Diversicare Healthcare Services (DVCR) 10-K2020 FY Annual report

Diversicare Healthcare Services, Inc. provides post-acute care services to skilled nursing facilities, referred to as "skilled nursing centers," "nursing centers," or "centers," patients and residents in eight states, primarily in the Southeast, Midwest, and Southwest United States. Unless the context indicates otherwise, references herein to “Diversicare,” “the Company,” “we,” “us” and “our” include Diversicare Healthcare Services, Inc. and all of our consolidated subsidiaries. Diversicare Healthcare Services, Inc. was incorporated as a Delaware corporation in 1994.

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

Our operating objective is to optimize market position in the delivery of health care and related services to the patients and residents in need of post-acute care in the communities in which we operate. Our strategic operations development plan focuses on (i) providing a broad range of high quality, cost-effective post-acute care services; (ii) improving skilled mix in our nursing centers via enhanced capabilities for rehabilitation and transitional care; (iii) building clinical competencies and programs consistent with marketplace needs; and (iv) clustering our operations on a regional basis. Interwoven into our objectives and operating strategy is our mission:

Diversicare provides a broad range of post-acute care services to patients and residents including skilled nursing, ancillary health care services, and assisted living. In addition to the nursing and social services usually provided in long-term care centers, we offer a variety of rehabilitative, nutritional, respiratory, and other specialized ancillary services. As of December 31, 2020, our continuing operations consist of 61 nursing centers with 7,250 licensed skilled nursing beds. Our nursing centers range in size from 50 to 320 licensed nursing beds. The licensed nursing bed count does not include 397 licensed assisted living beds. Our continuing operations include centers in Alabama, Indiana, Kansas, Mississippi, Missouri, Ohio, Tennessee, and Texas.

The following table summarizes certain information with respect to the nursing centers we own or lease as of December 31, 2020:

Our nursing centers provide skilled nursing health care services, including nutrition services, recreational therapy, social services, housekeeping, and laundry services. Skilled nursing care is provided for post-acute patients and residents with comorbidities. This care includes assessment using evidence based tools, individualized care plan development based on identified areas of risk and care needs, and skilled interventions such as IV services. We also provide for the delivery of ancillary medical services at the nursing centers we operate. These specialty services include rehabilitation therapy services, such as audiology, speech, occupational, and physical therapies, which are provided through licensed therapists and registered nurses, and the provision of medical supplies, nutritional support, infusion therapies and related clinical services. The majority of these services are provided using our internal resources and clinicians.

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

We believe that skilled nursing care is fundamentally a local business in which both patients and their referral sources are typically based in the immediate geographic area in which the nursing center is located. Our marketing plan and related support activities emphasize the role and contributions of the administrators, admissions coordinators, and clinical liaisons of each nursing center, all of whom are responsible for developing relationships with various referral sources such as doctors, hospitals, hospital case managers and discharge planners, and various healthcare and community organizations. Training, sales tools and job aids are provided for the sales and marketing teams for the product knowledge, market knowledge, and selling skills necessary to support their efforts in the field. As part of our business strategy, we have dedicated sales and marketing personnel who develop strong partnerships with physicians and hospital executives as well as Accountable Care Organizations ("ACO"), Bundled Payments for Care Improvement ("BPCI") providers, and Managed Care organizations. We believe these relationships will be mutually beneficial, providing the community with high quality healthcare while helping customers to navigate choices, manage transitions, and control costs.

In addition to soliciting admissions from current and potential referral sources, we emphasize involvement in community and healthcare events and opportunities to promote a public awareness of our nursing centers and services. Activities include ongoing family councils and community based “family night” functions, providing the opportunity to educate the public on various topics such as Medicare benefits, powers of attorney, and other topics of interest. We also promote a positive customer experience, best practices, strong surveys, and a high star rating; we seek feedback through third-party resident and family surveys. We host tours and “open house” opportunities, where members of the local community are invited to visit the center to

see any improvements or to better understand our environment and services. We look for ways to offer increased clinical capabilities and services to better meet the needs of the community and referral sources. In addition, we have regional oversight to support the overall marketing strategies in each local center, in order to promote higher occupancy levels and improved payor and case mixes at our nursing centers. We offer the resources and metrics for strong healthcare partnerships with our referral sources, including ACOs and other Managed Care partners. Our support center marketing personnel support regional and local marketing personnel and efforts.

