will be prepaid on March 1, 2014.

Scheduled Maturities

The schedule below summarizes the scheduled maturities as of September 30, 2013 for each of the next five years and thereafter.



	(Amounts in 000’s)
2014	$	38,314
2015	36,115
2016	17,558
2017	19,715
2018	3,728
Thereafter	51,457
Subtotal	166,887
Less: unamortized discounts ($57 classified as current)	(476		)
Plus: unamortized premiums ($291 classified as current)	291
Total notes and other debt	$	166,702

Debt Covenant Compliance

As of September 30, 2013, the Company (including its consolidated VIE) has more than forty credit related instruments (credit facilities, mortgage notes, bonds and other credit obligations) outstanding that include various financial and administrative covenant requirements. Covenant requirements include, but are not limited to, fixed charge coverage ratios, debt service coverage ratios, minimum EBITDA or EBITDAR, current ratios and tangible net worth requirements. Certain financial covenant requirements are based on consolidated financial measurements whereas others are based on subsidiary level (i.e., facility, multiple facilities or a combination of subsidiaries comprising less than the Company’s consolidated financial measurements). Some covenants are based on annual financial metric measurements whereas others are based on monthly or quarterly financial metric measurements. The Company routinely tracks and monitors its compliance with its covenant requirements. In recent periods, including as of September 30, 2013, the Company has not been in compliance with certain financial and administrative covenants. For each instance of such non-compliance, the Company has obtained waivers or amendments to such requirements including as necessary modifications to future covenant requirements or the elimination of certain requirements in future periods.

Senior Debt—Guaranteed by HUD

Hearth and Home of Vandalia

In connection with the Company’s January 2012 refinancing of the assisted living facility known as Hearth and Home of Vandalia (“Vandalia”), owned by a wholly owned subsidiary of AdCare, the Company issued a note, insured by HUD, to a financial institution for a total amount of $3.7 million that matures in 2041. The HUD note requires monthly principal and interest payments with a fixed interest rate of 3.74%. The Company incurred deferred financing costs on the note of approximately $0.2 million, which are being amortized to interest expense over the life of the note. The HUD note has a prepayment penalty of 8% starting in 2014 declining by 1% each year through 2022. This note was assumed by the buyer in the closing of the sale of this facility that occurred in May 2013 pursuant to the terms of the sale agreement related to the sale of six of the Company’s assisted living facilities located in Ohio.

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Senior Debt - Other Mortgage Indebtedness

Little Rock

On June 27, 2013, certain wholly-owned subsidiaries of the Company entered into a Third Modification Agreement with PrivateBank, dated as of June 26, 2013, which modified that certain Loan Agreement, dated March 30, 2012, between such subsidiaries and PrivateBank. Pursuant to the modification, PrivateBank waives certain financial covenants under the credit facility regarding the minimum fixed charge coverage ratio and minimum EBITDAR of one of the subsidiaries that is the operator of the Company’s skilled nursing facility located in Little Rock, Arkansas.

Quail Creek Credit Facility

On September 27, 2013, QC Property Holdings, LLC (“QC”), a wholly owned subsidiary of the Company, entered into a Loan and Security Agreement (the “Quail Creek Credit Facility”), with Housing & Healthcare Funding, LLC (“HHCF”). The Quail Creek Credit Facility provides for a $5.0 million principal amount secured credit facility. The proceeds of the Quail Creek Credit Facility will be used primarily to repay certain outstanding bonds that were assumed by QC upon its acquisition of the 118-bed skilled nursing facility located in Oklahoma City, Oklahoma known as the Quail Creek Nursing & Rehabilitation Center in July 2012. Pursuant to the loan agreement, the outstanding bonds will be prepaid on March 1, 2014 at par plus accrued interest to the prepayment date. The outstanding principal and accrued interest to the prepayment date in the amount of $3.1 million has been deposited into a restricted defeased bonds escrow account.

The Quail Creek Credit Facility matures on September 27, 2016. Interest on the Quail Creek Credit Facility accrues on the principal balance thereof at an annual rate of 4.75% plus the current one-month LIBOR rate (but in no event shall the interest rate be less than 5.75%). The Quail Creek Credit Facility is secured by: (i) a first mortgage on the real property and improvements constituting the Quail Creek Facility; (ii) a first priority interest on all furnishings, fixtures and equipment associated with the Quail Creek Facility; and (iii) an assignment of all rents paid under any existing or future leases and rental agreements with respect to the Quail Creek Facility. The Company has unconditionally guaranteed all amounts owing under the Quail Creek Credit Facility.

The Quail Creek Credit Facility contains customary events of default, including material breach of representations and warranties, failure to make required payments, failure to comply with certain agreements or covenants and certain events of bankruptcy and insolvency. Upon the occurrence of an event of default, HHCF may terminate the Quail Creek Credit Facility and all amounts under the Quail Creek Credit Facility will become immediately due and payable.

In connection with entering into the Quail Creek Credit Facility, certain affiliates of the Company and QC, as applicable, entered into environmental indemnities, pledge and security agreements, subordination and attornment agreements and subordination of management fee agreements, each containing customary terms and conditions.

Revolving Credit Facilities and Lines of Credit

PrivateBank Credit Facility

On January 25, 2013, the Company entered into a Memorandum of Agreement with The PrivateBank and Trust Company (“PrivateBank”). Pursuant to the memorandum, three of the Company’s subsidiaries and their collateral, which comprise the three skilled nursing facilities located in Arkansas known as the Aviv facilities, were released from liability under that certain Loan and Security Agreement, dated October 26, 2012 and as so amended, between PrivateBank and the Company (the “PrivateBank Credit Facility”). In exchange for the release from liability under the loan agreement, the Company made a payment in the amount of $0.7 million on December 28, 2012. The memorandum did not change the maximum amount that may be borrowed under the loan agreement by the Company, which remains $10.6 million.

On September 30, 2013, certain wholly-owned subsidiaries of the Company entered into a Third Modification Agreement with PrivateBank, which modified that certain Loan Agreement, dated September 20, 2012, between such subsidiaries and PrivateBank. Pursuant to the modification: (i) a wholly-owned subsidiary of the Company was added as a borrower to the PrivateBank Credit Facility; and (ii) three of the subsidiaries and their collateral were released from their obligations under the PrivateBank Credit Facility because such entities no longer operate skilled nursing facilities.

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As of September 30, 2013, $6.2 million was outstanding of the maximum borrowing amount of $10.6 million under the PrivateBank Credit Facility, subject to borrowing base limitations. There were also $2.5 million of outstanding letters of credit that are pledged as collateral of the borrowing capacity on this revolver.

Gemino Northwest Credit Facility

On May 30, 2013, NW 61^st Nursing, LLC (“Northwest”), a wholly-owned subsidiary of the Company, entered into a Credit Agreement (the “Northwest Credit Facility”) with Gemino Healthcare Finance, LLC (“Gemino”). The Northwest Credit Facility provides for a $1.0 million principal amount senior-secured revolving credit facility.

The Northwest Credit Facility matures on January 31, 2015 and interest accrues on the principal balance thereof at an annual rate of 4.75% plus the current LIBOR rate. Northwest shall also pay to Gemino: (i) a collateral monitoring fee equal to 1.0% per annum of the daily outstanding balance of the Northwest Credit Facility; and (ii) a fee equal to 0.5% per annum of the unused portion of the Northwest Credit Facility. In the event the Northwest Credit Facility is terminated prior to January 31, 2015, Northwest shall also be required to pay a fee to Gemino in an amount equal to 1.0% of the Northwest Credit Facility. The Northwest Credit Facility is secured by a security interest in, without limitation, the accounts receivable and the collections and proceeds thereof relating to the Company’s skilled nursing facility located in Oklahoma City, Oklahoma known as the Northwest Nursing Center. The Company has unconditionally guaranteed all amounts owing under the Northwest Credit Facility.

The Northwest Credit Facility contains customary events of default, including material breach of representations and warranties, failure to make required payments, failure to comply with certain agreements or covenants and certain events of bankruptcy and insolvency. Upon the occurrence of an event of default, Gemino may terminate the Northwest Credit Facility.

In connection with entering into the Northwest Credit Facility, certain affiliates of the Company and Northwest, as applicable, also entered into an intercreditor and subordination agreement, governmental depository agreement and subordination of management fee agreement, each containing customary terms and conditions.

On June 25, 2013, Northwest entered into a First Amendment to the Credit Agreement which amended the Northwest Credit Facility. The amendment, among other things: (i) amends certain financial covenants regarding fixed charge coverage ratio and minimum EBITDA; and (ii) amends the credit facility to include the Bonterra Credit Facility (discussed below) as an affiliated credit agreement in determining whether certain financial covenants are being met.

On June 28, 2013, Georgetown HC&R Nursing, LLC and Sumter N&R, LLC, both wholly-owned subsidiaries of the Company, entered into a Joinder Agreement, Second Amendment and Supplement to Credit Agreement with Northwest and Gemino pursuant to which such subsidiaries became additional borrowers under the Northwest Credit Facility. Pursuant to the joinder, the borrowers granted a continuing security interest in, among other things, their accounts receivables, payment intangibles, chattel paper, general intangibles, collateral relating to any accounts or payment intangibles, commercial lockboxes and cash, as additional collateral under the Northwest Credit Facility. In connection with the execution of the joinder, the borrowers issued an amended and restated revolving promissory note in favor of Gemino in the amount of $1.5 million.

As of September 30, 2013, $1.5 million was outstanding of the maximum borrowing amount of $1.5 million under the Northwest Credit Facility.

Gemino Bonterra Credit Facility

On May 30, 2013, the ADK Bonterra/Parkview, LLC, a wholly-owned subsidiary of the Company (“Bonterra”), entered into a Fourth Amendment to Credit Agreement with Gemino, which amended that certain Credit Agreement dated April 27, 2011 between Bonterra and Gemino (as amended, the “Bonterra Credit Facility”). The amendment, among other things: (i) extends the term of the Bonterra Credit Facility from January 31, 2014 to January 31, 2015; (ii) amends certain financial covenants regarding Bonterra’s fixed charge coverage ratio and maximum loan turn days; and (iii) amends the Gemino-Bonterra credit facility to include the Northwest Credit Facility as an affiliated credit agreement in determining whether certain financial covenants are being met.

As of September 30, 2013, $1.4 million was outstanding of the maximum borrowing amount of $2.0 million under the Bonterra Credit Facility.

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KeyBank Credit Facility

On May 31, 2013, certain subsidiaries of the Company entered into a First Amendment to Secured Loan Agreement and Payment Guaranty (the “KeyBank Amendment”) with KeyBank National Association (“KeyBank”) which amended that certain Secured Loan Agreement, dated December 28, 2012, between the Company and KeyBank (the “KeyBank Credit Facility”). Pursuant to the KeyBank Amendment, KeyBank waives any default or events of default that may exist relating to the Company’s: (i) failure to timely file with the SEC its Annual Report on Form 10-K for the year ended December 31, 2012; (ii) process of restating its previously issued financial statements for the quarters ended March 31, 2012, June 30, 2012 and September 30, 2012; and (iii) non-compliance with the continued listing standards of the NYSE MKT LLC, as well as certain other events. The KeyBank Amendment, among other things: (1) establishes a special account under the sole dominion and control of KeyBank pursuant to which certain subsidiaries of the Company shall deposit certain funds, on a monthly basis, to be held as collateral; (2) amends certain financial covenants regarding such subsidiaries implied debt service coverage and furnishing of certain financial information; and (3) amends certain financial covenants provided for in a guaranty made by the Company for the benefit of KeyBank relating to the KeyBank Credit Facility. In addition, as a condition precedent for KeyBank to enter into the KeyBank Amendment, the Company granted a first-priority security interest in the real property and improvements, leases and rents, revenues and accounts receivables relating to the 32 unit assisted-living facility located in Mountain View, Arkansas known as the Stone County Residential Care Center. The KeyBank Amendment also requires the Company to pledge to KeyBank, as additional collateral, that certain secured promissory note dated December 28, 2012, issued by CHP Acquisition Company, LLC (“CHP”) to the Company in the amount of $3.6 million (as amended, the “CHP Note”); provided, however, that the Company shall be entitled to any excess payments of principal or prepayments over $2.0 million made by CHP on the CHP Note (see Note 11 — Discontinued Operations ).

On June 27, 2013, the Company entered into a Second Amendment to Secured Loan Agreement and Payment Guaranty with KeyBank, which amended the KeyBank Credit Facility. Pursuant to the amendment: (i) KeyBank waives the failure of certain financial covenants of such subsidiaries regarding fixed charge coverage ratio and implied debt service coverage such that no default or events of default under the KeyBank Credit Facility occurred due to such failure; and (ii) KeyBank and the Company agreed to amend certain financial covenants regarding the Company’s fixed charge ratio.

As of September 30, 2013, $15.4 million was outstanding under the KeyBank Credit Facility.

Convertible Debt

Subordinated Convertible Promissory Notes Issued in 2010

During the nine months ended September 30, 2013, there were conversions of approximately $2.3 million of convertible promissory notes and accrued interest, which were part of the October 26, 2010 note offering, at a price of $3.73 per share. The schedule below summarizes the note conversions and number of shares of common stock issued for each conversion.



Month of conversion	Debt and Interest Converted (000's)		Shares of Common Stock Issued
February	$	25	6,635
March	$	25	6,635
April	$	250	67,024
August	$	1,063	284,878
September	$	919	246,264
Total	$	2,282	611,436

Subordinated Convertible Promissory Notes Issued in 2011

In April 2013, there was a conversion of a $0.05 million convertible promissory note, which was part of the March 31, 2011 note offering, at a price of $4.80 per share and resulted in the issuance of 10,438 shares of common stock.

Other Debt

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During March 2013, the Company obtained financing from AON Premium Finance, LLC and entered into Commercial Insurance Premium Finance Security Agreements for several insurance programs, including general and professional liability, property, casualty, crime, and employment practices liability effective January 1, 2013 and maturing on December 31, 2013. The total amount financed was approximately $2.4 million requiring monthly payments of $0.2 million with interest ranging from 2.87% to 4.79%. The outstanding amount was approximately $0.6 million at September 30, 2013.

On June 11, 2013, the Company completed the sale of its former Springfield, Ohio corporate office building which was sold for the approximate net book value. The Company used the proceeds to pay the principal balance of the mortgage note with respect to the building of approximately $0.1 million.

NOTE 10. ACQUISITIONS

On February 15, 2013, the Company entered into a Purchase and Sale Agreement with Avalon Health Care, LLC (“Avalon”)

to acquire certain land, buildings, improvements, furniture, vehicles, contracts, fixtures and equipment comprising: (i) a 180-bed skilled nursing facility known as Bethany Health and Rehab; and (ii) a 240-bed skilled nursing facility known as Trevecca Health and Rehab, both located in Nashville, Tennessee. The Company deposited $0.4 million of earnest money escrow deposits in February 2013. On June 1, 2013, the Purchase and Sale Agreement was terminated due to the failure of the transaction to close by May 31, 2013. In connection with the termination of the Purchase and Sale Agreement, the Company was seeking the return of $0.4 million previously deposited earnest money escrow deposits. On August 1, 2013, the Company entered into a settlement agreement regarding the return of the $0.4 million previously deposited earnest money escrow deposits. Pursuant to the agreement, the previously deposited earnest money escrow deposits were released and distributed, $0.3 million to the Company and $0.1 million to Avalon, respectively.

The Company incurred acquisition costs of approximately $0.03 million and $0.6 million during the three and nine months ended September 30, 2013, and $0.3 million and $1.2 million during the three and nine months ended September 30, 2012, respectively. Acquisition costs are recorded in “Other Income (Expense)” section of the Consolidated Statements of Operations.

