##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
 (Mark One)
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2007
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934
 For the transition period from  to.
 Commission file number 1-12996
 ADVOCAT INC.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    62-1559667(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)1621 Galleria Boulevard, Brentwood, TN
    
    37027(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (615) 771-7575
 Securities registered pursuant to Section 12(b) of the Act:
 Title of each class
    
    Name of each Exchange on which registeredCommon Stock, $0.01 par value per share
    
    The NASDAQ Capital Market
 Securities registered pursuant to Section 12(g) of the Act:
 None.
 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act.
Yes o No þ .
 Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act.
Yes o No þ .
 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to the filing requirements for the past 90 days. Yes þ No o .
 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of Registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. 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 the definitions of large accelerated filer, accelerated filer and smaller reporting company
in Rule 12b-2 of the Exchange Act. (Check one):
 Large accelerated filero
    
    Accelerated filer þ
    
    Non-accelerated filero
    
    Smaller reporting companyo(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
Act). Yes o No þ .
 The aggregate market value of Common Stock held by non-affiliates on June 29, 2007 (based on the
closing price of such shares on the NASDAQ Capital Market) was approximately $58,119,000. For
purposes of the foregoing calculation only, all directors, named executive officers and persons
known to the Registrant to be holders of 5% or more of the Registrants Common Stock have been
deemed affiliates of the Registrant.
 On March 3, 2008, 5,750,787 shares of the registrants $0.01 par value Common Stock were
outstanding.
 Documents Incorporated by Reference:
 The following documents are incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of
this Form 10-K: The Registrants definitive proxy materials for its 2008 annual meeting of
shareholders.




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TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 1A. RISK FACTORSITEM 1B. UNRESOLVED STAFF COMMENTSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESITEM 6. SELECTED CONSOLIDATED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 9A. CONTROLS AND PROCEDURESITEM 9B. OTHER INFORMATIONPART IIIITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCEITEM 11. EXECUTIVE COMPENSATIONITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERSITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICESPART IVITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULESSIGNATURESEx-3.4 Bylaw Amendment adopted November 5, 2007Ex-10.56 First Amendment to Consolidated Amended and Restated Master LeaseEx-21 Subsidiaries of the RegistrantEx-23.1 Consent of BDO SeidmanEx-31.1 Section 302 Certification of the CEOEx-31.2 Section 302 Certification of the CFOEx-32 Section 906 Certification of the CEO & CFO    Table of Contents  
 PART I
 
 ITEM 1. BUSINESS
 Introductory Summary.
    
    
    Committed to Compassion
    
    Striving for Excellence
    
    Serving Responsibly
  Operating and Growth Strategy.
  Provide a broad range of cost-effective services.
 Increase occupancy through physical plant improvements and emphasis on marketing efforts
 Improve quality of payor mix.
 Cluster operations on a regional basis.
 2




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Increase revenues and profitability at existing facilities.
 Improve physical plants
 Development of additional specialty services
 Acquisition, leasing and development of new homes
 Nursing Centers and Services.
   Number of
    
    Licensed Nursing
    
    Available Nursing
    
    AssistedCenters
    
    Beds (1)
    
    Beds (1)
    
    Living UnitsOperating Locations:Alabama
    
    
    6
    
    
    
    711
    
    
    
    699
    
    
    
    52Arkansas
    
    
    12
    
    
    
    1,311
    
    
    
    1,163
    
    
    
    12Florida
    
    
    5
    
    
    
    502
    
    
    
    460
    
    
    
    0Kentucky
    
    
    6
    
    
    
    474
    
    
    
    470
    
    
    
    2Ohio
    
    
    1
    
    
    
    151
    
    
    
    122
    
    
    
    0Tennessee
    
    
    5
    
    
    
    617
    
    
    
    586
    
    
    
    0Texas
    
    
    13
    
    
    
    1,857
    
    
    
    1,646
    
    
    
    0West Virginia
    
    
    2
    
    
    
    150
    
    
    
    150
    
    
    
    050
    
    
    
    5,773
    
    
    
    5,296
    
    
    
    66Classification:Owned
    
    
    9
    
    
    
    942
    
    
    
    868
    
    
    
    17Leased
    
    
    41
    
    
    
    4,831
    
    
    
    4,428
    
    
    
    49Total
    
    
    50
    
    
    
    5,773
    
    
    
    5,296
    
    
    
    66
 3




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(1)
    
    The number of Licensed beds is based on the licensed capacity of the facility. The Company
reports its occupancy based on licensed beds. The number of Available Beds represents
licensed beds less beds removed from service. Available beds is subject to change based
upon the needs of the facilities, including configuration of patient rooms and offices, status
of beds (private, semi-private, ward, etc.) and renovations.   Life Steps Unit.
 Lighthouse Unit.
 Assisted Living Units.
 Other Specialty Programming.
  Continuous Quality Improvement
 4




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Organization .
 Marketing.
     Acquisitions and New Lease.
 2007 Acquisition
 Texas Facility
 Divestitures.
  5




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Nursing Center Profession.
  Demographic trends.
 Cost containment pressures.
 Limited supply of centers.
 Reduced reliance on family care.
 Competition.
   6




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Payor Sources.
   Year Ended December 31,(Dollars in thousands)2007
    
    
    2006
    
    
    2005Medicaid
    
    $
    136,566
    
    
    
    55.7
    %
    
    $
    121,138
    
    
    
    56.4
    %
    
    $
    116,624
    
    
    
    58.0
    %Medicare
    
    
    76,364
    
    
    
    31.2
    
    
    
    65,666
    
    
    
    30.6
    
    
    
    60,508
    
    
    
    30.0Private Pay
    
    
    32,131
    
    
    
    13.1
    
    
    
    27,849
    
    
    
    13.0
    
    
    
    24,102
    
    
    
    12.0Total
    
    $
    245,061
    
    
    
    100.0
    %
    
    $
    214,653
    
    
    
    100.0
    %
    
    $
    201,234
    
    
    
    100.0
    %
  Year Ended December 31,2007
    
    
    2006
    
    
    2005Medicaid
    
    
    2,708
    
    
    
    70.2
    %
    
    
    2,483
    
    
    
    70.6
    %
    
    
    2,461
    
    
    
    71.6
    %Medicare
    
    
    523
    
    
    
    13.6
    
    
    
    487
    
    
    
    13.8
    
    
    
    450
    
    
    
    13.0Private Pay
    
    
    626
    
    
    
    16.2
    
    
    
    548
    
    
    
    15.6
    
    
    
    528
    
    
    
    15.4Total
    
    
    3,857
    
    
    
    100.0
    %
    
    
    3,518
    
    
    
    100.0
    %
    
    
    3,439
    
    
    
    100.0
    %
  Reimbursement.
    7




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Employees.
   Supplies and Equipment.
  Government Regulation.
  8




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Licensure and Certification.
 Medicare and Medicaid.
  HIPAA Compliance
    9




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Self-Referral and Anti-Kickback Legislation.
 Available Information.
  
 ITEM 1A. RISK FACTORS
  We are substantially self-insured and have significant potential professional liability exposure.
   We have had substantial downward adjustments to our accrual for professional liability claims which
has caused significant increases in our net earnings.
  10




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Our outstanding indebtedness is subject to floating rates of interest which could be subject to
fluctuations based on changing interest rates and subject to various financial covenants.
  We are highly dependent on reimbursement by third-party payors.
    We are subject to significant government regulation.
   11




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The health care industry has been the subject of increased regulatory scrutiny recently.
  We have significant deferred tax assets which we may not be able to realize.
 
 We are subject to claims under the self-referral and anti-kickback legislation.
  We operate in an industry that is highly competitive
  We have a number of policies in place that could be considered anti-takeover protections
  12




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If we are unable to successfully integrate the business operations of the SMSA facilities into our
business operations, we will not realize the anticipated potential benefits from the acquisition
and our business could be adversely affected.
  
 ITEM 1B. UNRESOLVED STAFF COMMENTS
  
 ITEM 2. PROPERTIES
  Description of Lease Agreements.
  Omega Master Lease.
    13




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Florida Leases.
 Other Leases.
 
 ITEM 3. LEGAL PROCEEDINGS
    
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  14




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PART II
 
 ITEM 5.
    
    MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
 Market Information.
 Period
    
    High
    
    Low2006 - 1st Quarter
    
    
    9.40
    
    
    
    5.252006 - 2nd Quarter
    
    
    17.80
    
    
    
    8.852006 - 3rd Quarter
    
    
    20.49
    
    
    
    13.502006 - 4th Quarter
    
    
    21.03
    
    
    
    15.232007 - 1st Quarter
    
    
    17.89
    
    
    
    10.732007 - 2nd Quarter
    
    
    13.77
    
    
    
    11.072007 - 3rd Quarter
    
    
    12.71
    
    
    
    9.252007 - 4th Quarter
    
    
    12.00
    
    
    
    9.99
  Holders
 Dividends
 Equity Compensation Plan Information
  Number of SecuritiesNumber of Securities
    
    
    
    
    
    
    Available for Futureto be Issued Upon
    
    
    Weighted-Average
    
    
    Issuance Under EquityExercise of
    
    
    Exercise Price of
    
    
    Compensation PlansOutstanding Options,
    
    
    Outstanding Options,
    
    
    (excluding SecuritiesWarrants and Rights
    
    
    Warrants and Rights
    
    
    Reflected in Column (a))Plan Category
    
    (a)
    
    
    (b)
    
    
    (c)Equity Compensation Plans Approved
by Securities Holders
    
    
    472,000
    
    
    $
    6.02
    
    
    
    258,000Equity Compensation Plans Not
Approved by Securities Holders
    
    None
    
    None
    
    NoneTotal
    
    
    472,000
    
    
    $
    6.02
    
    
    
    258,000
 Repurchase of Common Stock
 Total Number of
    
    Maximum ApproximateShares Purchased as
    
    Dollar Value of SharesPart of Publicly
    
    That May Yet BeTotal Number of
    
    Average Price
    
    Announced Plans or
    
    Purchased Under thePeriod
    
    Shares Purchased
    
    Paid per Share
    
    Programs (1)
    
    Plans or Programs (1)November 7 through 30
    
    
    25,500
    
    
    $
    10.97
    
    
    
    25,500
    
    
    $
    2,220,000December 1 through 31
    
    
    49,000
    
    
    $
    10.96
    
    
    
    74,500
    
    
    $
    1,683,000Total
    
    
    74,500
 
 (1)
    
    All share repurchases between November 7, 2007 and December 31, 2007 were
made pursuant to a share repurchase program authorized by the Companys Board of
Directors and publicly announced on November 6, 2007, which allows 15




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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
  Year Ended December 31,2007
    
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003Statement of Operations Data
    
    (in thousands, except per share amounts)REVENUES:Patient revenues, net
    
    $
    245,061
    
    
    $
    214,653
    
    
    $
    201,234
    
    
    $
    188,712
    
    
    $
    169,667EXPENSES:Operating
    
    
    187,463
    
    
    
    163,386
    
    
    
    153,273
    
    
    
    145,524
    
    
    
    133,190Lease
    
    
    20,019
    
    
    
    16,082
    
    
    
    15,836
    
    
    
    15,283
    
    
    
    14,883Professional liability
    
    
    (1,663
    )
    
    
    (5,354
    )
    
    
    (4,532
    )
    
    
    (2,001
    )
    
    
    14,989General and administrative
    
    
    17,552
    
    
    
    21,032
    
    
    
    13,311
    
    
    
    11,692
    
    
    
    10,628Depreciation and amortization
    
    
    4,093
    
    
    
    3,614
    
    
    
    3,454
    
    
    
    3,180
    
    
    
    3,121Asset impairment and other charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    219
    
    
    
    227,464
    
    
    
    198,760
    
    
    
    181,342
    
    
    
    173,897
    
    
    
    176,811OPERATING INCOME (LOSS)
    
    
    17,597
    
    
    
    15,893
    
    
    
    19,892
    
    
    
    14,815
    
    
    
    (7,144
    )OTHER INCOME (EXPENSE):Foreign currency transaction gain
    
    
    808
    
    
    
    21
    
    
    
    161
    
    
    
    784
    
    
    
    Other income
    
    
    
    
    
    
    207
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    1,016
    
    
    
    679
    
    
    
    534
    
    
    
    286
    
    
    
    102Interest expense
    
    
    (3,549
    )
    
    
    (3,707
    )
    
    
    (3,382
    )
    
    
    (3,069
    )
    
    
    (3,091
    )Debt retirement costs
    
    
    (116
    )
    
    
    (194
    )
    
    
    
    
    
    
    
    
    
    
    (1,841
    )
    
    
    (2,994
    )
    
    
    (2,687
    )
    
    
    (1,999
    )
    
    
    (2,989
    )INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES
    
    
    15,756
    
    
    
    12,899
    
    
    
    17,205
    
    
    
    12,816
    
    
    
    (10,133
    )PROVISION (BENEFIT) FOR INCOME TAXES
    
    
    6,270
    
    
    
    (9,496
    )
    
    
    (13,811
    )
    
    
    266
    
    
    
    NET INCOME (LOSS) FROM CONTINUING OPERATIONS
    
    
    9,486
    
    
    
    22,395
    
    
    
    31,016
    
    
    
    12,550
    
    
    
    (10,133
    )DISCONTINUED OPERATIONS, net of taxes
    
    
    (99
    )
    
    
    (451
    )
    
    
    (5,714
    )
    
    
    (9,769
    )
    
    
    (1,088
    )NET INCOME (LOSS)
    
    $
    9,387
    
    
    $
    21,944
    
    
    $
    25,302
    
    
    $
    2,781
    
    
    $
    (11,221
    )INCOME (LOSS) PER COMMON SHARE:Basic-Continuing operations
    
    $
    1.56
    
    
    $
    3.81
    
    
    $
    5.36
    
    
    $
    2.16
    
    
    $
    (1.90
    )Discontinued operations
    
    
    (0.02
    )
    
    
    (0.07
    )
    
    
    (1.00
    )
    
    
    (1.72
    )
    
    
    (0.19
    )Net per common share
    
    $
    1.54
    
    
    $
    3.74
    
    
    $
    4.36
    
    
    $
    0.44
    
    
    $
    (2.09
    )Diluted-Continuing operations
    
    $
    1.49
    
    
    $
    3.42
    
    
    $
    4.76
    
    
    $
    1.94
    
    
    $
    (1.90
    )Discontinued operations
    
    
    (0.01
    )
    