We have monthly marketing programs and ongoing marketing initiatives, developed internally, that focus on educating and meeting the needs of our customers while growing our business. Resources are also available to assist each nursing center administrator in analysis of local demographics and competition with a view toward complementary service development. We consider the primary referral area in long-term care to generally lie within a five-to-fifteen-mile radius of each nursing center depending on population density; consequently, we focus on local marketing efforts rather than broad-based advertising.

Effective November 1, 2020, the Company entered into agreements with a third party therapy company to outsource the therapy services that were previously provided by the Company through its wholly owned subsidiary Diversicare Therapy Services. The outsourced services include all physical, occupational, and speech therapy provided to patients of the Company’s facilities. The contracts are for a three-year term, absent termination for cause by either party. The third party provider has extensive expertise in providing therapy, and the Company believes that the therapy company's expertise in this area will benefit our patients and result in an overall operational cost savings for the Company.

During 2019, the Company expanded its participation in the Texas Quality Incentive Program ("QIPP") as administered by the Texas Health and Human Services Commission. QIPP provides supplemental Medicaid payments for skilled nursing centers that achieve certain quality measures. Eleven of the Company’s Texas centers currently participate in the QIPP. To allow four of these centers to meet the QIPP participation requirements, the Company entered into a transaction with a Texas medical district already participating in the QIPP, providing for the transfer of the related provider licenses from the Company to the medical district. The Company’s operating subsidiary retained the management of the centers on behalf of the medical district. In response to the COVID-19 pandemic, the Texas Health and Human Services Commission waived some of the performance and reporting requirements for QIPP effective March 1, 2020 through the remainder of the state's 2021 fiscal year.

On October 1, 2018, the Company entered into a new Master Lease Agreement (the "Omega Master Lease") with Omega Healthcare Investors (the "Lessor") to lease 34 centers currently owned by Omega and operated by Diversicare. The old Master Lease with Omega provided for its operation of 23 skilled nursing centers in Texas, Kentucky, Alabama, Tennessee, Florida, and Ohio. Additionally, Diversicare operated 11 centers owned by Omega under separate leases in Missouri, Kentucky, Indiana, and Ohio. The Lease entered into by Diversicare and Omega consolidated the leases for all 34 centers under one new Maser Lease. The Lease was subsequently amended on August 30, 2019 when the Company terminated operations of the Kentucky Centers and concurrently transferred operations to a new operator. The agreement effectively amended the Lease with the Lessor to remove the ten Kentucky facilities, reduce the annual rent expense, and release the Company from any further obligations arising under the Master Lease Agreement with respect to the Kentucky facilities. The remaining Lease terms remain unchanged with an initial term of twelve years and two optional 10-year extensions. The annual lease fixed escalator remains at 2.15% which began on October 1, 2019.

On December 1, 2020, the Company entered into an agreement with Omega to transfer operations of a facility located in Florida to another operator. The agreement effectively amended the Master Lease to remove the center, reduced the annual rent

expense, and released the Company from any further obligations arising under the Master Lease with respect to the Florida facility. The remaining Lease terms remain unchanged with an initial term of twelve years and two optional 10-year extensions. The annual lease fixed escalator remains at 2.15%.

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

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

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

We classify our revenues earned from patients and residents into four major categories: Medicaid, Medicare, Managed Care, and Private Pay and Other. Medicaid revenues are those received under the traditional Medicaid program, which provides benefits to those in need of financial assistance in the securing of medical services. Medicare revenues include revenues received under both Part A and Part B. Managed Care revenues are received from insurance entities, including third-party plans that administer Medicare benefits, known as Medicare Advantage plans. Private Pay and Other revenues are composed primarily of individuals or parties who directly pay for their services. Included in the Private Pay and Other category are patients who are hospice beneficiaries as well as the recipients of Veterans Administration benefits. Veterans Administration payments are made pursuant to renewable contracts negotiated with these payors.