During the nine months ended September 30, 2012, the Company acquired a total of eight skilled nursing facilities and one assisted living facility.

Unaudited Pro forma Financial Information

Acquisitions have been included in the consolidated financial statements since the dates of the acquisition. The following table represents pro forma results of consolidated operations as if all of the 2012 acquisitions had occurred at the beginning of the earliest fiscal year being presented, after giving effect to certain adjustments.



(Amounts in 000s)	Three Months Ended September 30, 2012
Pro forma revenue	$	58,061
Pro forma operating expenses	$	56,463
Pro forma (loss) income from operations	$	1,598



(Amounts in 000s)	Nine Months Ended September 30, 2012
Pro forma revenue	$	171,551
Pro forma operating expenses	$	165,935
Pro forma (loss) income from operations	$	5,616

The forgoing pro forma information is not indicative of what the results of operations would have been if the acquisitions had actually occurred at the beginning of the periods presented and is not intended as a projection of future results or trends.

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NOTE 11. DISCONTINUED OPERATIONS

As part of the Company’s strategy to focus on the growth of its skilled nursing segment, the Company decided in the fourth quarter of 2011 to exit the home health segment of the business. In the fourth quarter of 2012, the Company continued this strategy and entered into an agreement to sell six assisted living facilities located in Ohio. The Company also entered into a sublease arrangement in the fourth quarter of 2012 to exit the operations of a skilled nursing facility in Jeffersonville, Georgia. On June 12, 2013, the Company executed two sublease agreements to exit the skilled nursing business in Tybee Island, Georgia effective June 30, 2013 relating to two facilities. The results of operations and cash flows for the home health business, the six Ohio assisted living facilities, the Jeffersonville, Georgia skilled nursing facility, and the two facilities in Tybee Island, Georgia are reported as discontinued operations in 2013 and 2012.

Total revenues from discontinued operations were $0.01 million and $4.0 million for the three and nine months ended September 30, 2013, respectively, and $5.4 million and $15.7 million for the three and nine months ended September 30, 2012, respectively. Net loss from discontinued operations was $0.2 million and $1.4 million for the three and nine months ended September 30, 2013, respectively, and net income of $0.1 million and $0.2 million for the three and nine months ended September 30, 2012, respectively. Interest expense included in discontinued operations was none and $0.1 million for the three and nine months ended September 30, 2013, respectively, and $0.2 million and $0.5 million for the three and nine months ended September 30, 2012, respectively. For the nine months ended September 30, 2013, the Company recognized an impairment loss of $0.7 million related to two facilities in Tybee Island, Georgia.

On February 28, 2013, the Company completed the sale of the facility known as Lincoln Lodge Retirement Residence and used the proceeds to pay the principal balance of the HUD mortgage note with respect to the facility of $1.9 million. The Company recognized a gain on the sale of $0.1 million and cash proceeds, net of costs and debt payoff, of $0.7 million.

On May 6, 2013, Hearth & Home of Vandalia, Inc. (the “Vandalia Seller”), a wholly owned subsidiary of the Company, sold to H & H of Vandalia LLC (the “Vandalia Purchaser”), pursuant to that certain Agreement of Sale, dated October 11, 2012 and amended December 28, 2012 (as amended, the “Ohio Sale Agreement”), between the Company and certain of its subsidiaries, including the Vandalia Seller (together, the “Ohio ALF Sellers”), on the one hand, and CHP Acquisition Company, LLC (“CHP”) on the other hand, certain land, buildings, improvements, furniture, fixtures and equipment comprising the Vandalia facility located in Vandalia, Ohio. CHP had previously assigned its rights in the Ohio Sale Agreement with respect to the Vandalia facility to the Vandalia Purchaser.

The sale price for the Vandalia facility consisted of, among other items: (i) an assumption, by the Vandalia Purchaser, of a mortgage in an aggregate amount of $3.6 million (the “Vandalia Mortgage”) that secures the Vandalia facility; and (ii) a release of the Vandalia Seller from its obligations to Red Mortgage Capital, LLC (the “Vandalia Mortgagee”) and HUD with respect to the Vandalia Mortgage, pursuant to a release and assumption agreement entered into among the Vandalia Purchaser, the Vandalia Seller, HUD and the Vandalia Mortgagee. In connection with the sale of the Vandalia facility, the Vandalia Seller and Vandalia Purchaser also entered into an assignment and assumption agreement of trust funds and service contracts, containing customary terms and conditions.

In June 2013, the Company entered into a Release Agreement with CHP amending the terms of the $3.6 million Seller Note issued in the connection with the sale of four of the six Ohio assisted living facilities sold to CHP in the fourth quarter of 2012. In exchange for a reduction in the Vandalia purchase price by $0.4 million, CHP agreed to immediately payoff the Seller Note resulting in a net payment of $3.2 million. Proceeds from the $3.2 million payment were used to fund a $2.0 million increase in collateralized restricted cash required by one of the Company’s lenders and $1.2 million was received by the Company for working capital purposes. The Company recognized a loss on the sale of Vandalia of $0.4 million.

Assets and liabilities of the disposal groups held for sale at September 30, 2013 and December 31, 2012, which includes the Rogers, Arkansas office building held for sale in property and equipment, net, are as follows:

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(Amounts in 000’s)	September 30, 2013		December 31, 2012
Property and equipment, net	$	400	$	5,840
Other assets	—		319
Assets of disposal group held for sale	$	400	$	6,159

Other liabilities	$	93	$	—
Notes payable	—		3,662
Liabilities of disposal group held for sale	$	93	$	3,662

NOTE 12. PREFERRED STOCK AND STOCKHOLDERS’ EQUITY

Preferred Stock

On November 14, 2012, the Company closed a “best efforts” public offering of 450,000 shares of its then newly designated Series A Preferred Stock at $23.00 per share. The Company received net proceeds of approximately $9.2 million from the offering after deducting underwriting discounts and other offering-related expenses of approximately $1.2 million. The liquidation preference per share is $25.00. Cumulative dividends accrue and are paid in the amount of $2.72 per share each year, which is equivalent to 10.875% of the $25.00 liquidation preference per share. The dividend rate may increase under certain circumstances.

Holders of the Series A Preferred Stock generally have limited voting rights under certain circumstances. The Company may not redeem the Series A Preferred Stock before December 1, 2017, however the Company is required to redeem the Series A Preferred Stock following a “Change of Control,” as defined. On and after December 1, 2017, the Company may, at its option, redeem the Series A Preferred Stock, in whole or in part, by paying $25.00 per share, plus any accrued and unpaid dividends to the redemption date.

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

Preferred Stock Dividends

On September 9, 2013, the Company declared a quarterly dividend out of capital surplus of $0.68 per share on the Series A Preferred Stock. The dividend payment is equivalent to an annualized 10.875% per share, based on the $25.00 per share stated liquidation preference, accruing from July 1, 2013. The dividend was paid on September 30, 2013 to holders of the Series A Preferred Stock of record on September 20, 2013.

On June 7, 2013, the Company declared a quarterly dividend out of capital surplus of $0.68 per share on the Series A Preferred Stock. The dividend payment is equivalent to an annualized 10.875% per share, based on the $25.00 per share stated liquidation preference, accruing from April 1, 2013. The dividend was paid on July 1, 2013 to holders of the Series A Preferred Stock of record on June 20, 2013.

On March 8, 2013, the Company declared a quarterly dividend out of capital surplus of $0.68 per share on the Series A Preferred Stock. The dividend payment is equivalent to an annualized 10.875% per share, based on the $25.00 per share stated liquidation preference, accruing from January 1, 2013. The dividend was paid on April 1, 2013 to holders of the Series A Preferred Stock of record on March 21, 2013.

Stock Dividend

On September 6, 2012, the Company’s Board of Directors declared a 5% stock dividend issued on October 22, 2012 to holders of the common stock as of October 8, 2012. As a result of the stock dividend, the number of outstanding shares of common stock increased by 0.7 million shares in 2012.

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2012 Public Common Stock Offering

In March 2012, the Company closed a firm commitment underwritten public offering of 1.1 million shares of common stock at an offering price to the public of $3.75 per share. The Company also granted the underwriter in the offering an option for 45 days to purchase up to an additional 165,000 shares of common stock to cover over-allotments, if any. In connection with the underwriter’s partial exercise of this option, the Company issued an additional 65,000 shares of common stock at an offering price to the public of $3.75 per share on May 22, 2012. The Company received net proceeds of $3.8 million after deducting underwriting discounts and other offering-related expenses of $0.6 million.

NOTE 13. STOCK BASED COMPENSATION

Stock Incentive Plans

The Company has three share-based compensation plans: the AdCare Health Systems, Inc. 2011 Stock Incentive Plan (the “2011 Plan”), the 2005 Stock Option Plan of AdCare Health Systems, Inc. (the “2005 Plan”) and the 2004 Stock Option Plan of AdCare Health Systems, Inc. (the “2004 Plan”) which provide for the granting of qualified incentive and non-qualified stock options to employees, directors, consultants and advisors. The 2011 Plan also permits the granting of restricted stock to employees, directors, consultants and advisors. The awards are subject to a vesting schedule as set forth in each individual agreement. The Company intends to use only the 2011 Plan to make future grants. The number of options under the 2004 Plan and 2005 Plan outstanding at September 30, 2013 totaled 31,528. The maximum number of shares of common stock which can be issued under the 2011 Plan is 2,252,500 at September 30, 2013.

The fair value of options granted by the Company is estimated on the date of grant using the Black-Scholes-Merton option-pricing model that uses assumptions for expected volatility, expected dividends, expected term, and the risk-free interest rate. Expected volatilities are based on historical volatility of the Company’s common stock. The term of employee options and warrants granted is based on historical exercises of employee options and warrants. The term of non-employee warrants is based on the term of the associated contract. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the period of the expected term as described.

The assumptions used in calculating the fair value of employee common stock options granted during the nine months ended September 30, 2013, using the Black-Scholes-Merton option-pricing model are set forth in the following table:



	Nine Months Ended September 30, 2013
Expected volatility	60.0 - 63.2%
Expected life (in years)	5.2
Expected dividend yield	—
Risk-free interest rate	0.71% - 0.80%

The weighted-average grant date fair value for options granted during the nine months ended September 30, 2013 was approximately $2.41.

The assumptions used in calculating the fair value of employee common stock warrants granted during the nine months ended September 30, 2013, using the Black-Scholes-Merton option-pricing model are set forth in the following table:



	Nine Months Ended September 30, 2013
Expected volatility	60.1	%
Expected life (in years)	5.2
Expected dividend yield	—
Risk-free interest rate	0.88	%

The weighted-average grant date fair value for warrants granted during the nine months ended September 30, 2013 was approximately $3.06.

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Employee Common Stock Options

Activity with respect to employee stock options is summarized as follows:



	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in 000’s)
Outstanding, December 31, 2012	1,350,861		$	4.57
Granted	258,000		$	4.59
Exercised	(10,370	)	$	3.52
Unvested options forfeited or cancelled	(202,633	)	$	4.11
Vested options expired	(38,609	)	$	1.85
Outstanding, September 30, 2013	1,357,249		$	4.73	6.6	$	161
Vested or expected to vest at September 30, 2013	1,221,023		$	4.79	6.5	$	152

Total unrecognized compensation expense related to non-vested stock options at September 30, 2013, was approximately $0.9 million and is expected to be recognized over a weighted-average period of 1.98 years.

Employee Common Stock Warrants

Activity with respect to employee common stock warrants is summarized as follows:



	Number of Shares	Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in 000’s)
Outstanding, December 31, 2012	1,806,024	$	2.99
Granted	70,000	$	5.90
Exercised	—	$	—
Unvested warrants forfeited or cancelled	—	$	—
Vested warrants expired	—	$	—
Outstanding, September 30, 2013	1,876,024	$	3.09	5.1	$	2,019
Vested or expected to vest at September 30, 2013	1,850,101	$	3.06	5.0	$	2,018

Total unrecognized compensation expense related to non-vested employee stock warrants at September 30, 2013, was approximately $0.3 million and is expected to be recognized over a weighted-average period of 2.2 years.

Restricted Stock

In June 2012, the Company approved issuing, pursuant to the 2011 Plan, 270,000 shares of common stock with a three-year restriction on transfer to its nine directors. The restricted stock has all the rights of a shareholder from the date of grant, including, without limitation the right to receive dividends and the right to vote. The Company calculated the fair value of the restricted stock to be equal to the closing stock price of $3.20 on the date of grant. The related compensation expense is being recognized over the three-year restricted period.

On July 2, 2012, in connection with the issuance of the $7.5 million principal amount of 8% subordinated convertible notes, the Company granted 50,000 shares of restricted common stock with a one year restriction on transferability to the placement agent as partial consideration for its service on the offering. The Company calculated the fair value of the restricted stock to be equal to the closing stock price of $3.50 on the date of grant date. The related compensation expense is included in deferred loan costs and is being amortized as interest expense over the term of the 8% subordinated convertible notes. The expense for the three and nine months ended September 30, 2013 was approximately $0.02 million and $0.04 million, respectively, with unrecognized expense of approximately $0.1 million remaining at September 30, 2013.

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Activity with respect to restricted stock is summarized as follows:



	Number of Shares	Weighted Avg. Grant Date Fair Value
Unvested at December 31, 2012	283,500	$	3.20
Granted	—	$	—
Vested	—	$	—
Forfeited	—	$	—
Unvested at September 30, 2013	283,500	$	3.20

Total unrecognized compensation expense related to non-vested restricted stock at September 30, 2013, was approximately $0.5 million and is expected to be recognized over a weighted-average period of 1.7 years.

Nonemployee Common Stock Warrants

The Company grants common stock warrants in connection with equity share purchases by investors as an additional incentive for providing long-term equity capital to the Company and as additional compensation to consultants and advisors. The warrants are granted at negotiated prices in connection with the equity share purchases and at the market price of the common stock in other instances. The warrants have been issued for terms between two and ten years.

Activity with respect to nonemployee common stock warrants is summarized as follows:



	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Outstanding, December 31, 2012	1,961,457		$	3.78
Granted	—		$	—
Exercised	(28,825	)	$	1.05
Unvested warrants forfeited or cancelled	—		$	—
Vested warrants expired	(28,941	)	$	2.27
Outstanding, September 30, 2013	1,903,691		$	3.84	1.2	$	623
Vested or expected to vest at September 30, 2013	1,903,691		$	3.84	1.2	$	623

For the three and nine months ended September 30, 2013 and 2012, the Company recognized stock-based compensation as follows:



	Three Months Ended September 30,					Nine Months Ended September 30,
(Amounts in 000’s)	2013		2012			2013		2012
Employee compensation:
Stock options	$	81	$	135		$	423	$	357
Employee warrants	35		57			95		172
Total option and warrants compensation	$	116	$	192		$	518	$	529
Board restricted stock	70		77			219		110
Total Employee Compensation Expense	$	186	$	269		$	737	$	639

Non-employee compensation:
Warrants	$	—	$	49		$	—	$	837
Less: Deferred financing and prepaid services	—		(49		)	—		(812		)
Amortization of prepaid services	4		324			12		626
Total Nonemployee Compensation Expense	$	4	$	324		$	12	$	651

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NOTE 14. VARIABLE INTEREST ENTITIES

As further described in Note 20 to our Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, the Company has certain variable interest entities that are required to be consolidated because AdCare has control as primary beneficiary. A “primary beneficiary” is the party in a VIE that has both of the following characteristics: (a) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

On June 22, 2013, the Company and Riverchase Village ADK, LLC (“Riverchase”), an entity owned and controlled by Christopher Brogdon (the Company’s Vice Chairman and a greater than 10% beneficial owner of the common stock), agreed to mutually terminate the five-year year management agreement, dated June 22, 2010. Riverchase owns Riverchase Village, a 105-bed assisted living facility located in Hoover, Alabama. Pursuant to the management agreement, a subsidiary of the Company supervised the management of the Riverchase Village facility for a monthly fee equal to 5% of the monthly gross revenues of the Riverchase Village facility.