    
    (0.07
    )
    
    
    (0.88
    )
    
    
    (1.52
    )
    
    
    (0.19
    )Net per common share
    
    $
    1.48
    
    
    $
    3.35
    
    
    $
    3.88
    
    
    $
    0.42
    
    
    $
    (2.09
    )WEIGHTED AVERAGE COMMON SHARES:Basic
    
    
    5,870
    
    
    
    5,784
    
    
    
    5,725
    
    
    
    5,660
    
    
    
    5,493Diluted
    
    
    6,127
    
    
    
    6,507
    
    
    
    6,498
    
    
    
    6,437
    
    
    
    5,493
 December 31,2007
    
    2006
    
    2005
    
    2004
    
    2003Balance Sheet Data
    
    
    
    
    
    
    
    
    
    (in thousands)Working capital (deficit)
    
    $
    15,677
    
    
    $
    8,174
    
    
    $
    (39,970
    )
    
    $
    (45,489
    )
    
    $
    (54,302
    )Total assets
    
    $
    110,090
    
    
    $
    96,901
    
    
    $
    93,762
    
    
    $
    72,392
    
    
    $
    94,934Short-term borrowings and long-term debt including
current portion
    
    $
    34,455
    
    
    $
    31,516
    
    
    $
    47,547
    
    
    $
    47,024
    
    
    $
    52,544Preferred Stock  Series B
    
    
    
    
    
    
    
    
    
    $
    4,750
    
    
    $
    4,432
    
    
    $
    4,135Preferred Stock  Series C (including unamortized premium)
    
    $
    9,590
    
    
    $
    11,289
    
    
    
    
    
    
    
    
    
    
    
    Shareholders Equity (deficit)
    
    $
    12,744
    
    
    $
    3,837
    
    
    $
    (16,870
    )
    
    $
    (41,854
    )
    
    $
    (42,759
    )
 16




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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Overview
   Acquisitions and New Lease
 Divestitures.
  Basis of Financial Statements.
 Selected Financial and Operating Data
  Year Ended December 31,(Dollars in thousands)2007
    
    
    2006
    
    
    2005Revenues:Patient revenues, net
    
    $
    245,061
    
    
    
    100.0
    %
    
    $
    214,653
    
    
    
    100.0
    %
    
    $
    201,234
    
    
    
    100.0
    %Expenses:Operating
    
    
    187,463
    
    
    
    76.5
    
    
    
    163,386
    
    
    
    76.1
    
    
    
    153,273
    
    
    
    76.2Lease
    
    
    20,019
    
    
    
    8.2
    
    
    
    16,082
    
    
    
    7.5
    
    
    
    15,836
    
    
    
    7.9Professional liability
    
    
    (1,663
    )
    
    
    (0.7
    )
    
    
    (5,354
    )
    
    
    (2.5
    )
    
    
    (4,532
    )
    
    
    (2.3
    )General & administrative
    
    
    17,552
    
    
    
    7.1
    
    
    
    21,032
    
    
    
    9.8
    
    
    
    13,311
    
    
    
    6.6Depreciation and amortization
    
    
    4,093
    
    
    
    1.7
    
    
    
    3,614
    
    
    
    1.7
    
    
    
    3,454
    
    
    
    1.7227,464
    
    
    
    92.8
    
    
    
    198,760
    
    
    
    92.6
    
    
    
    181,342
    
    
    
    90.1Operating income
    
    
    17,597
    
    
    
    7.2
    
    
    
    15,893
    
    
    
    7.4
    
    
    
    19,892
    
    
    
    9.9Other income (expense):Foreign currency transaction gain
    
    
    808
    
    
    
    0.3
    
    
    
    21
    
    
    
    0.0
    
    
    
    161
    
    
    
    0.1Other Income
    
    
    
    
    
    
    
    
    
    
    207
    
    
    
    0.1
    
    
    
    
    
    
    
    Interest income
    
    
    1,016
    
    
    
    0.4
    
    
    
    679
    
    
    
    0.3
    
    
    
    534
    
    
    
    0.2Interest expense
    
    
    (3,549
    )
    
    
    (1.5
    )
    
    
    (3,707
    )
    
    
    (1.7
    )
    
    
    (3,382
    )
    
    
    (1.7
    )Debt retirement costs
    
    
    (116
    )
    
    
    
    
    
    
    (194
    )
    
    
    (0.1
    )
    
    
    
    
    
    
    (1,841
    )
    
    
    (0.8
    )
    
    
    (2,994
    )
    
    
    (1.4
    )
    
    
    (2,687
    )
    
    
    (1.4
    )Income from continuing operations before income taxes
    
    
    15,756
    
    
    
    6.4
    
    
    
    12,899
    
    
    
    6.0
    
    
    
    17,205
    
    
    
    8.5Provision (benefit) for income taxes
    
    
    6,270
    
    
    
    2.5
    
    
    
    (9,496
    )
    
    
    (4.4
    )
    
    
    (13,811
    )
    
    
    (6.9
    )Net income from continuing operations
    
    $
    9,486
    
    
    
    3.9
    %
    
    $
    22,395
    
    
    
    10.4
    %
    
    $
    31,016
    
    
    
    15.4
    %
 17




---



##### Table of Contents



December 31,2007
    
    2006
    
    2005Licensed Nursing Home Beds:Owned
    
    
    942
    
    
    
    942
    
    
    
    942Leased
    
    
    4,831
    
    
    
    3,463
    
    
    
    3,463Total
    
    
    5,773
    
    
    
    4,405
    
    
    
    4.405Assisted Living Units:Owned
    
    
    17
    
    
    
    17
    
    
    
    17Leased
    
    
    49
    
    
    
    49
    
    
    
    61Total
    
    
    66
    
    
    
    66
    
    
    
    78Total Beds/Units:Owned
    
    
    959
    
    
    
    959
    
    
    
    959Leased
    
    
    4,880
    
    
    
    3,512
    
    
    
    3,524Total
    
    
    5,839
    
    
    
    4,471
    
    
    
    4,483Facilities:Owned
    
    
    9
    
    
    
    9
    
    
    
    9Leased
    
    
    41
    
    
    
    33
    
    
    
    33Total
    
    
    50
    
    
    
    42
    
    
    
    42Average Occupancy:Nursing centers
    
    
    77.6
    %(1)
    
    
    78.8
    %
    
    
    76.9
    %Assisted living units
    
    
    63.1
    
    
    
    60.0
    
    
    
    64.6Total
    
    
    77.4
    %
    
    
    78.5
    %
    
    
    76.7
    %
 
 (1)
    
    On a same center basis, occupancy was 78.8% for 2007. Critical Accounting Policies and Judgments
  Revenues
 Patient Revenues
  Allowance for Doubtful Accounts
  18




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##### Table of Contents



Professional Liability and Other Self-Insurance Reserves
 Accrual for Professional and General Liability Claims -
    December 31,Policy Year End March 9,
    
    2007
    
    
    20062008
    
    $
    5,134,000
    
    
    $
    2007
    
    
    7,625,000
    
    
    
    6,992,0002006
    
    
    4,757,000
    
    
    
    7,629,0002005
    
    
    2,339,000
    
    
    
    6,042,0002004
    
    
    500,000
    
    
    
    3,228,0002003 and earlier
    
    
    320,000
    
    
    
    1,826,000$
    20,675,000
    
    
    $
    25,717,000
   19




---



##### Table of Contents



Accrual for Other Self-Insured Claim s-
   Asset Impairment
  Business Combinations
  Stock-Based Compensation
  20




---



##### Table of Contents



Income Taxes
  Contractual Obligations and Commercial Commitments
  Less than
    
    
    2 to 3
    
    
    4 to 5
    
    
    AfterContractual Obligations
    
    Total
    
    
    1 year
    
    
    Years
    
    
    Years
    
    
    5 YearsLong-term debt obligations (1)
    
    $
    43,714
    
    
    $
    4,749
    
    
    $
    11,129
    
    
    $
    27,836
    
    
    $
    Series C Preferred Stock (2)
    
    $
    5,864
    
    
    $
    344
    
    
    $
    5,520
    
    
    $
    
    
    
    $
    Elimination of Preferred Stock Conversion feature (3)
    
    $
    7,383
    
    
    $
    687
    
    
    $
    1,374
    
    
    $
    1,374
    
    
    $
    3,948Operating leases
    
    $
    605,789
    
    
    $
    21,177
    
    
    $
    42,709
    
    
    $
    42,772
    
    
    $
    499,131Required capital expenditures under mortgage loans (4)
    
    $
    877
    
    
    $
    245
    
    
    $
    490
    
    
    $
    142
    
    
    $
    Required capital expenditures under operating leases (5)
    
    $
    32,572
    
    
    $
    1,118
    
    
    $
    2,190
    
    
    $
    2,124
    
    
    $
    27,140Total
    
    $
    696,199
    
    
    $
    28,320
    
    
    $
    63,412
    
    
    $
    74,248
    
    
    $
    530,219
 
 (1)
    
    Long-term debt obligations include scheduled future payments of principal and
interest of long-term debt.(2)
    
    Series C Preferred Stock includes quarterly dividend payments and redemption value at
preferred shareholders earliest redemption date.(3)
    
    Payments for the elimination of preferred stock conversion feature.(4)
    
    Includes annual expenditure requirements for capital maintenance under mortgage loan
covenants.(5)
    
    Includes annual capital expenditure requirements under operating leases.  21




---



##### Table of Contents



Payor Sources
    Results of Operations
  (in thousands)
    
    Year Ended December 31,2007
    
    
    2006
    
    
    Change
    
    
    %PATIENT REVENUES, net
    
    $
    245,061
    
    
    $
    214,653
    
    
    $
    30,408
    
    
    
    14.2
    %EXPENSES:Operating
    
    
    187,463
    
    
    
    163,386
    
    
    
    24,077
    
    
    
    14.7
    %Lease
    
    
    20,019
    
    
    
    16,082
    
    
    
    3,937
    
    
    
    24.5
    %Professional liability
    
    
    (1,663
    )
    
    
    (5,354
    )
    
    
    3,691
    
    
    
    68.9
    %General and administrative
    
    
    17,552
    
    
    
    21,032
    
    
    
    (3,480
    )
    
    
    (16.5
    )%Depreciation and amortization
    
    
    4,093
    
    
    
    3,614
    
    
    
    479
    
    
    
    13.3
    %Total expenses
    
    
    227,464
    
    
    
    198,760
    
    
    
    28,704
    
    
    
    14.4
    %OPERATING INCOME
    
    
    17,597
    
    
    
    15,893
    
    
    
    1,704
    
    
    
    10.7
    %OTHER INCOME (EXPENSE):Foreign currency transaction gain
    
    
    808
    
    
    
    21
    
    
    
    787
    
    
    
    3,747.6
    %Other income
    
    
    
    
    
    
    207
    
    
    
    (207
    )
    
    
    (100.0
    )%Interest income
    
    
    1,016
    
    
    
    679
    
    
    
    337
    
    
    
    49.6
    %Interest expense
    
    
    (3,549
    )
    
    
    (3,707
    )
    
    
    158
    
    
    
    4.3
    %Debt retirement costs
    
    
    (116
    )
    
    
    (194
    )
    
    
    78
    
    
    
    40.2
    %(1,841
    )
    
    
    (2,994
    )
    
    
    1,153
    
    
    
    38.5
    %INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
    
    
    15,756
    
    
    
    12,899
    
    
    
    2,857
    
    
    
    22.1
    %PROVISION (BENEFIT) FOR INCOME TAXES
    
    
    6,270
    
    
    
    (9,496
    )
    
    
    15,766
    
    
    
    166.0
    %NET INCOME FROM CONTINUING OPERATIONS
    
    $
    9,486
    
    
    $
    22,395
    
    
    $
    (12,909
    )
    
    
    (57.6
    )%
 22




---



##### Table of Contents



(in thousands)
    
    Year Ended December 31,2006
    
    
    2005
    
    
    Change
    
    
    %PATIENT REVENUES, net
    
    $
    214,653
    
    
    $
    201,234
    
    
    $
    13,419
    
    
    
    6.7
    %EXPENSES:Operating
    
    
    163,386
    
    
    
    153,273
    
    
    
    10,113
    
    
    
    6.6
    %Lease
    
    
    16,082
    
    
    
    15,836
    
    
    
    246
    
    
    
    1.6
    %Professional liability
    
    
    (5,354
    )
    
    
    (4,532
    )
    
    
    (822
    )
    
    
    (18.1
    )%General and administrative
    
    
    21,032
    
    
    
    13,311
    
    
    
    7,721
    
    
    
    58.0
    %Depreciation and amortization
    
    
    3,614
    
    
    
    3,454
    
    
    
    160
    
    
    
    4.6
    %Total expenses
    
    
    198,760
    
    
    
    181,342
    
    
    
    17,418
    
    
    
    9.6
    %OPERATING INCOME
    
    
    15,893
    
    
    
    19,892
    
    
    
    (3,999
    )
    
    
    (20.1
    )%OTHER INCOME (EXPENSE):Foreign currency transaction gain
    
    
    21
    
    
    
    161
    
    
    
    (140
    )
    
    
    (87.0
    )%Other income
    
    
    207
    
    
    
    
    
    
    
    207
    
    
    
    N/AInterest income
    
    
    679
    
    
    
    534
    
    
    
    145
    
    
    
    27.2
    %Interest expense
    
    
    (3,707
    )
    
    
    (3,382
    )
    
    
    (325
    )
    
    
    (9.6
    )%Debt retirement costs
    
    
    (194
    )
    
    
    
    
    
    
    (194
    )
    
    
    N/A(2,994
    )
    
    
    (2,687
    )
    
    
    (307
    )
    
    
    11.4
    %INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
    
    
    12,899
    
    
    
    17,205
    
    
    
    (4,306
    )
    
    
    (25.0
    )%BENEFIT FOR INCOME TAXES
    
    
    (9,496
    )
    
    
    (13,811
    )
    
    
    4,315
    
    
    
    31.2
    %NET INCOME FROM CONTINUING OPERATIONS
    
    $
    22,395
    
    
    $
    31,016
    
    
    $
    (8,621
    )
    
    
    (27.8
    )%
  SAME CENTER(in thousands)
    