The Company recognized $17.0 million of Medicaid and Hospice stimulus dollars for the year ended December 31, 2020 that are reflected as patient revenues from Medicaid and Private Pay and Other in the Company's results of operations as included in the amounts presented in the table below. Refer to Note 2, "COVID-19 Pandemic" to the consolidated financial statements included in this report for more information. The following table set forth net patient revenues related to our continuing operations by payor source for the periods presented (dollar amounts in thousands): Refer to Note 5, "Revenue Recognition and Receivables" to the consolidated financial statements.

Consistent with the nursing center industry in general, changes in the mix of a center's patient population among Medicaid, Medicare, Managed Care, and Private Pay and Other can significantly affect the profitability of the center's operations. However, private payors, including managed care payors, are increasingly demanding that providers accept discounted fees or assume all or a portion of the financial risk for the delivery of health care services. Such measures may include capitated payments, which can result in significant losses to health care providers if patients require expensive treatment not adequately covered by the capitated rate.

A significant portion of our revenues are derived from government-sponsored health insurance programs, primarily Medicare and Medicaid. We employ third-party specialists in reimbursement and also use these services to monitor regulatory developments to comply with reporting requirements and to ensure that proper payments are made to our nursing centers.

In a final rule issued in July 2019, CMS set forth Medicare payment rates for skilled nursing facilities (“SNFs”) for federal fiscal year 2020, estimating a 2.4% increase in overall payments. This is based on a SNF market basket percentage increase of 2.8% with a negative 0.4 percentage point productivity adjustment. Effective October 1, 2019, CMS replaced the Resource

Utilization Group (“RUG-IV”) case-mix classification system with the Patient-Driven Payment Model (“PDPM”). The PDPM classifies residents in Medicare Part A-covered stays into payment groups based on clinically relevant factors using diagnosis codes, rather than by the volume of services. CMS has stated that it does not intend for the new model to change the aggregate amount of Medicare payments to SNFs. Rather, it intends the new model to more accurately reflect resource utilization.

On July 31, 2020, CMS issued a final rule outlining Medicare payment rates for skilled nursing facilities for federal fiscal year 2021. Effective October 1, 2020, payments to SNFs are estimated to increase by 2.2% based on a market basket percentage update of 2.2%, adjusted by a 0.0 percentage point multifactor productivity adjustment.

The payment rates described above are reduced pursuant to ongoing sequestration. The Budget Control Act of 2011 (“BCA”) requires automatic spending reductions to reduce the federal deficit, including Medicare spending reductions of up to 2% per fiscal year, with a uniform percentage reduction across all Medicare programs. CMS began imposing a 2% reduction on Medicare claims in April 2013. The Coronavirus Aid, Relief and Economic Security Act ("CARES Act") and related legislation suspends the Medicare sequestration payment adjustment from May 1, 2020 through March 31, 2021 (but extend sequestration through 2030).

CMS has implemented policies intended to shift Medicare to value-based payment methodologies, tying reimbursement to quality of care rather than quantity. For example, under the Quality Reporting Program ("QRP"), SNFs are required to report quality data to CMS or be subject to a 2% reduction to the annual market basket update. In response to the COVID-19 pandemic, CMS granted an exception to all SNFs, relieving them from data reporting requirements from October 1, 2019 to June 30, 2020. In federal fiscal year 2019, the Skilled Nursing Facility Value-Based Purchasing (“SNF VBP”) Program began making incentive payments available to skilled nursing centers based on their past performance on a specified quality measure related to hospital readmissions. CMS funds the SNF VPB Program incentive payment pool by withholding 2% of SNF payments and then redistributing some of the withheld payments. Data collected from each performance period affects Medicare payments two years later. CMS announced it would exclude certain measures from SNF VBP performance calculations from January 1, 2020 to June 30, 2020 due to the COVID-19 pandemic. CMS also finalized the SNF VBP's Extraordinary Circumstances Exception Policy, which may relieve facilities from program requirements due to natural disasters or other circumstances beyond the facility's control that may affect the facility's ability to provide quality care. Facilities must apply for the exception and demonstrate that an extraordinary circumstance affected the care provided to their patients. If CMS approves a facility's request, it will exclude the calendar months affected by the extraordinary circumstances from the facility's performance calculations.