On June 22, 2013, a wholly owned subsidiary of the Company and Mr. Brogdon amended the Option Agreement, dated June 22, 2010, pursuant to which the Company has the exclusive and irrevocable right to acquire from Mr. Brogdon all of the issued and outstanding membership interests in Riverchase, which owns the Riverchase Village facility. The amendment extended the option provided for thereby from June 22, 2013 to June 22, 2014.

The following summarizes the assets and liabilities of the variable interest entity included in the consolidated balance sheets:



(Amounts in 000’s)	September 30, 2013			December 31, 2012
Cash	$	(13	)	$	(38	)
Accounts receivable	82			—
Restricted investments	179			343
Property and equipment, net	5,937			5,974
Other assets	372			391
Total assets	$	6,557		$	6,670

Accounts payable	$	1,797		$	1,316
Accrued expenses	193			67
Current portion of notes payable	87			92
Notes payable, net of current portion	5,947			6,033
Non-controlling interest	(1,467		)	(838		)
Total liabilities	$	6,557		$	6,670

NOTE 15. FAIR VALUE MEASUREMENTS

The following are the major categories of assets and liabilities measured at fair value on a recurring basis during the nine months ended September 30, 2013, using quoted prices in active markets for identical assets (Level 1); significant other observable inputs (Level 2); and significant unobservable inputs (Level 3).



(Amounts in 000’s)	Level 1:	Level 2:	Level 3:		Total at September 30
Derivative liability - 2013	—	—	$	929	$	929
Derivative liability - 2012	—	—	$	3,630	$	3,630

Set forth below is a reconciliation of the beginning and ending balances for the derivative liability measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the nine months ended September 30, 2013:

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(Amounts in 000’s)	Derivative Liability
Beginning balance, December 31, 2012	$	3,630
Converted debt	(523		)
Derivative gain	(2,178		)
Ending balance, September 30, 2013	$	929

The derivative liability is the result of the Company issuing subordinated convertible notes in 2010. The notes are convertible into shares of common stock of the Company at a current conversion price of $3.73 (adjusted for various stock dividends) that is subject to future reductions if the Company issues equity instruments at a lower price. Because there is no minimum conversion price, an indeterminate number of shares may be issued in the future. Accordingly, the Company determined an embedded derivative existed that was required to be bifurcated from the subordinated convertible notes and accounted for separately as a derivative liability recorded at fair value. The Company estimates the fair value of the derivative liability using the Black-Scholes Merton option-pricing model with changes in fair value being reported in the consolidated statement of operations. This model requires certain key inputs that are significant unobservable inputs (Level 3).

The Company currently has no plans to issue equity instruments at a price lower than the conversion price of $3.73, the current conversion price of the subordinated convertible notes issued in 2010. The derivative liability is a non-cash item. Upon conversion to common stock, the debt and derivative liability will be extinguished, the current fair market value of the common stock will be reflected as common stock and additional paid-in capital, and there may be a resulting gain or loss on the debt extinguishment. If not converted to common stock, upon settlement at the date of maturity, the debt and derivative liability will result in a gain on debt extinguishment for the remaining fair value of the derivative.

NOTE 16. COMMITMENTS AND CONTINGENCIES

Regulatory Matters

Laws and regulations governing Federal Medicare and state Medicaid programs are complex and subject to interpretation. Compliance with such laws and regulations can be subject to future governmental review and interpretation as well as significant regulatory action including fines, penalties, and exclusion from certain governmental programs. The Company believes that it is in compliance in all material respects with all applicable laws and regulations.

A significant portion of the Company’s revenue is derived from Medicaid and Medicare, for which reimbursement rates are subject to regulatory changes and government funding restrictions. Any significant future change to reimbursement rates could have a material effect on the Company’s operations.

Operating Leases

The Company leases certain office space and nine skilled nursing facilities under non-cancelable operating leases, most of which have initial lease terms of ten to twelve years with rent escalation clauses and provisions for payments by the Company of real estate taxes, insurance and maintenance costs. Facility rent expense totaled $1.8 million and $5.3 million for the three and nine months ended September 30, 2013, respectively, and $1.8 million and $5.3 million for the three and nine months ended September 30, 2012, respectively.

Five of the Company’s facilities are operated under a single master lease arrangement. The lease has a term of ten years ending 2020. Under the master lease, a breach at a single facility could subject one or more of the other facilities covered by the same master lease to the same default risk. Failure to comply with regulations or governmental authorities, such as Medicare and Medicaid provider requirements, is a default under the Company’s master lease agreement. In addition, other potential defaults related to an individual facility may cause a default of the entire master lease agreement. With an indivisible lease, it is difficult to restructure the composition of the portfolio or economic terms of the lease without the consent of the landlord. The Company is not aware of any defaults and is in compliance as of September 30, 2013.

Two of the Company’s facilities are operated under a separate lease agreement. The lease is a single indivisible lease; therefore, a breach at a single facility could subject the second facility to the same default risk. The lease has a term of 12 years into 2022 and includes covenants and restrictions. A commitment is included that requires minimum capital expenditures of $375 per licensed bed per lease year at each facility which amounts to $0.1 million per year for both facilities. The Company is in compliance with financial and administrative covenants of this lease agreement as of September 30, 2013.

Legal Matters

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The skilled nursing business involves a significant risk of liability due to the age and health of the Company’s patients and residents and the services the Company provides. The Company and others in the industry are subject to an increasing number of claims and lawsuits, including professional liability claims, which may allege that services have resulted in personal injury, elder abuse, wrongful death or other related claims. The defense of these lawsuits may result in significant legal costs, regardless of the outcome, and can result in large settlement amounts or damage awards.

In addition to the potential lawsuits and claims described above, the Company is also subject to potential lawsuits under the Federal False Claims Act and comparable state laws alleging submission of fraudulent claims for services to any healthcare

program (such as Medicare) or payer. A violation may provide the basis for exclusion from federally funded healthcare programs. As of September 30, 2013, the Company does not have any material loss contingencies recorded or requiring disclosure based upon the evaluation of the probability of loss from known claims, except as disclosed below.

In 2012, the Company was named as a defendant in two related lawsuits asserting breach of contract claims arising out of consulting agreements executed in 2010 in connection with the Company’s becoming the operator of certain leased facilities that were previously operated by a third-party. The same transaction was already the subject of litigation commenced by the Company in 2011 against several entities which had previously operated the leased facilities. After becoming the operator of the leased facilities, the Company incurred certain losses for pre-closing activities for which the Company was entitled to indemnification. The Company sought to enforce its rights to indemnity by filing a lawsuit against the former operators of the leased facilities for breach of contract and related tort claims, and the Company proceeded to set off its losses against payment due under the consulting agreements referenced above. The defendants filed counterclaims against the Company. In the third quarter of 2012, a settlement was reached with respect to the three lawsuits that permitted the Company to eliminate a previously accrued liability in light of the lower than expected settlement amount of $1.0 million resulting in a non-cash settlement gain of $0.4 million recognized in the third quarter of 2012. During the third quarter of 2012, $0.3 million of the settlement was paid. During the nine months ended September 30, 2013, $0.1 million of the settlement was paid, leaving $0.1 million remaining balance to be paid during the remainder of 2013.

On June 24, 2013, South Star Services, Inc. (“SSSI”), Troy Clanton and Rose Rabon (collectively, the “Plaintiffs”) filed a complaint in the District Court of Oklahoma County, State of Oklahoma against: (i) AdCare, certain of its wholly owned subsidiaries and AdCare’s Chief Executive Officer (collectively, the “AdCare Defendants”); (ii) Christopher Brogdon, Vice Chairman of the Board of Directors, and his wife; and (iii) 5 entities controlled by Mr. and Mrs. Brogdon, which entities own 5 skilled-nursing facilities located in Oklahoma (the “Oklahoma Facilities”) that are managed by an AdCare subsidiary. The Company believes that the complaint is without merit and intends to vigorously defend itself against the claims set forth therein.

The complaint alleges, with respect to the AdCare Defendants, that: (i) the AdCare Defendants tortuously interfered with contractual relations between the Plaintiffs and Mr. Brogdon, and with Plaintiffs’ prospective economic advantage, relating to SSSI’s right to manage the Oklahoma Facilities and seven other skilled-nursing facilities located in Oklahoma (collectively, the “Facilities”), respectively; (ii) the AdCare Defendants fraudulently induced the Plaintiffs to perform work and incur expenses with respect to the Facilities; and (iii) one of the AdCare subsidiaries which is an AdCare Defendant provided false and defamatory information to an Oklahoma regulatory authority regarding SSSI’s management of one of the Oklahoma Facilities. The complaint seeks damages against the AdCare Defendants, including punitive damages, in an unspecified amount, as well as costs and expenses, including reasonable attorney fees. On July 26, 2013, the AdCare Defendants (with the other defendant parties) filed: (i) a motion to dismiss the fraud claims; and (ii) a motion to transfer the proceeding to the U.S. District Court for the Northern District of Georgia.

On October 2, 2013, the Company responded to certain letters (the "Letters") received from Georgia Department of Community Health ("GDCH") in September 2013 requesting payment of past due provider fees totaling$1.2 million for certain nursing facilities (collectively, the "Facilities") for periods prior to the Company's operation of the Facilities. The Company does not believe it is responsible for payment of these past due provider fees and has requested a final determination from GDCH confirming that it is not responsible for paying the fees described in the Letters.

Commitments

Special Termination Benefits

During the nine months ended September 30, 2013, the Company incurred certain salary retirement and continuation costs $0.2 million related to separation agreements with certain of the Company’s former officers. The benefits include wage continuation

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and fringe benefits which are to be paid out to these former employees over various future periods ranging up to a six-month period. The remaining unpaid balance accrued as of September 30, 2013 is $0.06 million.

Commitment to Future Lease Payments

A leased skilled nursing facility has signed a security agreement associated with the lessor, Covington Realty, LLC, in conjunction with the lessor’s refinancing of the project through HUD. The commitment gives the lender the right to pursue the facility for unpaid lease payments to the lessor.

NOTE 17. RELATED PARTY TRANSACTIONS

As of September 30, 2013, there have been no material changes to the disclosure with respect to related party transactions included in Item 13 to our Annual Report on Form 10-K for the year ended December 31, 2012, except for the following:

Riverchase—Management Agreement Termination

On June 22, 2013, the Company and Riverchase, an entity owned and controlled by Mr. Brogdon, agreed to mutually terminate the five-year year management agreement, dated June 22, 2010. Riverchase owns Riverchase Village, a 105-bed assisted living facility located in Hoover, Alabama. Pursuant to the management agreement, a subsidiary of the Company supervised the management of the Riverchase Village facility for a monthly fee equal to 5% of the monthly gross revenues of the Riverchase Village facility.

Riverchase—Option Agreement Extension

Harrah, McLoud and Meeker—Management Agreement

On July 26, 2013, a wholly-owned subsidiary of the Company entered into management agreements with entities owned and controlled by Mr. Brogdon, which entities own the skilled-nursing facilities located in Oklahoma known as Harrah Nursing Center, McLoud Nursing Center and Mecker Nursing Center. Pursuant to the management agreements, the AdCare subsidiary has agreed to manage the operations of these facilities. The management agreements have initial terms of five years and shall renew automatically for one-year terms thereafter. Pursuant to the management agreements, the entities owned and controlled by Mr. Brogdon which own the facilities shall pay to the AdCare subsidiary a fee equal to 5% of the monthly gross revenues of the facilities. The management agreements may be terminated by the parties at any time upon 30 days’ prior written notice.

NOTE 18. SUBSEQUENT EVENTS

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

On October 1, 2013, the Company entered into a letter agreement with Park City Capital, LLC and Michael J. Fox, Chief Executive Officer of Park City. Pursuant to the agreement, effective October 1, 2013, the Board of Directors of the Company increased the size of the Board from nine to ten members and appointed Mr. Fox as a director of the Company to fill the vacancy created thereby for a term that expires at the Company’s next annual meeting of shareholders, which is expected to be held in December 2013. The Company also has agreed: (i) to include Mr. Fox in its slate of nominees for election as a Class I director at the 2013 annual meeting to hold office until the Company’s 2014 annual meeting of shareholders; and (ii) to use its reasonable best efforts to cause the re-election of Mr. Fox to the Board as a Class I director at the 2013 annual meeting.

On October 17, 2013, the Company filed a Certificate of Amendment to its Articles of Incorporation with the Ohio Secretary of State to designate 200,000 undesignated shares of the Company’s preferred stock, no par value per share, as shares of the Company’s 10.875% Series A Cumulative Redeemable Preferred Stock. As a result of the Certificate of Amendment, the Company has the authority to issue up to 950,000 shares of Series A Preferred Stock. The Certificate of Amendment does not otherwise affect the terms of the Series A Preferred Stock.

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In October 2013, the Company issued to holders of the Company’s subordinated convertible promissory notes dated October 26, 2010, an aggregate of 448,215shares of the Company’s common stock, no par value upon conversion of $1,670,503 of the aggregate principal amount and $1,337 in interest amount thereof. Specifically, the Company issued the following amounts of shares of common stock to holders thereof on the following dates: (i) October 18, 2013, an aggregate amount of 134,048shares; (ii) October 22, 2013, an aggregate amount of 268,097shares; and (iii) October 25, 2013, and aggregate amount of 46,070 shares. The conversion price was $3.73 per share of common stock. The subordinated convertible promissory notes were issued, and the shares of common stock issued upon conversion thereof were issued, pursuant to an exemption from the registration requirements of the Securities Act afforded by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. The Company relied upon such exemption based upon representations made by each such holder regarding, among other things, the holder’s status as an accredited investor (as such term is defined under the Securities Act).

On October 28, 2013, the Company closed a “best efforts” public offering of 500,000 shares of its Series A Preferred Stock at a price of $25.00 per share. The Company received net proceeds of approximately $11.2 million from the offering after deducting underwriting discounts and other offering-related expenses of approximately $1.3 million. The liquidation preference per share is $25.00. Cumulative dividends accrue and are paid in the amount of $2.72 per share each year, which is equivalent to 10.875% of the $25.00 liquidation preference per share. The dividend rate may increase under certain circumstances.

In October 2013, the Company settled certain alleged claims made by Anthony J. Cantone, Cantone Asset Management LLC and Cantone Research, Inc ("CRI") with respect to their prior dealings with the Company, including, among other things, the Company's offering of convertible promissory notes issued in 2012 (the "Cantone Settlement"). In connection with the Cantone Settlement, the Company issued to CRI a two-year warrant to purchase 75,000 shares of common stock and will expense the related cost of $0.08 million in the fourth quarter of 2013.

On November 8, 2013, certain wholly-owned subsidiaries of the Company entered into a Fourth Modification Agreement with PrivateBank which modified that certain Loan Agreement, dated March 30, 2012, between such subsidiaries and PrivateBank. Pursuant to the modification, among other things: (i) paid down $1.8 million of loan principal from the release of$1.4 million from certain collateral account and from the release of $0.4 million from certain sinking fund account, (ii) deposited $0.9 million into certain debt service reserve account, and (iv) modified certain financial covenants under the credit facility regarding the minimum fixed charge coverage ratio and minimum EBITDAR, of one of the subsidiaries that is the operator of the Company’s skilled nursing facility located in Little Rock, Arkansas.