    Year Ended December 31,2007
    
    
    2006
    
    
    Change
    
    
    %PATIENT REVENUES, net
    
    $
    225,449
    
    
    $
    214,653
    
    
    $
    10,796
    
    
    
    5.0
    %EXPENSES:Operating
    
    
    170,429
    
    
    
    163,386
    
    
    
    7,043
    
    
    
    4.3
    %Lease
    
    
    18,506
    
    
    
    16,082
    
    
    
    2,424
    
    
    
    15.1
    %Professional liability
    
    
    (1,854
    )
    
    
    (5,354
    )
    
    
    3,500
    
    
    
    65.4
    %General and administrative
    
    
    16,866
    
    
    
    21,032
    
    
    
    (4,166
    )
    
    
    (19.8
    )%Depreciation and amortization
    
    
    3,783
    
    
    
    3,614
    
    
    
    169
    
    
    
    4.7
    %Total expenses
    
    
    207,730
    
    
    
    198,760
    
    
    
    8,970
    
    
    
    4.5
    %OPERATING INCOME
    
    
    17,719
    
    
    
    15,893
    
    
    
    1,826
    
    
    
    11.5
    %OTHER INCOME (EXPENSE):Foreign currency transaction gain
    
    
    808
    
    
    
    21
    
    
    
    787
    
    
    
    3,747.6
    %Other income
    
    
    
    
    
    
    207
    
    
    
    (207
    )
    
    
    (100.0
    )%Interest income
    
    
    1,016
    
    
    
    679
    
    
    
    337
    
    
    
    49.6
    %Interest expense
    
    
    (3,174
    )
    
    
    (3,707
    )
    
    
    533
    
    
    
    14.4
    %Debt retirement costs
    
    
    (116
    )
    
    
    (194
    )
    
    
    78
    
    
    
    40.2
    %(1,466
    )
    
    
    (2,994
    )
    
    
    1,528
    
    
    
    51.0
    %INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
    
    $
    16,253
    
    
    $
    12,899
    
    
    $
    3,354
    
    
    
    26.0
    %
 Year Ended December 31, 2007 Compared With Year Ended December 31, 2006
   Patient Revenues
 23




---



##### Table of Contents



Year EndedDecember 31,2007
    
    2006Skilled nursing occupancy:Same center
    
    
    78.8
    %
    
    
    78.8
    %New Texas Facilities
    
    
    67.4
    %
    
    
    n/aTotal continuing operations
    
    
    77.6
    %
    
    
    78.8
    %Medicare census as percent of total:Same center
    
    
    13.6
    %
    
    
    13.8
    %New Texas Facilities
    
    
    12.9
    %
    
    
    n/aTotal continuing operations
    
    
    13.6
    %
    
    
    13.8
    %Medicare revenues as percent of total:Same center
    
    
    30.8
    %
    
    
    30.6
    %New Texas Facilities
    
    
    35.3
    %
    
    
    n/aTotal continuing operations
    
    
    31.2
    %
    
    
    30.6
    %Medicaid revenues as percent of total:Same center
    
    
    56.7
    %
    
    
    56.4
    %New Texas Facilities
    
    
    44.3
    %
    
    
    n/aTotal continuing operations
    
    
    55.7
    %
    
    
    56.4
    %Medicare average rate per day:Same center
    
    $
    351.80
    
    
    $
    324.48New Texas Facilities
    
    $
    390.54
    
    
    
    n/aTotal continuing operations
    
    $
    355.11
    
    
    $
    324.48Medicaid average rate per day:Same center
    
    $
    140.12
    
    
    $
    133.78New Texas Facilities
    
    $
    110.69
    
    
    
    n/aTotal continuing operations
    
    $
    137.79
    
    
    $
    133.78
  Operating expense
   24




---



##### Table of Contents



Lease expense
 Professional liability.
 General and administrative expense
   Depreciation and amortization
 Foreign currency transaction gain
 Interest expense
 Debt retirement costs.
 Income from continuing operations before income taxes; income from continuing operations per common
share
 25




---



##### Table of Contents



Income from discontinued operations
 Year Ended December 31, 2006 Compared With Year Ended December 31, 2005
  Patient revenues
  Operating expense
     Lease expense
 26




---



##### Table of Contents



Professional liability.
 General and administrative expense
    Depreciation
 Foreign currency transaction gain
 Interest expense
 Debt retirement costs.
 Income from continuing operations before income taxes; income from continuing operations per common
share
 Income from discontinued operations
 27




---



##### Table of Contents



Liquidity and Capital Resources
 Capital Resources
      Transaction with Omega
   28




---



##### Table of Contents



New Facility Construction
   Share Repurchase
   29




---



##### Table of Contents



Professional Liability
   Liquidity
    30




---



##### Table of Contents



Facility Renovations
    Receivables
    Stock Exchange
  Inflation
  Off-Balance Sheet Arrangements
   31




---



##### Table of Contents



Recent Accounting Pronouncements
    Forward-Looking Statements
  
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
   32




---



##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
  
 ITEM 9A. CONTROLS AND PROCEDURES.
 Evaluation of Disclosure Controls and Procedures
  Managements Report on Internal Control over Financial Reporting
  Changes in Internal Control over Financial Reporting
   33




---



##### Table of Contents



Report of Independent Registered Public Accounting Firm
 
 Internal Control-Integrated Framework
      
 
 ITEM 9B. OTHER INFORMATION
  34




---



##### Table of Contents



PART III
 
 ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
  
 ITEM 11. EXECUTIVE COMPENSATION
  
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER
MATTERS
  
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
  
 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
  35




---



##### Table of Contents



PART IV
 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
  Form 10-KPagesFinancial StatementsReport of Independent Registered Public Accounting Firm
    
    F-1Consolidated Balance Sheets as of December 31, 2007 and 2006
    
    F-2Consolidated Statements of Income for the Years Ended December 31, 2007, 2006 and 2005
    
    F-3Consolidated Statements of Shareholders Equity (Deficit) for the Years Ended December
31, 2007, 2006 and 2005
    
    F-4Consolidated Statements of Cash Flows for the Years Ended December 31, 2007, 2006 and 2005
    
    F-5Notes to Consolidated Financial Statements as of December 31, 2007, 2006 and 2005
    
    F-7 to F-33Financial Statement ScheduleSchedule II  Valuation and Qualifying Accounts
    
    S-1 to S-3
 Exhibits
  36




---



##### Table of Contents



SIGNATURES
  ADVOCAT INC./s/ Wallace E. OlsonWallace E. OlsonChairman of the BoardMarch 11, 2008/s/ William R. Council, IIIWilliam R. Council, IIIPresident and Chief Executive Officer(Principal Executive Officer)March 11, 2008/s/ L. Glynn Riddle, Jr.L. Glynn Riddle, Jr.Vice President, Chief Financial Officer, Secretary(Principal Financial and Accounting Officer)March 11, 2008
  /s/ Wallace E. Olson
    
    
    
    /s/ William C. ONeil. Jr.Wallace E. Olson
    
    
    
    William C. ONeil, Jr.Chairman of the Board
    
    
    
    DirectorMarch 11, 2008
    
    
    
    March 11, 2008/s/ William R. Council, III
    
    
    
    /s/ Richard M. BrameWilliam R. Council, III
    
    
    
    Richard M. BramePresident and Chief Executive Officer
    
    
    
    DirectorDirector
    
    
    
    March 11, 2008March 11, 2008/s/ Robert Z. HensleyRobert Z. HensleyDirectorMarch 11, 2008
 37




---



##### Table of Contents



ADVOCAT INC. AND SUBSIDIARIES




---



##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 Report of Independent Registered Public Accounting Firm
    
    F-1Consolidated Balance Sheets
    
    F-2Consolidated Statements of Income
    
    F-3Consolidated Statements of Shareholders Equity (Deficit)
    
    F-4Consolidated Statements of Cash Flows
    
    F-5Notes to Consolidated Financial Statements
    
    F-7Schedule II  Valuation and Qualifying Accounts
    
    S-1




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
     Internal Control  Integrated Framework
  
 F-1




---



##### Table of Contents



ADVOCAT INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2007 AND 2006
 2007
    
    
    2006ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    11,658,000
    
    
    $
    12,344,000Receivables, less allowance for
doubtful accounts of $2,158,000 and $2,122,000,
respectively
    
    
    26,444,000
    
    
    
    16,902,000Current portion of note receivable
    
    
    629,000
    
    
    
    534,000Prepaid expenses and other current assets
    
    
    2,130,000
    
    
    
    2,706,000Insurance refunds receivable
    
    
    1,234,000
    
    
    
    3,519,000Deferred income taxes
    
    
    2,110,000
    
    
    
    1,785,000Total current assets
    
    
    44,205,000
    
    
    
    37,790,000PROPERTY AND EQUIPMENT, at cost
    
    
    64,294,000
    
    
    
    59,954,000Less accumulated depreciation
    
    
    (34,091,000
    )
    
    
    (32,757,000
    )Discontinued operations, net
    
    
    1,455,000
    
    
    
    1,576,000Property and equipment, net
    
    
    31,658,000
    
    
    
    28,773,000OTHER ASSETS:Deferred income taxes
    
    
    16,568,000
    
    
    
    21,849,000Note receivable, net of current portion
    
    
    4,983,000
    
    
    
    4,758,000Deferred financing and other costs, net
    
    
    1,239,000
    
    
    
    905,000Cash restricted for capital expenditures
    
    
    
    
    
    
    864,000Other assets
    
    
    1,945,000
    
    
    
    1,962,000Acquired leasehold interest, net
    
    
    9,492,000
    
    
    
    Total other assets
    
    
    34,227,000
    
    
    
    30,338,000$
    110,090,000
    
    
    $
    96,901,000LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Current portion of long-term debt
    
    $
    1,942,000
    
    
    $
    4,587,000Short-term debt
    
    
    
    
    
    
    2,662,000Trade accounts payable
    
    
    6,636,000
    
    
    
    4,566,000Accrued expenses:Payroll and employee benefits
    
    
    11,360,000
    
    
    
    9,363,000Current portion of self-insurance reserves
    
    
    4,597,000
    
    
    
    4,838,000Other current liabilities
    
    
    3,993,000
    
    
    
    3,600,000Total current liabilities
    
    
    28,528,000
    
    
    
    29,616,000NONCURRENT LIABILITIES:Long-term debt, less current portion
    
    
    32,513,000
    
    
    
    24,267,000Self-insurance reserves, less current portion
    
    
    17,578,000
    
    
    
    22,159,000Other noncurrent liabilities
    
    
    9,137,000
    
    
    
    5,733,000Total noncurrent liabilities
    
    
    59,228,000
    
    
    
    52,159,000COMMITMENTS AND CONTINGENCIESSERIES C REDEEMABLE PREFERRED STOCK,$.10 par
value, 5,000 shares authorized, issued and outstanding,
including premium of $4,672,000 and $6,371,000 at December
31, 2007 and 2006, respectively
    
    
    9,590,000
    
    
    
    11,289,000SHAREHOLDERS EQUITY:Series A preferred stock,
authorized 200,000 shares, $.10 par value, none issued and
outstandingCommon stock, authorized 20,000,000 shares, $.01 par
value, 5,878,000 and 5,866,000 shares issued, 5,804,000
and 5,866,000 shares outstanding, respectively
    
    
    59,000
    
    
    
    59,000Treasury stock at cost, 74,000 and 0 shares of
common stock at December 31, 2007 and 2006,
respectively
    
    
    (817,000
    )
    
    
    Paid-in capital
    
    
    15,804,000
    
    
    
    15,123,000Accumulated deficit
    
    
    (2,302,000
    )
    
    
    (11,345,000
    )Total shareholders equity
    
    
    12,744,000
    
    
    
    3,837,000$
    110,090,000
    
    
    $
    96,901,000
  F-2




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##### Table of Contents



ADVOCAT INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF INCOME
 Year Ended December 31,2007
    
    
    2006
    
    
    2005REVENUES:Patient revenues, net
    
    $
    245,061,000
    
    
    $
    214,653,000
    
    
    $
    201,234,000EXPENSES:Operating
    
    
    187,463,000
    
    
    
    163,386,000
    
    
    
    153,273,000Lease
    
    
    20,019,000
    
    
    
    16,082,000
    
    
    
    15,836,000Professional liability
    
    
    (1,663,000
    )
    
    
    (5,354,000
    )
    
    
    (4,532,000
    )General and administrative
    
    
    17,552,000
    
    
    
    21,032,000
    
    
    
    13,311,000Depreciation and amortization
    
    
    4,093,000
    
    
    
    3,614,000
    
    
    
    3,454,000227,464,000
    
    
    
    198,760,000
    
    
    
    181,342,000OPERATING INCOME
    
    
    17,597,000
    
    
    
    15,893,000
    
    
    
    19,892,000OTHER INCOME (EXPENSE):Foreign currency transaction gain
    
    
    808,000
    
    
    
    21,000
    
    
    
    161,000Other income
    
    
    
    
    
    
    207,000
    
    
    
    Interest income
    
    
    1,016,000
    
    
    
    679,000
    
    
    
    534,000Interest expense
    
    
    (3,549,000
    )
    
    
    (3,707,000
    )
    
    
    (3,382,000
    )Debt retirement costs
    
    
    (116,000
    )
    
    
    (194,000
    )
    
    
    (1,841,000
    )
    
    
    (2,994,000
    )
    
    
    (2,687,000
    )INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES
    
    
    15,756,000
    
    
    
    12,899,000
    
    
    
    17,205,000PROVISION (BENEFIT) FOR INCOME TAXES
    
    
    6,270,000
    
    
    
    (9,496,000
    )
    
    
    (13,811,000
    )NET INCOME FROM CONTINUING OPERATIONS
    
    
    9,486,000
    
    
    
    22,395,000
    
    
    
    31,016,000NET INCOME FROM DISCONTINUED OPERATIONS:Operating loss, net of tax
provision (benefit) of $(59,000), $0 and
$368,000, respectively
    
    
    (91,000
    )
    
    
    (337,000
    )
    
    
    (6,113,000
    )Gain (loss) on sale, net of tax
provision (benefit) of $(6,000), $0 and $0, respectively
    
    
    (8,000
    )
    
    
    (114,000
    )
    
    
    399,000DISCONTINUED OPERATIONS
    
    
    (99,000
    )
    