CMS publishes rankings based on performance scores on the Care Compare website. Care Compare is a streamlined redesign of eight existing CMS healthcare compare tools, including Nursing Home Compare, which is intended to assist the public in finding and comparing skilled care or other providers. The Care Compare website also publishes for each nursing home a rating between 1 and 5 stars as part of CMS’s Five-Star Quality Rating System. An overall star rating is determined based on three components (information from the last three years of health inspections, staffing information, and quality measures), each of which also has its own five-star rating. The ratings are based, in part, on the quality data nursing centers are required to report. For example, nursing centers must report the rate of short-stay residents who are successfully discharged into the community and the percentage who had an outpatient emergency department visit. As a result of the COVID-19 pandemic, CMS issued temporary waivers and flexibilities that impact the information posted on the Care Compare website and used in the Five-Star Quality Rating System. For example, CMS temporarily waived the requirement to submit staffing data and issued guidance prioritizing or suspending certain nursing home surveys. Some of these measures have been lifted, while some are subject to phased re-opening criteria. However, due to these changes and their impact on data, CMS adjusted some ratings (e.g., by holding specific quality measures constant) and did not report on certain data to the Quality Rating System, but resumed updating the quality measure data on the Care Compare website and Five-Star Quality Rating System on January 27, 2021. In addition to the standard Nursing Home Compare data, CMS is reporting COVID-19 data submitted by nursing homes to the Centers for Disease Control and Prevention's ("CDC") National Healthcare Safety Network and linking to this information from the Care Compare website. The information reported includes the number of confirmed and suspected cases of COVID-19 in each facility, resident deaths related to COVID-19, availability of personal protective equipment and COVID-19 testing, and potential staffing shortages.

We remain diligent in continuing to provide outstanding patient care to achieve high rankings for our centers as well as assuring that our rankings are correct and appropriately reflect our quality results. Our focus has been and continues to be on the delivery of quality care to our patients and residents.

applied to the second and subsequent therapy units, reducing reimbursement to 50% of the applicable PE component. Targeted medical reviews are performed when expenses for a beneficiary exceed a threshold of $3,000 for physical and speech therapy services combined or $3,000 for occupational therapy services alone. Deductible and coinsurance amounts paid by the beneficiary for therapy services count toward the amount applied to the limit. Claims above the threshold may be subject to post-payment review of medical necessity documentation by Supplemental Medical Review Contractors.

CMS has implemented value-based programs that affect Medicare payments for physician and other clinician services. Under the Quality Payment Program (“QPP”), a payment methodology intended to reward high-quality patient care, physicians and certain other clinicians, including therapists, are required to participate in one of two QPP tracks. Under both tracks, performance data collected in each performance year affects Medicare payments two years later. The Advanced Alternative Payment Model (“Advanced APM”) track makes incentive payments available for participation in specific innovative payment models approved by CMS. A provider with sufficient participation in an Advanced APM is exempt from the reporting requirements and payment adjustments imposed under the second track, the Merit-Based Incentive Payment System (“MIPS”). Providers electing to participate in MIPS receive either payment incentives or are subject to payment reductions based on their performance with respect to clinical quality, resource use, clinical improvement activities, and meaningful use of electronic health records. For performance data collected in 2021, CMS will continue to offer the Extreme and Uncontrollable Circumstances Policy. This policy is an exception providers must apply for, which allows reweighting for any or all MIPS performance categories for providers impacted by the COVID-19 pandemic. MIPS consolidates components of previously established incentive programs, including the Value-Based Payment Modifier program and the Physician Quality Reporting System.

Medicaid is a medical assistance program for the indigent that is funded jointly by the federal and state governments and administered by the states. Federal law requires states to cover certain nursing center services for Medicaid-eligible individuals when other payment options are unavailable. However, Medicaid eligibility requirements and benefits vary by state, and states may impose limitations on nursing services. States may also establish levels of service or payment methodologies by acuity or specialization of a nursing center.