On November 10, 2013, Joshua J. McClellan resigned from the Board of Directors (the “Board”) of the Company effective January 1, 2014. On November 11, 2013, each of Jeffrey L. Levine and Gary L. Wade also resigned from the Board effective January 1, 2014. The Company accepted all such resignations. Each of Messrs. Levine, McClellan and Wade’s decision to resign as a director was not due to any disagreements with the Company on any matter relating to the Company’s operations, policies or practices.

On November 12, 2013, the Compensation Committee of the Board of Directors (the “Board”) of the Company adopted a program, which also was approved by the entire Board, to replace certain cash compensation otherwise payable to the Company’s directors and officers with equity compensation, thereby reducing the amount of cash compensation payable by the Company and otherwise more closely aligning the interests of the Company’s directors and officers with those of the Company’s shareholders (the “Cash Compensation Reduction Program”). The Company’s officers who are party to employment agreements with the Company, including the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer, have agreed to participate in the Cash Compensation Reduction Program. The Cash Compensation Reduction Program is applicable commencing with compensation payable in respect of the year ending December 31, 2014.

On November 13, 2013, the Company entered into a Third Amendment to Secured Loan Agreement and Payment Guaranty with KeyBank, which amended the KeyBank Credit Facility. Pursuant to the amendment: (i) KeyBank waives the failure of certain financial covenants of such subsidiaries regarding fixed charge coverage ratio and implied debt service coverage such that no default or events of default under the KeyBank Credit Facility occurred due to such failure; and (ii) KeyBank and the Company agreed to amend certain financial covenants regarding the Company’s fixed charge ratio.

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

Overview

AdCare Health Systems, Inc. (“AdCare”) and its controlled subsidiaries (collectively with AdCare, the “Company” or “we”), owns and operates skilled nursing and assisted living facilities in the states of Alabama, Arkansas, Georgia, Missouri, North Carolina, Ohio, Oklahoma and South Carolina. The Company, through wholly owned separate operating subsidiaries, as of September 30, 2013, operates 47 facilities comprised of 43 skilled nursing facilities, three assisted living facilities and one independent living/senior housing facility totaling approximately 4,800 beds. The Company’s facilities provide a range of health care services to their patients and residents including, but not limited to, skilled nursing and assisted living services, social services, various therapy services, and other rehabilitative and healthcare services for both long-term residents and short-stay patients. As of September 30, 2013, of the total 47 facilities, the Company owned and operated 26 facilities, leased and operated nine facilities, managed 11 facilities for third parties and had one consolidated variable interest entity. As part of the Company’s strategy to focus on the growth of skilled nursing facilities, the Company decided in the fourth quarter of 2011 to exit the home health business; therefore, this business is reported as discontinued operations (see Note 11 — Discontinued Operations). The Company sold the assets of the home health business in 2012. Additionally, in the fourth quarter of 2012, the Company entered into an agreement to sell six assisted living facilities located in Ohio and executed a sublease arrangement to exit the skilled nursing business in Jeffersonville, Georgia. The six Ohio assisted living facilities and the Jeffersonville, Georgia skilled nursing facility have an aggregate of 313 units in service. These seven facilities are also reported as discontinued operations (see Note 11 — Discontinued Operations). The Company sold the assets of four of the six Ohio assisted living facilities in December 2012, one in February 2013, and one in May, 2013. On June 30, 2013, the Company executed two sublease agreements to exit the skilled nursing business in Tybee Island, Georgia. The two skilled nursing facilities had an aggregate of 135 units in service. These two facilities are also reported as discontinued operations (see Note 11 — Discontinued Operations).

The Company owns and manages skilled nursing facilities (“SNF”) and assisted living facilities. The Company delivers skilled nursing and assisted living services through wholly owned separate operating subsidiaries. During the first quarter of 2013, the Company discontinued management services on one facility, and in the second quarter the Company entered into two sublease agreements and reported two additional discontinued operations, bringing our Company’s total bed count to 4,781 at September 30, 2013. The following tables provide summary information regarding our recent acquisitions and facility composition.



		Number of Facilities at
		September 30, 2013
State	Number of Operational Beds/Units	Owned	Leased	Managed For Third Parties	VIE	Total
Alabama	408	2	—	—	1	3
Arkansas	1,041	10	—	—	—	10
Georgia	1,379	4	7	—	—	11
Missouri	80	—	1	—	—	1
North Carolina	106	1	—	—	—	1
Ohio	705	4	1	3	—	8
Oklahoma	882	3	—	8	—	11
South Carolina	180	2	—	—	—	2
Total	4,781	26	9	11	1	47

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Facility Type
Skilled Nursing	4,482	24	9	10	—	43
Assisted Living	216	2	—	—	1	3
Independent Living	83	—	—	1	—	1
Total	4,781	26	9	11	1	47

Liquidity

We anticipate that scheduled debt service (excluding approximately $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively, that the Company believes will be refinanced on a longer term basis but including principal, interest, collateral and capital improvement fund or other escrow deposits) will total approximately $33.4 million and cash outlays for acquisition costs, maintenance capital expenditures, dividends on our Series A Preferred Stock and income taxes will total approximately $5.3 million for the 12 months ending September 30, 2014. We routinely have ongoing discussions with existing and potential new lenders to refinance current debt on a longer term basis and, in recent periods, have refinanced shorter term acquisition debt, including seller notes, with traditional longer term mortgage notes, some of which have been executed under government guaranteed lending programs. Although we anticipate the conversion to common stock of the Company’s outstanding subordinated convertible promissory notes with a principal amount in the aggregate of $7.7 million that mature in August 2014, which excludes subordinated convertible promissory notes with a principal amount in the aggregate of $1.7 million that were converted into shares of common stock of the Company in October 2013 (see Note 18 - Subsequent Events), we believe that our anticipated cash flow and funding sources would allow us to pay these notes in cash. These promissory notes are convertible at the option of the holder into shares of common stock of the Company at $3.73 per share. The closing price of the common stock exceeded $3.79 per share from January 1, 2013 through November 6, 2013. We have been successful in recent years in raising new equity capital and in October 2013 the Company issued 500,000 shares of Series A Preferred Stock at $25 per share receiving proceeds of approximately $11.2 million after deducting underwriting discounts and other offering-related expenses (see Note 18 - Subsequent Events). As discussed further below, if we are unable to refinance the $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively, then the Company may be required to restructure its outstanding indebtedness, implement further cost reduction initiatives, sell assets, as well as delay, modify, or abandon its expansion plans due to our limited liquidity in such an event.

In order to satisfy these capital needs, we intend to: (i) improve our operating results by increasing facility occupancy, optimizing our payor mix by increasing the proportion of sub-acute patients within our skilled nursing facilities, continuing our cost optimization and efficiency strategies and acquiring additional long-term care facilities with existing operating cash flow; (ii) expand our borrowing arrangements with certain existing lenders; (iii) refinance current debt where possible to obtain more favorable terms; and (iv) raise capital through the issuance of debt or equity securities. We anticipate that these actions, if successful, will provide the opportunity for us to maintain liquidity on a short and long term basis, thereby permitting us to meet our operating and financing obligations for the next 12 months and provide for the continuance of our acquisition strategy. However, there is no guarantee that such actions will be successful or that anticipated operating results will be achieved. We currently have limited borrowing availability under our existing revolving credit facilities. If the Company is unable to improve operating resultsor refinance current debt (including the $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively), then the Company may be required to restructure its outstanding indebtedness, implement further cost reduction initiatives, sell assets, as well as delay, modify, or abandon its expansion plans.

Acquisitions

The Company has embarked on a strategy to grow its business through acquisitions and leases of senior care facilities.

On February 15, 2013, the Company entered into a Purchase and Sale Agreement with Avalon Health Care, LLC to acquire certain land, buildings, improvements, furniture, vehicles, contracts, fixtures and equipment comprising: (i) a 180-bed skilled nursing facility known as Bethany Health and Rehab; and (ii) a 240-bed skilled nursing facility known as Trevecca Health and Rehab, both located in Nashville, Tennessee. The Company deposited $0.4 million of earnest money escrow deposits in February 2013. On June 1, 2013, the Purchase and Sale Agreement was terminated due to the failure of the transaction to close by May 31, 2013. In connection with the termination of the Purchase and Sale Agreement, the Company is seeking the return of $0.4 million previously deposited earnest money escrow deposits. On August 1, 2013, the Company entered into a settlement agreement regarding the return of the $0.4 million previously deposited earnest money escrow deposits. Pursuant to the agreement, the previously deposited earnest money escrow deposits were released and distributed, $0.3 million to the Company and $0.1 million to Avalon, respectively.

The Company incurred acquisition costs total of approximately $0.03 million and $0.6 million during the three and nine months ended September 30, 2013, respectively, and $0.3 million and $1.2 million during the three and nine months ended September 30, 2012, respectively. Acquisition costs are recorded in “Other Income (Expense)” section of the consolidated statements of operations.

During the nine months ended September 30, 2012, the Company acquired a total of eight skilled nursing facilities and one assisted living facility.

Divestitures

As part of the Company’s strategy to focus on the growth of its skilled nursing business, the Company decided in the fourth quarter of 2011 to exit the home health business. In the fourth quarter of 2012, the Company continued this strategy and entered into an agreement to sell six assisted living facilities located in Ohio. The Company also entered into a sublease arrangement in the fourth quarter of 2012 to exit the operations of a skilled nursing facility in Jeffersonville, Georgia. On June 12, 2013, the Company executed two sublease arrangements to exit the skilled nursing business in Tybee Island, Georgia effective June 30, 2013 relating to two facilities. The results of operations and cash flows for the home health business, the six Ohio assisted living facilities, the Jeffersonville, Georgia skilled nursing facility, and the two facilities in Tybee Island, Georgia are reported as discontinued operations in 2013 and 2012.

On February 28, 2013, the Company completed the sale of the facility known as Lincoln Lodge Retirement Residence and used the proceeds to pay the principal balance of the HUD mortgage note with respect to the facility of $1.9 million. The Company recognized a gain on the sale of approximately $0.1 million and cash proceeds, net of costs and debt payoff, of $0.6 million.

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resulting in a net payment of $3.2 million. Proceeds from the $3.2 million payment were used to fund a $2.0 million increase in collateralized restricted cash required by one of the Company’s lenders and $1.2 million was received by the Company for working capital purposes. The Company recognized a loss on the sale of Vandalia of $0.4 million.

On June 11, 2013, the Company completed the sale of its former Springfield, Ohio corporate office building which was sold for the approximate net book value. The Company used the proceeds to payoff the principal balance of the mortgage note with respect to the building of approximately $0.1 million.

The following table summarizes the activity of Discontinued Operations for the three and nine months ended September 30, 2013 and 2012:



	Three Months Ended September 30,
(Amounts in 000’s)	2013			2012
Total revenues from discontinued operations	$	12		$	5,380
Net (loss) income from discontinued operations	$	(188	)	$	126
Interest expense, net from discontinued operations	$	—		$	166
Income tax (expense) benefit from discontinued operations	$	(33	)	$	1
(Loss) gain on disposal of assets from discontinued operations	$	(20	)	$	16



	Nine Months Ended September 30,
(Amounts in 000’s)	2013			2012
Total revenues from discontinued operations	$	3,954		$	15,666
Net (loss) income from discontinued operations	$	(1,402	)	$	203
Interest expense, net from discontinued operations	$	71		$	514
Income tax expense from discontinued operations	$	(33	)	$	3
(Loss) gain on disposal of assets from discontinued operations	$	(467	)	$	16

Primary Performance Indicators

The Company owns and manages skilled nursing facilities and assisted living facilities, and delivers its services through wholly owned separate operating subsidiaries.

The Company focuses on two primary indicators in evaluating its financial performance. Those indicators are facility occupancy and patient mix. Facility occupancy is critical, since higher occupancy generally leads to higher revenues. In addition, concentrating on increasing the number of Medicare covered admissions (“the patient mix”) helps in increasing revenues. The Company includes commercial insurance covered admissions that are reimbursed at the same level as those covered by Medicare in the Company’s Medicare utilization percentages and analysis. The Company also evaluates “Same Facilities” and “Recently Acquired Facilities” results. Same Facilities represent those owned and leased facilities the Company began to operate prior to January 1, 2012. Recently Acquired Facilities results represents those owned and leased facilities the Company began to operate subsequent to January 1, 2012.

Patient mix at the Company’s skilled nursing facilities for the three and nine months ended September 30, 2013 and 2012 was as follows:



	Patient Mix (SNF only)
	Three Months Ended September 30,
	Same Facilities				Recently Acquired Facilities				All Facilities
	2013		2012		2013		2012		2013		2012
Medicare	13.6	%	13.9	%	14.5	%	11.5	%	13.8	%	13.4	%
Medicaid	72.2	%	73.0	%	71.6	%	74.0	%	72.0	%	73.2	%
Other	14.2	%	13.1	%	13.9	%	14.5	%	14.2	%	13.4	%
Total	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

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	Patient Mix (SNF only)
	Nine Months Ended September 30,
	Same Facilities				Recently Acquired Facilities				All Facilities
	2013		2012		2013		2012		2013		2012
Medicare	15.0	%	15.0	%	16.0	%	10.4	%	15.2	%	14.5	%
Medicaid	71.2	%	72.2	%	71.4	%	75.0	%	71.3	%	72.5	%
Other	13.8	%	12.8	%	12.6	%	14.6	%	13.5	%	13.0	%
Total	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

Medicare reimburses our skilled nursing facilities under a prospective payment system (“PPS”) for certain inpatient covered services. Under the PPS, facilities are paid a predetermined amount per patient, per day, based on the anticipated costs of treating patients. The amount to be paid is determined by classifying each patient into a resource utilization group (“RUG”) category that is based upon each patient’s acuity level. In October 2010, the number of RUG categories was expanded from 53 to 66 as part of the implementation of the RUGs IV system and the introduction of a revised and substantially expanded patient assessment tool called the Minimum Data Set, version 3.0.

On July 29, 2011, the Centers for Medicare & Medicaid Services (“CMS”) issued a final rule providing for, among other things, a net 11.1% reduction in PPS payments to skilled nursing facilities for CMS’s fiscal year 2012 (which began October 1, 2011) as compared to PPS payments in CMS’s fiscal year 2011 (which ended September 30, 2011). The 11.1% reduction is on a net basis, after the application of a 2.7% market basket increase, and reduced by a 1.0% multi-factor productivity adjustment required by the Patient Protection and Affordable Care Act of 2010 (“PPACA”). The final CMS rule also adjusted the method by which group therapy is counted for reimbursement purposes, and changed the timing in which patients who are receiving therapy must be reassessed for purposes of determining their RUG category.

The Middle Class Tax Relief and Job Creation Act of 2012 was signed into law on February 22, 2012, extending the Medicare Part B outpatient therapy cap exceptions process through December 31, 2012. The statutory Medicare Part B outpatient therapy cap for occupational therapy (“OT”) was $1,880 for 2012, and the combined cap for physical therapy (“PT”) and speech-language pathology services (“SLP”) was also $1,880 for 2012. This is the annual per beneficiary therapy cap amount determined for each calendar year. Similar to the therapy cap, Congress established a threshold of $3,700 for PT and SLP services combined and another threshold of $3,700 for OT services. All therapy services rendered above the $3,700 amount are subject to manual medical review and may be denied unless pre-approved by the provider’s Medicare Administrative Contractor. The law requires an exceptions process to the therapy cap that allows providers to receive payment from Medicare for medically necessary therapy services above the therapy cap amount. Beginning October 1, 2012, some therapy providers may submit requests for exceptions (pre-approval for up to 20 therapy treatment days for beneficiaries at or above the $3,700 threshold) to avoid denial of claims for services above the threshold amount. The $3,700 figure is the defined threshold that triggers the provision for an exception request. Prior to October 1, 2012, there was no provision for an exception request when the threshold was exceeded.