    
    (451,000
    )
    
    
    (5,714,000
    )NET INCOME
    
    
    9,387,000
    
    
    
    21,944,000
    
    
    
    25,302,000PREFERRED STOCK DIVIDENDS
    
    
    344,000
    
    
    
    340,000
    
    
    
    318,000NET INCOME FOR COMMON STOCK
    
    $
    9,043,000
    
    
    $
    21,604,000
    
    
    $
    24,984,000NET INCOME PER COMMON SHARE:Per common share  basicContinuing operations
    
    $
    1.56
    
    
    $
    3.81
    
    
    $
    5.36Discontinued operations
    
    
    (0.02
    )
    
    
    (0.07
    )
    
    
    (1.00
    )$
    1.54
    
    
    $
    3.74
    
    
    $
    4.36Per common share  dilutedContinuing operations
    
    $
    1.49
    
    
    $
    3.42
    
    
    $
    4.76Discontinued operations
    
    
    (0.01
    )
    
    
    (0.07
    )
    
    
    (0.88
    )$
    1.48
    
    
    $
    3.35
    
    
    $
    3.88WEIGHTED AVERAGE COMMON SHARES:Basic
    
    
    5,870,000
    
    
    
    5,784,000
    
    
    
    5,725,000Diluted
    
    
    6,127,000
    
    
    
    6,507,000
    
    
    
    6,498,000
  F-3




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##### Table of Contents



ADVOCAT INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY (DEFICIT)
 Common Stock
    
    
    Treasury Stock
    
    
    Paid-in
    
    
    AccumulatedShares Issued
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    TotalBALANCE, DECEMBER 31, 2004
    
    
    5,725,000
    
    
    $
    57,000
    
    
    
    
    
    
    $
    
    
    
    $
    16,022,000
    
    
    $
    (57,933,000
    )
    
    $
    (41,854,000
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,302,000
    
    
    
    25,302,000Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (318,000
    )
    
    
    (318,000
    )BALANCE, DECEMBER 31, 2005
    
    
    5,725,000
    
    
    
    57,000
    
    
    
    
    
    
    
    
    
    
    
    16,022,000
    
    
    
    (32,949,000
    )
    
    
    (16,870,000
    )Exercise of stock options
    
    
    141,000
    
    
    
    2,000
    
    
    
    
    
    
    
    
    
    
    
    556,000
    
    
    
    
    
    
    
    558,000Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,944,000
    
    
    
    21,944,000Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (340,000
    )
    
    
    (340,000
    )Elimination of preferred
stock conversion feature
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,700,000
    )
    
    
    
    
    
    
    (6,700,000
    )Tax impact of stock
options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    61,000
    
    
    
    
    
    
    
    61,000Stock based compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,184,000
    
    
    
    
    
    
    
    5,184,000BALANCE, DECEMBER 31, 2006
    
    
    5,866,000
    
    
    
    59,000
    
    
    
    
    
    
    
    
    
    
    
    15,123,000
    
    
    
    (11,345,000
    )
    
    
    3,837,000Exercise of stock options
    
    
    12,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    65,000
    
    
    
    
    
    
    
    65,000Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,387,000
    
    
    
    9,387,000Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (344,000
    )
    
    
    (344,000
    )Repurchase of common stock
    
    
    
    
    
    
    
    
    
    
    74,000
    
    
    
    (817,000
    )
    
    
    
    
    
    
    
    
    
    
    (817,000
    )Tax impact of stock
options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32,000
    )
    
    
    
    
    
    
    (32,000
    )Stock based compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    648,000
    
    
    
    
    
    
    
    648,000BALANCE, DECEMBER 31, 2007
    
    
    5,878,000
    
    
    $
    59,000
    
    
    
    74,000
    
    
    $
    (817,000
    )
    
    $
    15,804,000
    
    
    $
    (2,302,000
    )
    
    $
    12,744,000
  F-4




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##### Table of Contents



ADVOCAT INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Year Ended December 31,2007
    
    
    2006
    
    
    2005CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    9,387,000
    
    
    $
    21,944,000
    
    
    $
    25,302,000Discontinued operations
    
    
    (99,000
    )
    
    
    (451,000
    )
    
    
    (5,714,000
    )Net income from continuing operations
    
    
    9,486,000
    
    
    
    22,395,000
    
    
    
    31,016,000Adjustments to reconcile net income from continuing
operations to net cash provided by operating
activities:Depreciation and amortization
    
    
    4,093,000
    
    
    
    3,614,000
    
    
    
    3,454,000Provision for doubtful accounts
    
    
    1,089,000
    
    
    
    1,610,000
    
    
    
    1,557,000Deferred income tax provision (benefit)
    
    
    5,137,000
    
    
    
    (9,719,000
    )
    
    
    (13,851,000
    )Benefit from self-insured professional liability,
net of cash payments
    
    
    (5,054,000
    )
    
    
    (9,323,000
    )
    
    
    (9,250,000
    )Stock-based compensation
    
    
    648,000
    
    
    
    5,184,000
    
    
    
    Amortization of deferred balances
    
    
    334,000
    
    
    
    289,000
    
    
    
    342,000Provision for leases in excess of cash payments
    
    
    2,234,000
    
    
    
    606,000
    
    
    
    158,000Gain on sale of bed license
    
    
    
    
    
    
    (207,000
    )
    
    
    Foreign currency transaction gain
    
    
    (808,000
    )
    
    
    (21,000
    )
    
    
    (161,000
    )Debt retirement costs
    
    
    116,000
    
    
    
    194,000
    
    
    
    Non-cash interest income
    
    
    (132,000
    )
    
    
    (270,000
    )
    
    
    (428,000
    )Non-cash interest expense
    
    
    
    
    
    
    86,000
    
    
    
    164,000Changes in other assets and liabilities affecting
operating activities:Receivables, net
    
    
    (10,633,000
    )
    
    
    (393,000
    )
    
    
    (3,798,000
    )Prepaid expenses and other assets
    
    
    2,781,000
    
    
    
    928,000
    
    
    
    (2,516,000
    )Trade accounts payable and accrued expenses
    
    
    3,374,000
    
    
    
    425,000
    
    
    
    2,745,000Net cash provided by continuing
operations
    
    
    12,665,000
    
    
    
    15,398,000
    
    
    
    9,432,000Discontinued operations
    
    
    22,000
    
    
    
    265,000
    
    
    
    (441,000
    )Net cash provided by operating activities
    
    
    12,687,000
    
    
    
    15,663,000
    
    
    
    8,991,000
  F-5




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##### Table of Contents



ADVOCAT INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Year Ended December 31,2007
    
    
    2006
    
    
    2005CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    $
    (6,827,000
    )
    
    $
    (4,089,000
    )
    
    $
    (3,394,000
    )Acquisition of leasehold interest
    
    
    (9,096,000
    )
    
    
    
    
    
    
    Purchase of skilled nursing center
    
    
    
    
    
    
    
    
    
    
    (6,753,000
    )Proceeds from sale of discontinued operations and
bed license
    
    
    180,000
    
    
    
    10,439,000
    
    
    
    399,000Decrease in restricted cash deposits
    
    
    246,000
    
    
    
    212,000
    
    
    
    148,000Decrease (increase) in cash restricted for capital
Expenditures
    
    
    864,000
    
    
    
    (864,000
    )
    
    
    Note receivable issued
    
    
    (1,800,000
    )
    
    
    
    
    
    
    Notes receivable collected
    
    
    2,500,000
    
    
    
    718,000
    
    
    
    589,000Proceeds from sale of lessors property
    
    
    
    
    
    
    
    
    
    
    780,000Deposits and other deferred balances
    
    
    (120,000
    )
    
    
    (422,000
    )
    
    
    (84,000
    )Net cash provided (used) by continuing
operations
    
    
    (14,053,000
    )
    
    
    5,994,000
    
    
    
    (8,315,000
    )Discontinued operations
    
    
    
    
    
    
    (28,000
    )
    
    
    (856,000
    )Net cash provided (used) in investing activities
    
    
    (14,053,000
    )
    
    
    5,966,000
    
    
    
    (9,171,000
    )CASH FLOWS FROM FINANCING ACTIVITIES:Repayment of debt obligations
    
    
    (13,437,000
    )
    
    
    (46,601,000
    )
    
    
    (9,966,000
    )Proceeds from issuance of debt
    
    
    16,500,000
    
    
    
    30,625,000
    
    
    
    11,700,000Financing costs
    
    
    (839,000
    )
    
    
    (765,000
    )
    
    
    (313,000
    )Payment of preferred stock dividends
    
    
    (344,000
    )
    
    
    (172,000
    )
    
    
    Repurchases of common stock
    
    
    (817,000
    )
    
    
    
    
    
    
    Payment for preferred stock restructuring
    
    
    (448,000
    )
    
    
    
    
    
    
    Proceeds from exercise of stock options
    
    
    65,000
    
    
    
    558,000
    
    
    
    Net cash provided (used) in financing
activities
    
    
    680,000
    
    
    
    (16,355,000
    )
    
    
    1,421,000NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    (686,000
    )
    
    
    5,274,000
    
    
    
    1,241,000CASH AND CASH EQUIVALENTS, beginning of period
    
    
    12,344,000
    
    
    
    7,070,000
    
    
    
    5,829,000CASH AND CASH EQUIVALENTS, end of period
    
    $
    11,658,000
    
    
    $
    12,344,000
    
    
    $
    7,070,000SUPPLEMENTAL INFORMATION:Cash payments of interest
    
    $
    3,325,000
    
    
    $
    3,426,000
    
    
    $
    3,029,000Cash payments of income taxes, net of refunds
    
    $
    1,658,000
    
    
    $
    378,000
    
    
    $
    111,000
 NON-CASH INVESTING AND FINANCING ACTIVITIES:
    F-6




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##### Table of Contents



ADVOCAT INC. AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER 31, 2007, 2006 AND 2005
 1.
    
    COMPANY AND ORGANIZATIONAdvocat Inc. (together with its subsidiaries, Advocat or the Company) provides long-term care
services to nursing center patients in eight states, primarily in the Southeast and Southwest. The
Companys centers provide a range of health care services to their patients and residents. In
addition to the nursing, personal care and social services usually provided in long-term care
centers, the Company offers a variety of comprehensive rehabilitation services as well as
nutritional support services.As of December 31, 2007, the Companys continuing operations consist of 50 nursing centers with
5,773 licensed nursing beds and 66 assisted living units. The Companys continuing operations
include nine owned nursing centers and 41 leased nursing centers. The Companys continuing
operations include centers in Alabama, Arkansas, Florida, Kentucky, Ohio, Tennessee, Texas and West
Virginia.2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESConsolidationThe consolidated financial statements include the operations and accounts of Advocat and its
subsidiaries, all wholly-owned. All significant intercompany accounts and transactions have been
eliminated in consolidation. As discussed in Note 9, the consolidated financial statements of the
Company have been reclassified to present the results of certain operations as discontinued
operations.The Company is managed as one reporting unit for internal purposes and for decision making.
Therefore, management has concluded that the Company is operated as a single reportable segment, as
defined in Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about
Segments of an Enterprise and Related Information.Revenues
 Patient Revenues
  F-7




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##### Table of Contents



Allowance for Doubtful Accounts
   Lease Expense
   Classification of Expenses
  Property and Equipment
  Buildings and improvements
    
    
    
    5 to 40 yearsLeasehold improvements
    
    
    
    2 to 10 yearsFurniture, fixtures and equipment
    
    
    
    2 to 15 years
   F-8




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##### Table of Contents



Cash and Cash Equivalents
  Deferred Financing and Other Costs
  Cash Restricted for Capital Expenditures
  Acquired Leasehold Interest
  Self Insurance
   F-9




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##### Table of Contents



Income Taxes
  Disclosure of Fair Value of Financial Instruments
  Use of Estimates
  F-10




---



##### Table of Contents



Net Income per Common Share
  Stock-Based Compensation
    Recent Accounting Pronouncements
   F-11




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##### Table of Contents



In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS No.
141R). SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and
measures in its financial statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree as well as the goodwill acquired or gain recognized in a
bargain purchase. SFAS No. 141R also establishes disclosure requirements to enable the evaluation
of the nature and financial effects of the business combination. The provisions of SFAS No. 141R
are effective for the Company beginning January 1, 2009.ReclassificationsAs discussed in Note 9, the consolidated financial statements of the Company have been reclassified
to reflect as discontinued operations certain divestitures and lease terminations. Certain amounts
in the 2006 and 2005 financial statements related to continuing operations have also been
reclassified to conform to the 2007 presentation. In 2006, amounts for stock-based compensation
charges were separately stated on the income statement. In 2007, stock-based compensation expense
has been reclassified into the same income statement caption as the salaries of the related
employees. The 2006 non-cash charge for stock-based compensation of $5,184,000 was reclassified to
general and administrative expense of $5,057,000 and operating expense of $127,000 based upon the
classification of cash compensation paid to the related employees.3.
    