The Affordable Care Act requires states to expand Medicaid coverage by adjusting eligibility requirements such as income thresholds. However, certain members of Congress continue to attempt to repeal or significantly modify the Affordable Care Act, which may result in changes to Medicaid. Further, states may opt out of the Medicaid expansion. Some states use or have applied to use waivers granted by CMS to implement expansion, impose different eligibility or enrollment restrictions, or otherwise implement programs that vary from federal standards. CMS administrators have indicated that they intend to increase state flexibility in the administration of Medicaid programs. However, President Biden has issued an executive order directing agencies to re-examine measures that reduce coverage or undermine Medicaid programs, including work requirements.

Medicaid reimbursement is often less than a skilled nursing center’s cost of caring for patients. Some states make supplemental payments to Medicaid providers beyond the base payment for specific claims. Upper payment level (“UPL”) supplemental payments are intended to address the difference between Medicaid fee-for-service payments and Medicare reimbursement rates. The CAA requires the Department of Health and Human Services ("HHS") to develop a system for states to report supplemental payments data by October 2021 and publish such data on CMS's website. CMS is also considering making additional changes affecting supplemental payments. The Company receives supplemental payments, including through Indiana's UPL program, which provides supplemental Medicaid payments for skilled nursing centers that are licensed to non-state government entities such as county hospital districts. One skilled nursing center previously operated by the Company entered into a transaction with one such hospital district participating in the UPL program, providing for the transfer of the license from the Company to the hospital district. The Company’s operating subsidiary retained the management of the center on behalf of the hospital district. The agreement between the hospital district and the Company is terminable by either party.

We receive the majority of our annual Medicaid rate increases during the third quarter of each year. The rate changes received in 2020 and 2019, along with increased Medicaid acuity in our acuity based states, were the primary contributor to our 1.7% increase in average rate per day for Medicaid patients in 2020 compared to 2019. Based on the rate changes received during the third quarter of 2020, we expect a favorable impact to our rate per day for Medicaid patients as we move into 2021 due to modest rate increases in many of the states in which we operate.

Several states in which we operate face budget shortfalls, which could result in reductions in Medicaid funding for nursing centers. Pressures on state budgets are expected to continue in the future. Certain of the states in which we operate are actively seeking ways to reduce Medicaid spending for nursing center care by such methods as capitated payments and substantial reductions in reimbursement rates. In addition, enrollment in managed Medicaid plans has increased in recent years as states seek to manage costs, utilization, and quality. Managed Medicaid programs enable states to contract with private entities for the delivery of Medicaid health benefits and to handle program responsibilities like care management and claims adjudication.

Some states and managed care plans are promoting alternatives to nursing center care, such as community and home-based services.

Legislation and administrative actions at the federal and state levels may significantly alter the funding for, or structure of, Medicaid programs. CMS administrators have also signaled interest in changing Medicaid payment models, including through increased use of value-based care models. We are unable to predict what, if any, reform proposals or reimbursement limitations will be implemented in the future, or the effect such changes would have on our operations. For the year ended December 31, 2020, we derived 19.8% and 45.6% of our total patient revenues related to continuing operations from the Medicare and Medicaid programs, respectively.  Any health care reforms that significantly limit rates of reimbursement under these programs could, therefore, have a material adverse effect on our financial position and profitability. 

As of March 1, 2021, we employed approximately 4,800 employees, referred to as "team members," in connection with our continuing operations, approximately 2,700 of which are considered full-time team members. Approximately 600 of our team members are represented by a labor union. We believe that we staff appropriately, focusing primarily on the acuity level and day-to-day needs of our patients and residents. In most states where we operate, our skilled nursing facilities are subject to state mandated minimum staffing ratios, so our ability to reduce costs by decreasing staffing, notwithstanding decreases in acuity or need, is limited and subject to government audits and penalties in some states. We seek to manage our labor costs by improving team member retention, improving operating efficiencies, maintaining competitive benefits and reducing reliance on overtime compensation and temporary nursing agency services. We believe that our ability to attract and retain qualified professional team members stems from our ability to offer attractive benefit packages, a high level of employee training, and a culture that provides incentives for a quality work environment.