On July 27, 2012, CMS issued a final rule providing for, among other things, a net 1.8% increase in PPS payments to skilled nursing facilities for CMS’s fiscal year 2013 (which began on October 1, 2012) as compared to PPS payments to skilled nursing facilities in CMS’s fiscal year 2012 (which ended September 30, 2012). The 1.8% increase was on a net basis, reflecting the application of a 2.5% market basket increase, less a 0.7% multi-factor productivity adjustment mandated by PPACA. This increase is offset by the 2% sequestration reduction, discussed below, which became effective April 1, 2013.

On January 1, 2013 the American Taxpayer Relief Act of 2012 (the “ATRA”) extended the therapy cap exception process for one year. The ATRA also made additional changes to the Multiple Procedure Payment Reduction previously implemented in 2010. The existing discount to multiple therapy procedures performed in an outpatient environment during a single day was 25%. Effective April 1, 2013, ATRA increased the discount rate by an additional 25% to 50%. The ATRA additionally delayed the sequestration reductions of 2% to all Medicare payments until April 1, 2013.

On July 31, 2013, CMS issued its final rule outlining fiscal year 2014 Medicare payment rates for skilled nursing facilities. CMS estimates that aggregate payments to skilled nursing facilities will increase by $470 million, or 1.3% for fiscal year 2014, relative to payments in 2013. This estimated increase is attributable to a 2.3% market basket increase, reduced by the 0.5% forecast error correction and further reduced by the 0.5% multi-factor productivity adjustment (MFP) as required by PPACA. The forecast error correction is applied when the difference between the actual and projected market basket percentage change for the most recent available fiscal year exceeds the 0.5% threshold. For fiscal year 2012 (most recent availa

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ble fiscal year), the projected market basket percentage change exceeds the actual market basket percentage change by 0.51%. The 2014 Medicare payment rates for skilled nursing facilities were effective on October 1, 2013.

Should future changes in PPS include further reduced rates or increased standards for reaching certain reimbursement levels (including as a result of automatic cuts tied to federal deficit cut efforts or otherwise), our Medicare revenues derived from our skilled nursing facilities) could be reduced, with a corresponding adverse impact on our financial condition or results of operation.

We also derive a substantial portion of our consolidated revenue from Medicaid reimbursement, primarily through our skilled nursing business. Medicaid programs are administered by the applicable states and financed by both state and federal funds. Medicaid spending nationally has increased significantly in recent years, becoming an increasingly significant component of state budgets. This, combined with slower state revenue growth and other state budget demands, has led both the federal government to institute measures aimed at controlling the growth of Medicaid spending and, in some instances, reducing it.

Historically, adjustments to reimbursement under Medicare and Medicaid have had a significant effect on our revenue and results of operations. Recently enacted, pending and proposed legislation and administrative rulemaking at the federal and state levels could have similar effects on our business. Efforts to impose reduced reimbursement rates, greater discounts and more stringent cost controls by government and other payors are expected to continue for the foreseeable future and could adversely affect our business, financial condition and results of operations. Additionally, any delay or default by the federal or state governments in making Medicare and/or Medicaid reimbursement payments could materially and adversely affect our business, financial condition and results of operations.

Average occupancy and reimbursement rates at the Company’s skilled nursing facilities for the three months ended September 30, 2013 and 2012 were as follows:



	For the Three Months Ended September 30, 2013
State (SNF only)	Operational Beds at Period End (1)	Period's Average Operational Beds	Occupancy (Operational Beds)		Medicare Utilization (Skilled %ADC) (2)		Total Revenues		Medicare (Skilled) $PPD (3)		Medicaid $PPD (3)
Alabama	304	304	70.5	%	11.5	%	$	3,889	$	393.61	$	165.72
Arkansas	1,009	1,009	63.2	%	15.0	%	$	12,869	$	461.61	$	162.71
Georgia	1,379	1,379	88.8	%	14.5	%	$	23,781	$	452.07	$	156.57
Missouri	80	80	72.0	%	9.4	%	$	926	$	395.01	$	134.76
North Carolina	106	106	67.9	%	16.4	%	$	1,496	$	448.49	$	162.53
Ohio	293	293	83.4	%	12.5	%	$	4,931	$	422.42	$	165.95
Oklahoma	318	318	67.4	%	9.4	%	$	3,673	$	450.32	$	146.75
South Carolina	180	180	82.1	%	16.1	%	$	2,680	$	411.17	$	144.42
Total	3,669	3,669	76.7	%	13.8	%	$	54,245	$	444.92	$	157.66

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	For the Three Months Ended September 30, 2012
State (SNF only)	Operational Beds at Period End (1)	Period's Average Operational Beds	Occupancy (Operational Beds)		Medicare Utilization (Skilled %ADC) (2)		Total Revenues		Medicare (Skilled) $PPD (3)		Medicaid $PPD (3)
Alabama	304	304	78.1	%	8.6	%	$	4,318	$	401.93	$	169.20
Arkansas	1,009	1,009	61.9	%	12.5	%	$	11,972	$	394.56	$	173.60
Georgia	1,379	1,379	89.6	%	14.0	%	$	24,970	$	453.79	$	170.19
Missouri	80	80	63.8	%	12.6	%	$	852	$	444.79	$	135.04
North Carolina	106	106	84.9	%	19.8	%	$	1,870	$	446.67	$	162.67
Ohio	293	293	85.7	%	14.9	%	$	5,386	$	465.82	$	167.02
Oklahoma	230	170	73.7	%	13.5	%	$	2,166	$	434.15	$	131.55
South Carolina	—	—	n/a		n/a		—		n/a		n/a
Total	3,401	3,341	78.3	%	13.4	%	$	51,534	$	437.38	$	168.17

(1) Excludes managed beds which are not consolidated.

(2) ADC is the Average Daily Census.

(3) PPD is the Per Patient Day equivalent.

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Average occupancy and reimbursement rates at the Company’s skilled nursing facilities for the nine months ended September 30, 2013 and 2012 were as follows:



	For the Nine Months Ended September 30, 2013
State (SNF only)	Operational Beds at Period End (1)	Period's Average Operational Beds	Occupancy (Operational Beds)		Medicare Utilization (Skilled %ADC) (2)		Total Revenues		Medicare (Skilled) $PPD (3)		Medicaid $PPD (3)
Alabama	304	304	72.1	%	11.2	%	$	11,570	$	392.61	$	166.33
Arkansas	1,009	1,009	61.8	%	17.0	%	$	38,400	$	444.21	$	169.55
Georgia	1,379	1,379	88.7	%	15.6	%	$	71,130	$	449.79	$	156.93
Missouri	80	80	73.7	%	14.3	%	$	2,978	$	417.23	$	134.52
North Carolina	106	106	73.7	%	15.9	%	$	4,816	$	453.74	$	163.74
Ohio	293	293	84.2	%	15.3	%	$	15,565	$	438.51	$	166.70
Oklahoma	318	318	67.8	%	12.6	%	$	11,154	$	440.42	$	140.90
South Carolina	180	180	81.8	%	14.1	%	$	8,062	$	402.72	$	157.27
Total	3,669	3,669	76.7	%	15.2	%	$	163,675	$	440.75	$	159.78



	For the Nine Months Ended September 30, 2012
State (SNF only)	Operational Beds at Period End (1)	Period's Average Operational Beds	Occupancy (Operational Beds)		Medicare Utilization (Skilled %ADC) (2)		Total Revenues		Medicare (Skilled) $PPD (3)		Medicaid $PPD (3)
Alabama	304	304	81.4	%	10.9	%	$	14,183	$	385.42	$	181.45
Arkansas	1,009	822	63.4	%	12.0	%	$	29,262	$	383.90	$	172.28
Georgia	1,379	1,290	89.6	%	15.7	%	$	67,656	$	456.11	$	156.56
Missouri	80	80	62.7	%	17.5	%	$	2,587	$	410.87	$	132.37
North Carolina	106	106	84.5	%	18.6	%	$	5,483	$	453.95	$	160.27
Ohio	293	293	84.4	%	16.2	%	$	15,943	$	465.11	$	161.70
Oklahoma	230	57	73.7	%	13.5	%	$	2,166	$	434.15	$	131.55
South Carolina	—	—	n/a		n/a		—		n/a		n/a
Total	3,401	2,952	79.7	%	14.5	%	$	137,280	$	436.77	$	162.67

(1) Excludes managed beds which are not consolidated.

(2) ADC is the Average Daily Census.

(3) PPD is the Per Patient Day equivalent.

Critical Accounting Policies

The Company prepares financial statements in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. The Company bases estimates on historical experience, business knowledge and on various other assumptions that the Company believes to be reasonable under the circumstances at the time. Actual results may vary from our estimates. These estimates are evaluated by management and revised as circumstances change.

There have been no significant changes during the nine months ended September 30, 2013 to the items that the Company disclosed as its critical accounting policies and use of estimates in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Results of Operations

Same and Recently Acquired Facility Occupancy and Revenue Analysis:



	Average Occupancy
	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Same Facilities	79.8	%	82.5	%	80.1	%	82.4	%
Recently Acquired Facilities	68.0	%	62.8	%	67.4	%	58.5	%
All Facilities	76.3	%	78.0	%	76.4	%	79.2	%



	Total Revenues
	Three Months Ended September 30,				Nine Months Ended September 30,
(Amounts in 000’s)	2013		2012		2013		2012
Same Facilities	$	39,865	$	43,090	$	121,451	$	126,789
Recently Acquired Facilities	15,479		9,543		45,535		13,733
All Facilities	$	55,344	$	52,633	$	166,986	$	140,522

Comparison for the three months ended September 30, 2013 and 2012

The table below summarizes the operating results for the three months ended September 30, 2013 and 2012:



	Three Months Ended September 30,
(Amounts in 000’s)	2013			2012			Change			Percent Change
Revenues:
Patient care revenues	$	55,344		$	52,633		$	2,711		5	%
Management revenues	521			588			(67		)	(11	)%
Total revenues	55,865			53,221			2,644			5	%
Expenses:
Cost of services (exclusive of facility rent, depreciation and amortization)	46,102			44,475			1,627			4	%
General and administrative expense	4,583			3,957			626			16	%
Audit committee investigation expense	302			—			302			—	%
Facility rent expense	1,761			1,775			(14		)	(1	)%
Depreciation and amortization	1,888			1,760			128			7	%
Salary retirement and continuation costs	5			38			(33		)	(87	)%
Total expenses	54,641			52,005			2,636			5	%

Income from Operations	1,224			1,216			8			1	%
Other Income (Expense):
Interest expense, net	(3,462		)	(3,695		)	233			(6	)%
Acquisition costs, net of gains	(33		)	(342		)	309			(90	)%
Derivative gain (loss)	1,989			(2,105		)	4,094			(194	)%
(Loss) gain on extinguishment of debt	(6		)	500			(506		)	(101	)%
Loss on disposal of assets	(6		)	—			(6		)	—	%
Other income (expense)	15			(229		)	244			(107	)%
Total other expense, net	(1,503		)	(5,871		)	4,368			(74	)%

Loss from Continuing Operations Before Income Taxes	(279		)	(4,655		)	4,376			(94	)%
Income tax benefit (expense)	54			(111		)	165			(149	)%
Loss from Continuing Operations	$	(225	)	$	(4,766	)	$	4,541		(95	)%

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Patient Care Revenues—Total patient care revenues increased by $2.7 million, or 5% for the three months ended September 30, 2013 as compared to the same period in 2012. The increase was primarily the result of the eleven skilled nursing facilities and one assisted living facility acquired in 2012, as well as the improvement in patient mix and average Medicare reimbursement rate per patient day, partially offset by reductions in average Medicaid reimbursement rates per patient day and facility occupancy.

Management Revenues—Management revenues (net of eliminations) decreased by $0.07 million, or 11% for the three months ended September 30, 2013, as compared to the same period in 2012. The decrease was primarily due to the discontinuance of one management contract in February 2013.

Cost of Services—Cost of services increased by $1.6 million, or 4%, during the three months ended September 30, 2013, as compared to the same period in 2012. The increase was primarily due to the eleven skilled nursing facilities and one assisted living facility acquired during 2012 partially offset by a decrease of approximately $1.2 million in employee benefits expense. Cost of services as a percentage of patient care revenue decreased from 84.5% at September 30, 2012 to 83.3% at September 30, 2013. The decrease in cost of services as a percentage of patient care revenue is primarily due to the progress the Company has made in its cost reduction optimization strategy in the operations of certain 2012 acquired facilities.

General and Administrative—General and administrative costs increased by $0.6 million to $4.6 million for the three months ended September 30, 2013, compared to $4.0 million for the same period in 2012. The increase is primarily due to the following: (i) increase of approximately $0.3 million in expense due to a new data center agreement, (ii) increase of approximately $0.3 million in salaries, wage and employee benefits expense, (iii) increase of approximately $0.2 million in accounting and audit expense, (iv) increase of approximately $0.1 million in recruiting costs, partially offset by (v) increase of approximately $0.2 million in purchasing rebates, and (vi) decrease of approximately $0.1 million in investor relations costs. As a percentage of revenue, general and administrative costs increased to 8.2% for the three months ended September 30, 2013, compared to 7.4% for the same period in 2012.

Audit Committee Investigation Expense—As previously disclosed, the Audit Committee, in consultation with management, concluded that: (i) the Company’s previously issued financial statements for the quarters ended March 31, 2012, June 30, 2012 and September 30, 2012 (the “Relevant Financial Statements”) should no longer be relied upon due to errors in the Relevant Financial Statements identified in connection with the audit of the Company’s financial statements for the year ended December 31, 2012; and (ii) the Company would restate the Relevant Financial Statements. The Audit Committee initiated a further review of, and inquiry with respect to, the accounting and financial issues related to these and other potential errors and engaged counsel to assist the Audit Committee with such matters. The Audit Committee completed its inquiry and, in connection therewith, assisted in the correction of certain errors relating to accounting and financial matters and identified certain material weaknesses in the Company’s internal control over financial reporting, including weakness in the Company’s ability to appropriately account for complex or non-routine transactions and in the quality and sufficiency of the Company’s finance and accounting resources. On July 8, 2013, the Company restated the Relevant Financial Statements by filing with the SEC amendments to its Quarterly Reports on Form 10-Q/A for the quarters ended March 31, 2012, June 30, 2012 and September 30, 2012.

In connection with the restatement process and the Audit Committee’s review and inquiry, the Company has incurred significant professional services costs and other expenses which have been recognized as a special charge for approximately $0.3 million for the three months ended September 30, 2013.

Depreciation and Amortization—Depreciation and amortization for the three months ended September 30, 2013 increased by$0.1 million to $1.9 million, compared to $1.8 million for the same period in 2012. The depreciation increase is directly related to the 2012 acquisition activity.

Interest Expense, net—Interest expense, net decreased by $0.2 million, or 6%, to $3.5 million for the three months ended September 30, 2013, compared to $3.7 million for the same period in 2012. The Company has entered into numerous debt instruments in relation to the Company’s growth strategy for the acquisition of the facilities which began in the third quarter of 2010.

Acquisition Costs, net of Gains—For the three months ended September 30, 2013, acquisition costs were $0.03 million compared to $0.3 million for the same period in 2012. The decrease was a result of less acquisition activity during the three months ended September 30, 2013 compared to the same period in 2012.