    ACQUISITIONSEffective August 11, 2007, the Company purchased the leasehold interests and operations of seven
skilled nursing facilities from Senior Management Services of America North Texas, Inc. (SMSA or
SMSA Acquisition) for a price of approximately $9,947,000, including approximately $8,570,000 in
cash, the assumption of approximately $853,000 in liabilities, and transaction costs of $525,000.
These facilities include 1,266 licensed nursing beds, with 1,105 nursing beds currently available
for use. The SMSA facilities had unaudited revenues of approximately $52.1 million for the year
ended December 31, 2006. The SMSA facilities are in the Companys existing geographic and
operational footprint and are expected to contribute to the Companys growth strategy and existing
base of operations.The facilities were part of a larger organization that had been in bankruptcy since January 2007.
Under the terms of the purchase agreement, the Company acquired the leases and leasehold interests
in the facilities, inventory and certain equipment, but did not acquire working capital or assume
liabilities, apart from certain obligations for employee paid-time-off benefits, specified lease
related obligations and 2007 property taxes. As part of the acquisition terms, the Company loaned
the seller $1,800,000 with repayment terms of up to one year to fund the sellers immediate
obligations under the confirmed bankruptcy plan of liquidation. During 2007, the seller repaid the
loan in full and the loan was cancelled. The loan was secured by the accounts receivable of the
seller and provided for interest at 12.5% annually.The facilities are leased from a subsidiary of Omega. Prior to the SMSA Acquisition, the Company
leased 28 facilities from Omega under a master lease agreement (the Master Lease). In connection
with this acquisition, the Company amended the Master Lease to include the seven SMSA facilities.
The substantive terms of the SMSA lease, including payment provisions and lease period including
renewal options, were not changed by this amendment. The lease terms for the seven SMSA facilities
provide for an initial term and renewal periods at the Companys option through May 31, 2035. The
lease provides for annual increases in lease payments equal to the increase in the consumer price
index, not to exceed 2.5%.The SMSA Acquisition is accounted for using the purchase method of accounting. The purchase price
of this transaction was allocated to the identifiable assets acquired based upon their respective
fair values and the liabilities assumed are based on the expected or paid settlement amounts. The
purchase price allocation is subject to change during the twelve month period subsequent to the
acquisition date for items including actual settlement of the assumed liabilities. The operating
results have been included in the Companys consolidated financial statements since the date of the
acquisition.
 F-12




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##### Table of Contents



Current assets
    
    $
    70,000Property and equipment
    
    
    132,000Deferred tax asset
    
    
    116,000Acquired leasehold interest intangible
    
    
    9,629,000Total assets acquired
    
    
    9,947,000Current liabilities
    
    
    853,000Total net assets acquired
    
    $
    9,094,000
   2008
    
    $
    346,0002009
    
    
    346,0002010
    
    
    346,0002011
    
    
    346,0002012
    
    
    346,000thereafter
    
    
    7,762,000$
    9,492,000
   Supplemental Pro Forma Data (Unaudited)
  Years Ended December 31,2007
    
    2006Pro forma Revenue
    
    $
    276,512,000
    
    
    $
    266,731,000Pro forma Income from Continuing Operations
    
    $
    9,239,000
    
    
    $
    22,564,000Pro forma Net Income
    
    $
    9,140,000
    
    
    $
    22,113,000Pro forma Net Income per Diluted Common Share
    
    $
    1.44
    
    
    $
    3.37
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4.
    
    TRANSACTION WITH OMEGAOn October 20, 2006, the Company and Omega entered into a Restructuring Stock Issuance and
Subscription Agreement (Restructuring Agreement) to restructure its Series B Redeemable
Convertible Preferred Stock held by Omega, eliminating the option of Omega to convert the Preferred
Stock into shares of Advocat common stock. Advocat and Omega also entered into a Third Amendment
to Consolidated Amended and Restated Master Lease (Lease Amendment) to extend the term of its
lease covering 28 nursing centers it currently leases from Sterling Acquisition Corp., a
wholly-owned subsidiary of Omega. In addition, Omega agreed to provide up to $5,000,000 to fund
capital improvements made to certain nursing centers.Preferred Stock Restructuring-Under the terms of the Restructuring Agreement, the Series B Redeemable Convertible Preferred Stock
(Series B Preferred Stock) held by Omega was exchanged for a new Series C Preferred Stock that is
not convertible.At the time of the Restructuring Agreement, the Series B Preferred Stock had a recorded value
(including accrued dividends) of approximately $4,918,000. The Series B Preferred Stock accrued
dividends at an annual rate of 7% of the stated value, compounded quarterly, and was convertible
into approximately 792,000 shares of common stock.The Restructuring Agreement required the Company to issue to Omega 5,000 shares of Series C
Preferred Stock in exchange for the 393,658 shares of Series B Preferred Stock held by Omega. The
new Series C Preferred Stock has a stated value of approximately $4,918,000 and carries an annual
dividend rate of 7% of its stated value. The Series C Preferred Stock pays quarterly cash
dividends. The Series C Preferred Stock is not convertible, but is redeemable at its stated value
at Omegas option after September 30, 2010, and was redeemable at its stated value at the Companys
option after September 30, 2007, subject to certain limitations. In connection with the
termination of the conversion feature, the Company agreed to pay Omega an additional $687,000
annually under the Lease Amendment.The Company recorded the fair value of the elimination of the conversion feature as a reduction in
Paid In Capital with an offsetting increase to record a premium on the Series C Preferred Stock.
As a result, the Series C Preferred Stock was initially recorded at a total value of $11,619,000,
equal to the stated value of the Series B Preferred Stock, $4,918,000, plus the negotiated value of
the conversion feature, $6,701,000. The agreed upon additional rental payments of $687,000
annually were discounted over the twelve year term of the renewal so that the net present value of
the payments equals the $6,701,000 preferred stock premium. As payments are made, the preferred
stock premium is reduced, interest expense is recorded and cash is reduced.Subordinated Promissory Note-In connection with the Restructuring Agreement, the Company also replaced a Subordinated Promissory
Note which was convertible at the Companys option with a new Subordinated Note, which was not
convertible. Except for eliminating the conversion feature, the terms of the new Subordinated Note
were the same as the original Subordinated Promissory Note. As described in Note 8, the new
Subordinated Note was retired in connection with a financing transaction in August 2007.Master Lease Amendment-Under the terms of the Lease Amendment, Advocat and Omega also agreed to amend and renew the master
lease covering 28 nursing centers. The initial term of the lease was set to expire in September
2010, with a ten year renewal option. The amended master lease commenced on October 1, 2006, and
extends to September 30, 2018. The Lease Amendment also provides for a renewal option of an
additional twelve years. Other than the change in rent associated with the restructuring of the
preferred stock described above, there was no change in the base rental amounts as a result of the
Lease Amendment. Consistent with prior terms, the lease provides for annual increases in lease
payments equal to the lesser of two times the increase in the Consumer Price Index or 3 percent.
Under generally accepted accounting principles, the Company reports these scheduled rent increases
on a straight line basis over the 12 year term of the renewal period. As a result of accruing the
scheduled rent increases, the Companys annual rent expense increased by approximately $2.7 million
effective October 1, 2006.
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This increase has no effect on cash rent payments at the start of the lease term and will only
result in additional cash outlay as the 3 percent annual increases take effect each year.In addition, Omega agreed to provide up to $5 million to fund capital improvements made to certain
nursing centers. This funding is in addition to $5 million provided in 2005. The annual base rent
related to these nursing centers will be increased to reflect the amount of capital improvements
made to the facilities. See Note 14 for further discussion.5.
    
    RECEIVABLESReceivables, before the allowance for doubtful accounts, consist of the following components:
 December 31,2007
    
    
    2006Medicare
    
    $
    13,891,000
    
    
    $
    7,567,000Medicaid and other non-federal government programs
    
    
    9,594,000
    
    
    
    7,810,000Other patient and resident receivables
    
    
    4,417,000
    
    
    
    3,282,000Other receivables and advances
    
    
    700,000
    
    
    
    365,000$
    28,602,000
    
    
    $
    19,024,000
 The SMSA Acquisition resulted in an increase in accounts receivable of approximately $8,784,000 at
December 31, 2007. As part of the procedural Medicare and Medicaid change of ownership process,
payments from Medicaid and Medicare for these facilities were temporarily delayed, and $4,700,000
of the total $8,784,000 increase in receivables was due to these delays. These payments from
Medicare and Medicaid are expected to be collected during the first half of 2008.The Company provides credit for a substantial portion of its revenues and continually monitors the
credit-worthiness and collectibility from its patients, including proper documentation of
third-party coverage. The Company is subject to accounting losses from uncollectible receivables
in excess of its reserves.Substantially all receivables are provided as collateral on the Companys debt obligations.6.
    
    PROPERTY AND EQUIPMENTProperty and equipment, at cost, consists of the following:
 December 31,2007
    
    
    2006Land
    
    $
    1,573,000
    
    
    $
    1,573,000Buildings and leasehold improvements
    
    
    42,835,000
    
    
    
    39,880,000Furniture, fixtures and equipment
    
    
    19,886,000
    
    
    
    18,501,000$
    64,294,000
    
    
    $
    59,954,000
 Substantially all of the Companys property and equipment are provided as collateral for debt
obligations. The Company capitalizes leasehold improvements which will revert back to the lessor
of the property at the expiration or termination of the lease, and depreciates these
improvements over the shorter of the remaining lease term or the assets estimated useful lives.
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7.
    
    SHORT-TERM DEBTShort-term debt consists of the following:
 December 31,2007
    
    
    2006Subordinated note
payable to Omega;
secured by accounts
receivable and other
assets of the
facilities leased
from Omega; interest
at 7.00%; retired in
conjunction with
financing
transaction
described in Note 8.
    
    $
    
    
    
    $
    2,534,000Promissory notes;
non-interest
bearing; net of
unamortized discount
of $1,000, imputed
at 7.5%; monthly
payments through
February 2007.
    
    
    
    
    
    
    124,000Promissory note;
interest rate of 7%;
principal and
interest due in
monthly payments
through February
2007.
    
    
    
    
    
    
    4,000$
    
    
    
    $
    2,662,000
 Promissory notes were issued during 2005 and 2004 in settlement of certain professional liability
claims and other disputes.As of December 31, 2007, the Company had no outstanding short term debt.8.
    
    LONG-TERM DEBTLong-term debt consists of the following:
 December 31,2007
    
    
    2006Mortgage loan payable to a commercial
finance company; issued in August 2006;
secured by seven nursing centers; payable
monthly, interest at 3.75% above LIBOR
(8.35% and 9.1% at December 31, 2007 and
2006, respectively).
    
    $
    22,163,000
    
    
    $
    22,420,000Term loan payable to a commercial finance
company; issued in August 2006; payable
monthly, interest at 6.25% above LIBOR
retired in conjunction with the financing
transaction described below.
    
    
    
    
    
    
    6,434,000Term loan payable to a bank; issued in
August 2007; interest 2.5% above LIBOR
(7.1% at December 31, 2007); entered into
in transaction discussed below.
    
    
    12,292,000
    
    
    
    34,455,000
    
    
    
    28,854,000Less current portion
    
    
    (1,942,000
    )
    
    
    (4,587,000
    )$
    32,513,000
    
    
    $
    24,267,000
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2008
    
    $
    1,942,0002009
    
    
    4,318,0002010
    
    
    1,999,0002011
    
    
    22,853,0002012
    
    
    3,343,000Thereafter
    
    
    Total
    
    $
    34,455,000
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9.
    
    DISCONTINUED OPERATIONSEffective March 31, 2007, the Company terminated operations at its leased facility in Eureka
Springs, Arkansas. The owner of the property, a subsidiary of Omega, sold the property and the
Company cooperated in an orderly transition to the new owner.The facility had low occupancy and operated at a loss. The facility had been leased subject to a
master lease covering 29 nursing centers. Under the terms of that lease, the master lease rental
payment was not reduced. The discontinued facility contributed revenues of $575,000 and $2,110,000
during the periods ended December 31, 2007 and 2006, respectively. In 2003, the Company recorded
an impairment charge of $178,000 to reduce the net book value of this property to its estimated
realizable value in accordance with the provisions of SFAS No. 144. No material loss was incurred
in connection with the lease termination.In May 2006, the Company completed the sale of certain assets of eleven assisted living facilities
located in North Carolina for a sales price of $11.0 million. In 2005, the Company recorded an
impairment charge of $4,397,000 to reduce the net book value of these properties to their estimated
realizable value, and no material gain or loss was recognized upon the completion of the sale in
2006. The Company closed its only remaining North Carolina assisted living facility in April 2006
and is continuing its efforts to sell this property. In September 2007, the Company sold
the bed license for the remaining North Carolina assisted living facility for a sales price of
$183,000, and recognized a pretax gain on sale of discontinued operations of $45,000.In February 2005, the Company sold two nursing centers in Texas that were operating with low
occupancy and experiencing operating losses. The net proceeds from the transactions were
approximately $375,000. In periods prior to the sale, the Company had recorded impairment
provisions and reduced the property to its estimated realizable value, and no material gain or loss
was realized on the transactions.Proceeds from these divestiture transactions were used to pay transaction costs and repay debt.
Each of these facilities and businesses constitute components under the provisions of SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, and, accordingly, the Company has
reclassified the operations and disposed property of each of these components as discontinued
operations for all periods presented in the Companys consolidated financial statements. The
results of discontinued operations do not reflect any allocation of corporate general and
administrative expense or any allocation of corporate interest expense.The net assets of discontinued operations presented on the balance sheet represent the Companys
only remaining assisted living facility that was closed in April 2006. The Company is continuing
its efforts to sell this property.10.
    
    NOTE RECEIVABLEIn May 2004, the Company sold the stock of its Canadian subsidiary, Diversicare Canada Management
Services Co., Inc. (DCMS), to DCMS Holding, Inc. (Holding), a privately-owned Ontario
corporation. DCMS operated 14 nursing centers and 24 assisted living facilities in the Canadian
provinces of Ontario, British Columbia and Alberta. The sales price was $16.5 million Canadian
(approximately $11.8 million US at the May 11, 2004 exchange rate). Approximately $8.5 million
Canadian ($6.1 million US) was received at closing, with the balance, $8.0 million Canadian ($5.7
million US), scheduled to be received in annual installments of $600,000 Canadian ($428,000 US) on
the anniversary of the closing for the first four years and a final installment of $5.6 million
Canadian ($4.0 million US) on the fifth anniversary of closing. The future payments may be
accelerated upon the occurrences of certain events. The installment portion of the purchase price
is evidenced by a promissory note that has been discounted to estimated fair value and was
initially recorded in the accompanying balance sheet at $4.7 million US.
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The Company received payments of $700,000, $718,000 and $589,000 in 2007, 2006 and 2005, respectively.
The balance of the note receivable was $5,612,000 at December 31, 2007, with $629,000 classified
as a current asset. Foreign currency transaction gain or loss related to this note is recorded as
other income on the Consolidated Statements of Income.11.
    