Although we believe we are able to employ sufficient clinical personnel to provide our services, a shortage of health care professional personnel in any of the geographic areas in which we operate could affect our ability to recruit and retain qualified team members and could increase our operating costs. Such shortages may be exacerbated by the COVID-19 pandemic. We compete with other health care providers for both professional and non-professional team members and with non-health care providers for non-professional team members. This competition continues to contribute to a consistent increase in the salaries that we have to pay to hire and retain these team members. As is common in the health care industry, we expect the salary and wage increases for our skilled healthcare providers will continue to be higher than average salary and wage increases nationally.

We purchase drugs, solutions and other materials and lease certain equipment required in connection with our business from many suppliers. We may experience supply chain disruptions, including delays and price increases in equipment, pharmaceuticals, and medical supplies. We have incurred additional expenditures preparing our centers for potential outbreaks of COVID-19 and providing care to our residents during required or recommended periods of isolation as a result of increased demand and supply chain constraints. National purchasing contracts are in place for all major supplies, such as food, linens and medical supplies. These contracts assist in maintaining quality, consistency and efficient pricing. Based on contract pricing for food and other supplies, we expect cost increases in 2021 to be relatively the same as we experienced in 2020.

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

All our nursing centers must be licensed by the state in which they are located in order to accept patients, regardless of payor source. In most states, nursing centers are subject to CON laws, which require us to obtain government approval for the construction of new nursing centers or the addition of new licensed beds to existing centers. Our nursing centers must comply with detailed statutory and regulatory requirements on an ongoing basis in order to qualify for licensure, as well as for certification as a provider eligible to receive payments from the Medicare and Medicaid programs. Generally, the requirements for licensure and Medicare/Medicaid certification are similar and relate to quality and adequacy of personnel, quality and necessity of medical care, record keeping, dietary services, patient rights, the physical condition of the nursing center, and the

adequacy of equipment used in the nursing center. In response to COVID-19, CMS has issued additional requirements for long-term care facilities, including requirements to test facility staff and residents for COVID-19 and report COVID-19 data to the CDC. Failure to comply with applicable laws and regulations could result in exclusion from the Medicare and Medicaid programs, which could have an adverse impact on our business, financial condition, or results of operations.

In 2016, CMS published a comprehensive update to the health and safety standards applicable to long-term care facilities participating in the Medicare or Medicaid programs. These revisions are aimed at improving quality of life, care, and services in long-term care facilities, optimizing resident safety, and reflecting current professional standards. For example, CMS added requirements related to infection prevention and control, compliance and ethics programs, staff training, and QAPI. We believe we have achieved substantial compliance with these requirements. In April 2019, CMS announced a comprehensive overview of regulations, guidelines, and processes related to safety and quality in nursing homes, including plans to enhance enforcement efforts and increase transparency through the Nursing Home Compare website, which transitioned to the new Care Compare website in September 2020. It is unclear how related initiatives will affect our operations.

Each of our centers is subject to periodic inspections, known as “surveys” by health care regulators, to determine compliance with all applicable licensure and certification standards. Such requirements are both subjective and subject to change. If a survey concludes that there are deficiencies in compliance, the center will be subject to various sanctions, including but not limited to monetary fines and penalties, suspension of new admissions, non-payment for new admissions and loss of licensure or certification. Generally, however, once a center receives written notice of any compliance deficiencies, it may submit a written plan of correction and is given a reasonable opportunity to correct the deficiencies. In March 2020, certain nursing home surveys were suspended due to the COVID-19 pandemic. CMS issued guidance instructing state survey agencies to resume survey activities as soon as they have resources to do so. There can be no assurance that we will be able to maintain such licenses and certifications for our centers in the future or that we will not be required to expend significant sums in order to comply with regulatory requirements.