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Derivative Gain/Loss—For the three months ended September 30, 2013, the derivative gain was $2.0 million, compared to a loss of $2.1 million for the same period in 2012. The increase of 194% was due to the decrease of the Company’s stock price during the third quarter of 2013 compared to an increase of the Company's stock price during the third quarter 2012. The derivative is a product of subordinated convertible promissory notes entered into during the third quarter of 2010. The expense associated with the derivative is subject to volatility based on a number of factors including increases or decreases in our stock price. Increases in our stock price generally result in increases in expense. Conversely, a decrease in our stock price generally results in the recognition of a gain in our statements of operations. The expense or gain recognized in a period is based on the fair value of the derivative instrument at the end of the period in comparison to the beginning of the period. The fair value of the derivative instrument was $0.9 million at September 30, 2013 compared to $3.6 million at December 31, 2012.

Comparison for the nine months ended September 30, 2013 and 2012

The table below summarizes the operating results for the nine months ended September 30, 2013 and 2012:



	Nine Months Ended September 30,
(Amounts in 000’s)	2013			2012		Change		Percent Change
Revenues:
Patient care revenues	166,986			140,522		26,464		19	%
Management revenues	1,529			1,637		(108	)	(7	)%
Total revenues	168,515			142,159		26,356		19	%
Expenses:
Cost of services (exclusive of facility rent, depreciation and amortization)	141,219			115,645		25,574		22	%
General and administrative expense	14,017			12,204		1,813		15	%
Audit committee investigation expense	2,284			—		2,284		—
Facility rent expense	5,256			5,278		(22	)	—	%
Depreciation and amortization	5,558			4,730		828		18	%
Salary retirement and continuation costs	154			38		116		305	%
Total expense	168,488			137,895		30,593		22	%
Income from Operations	27			4,264		(4,237	)	(99	)%
Other Income (Expense):
Interest expense, net	(10,253		)	(9,475	)	(778	)	8	%
Acquisition costs, net of gains	(607		)	(1,160	)	553		(48	)%
Derivative gain (loss)	2,178			(1,342	)	3,520		(262	)%
(Loss) gain on extinguishment of debt	(33		)	500		(533	)	(107	)%
(Loss) gain on disposal of assets	(10		)	2		(12	)	(600	)%
Other income (expense)	15			(258	)	273		(106	)%
Total other expense, net	(8,710		)	(11,733	)	3,023		(26	)%
Loss from Continuing Operations Before Income Taxes	(8,683		)	(7,469	)	(1,214	)	16	%
Income tax expense	(24		)	(132	)	108		(82	)%
Loss from Continuing Operations	$	(8,707	)	(7,601	)	(1,106	)	15	%

Patient Care Revenues—Total patient care revenues increased by $26.5 million, or 19% for the nine months ended September 30, 2013 as compared to the same period in 2012. The increase was primarily the result of the eleven skilled nursing facilities and one assisted living facility acquired in 2012, as well as the improvement in patient mix and average Medicare reimbursement rate per patient day, partially offset by reductions in average Medicaid reimbursement rates per patient day and facility occupancy.

Management Revenues—Management revenues (net of eliminations) decreased by $0.1 million, or 7% for the nine months ended September 30, 2013, as compared to the same period in 2012. The decrease was primarily due to the discontinuance of one management contract in February 2013.

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Cost of Services—Cost of services increased by $25.6 million, or 22%, during the nine months ended September 30, 2013, as compared to the same period in 2012. The increase was primarily due to the eleven skilled nursing facilities and one assisted living facility acquired during 2012. Cost of services as a percentage of patient care revenue increased from 82.3% at September 30, 2012 to 84.6% at September 30, 2013. The increase in cost of services as a percentage of patient care revenue is primarily due to the effect in 2013 from the operations of certain 2012 acquired facilities prior to the Company achieving completion of its cost reduction optimization strategy for acquired facilities. In addition, in 2012, the Company limited the ability for employees to accumulate earned but unused vacation beyond the current calendar year. As a result, the vacation time previously accumulated must be used by the employee by the end of the calendar year or it will be forfeited; therefore, the vacation accrual and expense were adjusted accordingly.

General and Administrative—General and administrative costs increased by $1.8 million to $14.0 million for the nine months ended September 30, 2013, compared to $12.2 million for the same period in 2012. The increase is primarily due to the following: (i) increases in salaries, wage and employee benefits expense of approximately $0.8 million due to the Company’s increased corporate overhead structure in response to the growth needs and the opening of an accounting service center located in Roswell, Georgia, (ii) increase of approximately $0.6 million in accounting and auditing expense, (iii) increase of approximately $0.3 million in expense due to a new data center agreement, (iv) increase of approximately $0.2 million in contract services expense, (v) increase of approximately $0.2 million in non-employee stock compensation amortization expense, (vi) increase of approximately $0.1 million in repair and maintenance expense, (vii) increase of approximately $0.1 million in recruiting cost, partially offset by (viii) increase of approximately $0.3 million in purchasing rebates, (ix) decrease of approximately $0.1 million in investor relations expense, and a (x) decrease of approximately $0.1 million in insurance expense. As a percentage of revenue, general and administrative costs declined to 8.3% for the nine months ended September 30, 2013, compared to 8.6% for the same period in 2012, reflecting increased leverage of the Company’s fixed costs over the scale of expanding operations from acquisitions.

In connection with the restatement process and the Audit Committee’s review and inquiry, the Company has incurred significant professional services costs and other expenses which have been recognized as a special charge for approximately $2.3 million for the nine months ended September 30, 2013.

Depreciation and Amortization—Depreciation and amortization for the nine months ended September 30, 2013 increased by $0.8 million to $5.6 million, compared to $4.7 million for the same period in 2012. The depreciation increase is directly related to the 2012 acquisition activity.

Salary Retirement and Continuation Costs—For the nine months ended September 30, 2013, salary retirement and continuation costs were $0.2 million relating to separation agreements with certain of the Company’s former officers. The costs include wage continuation and fringe benefits which are to be paid out to these former employees through December 2013.

Interest Expense, net—Interest expense, net increased by $0.8 million, or 8%, to $10.3 million for the nine months ended September 30, 2013, compared to $9.5 million for the same period in 2012. The Company has entered into numerous debt instruments in relation to the Company’s growth strategy for the acquisition of the facilities which began in the third quarter of 2010.

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Acquisition Costs, net of Gains—For the nine months ended September 30, 2013, acquisition costs decreased by $0.6 million, or 48%, to $0.6 million, compared to $1.2 million for the same period in 2012. The decrease was a result of less acquisition activity during the nine months ended September 30, 2013 compared to the same period in 2012.

Derivative Gain/Loss—For the nine months ended September 30, 2013, the derivative gain was $2.2 million, compared to the derivative loss of $1.3 million for the same period in 2012. The increase of 262% was due to the decrease of the Company’s stock price during the second quarter of 2013 compared to the increase in the Company's stock price during the second quarter of 2012. The derivative is a product of subordinated convertible promissory notes entered into during the third quarter of 2010. The expense associated with the derivative is subject to volatility based on a number of factors including increases or decreases in our stock price. Increases in our stock price generally result in increases in expense. Conversely, a decrease in our stock price generally results in the recognition of a gain in our statements of operations. The expense or gain recognized in a period is based on the fair value of the derivative instrument at the end of the period in comparison to the beginning of the period. The fair value of the derivative instrument was $0.9 million at September 30, 2013 compared to $3.6 million at December 31, 2012.

Income Tax Expense—The Company recognized an income tax expense for the nine months ended September 30, 2013, of $0.02 million, compared to an income tax expense of $0.1 million for the same period in 2012. Income tax expense for the Company is related to state and local taxes.

Liquidity and Capital Resources

We anticipate that scheduled debt service (excluding approximately $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively, that the Company believes will be refinanced on a longer term basis but including principal, interest, collateral and capital improvement fund or other escrow deposits) will total approximately $33.4 million and cash outlays for acquisition costs, maintenance capital expenditures, dividends on our Series A Preferred Stock and income taxes will total approximately $5.3 million for the 12 months ending September 30, 2014. We routinely have ongoing discussions with existing and potential new lenders to refinance current debt on a longer term basis and, in recent periods, have refinanced shorter term acquisition debt, including seller notes, with traditional longer term mortgage notes, some of which have been executed under government guaranteed lending programs. Although we anticipate the conversion to common stock of the Company’s outstanding subordinated convertible promissory notes with a principal amount in the aggregate of $7.7 million that mature in August 2014, which excludes subordinated convertible promissory notes with a principal amount in the aggregate of $1.7 million that were converted into shares of common stock of the Company in October 2013 (see Note 18 - Subsequent Events), we believe that our anticipated cash flow and funding sources would allow us to pay these notes in cash. These promissory notes are convertible at the option of the holder into shares of common stock of the Company at $3.73 per share. The closing price of the common stock exceeded $3.79 per share from January 1, 2013 through November 6, 2013. We have been successful in recent years in raising new equity capital and in October 2013 the Company issued 500,000 shares of Series A Preferred Stock at $25 per share receiving proceeds of approximately $11.2 million after deducting underwriting discounts and other offering-related expenses (see Note 18 - Subsequent Events). As discussed further below, if we are unable to refinance the $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively, then the Company may be required to restructure its outstanding indebtedness, implement further cost reduction initiatives, sell assets, as well as delay, modify, or abandon its expansion plans due to our limited liquidity in such an event.

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cost optimization and efficiency strategies and acquiring additional long-term care facilities with existing operating cash flow; (ii) expand our borrowing arrangements with certain existing lenders; (iii) refinance current debt where possible to obtain more favorable terms; and (iv) raise capital through the issuance of debt or equity securities. We anticipate that these actions, if successful, will provide the opportunity for us to maintain liquidity on a short and long term basis, thereby permitting us to meet our operating and financing obligations for the next 12 months and provide for the continuance of our acquisition strategy. However, there is no guarantee that such actions will be successful or that anticipated operating results will be achieved. We currently have limited borrowing availability under our existing revolving credit facilities. If the Company is unable to improve operating resultsor refinance current debt (including the $7.0 million and $6.5 million of bullet maturities due February 2014 and July 2014, respectively), then the Company may be required to restructure its outstanding indebtedness, implement further cost reduction initiatives, sell assets, as well as delay, modify, or abandon its expansion plans.

The following table presents selected data from the Company’s consolidated statement of cash flows for the periods presented:



	Nine Months Ended September 30,
(Amounts in 000’s)	2013			2012
Net cash provided by operating activities - continuing operations	$	2,383		$	2,673
Net cash provided by operating activities - discontinued operations	213			797
Net cash used in investing activities - continuing operations	(6,043		)	(56,965		)
Net cash provided by (used in) investing activities - discontinued operations	1,580			(293		)
Net cash flows provided by financing activities - continuing operations	801			56,467
Net cash flows used in financing activities - discontinued operations	(2,147		)	(170		)
Net change in cash and cash equivalents	(3,213		)	2,509
Cash and cash equivalents at beginning of period	15,937			7,364
Cash decrease due to deconsolidation of variable interest entities	—			(180		)
Cash and cash equivalents at end of period	$	12,724		$	9,693

Nine Months Ended September 30, 2013

Net cash provided by operating activities—continuing operations for the nine months ended September 30, 2013, was approximately $2.4 million, consisting primarily of the Company’s loss from operations, non cash charges and changes in working capital, including increased accounts payable and accrued expenses of $4.3 million, offset by increased accounts receivable of $2.7 million and increased prepaid expenses of $1.0 million.

Net cash used in investing activities—continuing operations for the nine months ended September 30, 2013, was approximately $6.0 million. This is primarily the result of proceeds received of $3.2 million from notes receivable, offset by capital expenditures and the increase in restricted cash and investments and escrow deposits for acquisitions. The net cash provided by investing activities—discontinued operations was approximately $1.6 million for the nine months ended September 30, 2013, related to proceedsfrom the sale of two additional assisted living facilities.

Net cash provided by financing activities—continuing operations was approximately $0.8 million for the nine months ended September 30, 2013. This is primarily the result of proceeds received of $2.4 million under the Company’s insurance premium financing, $5.0 million received under the refinanced debt , offset by repayment of $5.4 million on notes payable, $0.4 million in debt issuance costs and payment of preferred stock dividends of $0.9 million. Net cash used in financing activities—discontinued operations was approximately $2.1 million consisting of repayments of existing debt obligations related to the sale of the Lincoln Lodge Retirement Residence facility.

Nine Months Ended September 30, 2012

Net cash provided by operating activities—continuing operations for the nine months ended September 30, 2012, was $2.7 million, consisting primarily of the Company’s loss from operations, non cash charges and changes in working capital, including increased accounts payable and accrued expenses of $9.9 million, offset by increased accounts receivable of $10.7 million and increased prepaid expenses of $0.1 million.

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Net cash used in investing activities—continuing operations for the nine months ended September 30, 2012, was approximately $57.0 million. This is primarily the result of funding the Company’s acquisitions, including escrow deposits as well as capital expenditures.

Net cash provided by financing activities—continuing operations was approximately $56.5 million for the nine months ended September 30, 2012. This is primarily the result of cash proceeds received from debt financings to fund the Company’s acquisitions, proceeds from convertible debt, and the public stock offering, partially offset by repayments of existing debt obligations and debt issuance costs.

Notes Payable and Other Debt

Total notes payable and other debt obligations as of September 30, 2013 and December 31, 2012 were as follows:



(Amounts in 000’s)	September 30, 2013		December 31, 2012
Senior debt - guaranteed by HUD (a)	$	4,093	$	9,699
Senior debt - guaranteed by USDA	27,914		28,370
Senior debt - guaranteed by SBA	6,013		6,189
Senior debt - bonds, net of discount (b)	16,123		16,265
Senior debt - other mortgage indebtedness	78,361		75,188
Revolving credit facilities and lines of credit	9,278		9,204
Convertible debt issued in 2010, net of discount	9,344		10,948
Convertible debt issued in 2011	4,459		4,509
Convertible debt issued in 2012	7,500		7,500
Other debt	3,617		4,004
Total	$	166,702	$	171,876
Less: current portion	38,548		19,387
Less: portion included in liabilities of disposal group held for sale	—		3,662
Notes payable and other debt, net of current portion	$	128,154	$	148,827


(a)	The senior debt - guaranteed by the U.S. Department of Housing and Urban Development (“HUD”) includes $3.6 million related to the Vandalia HUD mortgage note classified as liabilities of disposal group held for sale at December 31, 2012, that was assumed by the buyer of the Hearth & Home of Vandalia assisted living facility that the Company sold in a transaction that closed in May 2013.


(b)	The senior debt - bonds, net of discount includes $3.1 million related to the outstanding bonds that were assumed by the Company upon its acquisition of the Quail Creek skilled nursing facility in July 2012, which pursuant to the applicable loan agreement, will be prepaid on March 1, 2014.

Scheduled Maturities

The schedule below summarizes the scheduled maturities as of September 30, 2013 for each of the next five years and thereafter.



	(Amounts in 000’s)
2014	$	38,314
2015	36,115
2016	17,558
2017	19,715
2018	3,728
Thereafter	51,457
Subtotal	166,887
Less: unamortized discounts ($57 classified as current)	(476		)
Plus: unamortized premiums ($291 classified as current)	291
Total notes and other debt	$	166,702

Debt Covenant Compliance

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As of September 30, 2013, the Company (including its consolidated variable interest entity) has more than forty credit related instruments (credit facilities, mortgage notes, bonds and other credit obligations) outstanding that include various financial and administrative covenant requirements. Covenant requirements include, but are not limited to, fixed charge coverage ratios, debt service coverage ratios, minimum EBITDA or EBITDAR, current ratios and tangible net worth requirements. Certain financial covenant requirements are based on consolidated financial measurements whereas others are based on subsidiary level (i.e.; facility, multiple facilities or a combination of subsidiaries comprising less than the Company’s consolidated financial measurements). Some covenants are based on annual financial metric measurements whereas others are based on monthly or quarterly financial metric measurements. The Company routinely tracks and monitors its compliance with its covenant requirements. In recent periods, including as of September 30, 2013, the Company has not been in compliance with certain financial and administrative covenants. For each instance of such non-compliance, the Company has obtained waivers or amendments to such requirements including as necessary modifications to future covenant requirements or the elimination of certain requirements in future periods.