    SHAREHOLDERS EQUITY, STOCK PLANS AND PREFERRED STOCKShareholders Rights PlanIn March 2005, the Company approved an amendment to its shareholders rights plan (the Plan),
which was originally adopted in 1995. The amendment extends the expiration date of the Plan to
March 20, 2010 and changes the exercise price of the rights under the Plan to $15. The Plan is
designed to protect the Companys shareholders from unfair or coercive takeover tactics. The Plan
provides for one right with respect to each share of common stock. The rights may be exercised
only upon the occurrence of certain triggering events, including the acquisition of, or a tender
offer for, 15.0% or more of the Companys common stock without the Companys prior approval.Stock-Based Compensation PlansBeginning January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment,
using the modified prospective method, in which compensation cost is recognized (a) for all
share-based payments granted after the effective date and (b) based on the requirements of SFAS No.
123 for all awards granted to employees prior to the effective date of SFAS No. 123R that remain
unvested on the effective date. The Company had no unvested awards granted to employees on the
effective date. In March 2005, the United States Securities and Exchange Commission (the SEC)
issued Staff Accounting Bulletin No. 107 (SAB 107), which provides supplemental implementation
guidance for SFAS No. 123(R). The Company has applied the provisions of SAB 107 in its adoption of
SFAS No. 123(R).Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic
value method as prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and the related Interpretations (APB No. 25). Under APB No. 25, no
compensation cost related to stock options was recognized because all options were issued with
exercise prices equal to the fair market value at the date of grant. Because the Company elected to
use the modified prospective method in adopting the provisions of SFAS No. 123R, results for prior
periods were not restated. Had compensation cost for the Companys stock-based compensation plans
in prior periods been determined consistent with SFAS No. 123R, the Companys net income for common
stock and net income per common share would not have differed from the amounts reported.In 1994, the Company adopted the 1994 Incentive and Nonqualified Stock Option Plan for Key
Personnel (the Key Personnel Plan) and the 1994 Nonqualified Stock Option Plan for the Directors
(the Director Plan). Under both plans, the option exercise price equals the stocks closing
market price on the day prior to the grant date. The maximum term of any option granted pursuant
to either the Key Personnel Plan or to the Director Plan is ten years. In accordance with their
terms, the Key Personnel Plan and the Director Plan expired in May 2004 and no further grants can
be made under these plans.In December 2005, the Compensation Committee of the Board of Directors adopted the 2005 Long-Term
Incentive Plan (the 2005 Plan). The 2005 Plan allows the Company to issue stock options and other
share and cash based awards. Under the 2005 Plan, 700,000 shares of the Companys common stock have
been reserved for issuance upon exercise of options granted thereunder. All options under this
plan expire 10 years from the date the shares were authorized by the Board of Directors.At the time of adoption, the Board approved the issuance of options to purchase approximately
332,000 shares of the Companys common stock at a purchase price of $5.44 per share, the market
price of the Companys common stock on the date the options were authorized. This issuance was
subject to shareholder approval of the 2005 Plan which occurred in June 2006 at the Companys 2006
Annual Shareholders Meeting. At the time of shareholder approval, the Companys stock price had
increased to $16.80. Upon shareholder approval, the options for the purchase of approximately
314,000 shares were
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vested with the remainder vesting one-half each on the next two anniversaries
of the date the shares were authorized by the Board of Directors.During 2007, the Compensation Committee of the Board of Directors approved the grant of Stock Only
Stock Appreciation Rights (SOSARs) at the market price of the Companys common stock on the date
the SOSARs were granted. The SOSARs vest one-third on the first, second and third anniversaries of
the grant date. The SOSARs are valued and recorded in the same manner as stock options under FAS
123R, and will be settled with issuance of new stock for the difference between the market price on
the date of exercise and the exercise price.The Company recorded non-cash stock-based compensation expense for equity grants issued under the
2005 Plan of $648,000 and $5,184,000 during the years ended December 31, 2007 and 2006,
respectively. Such amounts are included as components of general and administrative expense or
operating expense based upon the classification of cash compensation paid to the related employees.
As of December 31, 2007, there was $599,000 in unrecognized compensation costs related to
stock-based compensation to be recognized over the applicable remaining vesting periods. The
Company estimated the total recognized and unrecognized compensation using the Black-Scholes-Merton
equity grant valuation model.The table below shows the weighted average assumptions the Company used to develop the fair value
estimates under its option valuation model.
 Year EndedDecember 31,2007
    
    2006Expected volatility (range)
    
    119% - 143%
    
    140% - 153%Risk free interest rate (range)
    
    3.96% - 4.68%
    
    5.07% - 5.10%Expected dividends
    
    
    
    Weighted average expected term (years)
    
    6.0
    
    5.04
    WeightedRange of
    
    Average Exercise
    
    OptionsExercise Prices
    
    Prices
    
    Outstanding$9.94 to $11.59
    
    $
    11.24
    
    
    
    137,000$0.15 to $5.56
    
    $
    3.88
    
    
    
    335,000472,000
  F-20




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##### Table of Contents



WeightedAverageShares
    
    
    Exercise PriceOutstanding,December 31, 2005
    
    
    186,000
    
    
    $
    2.20Granted
    
    
    332,000
    
    
    
    5.44Exercised
    
    
    (141,000
    )
    
    
    3.96Expired or cancelled
    
    
    (2,000
    )
    
    
    9.75Outstanding,December 31, 2006
    
    
    375,000
    
    
    
    4.37Granted
    
    
    115,000
    
    
    
    11.53Exercised
    
    
    (12,000
    )
    
    
    5.44Expired or cancelled
    
    
    (6,000
    )
    
    
    9.75Outstanding,December 31, 2007
    
    
    472,000
    
    
    $
    6.02Exercisable, December 31, 2007
    
    
    361,000
    
    
    $
    4.32
  Series A Preferred Stock
  Series B and Series C Preferred Stock
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term of the
renewal so that the net present value of the payments equals the $6,701,000 preferred stock
premium. When payments are made, the preferred stock premium is reduced, interest expense is
recorded and cash is reduced.The Series C Preferred Stock shares have preference in liquidation but do not have voting rights.
The total redemption value is equal to the stated value plus any accrued but unpaid dividends. The
liquidation preference value is equal to the redemption value.12.
    
    NET INCOME (LOSS) PER COMMON SHAREInformation with respect to the calculation of basic and diluted net income ( loss) per common
share is presented below:
 2007
    
    
    2006
    
    
    2005Basic net income per common shareNet income from continuing operations
    
    $
    9,486,000
    
    
    $
    22,395,000
    
    
    $
    31,016,000Preferred stock dividends
    
    
    (344,000
    )
    
    
    (340,000
    )
    
    
    (318,000
    )Net income from continuing operations
for common stock
    
    
    9,142,000
    
    
    
    22,055,000
    
    
    
    30,698,000Discontinued operations:Operating loss, net of taxes
    
    
    (91,000
    )
    
    
    (337,000
    )
    
    
    (6,113,000
    )Gain (loss) on sale, net of taxes
    
    
    (8,000
    )
    
    
    (114,000
    )
    
    
    399,000Loss from discontinued
operations
    
    
    (99,000
    )
    
    
    (451,000
    )
    
    
    (5,714,000
    )Net income for common stock
    
    $
    9,043,000
    
    
    $
    21,604,000
    
    
    $
    24,984,000Basic weighted average common shares outstanding
    
    
    5,870,000
    
    
    
    5,784,000
    
    
    
    5,725,000Basic net income (loss) per common share:Net income from continuing operations
    
    $
    1.56
    
    
    $
    3.81
    
    
    $
    5.36Loss from discontinued operations
    
    
    (0.02
    )
    
    
    (0.05
    )
    
    
    (1.07
    )Gain (loss) on sale of discontinued operations
    
    
    
    
    
    
    (0.02
    )
    
    
    0.07Loss from discontinued operations
    
    
    (0.02
    )
    
    
    (0.07
    )
    
    
    (1.00
    )Basic net income per common share
    
    $
    1.54
    
    
    $
    3.74
    
    
    $
    4.36
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2007
    
    
    2006
    
    
    2005Diluted net income per common shareNet income from continuing operations
for common stock
    
    $
    9,142,000
    
    
    $
    22,055,000
    
    
    $
    30,698,000Add dilutive preferred stock dividends, for
effect of assumed conversion of
preferred stock
    
    
    
    
    
    
    272,000
    
    
    
    318,000Assumed interest on unpaid dividends
    
    
    
    
    
    
    (102,000
    )
    
    
    (105,000
    )Net income from continuing operations
for diluted net income per common share
    
    
    9,142,000
    
    
    
    22,225,000
    
    
    
    30,911,000Discontinued operations:Operating loss, net of taxes
    
    
    (91,000
    )
    
    
    (337,000
    )
    
    
    (6,113,000
    )Gain (loss) on sale
    
    
    (8,000
    )
    
    
    (114,000
    )
    
    
    399,000Net loss from discontinued operations
    
    
    (99,000
    )
    
    
    (451,000
    )
    
    
    (5,714,000
    )Net income for diluted net income per common share
    
    $
    9,043,000
    
    
    $
    21,774,000
    
    
    $
    25,197,000Basic weighted average common shares outstanding
    
    
    5,870,000
    
    
    
    5,784,000
    
    
    
    5,725,000Incremental shares from assumed exercise
of stock options
    
    
    257,000
    
    
    
    215,000
    
    
    
    137,000Incremental shares from assumed conversion
of preferred stock
    
    
    
    
    
    
    508,000
    
    
    
    636,000Diluted average common shares outstanding
    
    
    6,127,000
    
    
    
    6,507,000
    
    
    
    6,498,000Diluted net income per common shareNet income from continuing operations
    
    $
    1.49
    
    
    $
    3.42
    
    
    $
    4.76Income (loss) from discontinued operations
    
    
    (0.01
    )
    
    
    (0.05
    )
    
    
    (0.94
    )Gain (loss) on sale of discontinued operations
    
    
    
    
    
    
    (0.02
    )
    
    
    0.06Net loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.07
    )
    
    
    (0.88
    )Diluted net income per common share
    
    $
    1.48
    
    
    $
    3.35
    
    
    $
    3.88
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13.
    
    INCOME TAXESThe provision (benefit) for income taxes of continuing operations is composed of the following
components:
 Year Ended December 31,2007
    
    
    2006
    
    
    2005Current provision :Federal
    
    $
    223,000
    
    
    $
    
    
    
    $
    19,000State
    
    
    910,000
    
    
    
    223,000
    
    
    
    21,0001,133,000
    
    
    
    223,000
    
    
    
    40,000Deferred provision (benefit):Federal
    
    
    5,061,000
    
    
    
    (8,010,000
    )
    
    
    (13,851,000
    )State
    
    
    76,000
    
    
    
    (1,709,000
    )
    
    
    5,137,000
    
    
    
    (9,719,000
    )
    
    
    (13,851,000
    )Provision (benefit) for income taxes of
continuing operations
    
    $
    6,270,000
    
    
    $
    (9,496,000
    )
    
    $
    (13,811,000
    )
  Year Ended December 31,2007
    
    
    2006
    
    
    2005Provision for federal income taxes
at statutory rates
    
    $
    5,357,000
    
    
    $
    4,222,000
    
    
    $
    5,850,000Provision for state income taxes at
statutory rates, net of federal
benefit
    
    
    630,000
    
    
    
    497,000
    
    
    
    671,000Valuation allowance changes
affecting the provision (benefit)
for income taxes
    
    
    42,000
    
    
    
    (14,553,000
    )
    
    
    (20,264,000
    )Other
    
    
    241,000
    
    
    
    338,000
    
    
    
    (68,000
    )Provision (benefit) for income taxes
    
    $
    6,270,000
    
    
    $
    (9,496,000
    )
    
    $
    (13,811,000
    )
  December 31,2007
    
    
    2006Current deferred assets:Allowance for doubtful accounts
    
    $
    749,000
    
    
    $
    720,000Accrued liabilities
    
    
    2,584,000
    
    
    
    3,362,0003,333,000
    
    
    
    4,082,000Less valuation allowance
    
    
    (161,000
    )
    
    
    (145,000
    )3,172,000
    
    
    
    3,937,000Current deferred liabilities:Prepaid expenses
    
    
    (1,062,000
    )
    
    
    (2,152,000
    )$
    2,110,000
    
    
    $
    1,785,000
 F-24




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##### Table of Contents



December 31,2007
    
    
    2006Noncurrent deferred assets:Net operating loss and other
carryforwards
    
    $
    2,527,000
    
    
    $
    7,153,000Deferred lease costs
    
    
    654,000
    
    
    
    693,000Depreciation
    
    
    1,805,000
    
    
    
    1,344,000Tax goodwill and intangibles
    
    
    1,610,000
    
    
    
    2,286,000Stock-based compensation
    
    
    1,657,000
    
    
    
    1,439,000Accrued rent
    
    
    2,498,000
    
    
    
    1,126,000Impairment of long-lived assets
    
    
    355,000
    
    
    
    412,000Noncurrent self-insurance reserves
    
    
    6,887,000
    
    
    
    8,419,00017,993,000
    
    
    
    22,872,000Less valuation allowance
    
    
    (785,000
    )
    
    
    (759,000
    )17,208,000
    
    
    
    22,113,000Noncurrent deferred liabilities:Note receivable
    
    
    (640,000
    )
    
    
    (264,000
    )$
    16,568,000
    
    
    $
    21,849,000
      F-25




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##### Table of Contents



Balance at January 1, 2007
    
    $
    648,000Decreases in tax positions for prior years
    
    
    (331,000
    )Balance at December 31, 2007
    
    $
    307,000
 The unrecognized tax benefits are accrued in other current liabilities. The net decrease in the
amount of unrecognized tax benefits during the year ended December 31, 2007 was related to the
adjustment of the estimated liability, to the fluctuation of the exchange rate between US and
Canadian currencies and payments made to taxing authorities.The Company has chosen to classify interest and penalties as a component separate from income tax
expense in its consolidated statements of income. The tax years 2004 through 2006 remain open to
examination by major taxing jurisdictions in which the Company operates.14.
    
    COMMITMENTS AND CONTINGENCIESLease CommitmentsThe Company is committed under long-term operating leases with various expiration dates and varying
renewal options. Minimum annual rentals, including renewal option periods (exclusive of taxes,
insurance, and maintenance costs) under these leases beginning January 1, 2008, are as follows:
 2008
    
    $
    21,177,0002009
    
    
    21,804,0002010
    
    
    20,905,0002011
    
    
    21,125,0002012
    
    
    21,647,000Thereafter
    
    
    499,131,000$
    605,789,000
  F-26




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##### Table of Contents



Omega Leases
        F-27




---



##### Table of Contents



Single Facility Lease
  Florida Leases
   Insurance Matters
 Professional Liability and Other Liability Insurance
   Reserve for Estimated Self-Insured Professional Liability Claims
   F-28




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##### Table of Contents



December 31,2007
    
    
    2006Policy Year End March 9,
2008
    
    $
    5,134,000
    
    
    $
    2007
    
    
    7,625,000
    
    
    
    6,992,0002006
    
    
    4,757,000
    
    
    
    7,629,0002005
    
    
    2,339,000
    
    
    
    6,042,0002004
    
    
    500,000
    
    
    
    3,228,0002003 and earlier
    
    
    320,000
    
    
    
    1,826,000$
    20,675,000
    
    
    $
    25,717,000
  Other Insurance
    F-29




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##### Table of Contents



Employment Agreements
  Health Care Industry and Legal Proceedings
    F-30




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##### Table of Contents



Reimbursement
       F-31




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##### Table of Contents



delivery of health care services. Such measures may include capitated
payments, which can result in
significant losses to health care providers if patients require expensive treatment not adequately
covered by the capitated rate.15.
    