In recent years, the U.S. Congress and some state legislatures have considered and enacted significant legislation concerning health care and health insurance. The most prominent of these efforts, the Affordable Care Act, affects how health care services are covered, delivered and reimbursed. The Affordable Care Act expands coverage through a combination of public program expansion and private sector reforms, provides for reduced growth in Medicare program spending, and promotes initiatives that tie reimbursement to quality and care coordination. Some of the provisions, such as the requirement that large employers provide health insurance benefits to full-time employees, have increased our operating expenses. The Affordable Care Act expands the role of home-based and community services, which may place downward pressure on our sustaining population of Medicaid patients. Reforms that we believe have had, or may have in the future, a material impact on the long-term care industry and on our business include, among others, bundling of payments to cover both acute and post-acute care and the imposition of enrollment limitations on new providers. However, significant regulatory and statutory changes have been made to the statute, and there is considerable uncertainty regarding the future of the Affordable Care Act. For example, final rules issued in 2018 expand the availability of association health plans and allow the sale of short-term, limited-duration health plans, neither of which are required to cover all of the essential health benefits mandated by the Affordable Care Act. Certain members of Congress have stated their desire to repeal or make additional significant changes to the Affordable Care Act, its implementation or interpretation. Effective January 1, 2019, Congress eliminated the financial penalty associated with the individual mandate. As a result of this change, a federal judge in Texas ruled in December 2018 that the individual mandate was unconstitutional and determined that the rest of the Affordable Care Act was, therefore, invalid. In December 2019, the Fifth Circuit Court of Appeals upheld this decision with respect to the individual mandate, but remanded for further consideration of how this affects the rest of the law. On November 10, 2020, the Supreme Court heard oral arguments regarding this case, and the law remains in place pending the appeals process. The impact of the 2020 federal election on health reform is not yet known, although President Biden has indicated through executive orders that his administration intends to protect and strengthen the Affordable Care Act and Medicaid programs.

Skilled nursing centers are required to bill Medicare on a consolidated basis for certain items and services that they furnish to patients, regardless of the cost to deliver these services. This consolidated billing requirement essentially makes the skilled nursing center responsible for billing Medicare for all care services delivered to the patient during the length of stay. CMS has instituted a number of test programs designed to extend the reimbursement and financial responsibilities under consolidated billing beyond the traditional discharge date to include a broader set of bundled services. Such examples may include, but are not exclusive to, home health, durable medical equipment, home and community based services, and the cost of re-hospitalizations during a specified bundled period. Currently, these test programs for bundled reimbursement are confined to a small set of clinical conditions, but CMS has indicated that it is developing additional bundled payment models. This bundled form of reimbursement could be extended to a broader range of diagnosis related conditions in the future. The potential impact on skilled nursing center utilization and reimbursement is currently unknown. The process for defining bundled services has not

been fully determined by CMS and, therefore, is subject to change during the rule making process. CMS has indicated that it is working toward a unified payment system for post-acute care services, including those provided by skilled nursing centers.

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

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

The HIPAA privacy regulations establish limits on the use and disclosure of protected health information, provide for patients' rights, including rights to access, to request amendment of, and to receive an accounting of certain disclosures of protected health information, and require certain safeguards for protected health information. In addition, each covered entity must contractually bind individuals and entities that furnish services to the covered entity or perform a function on its behalf, and to which the covered entity discloses protected health information, to restrictions on the use and disclosure of that protected health information. Covered entities must report breaches of unsecured protected health information to affected individuals without unreasonable delay, but not to exceed 60 calendar days from the discovery of the breach. Notification must also be made to the Department of Health and Human Services and, in certain cases involving large breaches, to the media.

There are numerous other laws and legislative and regulatory initiatives at the federal and state levels addressing privacy and security concerns. We are subject to any federal and state laws that are more stringent or grant greater privacy rights to individuals. These laws vary and could impose additional penalties. For example, the Federal Trade Commission uses its consumer protection authority to initiate enforcement actions in response to data breaches.