The following table includes financial covenant requirements as of the last measurement date as of or prior to September 30, 2013 in instances where the Company was not in compliance with the financial covenant or it achieved compliance with the covenant requirement by a margin of 10% or less. The table also identifies the related credit facility, outstanding balance at September 30, 2013 and the next applicable future financial covenant requirement inclusive of adjustments to covenant requirements resulting from amendments executed subsequent to September 30, 2013.



Credit Facility	September 30, 2013 (000's)		Consolidated or Subsidiary Level Covenant Requirement	Financial Covenant	Measurement Period	Min/Max Financial Covenant Required		Financial Covenant Metric Achieved			Future Financial Covenant Metric Required
Gemino - Line of Credit	$	1,362	Consolidated	Fixed Charge Coverage Ratio (FCCR)	Quarterly	1.10		1.20			1.10
PrivateBank - Line of Credit	$	6,167	Subsidiary	Rent and debt service coverage ratio	Quarterly	1.25		1.59			1.25
			Consolidated	Guarantor minimum debt service coverage ratio (DSCR)	Annual	1.00		1.03			1.00
			Consolidated	Guarantor maximum leverage ratio	Annual	11.00		10.97			11.00
Contemporary Healthcare Capital - Term Note and Line of Credit - Companion Care	$	5,000	Subsidiary	Minimum implied current ratio	Quarterly	1.0		1.1			1.0
			Subsidiary	Minimum liquidity (000's)	Quarterly	$250		$803			$250
	$	289	Subsidiary	DSCR	Quarterly	1.15		(1.05	)	*	1.15
			Subsidiary	Minimum Occupancy	Quarterly	70	%	69	%	*	70	%
Bank of Atlanta (USDA) - Mortgage Note - Erin Nursing	$	4,799	Subsidiary	Current Ratio	Quarterly	1.0		1.0			1.0
PrivateBank - Mortgage Note - Valley River	$	11,312	Consolidated	DSCR	Annual	1.00		1.03			1.00
PrivateBank - Mortgage Note - Valley River			Subsidiary	DSCR	Annual	1.25		1.31			1.25
Square 1 USDA - Term Note - Homestead	$	3,477	Subsidiary	Current ratio	Quarterly	1.0		1.2			1.0
			Subsidiary	Maximum debt to net worth	Quarterly	9		3			9
			Subsidiary	Tangible net worth	Quarterly	10	%	25	%		10	%
PrivateBank - Mortgage Note - West Markham	$	13,665	Subsidiary	EBITDAR (000's)	Quarterly	N/A		$194			$215
			Subsidiary	DSCR	Annual	1.10		1.18			1.10
			Consolidated	DSCR	Annual	1.00		1.03			1.00
			Consolidated	Maximum Annual Leverage	Annual	11.00		10.97			11.00

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KeyBank - Mortgage Note - Northridge - Woodland Hills - Abington	$	15,400	Subsidiary	Implied DSCR	Quarterly	1.20		0.71		*	1.20
			Consolidated	FCCR	Quarterly	1.10		1.00		*	1.15
PrivateBank - Mortgage Note - Glenvue	$	6,459	Subsidiary	DSCR	Quarterly	1.35		4.04			1.35
			Subsidiary	DSCR	Annual	1.10		1.15			1.10
			Consolidated	DSCR	Annual	1.00		1.03			1.00
			Consolidated	Maximum leverage	Annual	11.00		10.97			11.00
PrivateBank - Mortgage Note - Woodland Manor	$	4,630	Subsidiary	Minimum quarterly EBITDAR (000's)	Quarterly	$250		$240		*	$250
PrivateBank - Mortgage Note - Woodland Manor			Subsidiary	Minimum trailing twelve month FCCR	Quarterly	1.10		1.42			1.10
Medical Clinic Board of the City of Hoover - Bonds	$	6,215	VIE	DSCR	Annual	1.20		(0.04	)	*	1.20
			VIE	Days cash on hand	Annual	15		15			15
			VIE	Trade payables	Annual	10	%	9	%		10	%
City of Springfield - Bonds	$	7,230	Subsidiary	DSCR	Annual	1.10		0.81		*	1.10
			Subsidiary	Days Cash on Hand	Annual	15		20			15
			Subsidiary	Trade payables	Annual	10	%	8	%		10	%

* - Waiver or amendment for violation of covenant obtained.

Senior Debt—Guaranteed by HUD

Hearth and Home of Vandalia

Senior Debt - Other Mortgage Indebtedness

Little Rock

Quail Creek Credit Facility

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of $3.1 million has been deposited into a restricted defeased bonds escrow account.

Revolving Credit Facilities and Lines of Credit

PrivateBank Credit Facility

Gemino Northwest Credit Facility

On May 30, 2013, NW 61st Nursing, LLC (“Northwest”), a wholly-owned subsidiary of the Company, entered into a Credit Agreement (the “Northwest Credit Facility”) with Gemino Healthcare Finance, LLC (“Gemino”). The Northwest Credit Facility provides for a $1.0 million principal amount senior-secured revolving credit facility.

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On June 25, 2013, the Northwest entered into a First Amendment to the Credit Agreement which amended the Northwest Credit Facility. The amendment, among other things: (i) amends certain financial covenants regarding fixed charge coverage ratio and minimum EBITDA; and (ii) amends the credit facility to include the Bonterra Credit Facility (discussed below) as an affiliated credit agreement in determining whether certain financial covenants are being met.

As of September 30, 2013, $1.5 million was outstanding of the maximum borrowing amount of $1.5 million under the Northwest Credit Facility.

Gemino Bonterra Credit Facility

On May 30, 2013, the ADK Bonterra/Parkview, LLC, a wholly-owned subsidiary of the Company (“Bonterra”), entered into a Fourth Amendment to Credit Agreement with Gemino, which amended that certain Credit Agreement dated April 27, 2011 between Bonterra and Gemino (as amended, the “Bonterra Credit Facility”) . The amendment, among other things: (i) extends the term of the Bonterra Credit Facility from January 31, 2014 to January 31, 2015; (ii) amends certain financial covenants regarding Bonterra’s fixed charge coverage ratio and maximum loan turn days; and (iii) amends the Gemino-Bonterra credit facility to include the Northwest Credit Facility as an affiliated credit agreement in determining whether certain financial covenants are being met.

As of September 30, 2013, $1.4 million was outstanding of the maximum borrowing amount of $2.0 million under the Bonterra Credit Facility.

KeyBank Credit Facility

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As of September 30, 2013, $15.4 million was outstanding under the KeyBank Credit Facility.

Convertible Debt

Subordinated Convertible Promissory Notes Issued in 2010



Month of conversion	Debt and Interest Converted (000's)		Shares of Common Stock Issued
February	$	25	6,635
March	$	25	6,635
April	$	250	67,024
August	$	1,063	284,878
September	$	919	246,264
Total	$	2,282	611,436

Subordinated Convertible Promissory Notes Issued in 2011

Other Debt

Receivables

The Company’s operations could be adversely affected if we experience significant delays in reimbursement from Medicare, Medicaid or other third-party revenue sources. The Company’s future liquidity will continue to be dependent upon the relative amounts of current assets (principally cash and patient accounts receivable) 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 the staff at our facilities 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 $30.3 million at September 30, 2013, compared to $27.5 million at December 31, 2012, representing approximately 49 and 50 days of revenue in accounts receivable as of September 30, 2013 and December 31, 2012, respectively. The increase in accounts receivable is primarily the result of increased revenue in 2013.

The allowance for bad debt was $5.4 million and $3.7 million at September 30, 2013 and December 31, 2012, respectively. The Company continually evaluates 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, as well as other factors. The Company continues to evaluate and implement additional processes to strengthen our collection efforts and reduce the incidence of uncollectible accounts.

Inflation

The Company has historically derived a substantial portion of our revenue from the Medicare program. The Company also derives revenue from state Medicaid and similar reimbursement programs. Payments under these programs generally provide for reimbursement levels that are adjusted for inflation annually based upon the state’s fiscal year for the Medicaid programs and in each October for the Medicare program. These adjustments may not continue in the future, and even if received, such adjustments may not reflect the actual increase in our costs for providing healthcare services.

Labor and supply expenses make up a substantial portion of our cost of services. Those expenses can be subject to increase in periods of rising inflation and when labor shortages occur in the marketplace. To date, the Company has generally been able to implement cost control measures or obtain increases in reimbursement sufficient to offset increases in these expenses. The Company may not be successful in offsetting future cost increases.

Off-Balance Sheet Arrangements

There were $2.5 million of outstanding letters of credit of September 30, 2013 that are pledged as collateral of borrowing capacity on the PrivateBank Credit Facility.

Contractual Obligations - Operating Leases

The Company leases certain office space and nine skilled nursing facilities under non-cancelable operating leases, most of which have initial lease terms of ten to twelve years with rent escalation clauses and provisions for payments by the Company of real estate taxes, insurance and maintenance costs. For the three months ended September 30, 2013 and 2012, facility rent expense totaled $1.8 million and $1.8 million, respectively. For the nine months ended September 30, 2013 and 2012, facility rent expense totaled $5.3 million and $5.3 million, respectively.

Five of the Company’s facilities are operated under a single master lease arrangement. The lease has a term of ten years terminating in 2020. Under the master lease, a breach at a single facility could subject one or more of the other facilities covered by the same master lease to the same default risk. Failure to comply with regulations or governmental authorities, such as Medicare and Medicaid provider requirements, is a default under the Company’s master lease agreement. In addition, other potential defaults related to an individual facility may cause a default of the entire master lease agreement. With an indivisible

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lease, it is difficult to restructure the composition of the portfolio or economic terms of the lease without the consent of the landlord. The Company is not aware of any defaults as of September 30, 2013.

Two of the Company’s facilities are operated under a separate lease agreement. The lease is a single indivisible lease; therefore, a breach at a single facility could subject the second facility to the same default risk. The lease has a term of 12 years into 2022 and includes covenants and restrictions. A covenant is included that requires minimum capital expenditures of $375 per licensed bed per lease year at each facility which amounts to $0.1 million per year for both facilities. The Company has been in compliance with financial and administrative covenants of this lease agreement during the three months ended September 30, 2013.

Adjusted EBITDA from continuing operations and Adjusted EBITDAR from continuing operations

Due to the material amount of non-cash related items included in the Company’s results of operations, the Company has developed an Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (“Adjusted EBITDA from continuing operations”) metric which provides management with a clearer view of operational use of cash (see the table below). The Adjusted EBITDA from continuing operations for the nine months ended September 30, 2013 was $8.8 million compared $9.6 million for the nine months ended September 30, 2012. The Company has also developed an Adjusted Earnings Before Interest, Taxes, Depreciation, Amortization and Rent (“Adjusted EBITDAR from continuing operations”) metric that is used primarily in some debt covenants of the Company’s loans.

“Adjusted EBITDA from continuing operations” and “Adjusted EBITDAR from continuing operations” are measures of operating performance that are not calculated in accordance with GAAP. The Company defines: (i) “Adjusted EBITDA from continuing operations” as net income (loss) from continuing operations before interest expense, income tax expense; depreciation and amortization (including amortization of non-cash stock-based compensation), acquisition costs (net of gains), loss on extinguishment of debt, derivative loss or gain, other non-routine adjustments; and (ii) “Adjusted EBITDAR from continuing operations” as net income (loss) from continuing operations before interest expense; income tax expense, depreciation and amortization (including amortization of non-cash stock-based compensation), acquisition costs (net of gains), loss on extinguishment of debt, derivative loss; other non-routine adjustments. The Company has provided below for your reference, supplemental financial disclosure for these measures, including the most directly comparable GAAP measure (Net Loss) and an associated reconciliation.

The following table provides reconciliation of reported Net Loss on a GAAP basis to Adjusted EBITDA from continuing operations and EBITDAR from continuing operations for the three and nine months ended September 30, 2013 and 2012:

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	Three Months Ended September 30,						Nine Months Ended September 30,
(Amounts in 000’s)	2013			2012			2013			2012
Condensed Consolidated Statement of Operations Data:
Net loss	$	(413	)	$	(4,640	)	$	(10,109	)	$	(7,398	)
Discontinued operations	(188		)	126			(1,402		)	203
Loss from continuing operations (Per GAAP)	(225		)	(4,766		)	(8,707		)	(7,601		)
Add back:
Interest expense, net	3,462			3,695			10,253			9,475
Income tax (benefit) expense	(54		)	111			24			132
Amortization of stock based compensation	186			269			737			639
Depreciation and amortization	1,888			1,760			5,558			4,730
Acquisition costs, net of gain	33			342			607			1,160
Loss (gain) on extinguishment of debt	6			(500		)	33			(500		)
Derivative (gain) loss	(1,989		)	2,105			(2,178		)	1,342
Loss (gain) on disposal of assets	6			—			10			(2		)
Audit committee investigation expense	302			—			2,284			—
Other (income) expense	(15		)	218			(15		)	218
Salary retirement and continuation costs	5			38			154			38
Adjusted EBITDA from continuing operations	3,605			3,272			8,760			9,631
Facility rent expense	1,761			1,775			5,256			5,278
Adjusted EBITDAR from continuing operations	$	5,366		$	5,047		$	14,016		$	14,909

Adjusted EBITDA from continuing operations and Adjusted EBITDAR from continuing operations should not be considered in isolation or as a substitute for net income, income from operations or cash flows provided by, or used in, operations as determined in accordance with GAAP. Adjusted EBITDA from continuing operations and Adjusted EBITDAR from continuing operations are used by management to focus on operating performance and management without mixing in items of income and expense that relate to the financing and capitalization of the business, fixed rent or lease payments of facilities, derivative loss or gain, certain acquisition related charges and other non-routine adjustments.

The Company believes these measures are useful to investors in evaluating the Company’s performance, results of operations and financial position for the following reasons:


•	They are helpful in identifying trends in the Company’s day-to-day performance because the items excluded have little or no significance to the Company’s day-to-day operations;


•	They provide an assessment of controllable expenses and afford management the ability to make decisions which are expected to facilitate meeting current financial goals as well as achieve optimal financial performance; and


•	They provide data that assists management determine whether or not adjustments to current spending decisions are needed.

AdCare believes that the use of the measures provides a meaningful and consistent comparison of the Company’s underlying business between periods by eliminating certain items required by GAAP, which have little or no significance in the Company’s day-to-day operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

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

Item 4. Controls and Procedures.

Audit Committee Review and Inquiry

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As previously disclosed, the Audit Committee, in consultation with management, concluded in March 2013 that: (i) the Relevant Financial Statements (i.e., the Company’s previously issued financial statements for the quarters ended June 30, 2012, June 30, 2012 and September 30, 2012) should no longer be relied upon due to errors in the Relevant Financial Statements identified in connection with the audit of the Company’s consolidated financial statements for the year ended December 31, 2012; and (ii) the Company would restate the Relevant Financial Statements.

The Audit Committee initiated a further review of, and inquiry with respect to, the accounting and financial issues related to these and other potential errors and engaged counsel to assist the Audit Committee with such matters. The Audit Committee completed its inquiry and, in connection therewith, assisted in the correction of certain errors relating to accounting and financial matters and identified certain material weaknesses in the Company’s internal control over financial reporting, including weakness in the Company’s ability to appropriately account for complex or non-routine transactions and in the quality and sufficiency of the Company’s finance and accounting resources.