    QUARTERLY FINANCIAL INFORMATION (Unaudited)Selected quarterly financial information for each of the quarters in the years ended December 31,
2007 and 2006 is as follows:
 Quarter2007
    
    First
    
    
    Second
    
    
    Third
    
    
    FourthNet revenues
    
    $
    54,592,000
    
    
    $
    55,381,000
    
    
    $
    63,884,000
    
    
    $
    71,204,000Professional liability expense
(benefit)(1)
    
    
    423,000
    
    
    
    (3,378,000
    )
    
    
    (6,000
    )
    
    
    1,298,000Net income from continuing
operations
    
    
    1,380,000
    
    
    
    4,261,000
    
    
    
    2,021,000
    
    
    
    1,824,000Income (loss) from
discontinued operations
    
    
    (19,000
    )
    
    
    (17,000
    )
    
    
    (72,000
    )
    
    
    9,000Net income for common stock
    
    $
    1,275,000
    
    
    $
    4,158,000
    
    
    $
    1,863,000
    
    
    $
    1,747,000Basic net income per common share:Net income from continuing
operations
    
    $
    0.22
    
    
    $
    0.71
    
    
    $
    0.33
    
    
    $
    0.30Loss from discontinued
operations
    
    
    
    
    
    
    
    
    
    
    (0.01
    )
    
    
    Net income per common share
    
    $
    0.22
    
    
    $
    0.71
    
    
    $
    0.32
    
    
    $
    0.30Diluted net income per
common share:Net income from continuing
operations
    
    $
    0.21
    
    
    $
    0.68
    
    
    $
    0.32
    
    
    $
    0.28Income (loss) from discontinued
operations
    
    
    
    
    
    
    
    
    
    
    (0.02
    )
    
    
    0.01Net income per common
share
    
    $
    0.21
    
    
    $
    0.68
    
    
    $
    0.30
    
    
    $
    0.29
 
 (1)
    
    The Companys quarterly results are significantly affected by the amounts
recorded for professional liability expense, as discussed further in Note 14. The amount
of expense (benefit) recorded for professional liability in each quarter of 2007 is set
forth in the table above. F-32




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##### Table of Contents



Quarter2006
    
    First
    
    
    Second
    
    
    Third
    
    
    FourthNet revenues
    
    $
    52,647,000
    
    
    $
    53,423,000
    
    
    $
    53,394,000
    
    
    $
    55,189,000Professional liability expense
(benefit)(1)
    
    
    (2,276,000
    )
    
    
    (3,982,000
    )
    
    
    782,000
    
    
    
    122,000Net income from continuing
operations(2)6,703,000
    
    
    
    3,668,000
    
    
    
    9,589,000
    
    
    
    2,435,000Loss from discontinued
operations
    
    
    (12,000
    )
    
    
    (222,000
    )
    
    
    (145,000
    )
    
    
    (72,000
    )Net income for common stock
    
    $
    6,608,000
    
    
    $
    3,361,000
    
    
    $
    9,358,000
    
    
    $
    2,277,000Basic net income per common share:Net income from continuing
operations
    
    $
    1.15
    
    
    $
    0.62
    
    
    $
    1.64
    
    
    $
    0.40Loss from discontinued
operations
    
    
    
    
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.01
    )Net income per common share
    
    $
    1.15
    
    
    $
    0.58
    
    
    $
    1.62
    
    
    $
    0.39Diluted net income per
common share:Net income from continuing
operations
    
    $
    1.03
    
    
    $
    0.55
    
    
    $
    1.41
    
    
    $
    0.38Income (loss) from
discontinued operations
    
    
    (0.01
    )
    
    
    (0.03
    )
    
    
    (0.02
    )
    
    
    (0.01
    )Net income per common share
    
    $
    1.02
    
    
    $
    0.52
    
    
    $
    1.39
    
    
    $
    0.37
 
 (1)
    
    The Companys quarterly results are significantly affected by the amounts
recorded for professional liability expense, as discussed further in Note 14. The amount
of expense (benefit) recorded for professional liability in each quarter of 2006 is set
forth in the table above.(2)
    
    Net income includes income tax benefit of $729,000, $387,000, $7,972,000 and
$408,000 for the first, second, third and fourth quarters, respectively, as further
discussed in Note 13. F-33




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibits3.1
    
    
    Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to
the Companys Registration Statement No. 33-76150 on Form S-1).3.2
    
    
    Certificate of Designation of Registrant (incorporated by reference to Exhibit 3.5 to the
Companys quarterly report on Form 10-Q for the quarter ended September 30, 2006).3.3
    
    
    Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Companys Registration
Statement No. 33-76150 on Form S-1).3.4
    
    

Bylaw
Amendment adopted November 5, 2007.3.5
    
    
    Amendment to Certificate of Incorporation dated March 23, 1995 (incorporated by reference to
Exhibit A of Exhibit 1 to the Companys Form 8-A filed March 30, 1995).3.6
    
    
    Certificate of Designation of Registrant (incorporated by reference to Exhibit 3.4 to the
Companys quarterly report on Form 10-Q for the quarter ended March 31, 2001).4.1
    
    
    Form of Common Stock Certificate (incorporated by reference to Exhibit 4 to the Companys
Registration Statement No. 33-76150 on Form S-1).4.2
    
    
    Rights Agreement dated March 13, 1995, between the Company and Third National Bank in
Nashville (incorporated by reference to Exhibit 1 to the Companys Current Report on Form 8-K
dated March 13, 1995).4.3
    
    
    Summary of Shareholder Rights Plan adopted March 13, 1995 (incorporated by reference to
Exhibit B of Exhibit 1 to Form 8-A filed March 30, 1995).4.4
    
    
    Rights Agreement of Advocat Inc. dated March 23, 1995 (incorporated by reference to Exhibit 1
to Form 8-A filed March 30, 1995).4.5
    
    
    Amended and Restated Rights Agreement dated as of December 7, 1998 (incorporated by reference
to Exhibit 1 to Form 8-A/A filed December 7, 1998).*10.1
    
    
    1994 Incentive and Non-Qualified Stock Plan for Key Personnel (incorporated by reference to
Exhibit 10.3 to the Companys Registration Statement No. 33-76150 on Form S-1).*10.2
    
    
    1994 Non-Qualified Stock Option Plan for Directors (incorporated by reference to Exhibit
10.4 to the Companys Registration Statement No. 33-76150 on Form S-1).




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibits*10.3
    
    
    Master Agreement and Supplemental Executive Retirement Plan (incorporated by reference to
Exhibit 10.6 to the Companys Registration Statement No. 33-76150 on Form S-1).10.4
    
    
    Form of Director Indemnification Agreement (incorporated by reference to Exhibit 10.8 to the
Companys Registration Statement No. 33-76150 on Form S-1).10.5
    
    
    Advocat Inc. Guaranty in favor of Omega Healthcare Investors, Inc. dated May 10, 1994
(incorporated by reference to Exhibit 10.11 to the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 1994).*10.6
    
    
    Amendment to 1994 Incentive and Non-Qualified Stock Plan for Key Personnel (incorporated by
reference to Exhibit A to the Companys Schedule 14A filed March 31, 1997).*10.7
    
    
    Amendment to 1994 Non-Qualified Stock Option Plan for Directors (incorporated by reference
to Exhibit A to the Companys Schedule 14A filed April 19, 1996).*10.8
    
    
    Amendment No. 3 Advocat Inc. 1994 Incentive and Nonqualified Stock Option Plan For Key
Personnel (incorporated by reference to Exhibit A to the Companys Schedule 14A filed April 3,
1998).10.9
    
    
    Settlement and Restructuring Agreement dated as of October 1, 2000 among Registrant,
Diversicare Leasing Corp., Sterling Health Care Management, Inc., Diversicare Management
Services Co., Advocat Finance, Inc., Omega Healthcare Investors, Inc. and Sterling Acquisition
Corp. (incorporated by reference to Exhibit 10.83 to the Companys Annual Report on Form 10-K
for the fiscal year ended December 31, 2000).10.10
    
    
    Consolidated Amended and Restated Master Lease dated November 8, 2000, effective October 1,
2000, between Sterling Acquisition Corp. (as Lessor) and Diversicare Leasing Corp. (as Lessee)
(incorporated by reference to Exhibit 10.84 to the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 2000).10.11
    
    
    Management Agreement effective October 1, 2000, between Diversicare Leasing Corp. and
Diversicare Management Services Co. (incorporated by reference to Exhibit 10.85 to the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2000).10.12
    
    
    Amended and Restated Security Agreement dated as of November 8, 2000 between Diversicare
Leasing Corp and Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.86 to the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2000).




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibits10.13
    
    
    Security Agreement dated as of November 8, 2000 between Sterling Health Care Management,
Inc. and Sterling Acquisition Corp. (incorporated by reference to Exhibit 10.87 to the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2000).10.14
    
    
    Guaranty given as of November 8, 2000 by Registrant, Advocat Finance, Inc., Diversicare
Management Services Co., in favor of Sterling Acquisition Corp. (incorporated by reference to
Exhibit 10.88 to the Companys Annual Report on Form 10-K for the fiscal year ended December
31, 2000).10.15
    
    
    Reaffirmation of Obligations (Florida Managed Facilities) by Registrant and Diversicare
Management Services Co. to and for the benefit of Omega Healthcare Investors (incorporated by
reference to Exhibit 10.89 to the Companys Annual Report on Form 10-K for the fiscal year
ended December 31, 2000).10.16
    
    
    Revenue Sharing Agreement as of the 30 day of September, 2001, by and among Advocat Inc.,
Diversicare Leasing Corp., Omega Healthcare Investors, Inc. and OHI Sunshine, Inc.
(incorporated by reference to Exhibit 10.125 to the Companys Annual Report on Form 10-K for
the year ended December 31, 2001).10.17
    
    
    First Amendment to Consolidated Amended and Restated Master lease dated September 30, 2001
by and between Sterling Acquisition Corp and Diversicare Leasing Corporation. (incorporated by
reference to Exhibit 10.126 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2001).10.18
    
    
    Purchase and Sale Agreement dated as of the 25th day of July, 2002 by and between
Diversicare Leasing Corp. and Sterling Healthcare, Inc. (incorporated by reference to Exhibit
10.3 to the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).*10.19
    
    
    Amended and Restated Employment Agreement dated as of March 28, 2003, by and among Advocat
Inc., a Delaware corporation, and William R. Council, III (incorporated by reference to
Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q for the quarter ended March 31,
2003).10.20
    
    
    Share Purchase Agreement dated as of August 25, 2003 by and between Diversicare Leasing
Corp., a Tennessee corporation, Advocat Inc., a Delaware corporation, Diversicare Canada
Management Services Co., Inc., an Ontario corporation, and DCMS Holdings Inc., an Ontario
corporation (incorporated by reference to Annex A to the Companys Proxy Statement filed
October 6, 2003).10.21
    
    
    Lease Termination Agreement dated as of May 29, 2003, by and among (i) Diversicare Assisted
Living Services, Inc., a Tennessee corporation, and Advocat Inc., a Delaware corporation, and
(ii) 570 Center Street, LLC, a South Carolina limited liability company, and Albert M. Lynch,
an individual (incorporated by reference to Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003).




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibits10.22
    
    
    Master Lease Agreement dated as of May 1, 2003 by and between Emerald-Cedar Hills, Inc.
Emerald-Golfview, Inc., Emerald-Southern Pines, Inc. and Emerald-Golfcrest, Inc. and Senior
Care Florida Leasing, LLC(incorporated by reference to Exhibit 10.13 to the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).10.23
    
    
    Security Agreement as of April 1, 2003 by and between Senior Care Florida Leasing, LLC, a
Delaware limited liability company, Senior Care Golfview, LLC, a Delaware limited liability
company, Senior Care Golfcrest, LLC, a Delaware limited liability company, Senior Care
Southern Pines, LLC, a Delaware limited liability company, Senior Care Cedar Hills, LLC, a
Delaware limited liability company and Omega Healthcare Investors, Inc., a Maryland
corporation (incorporated by reference to Exhibit 10.16 to the Companys Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003).10.24
    
    
    First Amendment to Share Purchase Agreement dated as of February ___, 2004, among Diversicare
Leasing Corp., a corporation incorporated under the laws of Tennessee, and Advocat Inc., a
corporation incorporated under the laws of Delaware, and Diversicare Canada Management
Services Co., Inc., a corporation incorporated under the laws of Ontario, and DCMS Holdings
Inc., a corporation incorporated under the laws of Ontario (incorporated by reference to
Exhibit 10.142 to the Companys Annual Report on Form 10-K for the year ended December 31,
2003).10.25
    
    
    Purchase and Sale Agreement dated as of 4th day of November, 2004, by and between McKesson
Medical-Surgical Minnesota Supply Inc. a Minnesota corporation, Advocat Distribution Services,
Inc., a Tennessee corporation and Diversicare Management Services, Inc. (incorporated by
reference to Exhibit 10.121 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2004).10.26
    
    
    Purchase and Sale Agreement made and entered into as of the 14th day of November, 2003 with
Addendum dated as of October 14, 2004 by and between Diversicare Assisted Living Services NC
II, LLC, a Delaware limited liability company, and Margaret Sutton (incorporated by reference
to Exhibit 10.122 to the Companys Annual Report on Form 10-K for the year ended December 31,
2004).10.27
    
    
    Purchase Agreement made and entered into as of the 14th day of January, 2005, by and between
(i) Diversicare Leasing Corp., a Tennessee corporation, and (ii) Salt Creek Holding Company,
Inc., a Texas corporation, and Goliad Manor, Inc., a Texas corporation (incorporated by
reference to Exhibit 10.123 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2004).




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibits10.28
    
    
    Purchase Agreement made and entered into as of the 14th day of January, 2005, by and between
(i) Diversicare Leasing Corp., a Tennessee corporation and (ii) Devils Run Holding Company,
Inc., a Texas corporation and Refugio Nursing and Rehabilitation Center, Inc., a Texas
corporation. (incorporated by reference to Exhibit 10.124 to the Companys Annual Report on
Form 10-K for the year ended December 31, 2004).10.29
    
    
    Second Amendment to Consolidated Amended and Restated Master Lease dated as of June 15, 2005
by and between Sterling Acquisition Corp. and Diversicare Leasing Corporation (incorporated by
reference to Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q for the quarter ended
June 30, 2005).10.30
    
    
    Purchase and Sale Agreement dated July 5, 2005 by and between Osborne F. Wilson Development
Corp., Inc. and a subsidiary of the Company (incorporated by reference to Exhibit 10.3 to the
Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).10.31
    
    
    Asset Purchase Agreement dated as of November 28, 2005, by and among Diversicare Assisted
Living Services NC I, LLC, a Delaware limited liability company, Diversicare Assisted Living
Services NC II, LLC, a Delaware limited liability company, and Agemark Acquisition, LLC, a
North Carolina limited liability company. (incorporated by reference to Exhibit 10.146 to the
Companys Annual Report on Form 10-K for the year ended December 31, 2005).10.32
    
    
    First Amendment to Amended and Restated Master Lease Agreement dated as of December 31, 2005
by and between Florida Lessor-Emerald, Inc. and Senior Care Florida Leasing, LLC.
(incorporated by reference to Exhibit 10.147 to the Companys Annual Report on Form 10-K for
the year ended December 31, 2005).10.33
    
    
    First Amendment to Master Lease Agreement dated as of December 31, 2005 by and between
Emerald-Cedar Hills, Inc., Emerald-Golfview, Inc., Emerald-Southern Pines, Inc. and
Emerald-Golfcrest, Inc. and Senior Care Florida Leasing, LLC. (incorporated by reference to
Exhibit 10.148 to the Companys Annual Report on Form 10-K for the year ended December 31,
2005).*10.36
    
    
    Amended and Restated Employment Agreement dated as of March 31, 2006, by and among Advocat
Inc., a Delaware corporation, and William R. Council, III (incorporated by reference to
Exhibit 10.1 to the Companys quarterly report on Form 10-Q for the quarter ended March 31,
2006).*10.37
    
    
    Employment Agreement dated as of March 31, 2006, by and among Advocat Inc., a Delaware
corporation, and Raymond L. Tyler. (incorporated by reference to Exhibit 10.2 to the Companys
quarterly report on Form 10-Q for the quarter ended March 31, 2006).




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibits*10.38
    
    
    Employment Agreement dated as of March 31, 2006, by and among Advocat Inc., a Delaware
corporation, and L. Glynn Riddle. (incorporated by reference to Exhibit 10.3 to the Companys
quarterly report on Form 10-Q for the quarter ended March 31, 2006).10.39
    
    
    First Amendment to Asset Purchase Agreement dated as of March 29, 2006, by and among
Diversicare Assisted Living Services NC I, LLC, a Delaware limited liability company,
Diversicare Assisted Living Services NC II, LLC, a Delaware limited liability company, and
Agemark Acquisition, LLC, a North Carolina limited liability company (incorporated by
reference to Exhibit 10.20 to the Companys quarterly report on Form 10-Q for the quarter
ended March 31, 2006).10.40
    
    
    Second amendment to Asset Purchase Agreement effective as of April 14, 2006, by and among
Diversicare Assisted Living Services NC I, LLC, a Delaware limited liability company,
Diversicare Assisted Living Services NC II, LLC, a Delaware limited liability company, and
Agemark Acquisition, LLC, a North Carolina limited liability company. (incorporated by
reference to Exhibit 10.1 to the Companys quarterly report on Form 10-Q for the quarter ended
June 30, 2006).10.41
    
    
    Loan Agreement dated as of the 7th day of August, 2006, by and between certain subsidiaries
of the Registrant and Capmark Finance Inc., formerly known as GMAC Commercial Mortgage
Corporation (incorporated by reference to Exhibit 10.1 to the Companys quarterly report on
Form 10-Q for the quarter ended September 30, 2006).10.42
    
    
    Promissory Note dated August 7, 2006 in the amount of $22,500,000 issued by certain
subsidiaries of the Registrant to Capmark Finance Inc. (incorporated by reference to Exhibit
10.2 to the Companys quarterly report on Form 10-Q for the quarter ended September 30, 2006).10.43
    
    
    Payment and Performance Guaranty Agreement effective as of the 7th day of August, 2006, by
Advocat Inc., for the benefit of Capmark Finance Inc., formerly known as GMAC Commercial
Mortgage Corporation (incorporated by reference to Exhibit 10.4 to the Companys quarterly
report on Form 10-Q for the quarter ended September 30, 2006).10.44
    
    
    Restructuring Stock Issuance and Subscription Agreement dated as of October 20, 2006 between
Advocat Inc. and Omega Healthcare Investors, Inc. (incorporated by reference to Exhibit 10.1
to the Companys current report on Form 8-K filed October 24, 2006).10.45
    
    
    Third Amendment to Consolidated Amended and Restated Master Lease executed as of October 20,
2006, to be effective as of October 1, 2006 by and between Sterling Acquisition Corp. and
Diversicare Leasing Corporation (incorporated by reference to Exhibit 10.2 to the Companys
current report on Form 8-K filed October 24, 2006).




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibits10.46
    
    
    Subordinated Promissory Note in the amount of $2,533,614.53 issued to Omega HealthCare
Investors Inc. dated as of October 1, 2006 (incorporated by reference to Exhibit 10.3 to the
Companys current report on Form 8-K filed October 24, 2006).10.47
    
    
    Fourth Amendment to Consolidated Amended and Restated Master Lease executed and delivered as
of April 1, 2007 by and between Sterling Acquisition Corp., a Kentucky corporation, and
Diversicare Leasing Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.1
to the Companys quarterly report on Form 10-Q for the quarter ended March 31, 2007).10.48
    
    
    Operations Transfer Agreement effective as of July 20, 2007, by and among certain
subsidiaries of the Company, and Senior Management Services of America North Texas, Inc., a
Texas corporation, Senior Management Services of Estates at Fort Worth, Inc., a Texas
corporation, Senior Management Services of Doctors at Dallas, Inc., a Texas corporation,
Senior Management Services of Humble, Inc., a Texas corporation, Senior Management Services of
Katy, Inc., a Texas corporation, Senior Management Services of Treemont, Inc., a Texas
corporation, Senior Management Services of Heritage Oaks at Ballinger, Inc., a Texas
corporation, and Senior Management Services of Normandy at San Antonio, Inc., a Texas
corporation (incorporated by reference to Exhibit 10.1 to the Companys quarterly report on
Form 10-Q for the quarter ended September 30, 2007).10.49
    
    
    Loan and Security Agreement made as of August 10, 2007, between Diversicare Leasing Corp., a
Tennessee corporation, and Bridge Associates LLC, as trustee for the SMSA Creditors Trust, a
Texas trust. (incorporated by reference to Exhibit 10.2 to the Companys quarterly report on
Form 10-Q for the quarter ended September 30, 2007).10.50
    
    
    Loan and Security Agreement dated as of August 10, 2007, is by and among the Company and
certain subsidiaries and LaSalle Bank National Association, a national banking association
(incorporated by reference to Exhibit 10.3 to the Companys quarterly report on Form 10-Q for
the quarter ended September 30, 2007).10.51
    
    
    Guaranty dated as of August 10, 2007, by Advocat Inc., a Delaware corporation to and for the
benefit of LaSalle Bank National Association, a national banking association (incorporated by
reference to Exhibit 10.4 to the Companys quarterly report on Form 10-Q for the quarter ended
September 30, 2007).10.52
    
    
    Revolving Credit Note dated August 10, 2007 in the principal amount of $21,000,000.00 from
the Company and certain subsidiaries to LaSalle Bank National Association, a national banking
association (incorporated by reference to Exhibit 10.5 to the Companys quarterly report on
Form 10-Q for the quarter ended September 30, 2007).10.53
    
    
    Term Loan Note dated August 10, 2007 in the principal amount of $16,500,000.00 from the
Company and certain subsidiaries to LaSalle Bank National Association, a national banking
association (incorporated by reference to Exhibit 10.6 to the Companys quarterly report on
Form 10-Q for the quarter ended September 30, 2007).




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##### Table of Contents



ExhibitNumber
    
    Description of Exhibits10.54
    
    
    Fifth Amendment to Consolidated Amended and Restated Master Lease dated as of August 10,
2007 by and between Sterling Acquisition Corp., a Kentucky corporation and Diversicare Leasing
Corp., a Tennessee corporation (incorporated by reference to Exhibit 10.7 to the Companys
quarterly report on Form 10-Q for the quarter ended September 30, 2007).10.56
    
    
    First Amendment to Loan Agreement dated as of December 18, 2007, by and among the Company
and certain subsidiaries and LaSalle Bank National Association, a national banking
association.21
    
    
    Subsidiaries of the Registrant.23.1
    
    
    Consent of BDO Seidman.31.1
    
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a).31.2
    
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a).32
    
    
    Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule
13a-14(b) or Rule 15d-14(b).
 *
    
    Indicates management contract or compensatory plan or arrangement.




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##### Table of Contents



ADVOCAT INC.
 SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS
OF CONTINUING OPERATIONS
(in thousands)
 Column A
    
    Column B
    
    Column C
    
    Column D
    
    Column EAdditions
    
    DeductionsBalanceat
    
    Charged
    
    
    
    
    
    
    
    
    
    
    
    
    
    BalanceBeginning
    
    to
    
    Charged
    
    
    
    
    
    (Write-offs)
    
    atof
    
    Costs and
    
    to Other
    
    
    
    
    
    net of
    
    End ofDescription
    
    Period (1)
    
    Expenses
    
    Accounts(1)
    
    Other
    
    Recoveries
    
    PeriodYear ended
December 31, 2007:Allowance for
doubtful accounts
    
    $
    2,122
    
    
    $
    1,089
    
    
    $
    23
    
    
    $
    
    
    
    $
    (1,076
    )
    
    $
    2,158Year ended
December 31, 2006:Allowance for
doubtful accounts
    
    $
    1,722
    
    
    $
    1,610
    
    
    $
    4
    
    
    $
    
    
    
    $
    (1,214
    )
    
    $
    2,122Year ended
December 31, 2005:Allowance for
doubtful accounts
    
    $
    1,712
    
    
    $
    1,557
    
    
    $
    167
    
    
    $
    
    
    
    $
    (1,714
    )
    
    $
    1,722
 (1)
    
    As discussed in Note 9 of the Consolidated
Financial Statements, the Company has presented the results of certain divestiture and lease
termination transactions as discontinued operations. These transactions generally resulted in the
surrender of property and equipment in the facilities, but did not result in the sale of accounts
receivable or other current assets or the assumption of current liabilities or debt. Accordingly,
such current assets and liabilities were not reclassified to discontinued operations.
 S-1




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##### Table of Contents



ADVOCAT INC.
 SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
 Column A
    
    Column B
    
    Column C
    
    Column D
    
    Column EAdditions
    
    DeductionsBalance at
    
    Charged
    
    
    
    
    
    
    
    
    
    
    
    
    
    BalanceBeginning
    
    to
    
    Charged
    
    
    
    
    
    
    
    
    
    atof
    
    Costs and
    
    to Other
    
    
    
    
    
    
    
    
    
    End ofDescription
    
    Period
    
    Expenses
    
    Accounts (2)
    
    Other
    
    Payments
    
    PeriodYear ended
December 31, 2007:Professional
Liability Reserve
    
    $
    25,717
    
    
    $
    (2,278
    )(1)
    
    $
    12
    
    
    $
    
    
    
    $
    (2,776
    )(4)
    
    $
    20,675Workers Compensation
Reserve
    
    $
    474
    
    
    $
    12
    
    
    $
    
    
    
    $
    
    
    
    $
    (124
    )
    
    $
    362Health Insurance
Reserve
    
    $
    932
    
    
    $
    6,705
    
    
    $
    15
    
    
    $
    
    
    
    $
    (6,514
    )
    
    $
    1,138Year ended
December 31, 2006:Professional
Liability Reserve
    
    $
    34,527
    
    
    $
    (5,962
    )(1)
    
    $
    513
    
    
    $
    
    
    
    $
    (3,361
    )(4)
    
    $
    25,717Workers Compensation
Reserve
    
    $
    560
    
    
    $
    (3
    )
    
    $
    
    
    
    $
    
    
    
    $
    (83
    )
    
    $
    474Health Insurance
Reserve
    
    $
    963
    
    
    $
    5,591
    
    
    $
    61
    
    
    $
    
    
    
    $
    (5,683
    )
    
    $
    932Year ended
December 31, 2005:Professional
Liability Reserve
    
    $
    42,900
    
    
    $
    (5,139
    )(1)
    
    $
    561
    
    
    $
    316
    (3)
    
    $
    (4,111
    )(4)
    
    $
    34,527Workers Compensation
Reserve
    
    $
    557
    
    
    $
    226
    
    
    $
    6
    
    
    $
    
    
    
    $
    (229
    )
    
    $
    560Health Insurance
Reserve
    
    $
    1,346
    
    
    $
    4,604
    
    
    $
    50
    
    
    $
    
    
    
    $
    (5,037
    )
    
    $
    963
 S-2




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##### Table of Contents



(1)
    
    Amounts charged to costs and expenses are negative during the years presented in this table as
a result of downward revisions in previous estimates of the Companys anticipated professional
liability costs.(2)
    
    As discussed in Note 9 of the Consolidated Financial Statements, the Company has presented the
results of certain divestiture and lease termination transactions as discontinued operations. The
amounts charged to Other Accounts represent the amounts charged to discontinued operations.(3)
    
    Other amounts represent reimbursements received by the Company for costs incurred in
connection with professional liability claims of certain homes it managed under management
contracts.(4)
    
    Payments include amounts paid for claims settled during the period as well as payments made
under promissory notes and other structured arrangements for claims settled in earlier periods.
 S-3