On July 8, 2013, the Company restated the Relevant Financial Statements by filing with the SEC amendments to its Quarterly Reports on Form 10 Q/A for the quarters ended June 30, 2012, June 30, 2012 and September 30, 2012.

Evaluation of Disclosure Controls and Procedures

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

Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 (the “Evaluation Date”). Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures were not effective.

Changes in Internal Control over Financial Reporting and Remediation

In response to the material weaknesses in the Company’s internal control over financial reporting identified by the Audit Committee’s review and inquiry and as identified in Management’s Report on Internal Control Over Financial Reporting included in Part II, Item 9A., “Controls and Procedures,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, and based in part on recommendations made by the Audit Committee to the Board of Directors following the completion of the Audit Committee’s review and inquiry, we have implemented, or plan to implement, the changes to our internal control over financial reporting discussed below.


•	We hired Ronald W. Fleming to serve as Chief Financial Officer of the Company effective May 15, 2013. Mr. Fleming has relevant industry experience as well as experience with generally accepted accounting principles and SEC reporting and compliance.


•	We have empowered Mr. Fleming to hire additional accounting and finance staff to ensure adequate internal control over financial reporting and operations.


•	We hired a Vice President, Controller and Chief Accounting Officer effective July 16, 2013.


•	We have expanded the scope of our annual internal audit plan to include quarterly internal audit procedures with emphasis on the review of journal entries and non-recurring transactions.

Since January 2013, the Company has hired 11 new finance and accounting personnel, including a Vice President of Facility Accounting Operations. Our new finance and accounting leadership continue to evaluate the qualifications and sufficiency of our accounting and finance department. The expanded internal audit scope has commenced and will be completed prior to the Company filing its Quarterly Reports on Form 10-Q for each of the remaining 2013 quarterly periods.

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Due to the short time period since we commenced our efforts to remediate our material weaknesses, we have not yet been able to fully evaluate the effectiveness of such efforts. We have incurred, and will continue to incur, additional incremental costs associated with our remediation efforts, primarily due to hiring new finance and accounting personnel and external consultants and the implementation and validation of improved accounting and financial reporting procedures. If we are not successful in remediating our material weaknesses, or if we determine in future fiscal periods that we have additional material weaknesses in our internal control over financial reporting, then the reliability of our financial reports may be adversely impacted, we may be unable to file our reports with the SEC in a timely fashion and we could be required to restate our financial results. This could cause our investors to lose confidence in our financial reporting, which could adversely affect the trading price of our stock.

Other than the remediation efforts discussed above, which occurred in 2013 and have included the involvement of our new finance and accounting leadership in the preparation, review, and approval of the consolidated financial statements included in this Quarterly Report, there have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the third quarter of 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings.

See Item I, Part II, of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, for a description of pending material legal proceedings.

Item 1A. Risk Factors.

Disclosure in response to Item 1A of Form 10-Q is not required to be provided by smaller reporting companies.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

On October 25, 2013, the Company issued to a holder of the Company’s convertible promissory notes dated October 26, 2010, an aggregate of 46,070 shares of common stock upon conversion of $170,503 of the principal amount and $1,337 in interest amount thereof. The conversion price was $3.73 per share of common stock. The convertible promissory notes were issued, and the shares of common stock issued upon conversion thereof were issued, pursuant to an exemption from the registration requirements of the Securities Act afforded by Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. The Company relied upon such exemption based upon representations made by the holder regarding, among other things, the holder’s status as an accredited investor (as such term is defined under the Securities Act).

On October 26, 2013, pursuant to the terms of the Cantone Settlement, the Company issued to CRI a two-year warrant to purchase 75,000 shares of common stock at an exercise price of $3.96 per share. The exercise price of the warrant is subject to certain anti-dilution adjustments. The warrant was issued, and the shares of common stock issued upon exercise of the warrant will be issued, pursuant to an exemption from the registration requirements of the Securities Act afforded by Section 4(a)(2) of the Securities Act. The Company relied upon such exemption due to the private nature of the transaction and based upon

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representations made by the holder regarding, among other things, the holder’s sophistication. For a further description of the Cantone Settlement, see Note 18 to the Consolidated Financial Statements included in this Quarterly Report.

Item 3. Defaults upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

The agreements included as exhibits to this Quarterly Report are included to provide information regarding the terms of these agreements and are not intended to provide any other factual or disclosure information about the Company, its business or the other parties to these agreements. These agreements may contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:

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•	should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;


•	have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;


•	may apply standards of materiality in a way that is different from what may be viewed as material to investors; and


•	were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.

Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time, and should not be relied upon by investors.

EXHIBIT INDEX



Exhibit No.	Description	Method of Filing

2.1	Purchase and Sale Agreement, dated February 15, 2013, by and among Avalon Health Care, LLC and AdCare Property Holdings, LLC	Incorporated by reference from Exhibit 2.27 of the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012

2.2	First Amendment to Purchase and Sale Agreement, dated March 14, 2013, by and between Avalon Health Care, LLC and AdCare Property Holdings, LLC	Incorporated by reference from Exhibit 2.28 of the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012

2.3	Reinstatement, Sixth Amendment and Assignment of Purchase and Sale Agreement, dated May 7, 2013, by and among First Commercial Bank, Brogdon Family, LLC and AdCare Property Holdings, LLC	Incorporated by reference from Exhibit 2.3 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

3.1	Amended and Restated Articles of Incorporation	Incorporated by reference from Exhibit 3.1 of the Registrant’s Registration Statement Form SB (Registration No. 333-131542) filed February 3, 2006

3.2	Code of Regulations	Incorporated by reference from Exhibit 3.2 of the Registrant’s Registration Statement Form SB (Registration No. 333-131542) filed February 3, 2006

3.3	Amendment to Amended and Restated Articles of Incorporation	Incorporated by reference to Exhibit 3.3 of the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011

3.4	Affidavit, dated June 28, 2012	Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on July 5, 2012

3.5	Certificate of Amendment to Amended and Restated Articles of Incorporation of AdCare Health Systems, Inc.	Incorporated by reference to Exhibit 3.1 of the Registrant’s Registration Statement on Form 8-A filed on November 7, 2012

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3.6	Amendment to Code of Regulations of AdCare Health Systems, Inc., adopted and effective as of November 16, 2007	Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on October 4, 2013

3.7	Certificate of Amendment to Amended and Restated Articles of Incorporation of AdCare Health Systems, Inc., dated October 17, 2013	Incorporated by reference to Exhibit 3.1 of the Registrant’s Current report on Form 8-K filed on October 17, 2013

4.1	Warrant to Purchase 70,000 shares of Common Stock, dated May 15, 2013, issued by AdCare Health Systems, Inc. to Ronald W. Fleming	Incorporated by reference from Exhibit 4.23 of the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012

4.2	Warrant to Purchase 75,000 shares of Common Stock, dated October 26, 2013, issued by AdCare Health Systems, Inc. to Cantone Research, Inc.	Filed herewith

10.1	Memorandum of Agreement, dated January 25, 2013, by and between The PrivateBank and Trust Company and the subsidiaries of AdCare Health Systems, Inc. named therein	Incorporated by reference from Exhibit 10.289 of the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012

10.2	Amendment to Secured Promissory Note, dated February 28, 2013, by and between CHP Acquisition Company, LLC and AdCare Health Systems, Inc.	Incorporated by reference from Exhibit 10.2 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.3	Assignment and Assumption of Leases, Rents and Security Deposits, dated February 28, 2013, by and among AdCare Health Systems, Inc., New Lincoln Ltd. and Lincoln Lodge Retirement Residence LLC	Incorporated by reference from Exhibit 10.3 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.4	Release and Assumption Agreement, dated May 6, 2013, by and among H & H of Vandalia LLC, Hearth & Home of Vandalia, Inc., Red Mortgage Capital, LLC and the Secretary of Housing and Urban Development	Incorporated by reference from Exhibit 10.4 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.5	Assignment and Assumption Agreement, dated May 6, 2013, by and between Hearth & Home of Vandalia, Inc. and H & H of Vandalia LLC	Incorporated by reference from Exhibit 10.5 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.6	Fourth Amendment to Credit Agreement, dated May 30, 2013, by and between ADK Bonterra/Parkview, LLC and Gemino Healthcare Finance, LLC	Incorporated by reference from Exhibit 10.6 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.7	Credit Agreement, dated May 30, 2012, by and among NW 61st Nursing, LLC and Gemino Healthcare Finance, LLC	Incorporated by reference from Exhibit 10.7 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

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10.8	Revolving Note, dated May 30, 2013, issued by NW 61st Nursing, LLC in favor of Gemino Healthcare Finance, LLC in the amount of $1,000,000	Incorporated by reference from Exhibit 10.8 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.9	Subordination Agreement, dated May 30, 2013, by and between First Commercial Bank and Gemino Healthcare Finance, LLC	Incorporated by reference from Exhibit 10.9 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.10	Guaranty Agreement, dated May 30, 2013, made by NW 61st Nursing, LLC in favor of Gemino Healthcare Finance, LLC	Incorporated by reference from Exhibit 10.10 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.11	Guaranty Agreement, dated May 30, 2013, made by AdCare Health Systems, Inc. in favor of Gemino Healthcare Finance, LLC	Incorporated by reference from Exhibit 10.11 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.12	First Amendment to Secured Loan Agreement and Payment Guaranty, dated May 31, 2013, by and among AdCare Health Systems, Inc., its subsidiaries named therein, AdCare Property Holdings, LLC, AdCare Operations, LLC and KeyBank National Association	Incorporated by reference from Exhibit 10.12 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.13	Mortgage, Assignment of Rents, Security Agreement and Fixture Filing, dated May 31, 2013, made by Mountain Top Property Holdings, LLC, to and for the benefit of KeyBank National Association	Incorporated by reference from Exhibit 10.13 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.14	Absolute Assignment of Leases and Rents, dated May 31, 2013, by Mountain Top Property Holdings, LLC in favor of KeyBank National Association	Incorporated by reference from Exhibit 10.14 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.15	Pledge and Security Agreement, dated May 31, 2013, between AdCare Health Systems, Inc. and KeyBank National Association	Incorporated by reference from Exhibit 10.15 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.16	Separation and Release Agreement, dated May 31, 2013, by and between AdCare Health Systems, Inc. and Martin D. Brew	Incorporated by reference from Exhibit 10.16 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.17	Second Amendment to Secured Loan Agreement and Payment Guaranty, dated June 27, 2013, by and among AdCare Health Systems, Inc., its subsidiaries named therein, AdCare Property Holdings, LLC, AdCare Operations, LLC and KeyBank National Association	Incorporated by reference from Exhibit 10.17 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.18	Third Modification Agreement, dated as of June 26, 2013, by and among Little Rock HC&R Property Holdings, LLC, AdCare Health Systems, Inc., Little Rock HC&R Nursing, LLC and The PrivateBank and Trust Company	Incorporated by reference from Exhibit 10.18 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

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10.19	Joinder Agreement, Second Amendment and Supplement to Credit Agreement , dated June 28, 2013, by and among NW 61st Nursing, LLC, Georgetown HC&R Nursing, LLC, Sumter N&R, LLC and Gemino Healthcare Finance, LLC	Incorporated by reference from Exhibit 10.19 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.20	Amended and Restated Revolving Note, dated June 28, 2013, issued by certain subsidiaries of AdCare Health Systems, Inc. in favor of Gemino Healthcare Finance, LLC in the amount of $1,500,000	Incorporated by reference from Exhibit 10.20 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.21	Management Fee Subordination Agreement, dated June 28, 2013, by and among Gemino Healthcare Finance, LLC, Georgetown HC&R Nursing, LLC, Sumter N&R, LLC and AdCare Administrative Services, LLC	Incorporated by reference from Exhibit 10.21 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.22	Sublease Termination Agreement, effective June 30, 2013, by and between ADK Georgia, LLC and ADK Oceanside Operator, LLC	Incorporated by reference from Exhibit 10.22 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.23	Sublease Termination Agreement, effective June 30, 2013, by and between ADK Georgia, LLC and ADK Savannah Beach Operator, LLC	Incorporated by reference from Exhibit 10.23 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.24	Sublease Agreement, effective June 30, 2013, by and between ADK Georgia, LLC and Tybee NH, LLC	Incorporated by reference from Exhibit 10.24 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.25	Sublease Agreement, effective June 30, 2013, by and between ADK Georgia, LLC and Tybee NH, LLC	Incorporated by reference from Exhibit 10.25 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended March 31, 2013

10.26	Employment Agreement, dated July 3, 2013, by and between AdCare Health Systems, Inc. and Ronald W. Fleming	Incorporated by reference from Exhibit 10.296 of the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012

10.27	Management Agreement, dated July 26, 2013, by and between Harrah White Meadows Nursing, LLC and AdCare Oklahoma Management, LLC	Incorporated by reference from Exhibit 10.27 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended June 30, 2013

10.28	Management Agreement, dated July 26, 2013, by and between MCL Nursing, LLC and AdCare Oklahoma Management, LLC	Incorporated by reference from Exhibit 10.28 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended June 30, 2013

10.29	Management Agreement, dated July 26, 2013, by and between Meeker Nursing, LLC and AdCare Oklahoma Management, LLC	Incorporated by reference from Exhibit 10.29 of the Registrant’s Quarterly Report on Form 10-Q for the three months ended June 30, 2013

10.30	Loan and Security Agreement, dated September 27, 2013, by and between QC Property Holdings, LLC and Housing & Healthcare Funding, LLC	Filed herewith

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10.31	Promissory Note, dated September 27, 2013, issued by QC Property Holdings, LLC to Housing & Healthcare Funding, LLC in the amount of $5,000,000	Filed herewith

10.32	Mortgage, Security Agreement Assignment of Leases and Rents and Fixture Filing, dated September 27, 2013, by QC Property Holdings, LLC to and for the benefit of Housing & Healthcare Funding, LLC	Filed herewith

10.33	Guaranty, dated September 27, 2013, by AdCare Health Systems, Inc. to and for the benefit of Housing & Healthcare Funding, LLC	Filed herewith

10.34	Assignment of Rents and Leases, dated September 27, 2013, by QC Property Holdings, LLC to and for the benefit of Housing & Healthcare Funding, LLC	Filed herewith

10.35	Third Modification Agreement, dated as of September 30, 2013, by and among The PrivateBank and Trust Company, AdCare Health Systems, Inc. and its subsidiaries named therein	Filed herewith

10.36	Letter Agreement, dated October 1, 2013, among AdCare Health Systems, Inc., Park City Capital, LLC and Michael J. Fox	Incorporated by reference from Exhibit 99.1 of the Registrant’s Current Report on Form 8-K filed on October 17, 2013

10.37	Waiver, Amendment and Forbearance, dated as of October 26, 2013, by and among AdCare Health Systems, Inc., Anthony J. Cantone and Attosa Financial LLC	Incorporated by reference from Exhibit 10.1 of the Registrant’s Current Report on From 8-K filed on October 31, 2013

31.1	Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act	Filed herewith

31.2	Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act	Filed herewith

32.1	Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act	Filed herewith

32.2	Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act	Filed herewith

101	The following financial information from AdCare Health Systems, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and 2012, (ii) Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012, (iii) Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012, (iv) Consolidated Statements of Stockholders’ Equity for the nine months ended September 30, 2013 and (v) the Notes to Consolidated Financial Statements.	Filed herewith

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused the report to be signed on its behalf by the undersigned, thereunto duly authorized.



		ADCARE HEALTH SYSTEMS, INC.
		(Registrant)

Date:	November 14, 2013	/s/ Boyd P. Gentry
		Boyd P. Gentry
		Chief Executive Officer
		(Principal Executive Officer)

Date:	November 14, 2013	/s/ Ronald W. Fleming
		Ronald W. Fleming
		Chief Financial Officer
		(Principal Financial and Accounting Officer)