Health care providers and industry participants are also subject to a growing number of requirements intended to promote the interoperability and exchange of patient health information. For example, beginning April 5, 2021, health care providers and certain other entities will be subject to information blocking restrictions pursuant to the 21st Century Cures Act that prohibit practices that are likely to interfere with the access, exchange or use of electronic health information, except as required by law or specified by HHS as a reasonable and necessary activity. Violations may result in penalties or other disincentives.

Although we believe that we are in material compliance with the HIPAA regulations and other federal and state laws and regulations related to privacy and security, inadvertent violations may occur in the course of our business. For this and other reasons, the HIPAA regulations and other federal and state laws are expected to continue to impact us operationally and financially and may pose increased regulatory risk.

The health care industry is subject to state and federal laws that regulate the relationships of providers of health care services, physicians and other clinicians. These restrictions include self-referral laws that impose restrictions on physician referrals to any entity with which they have a financial relationship, which is a broadly defined term. We believe our relationships with physicians comply with the self-referral laws. Failure to comply with self-referral laws could subject us to a range of sanctions, including civil monetary penalties and possible exclusion from government reimbursement programs. There are also federal and state laws making it illegal to offer anyone anything of value in return for referral of patients. These laws, generally known as “anti-kickback” laws, are broad and subject to interpretations that are highly fact dependent. Given the lack of clarity of these laws, there can be no absolute assurance that any health care provider, including us, will not be found in violation of the anti-kickback laws in any given factual situation. Strict sanctions, including fines and penalties, exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for violation of the anti-kickback laws. From time to time, the government issues regulations and guidance that interpret these laws, including final rules issued in November 2020, that are intended to modernize and clarify the federal self-referral and anti-kickback statutes.

There are a number of laws and regulations that govern the submission of claims for reimbursement from Medicare or Medicaid that, if not followed, can result in payment denials, significant fines, or criminal liability. Among the more serious of these laws, is the federal False Claims Act (“FCA”), pursuant to which actions may be brought against a provider by the federal government or by a private party on behalf of the federal government, known as a “qui tam relators” or “relators,” for the submission of false claims for reimbursement by Medicare or Medicaid. These actions can lead to significant civil monetary

penalties, significant criminal fines and imprisonment, and/or exclusion from participation in state and federally-funded healthcare programs. Relators are entitled to share in any amounts recovered by the government under the FCA. Both direct enforcement activity by the government and qui tam relator actions have increased significantly in recent years.

The basis of an FCA violation can include issues such as coding errors, billing for services not provided, billing for unnecessary services, or submitting false cost reports. Liability also arises for the known failure to report and refund an overpayment received from the government within 60 days of identifying such overpayment. An overpayment is deemed to be identified when a person has, or should have through reasonable diligence, determined that an overpayment was received and quantified the overpayment. Some courts have held that providers who allegedly have violated other statutes, such as self-referral or kickback laws, have thereby submitted false claims under the FCA. Allegations of poor quality of care can also lead to FCA actions under a theory of worthless services, which contends that care provided was so deficient that it was tantamount to no service at all.

As required by the Medicare Secondary Reporting Act and related laws and regulations, we report to CMS specific information regarding all claimants and claim settlements involving Medicare participants so CMS can recover Medicare funds expended to provide healthcare treatment to the claimant. The requirements are to ensure that CMS is notified so that it may recoup the amounts paid for services from the settlement proceeds. The requirements do not result in us making additional payments to CMS for these services provided and does not result in an incremental cost to us. Strict sanctions, including fines and penalties, exclusion from the Medicare and Medicaid programs and criminal penalties, may be imposed for non-compliance with these reporting obligations.

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

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

None.

We own 15 and lease 46 long-term care centers as discussed in “Item 1 Business - Nursing Centers and Services.” See further details below.

Our current operations include 46 nursing centers subject to operating leases, including 23 owned by Omega Health Investors ("Omega"), 20 owned by Golden Living and three owned by other parties. In our role as lessee, we are responsible for the day-to-day operations of all operated centers. These responsibilities include recruiting, hiring and training all nursing and other personnel, and providing patient care, nutrition services, marketing, quality improvement, accounting, and data processing services for each center. The lease agreements pertaining to our 46 leased centers are “triple net” leases, requiring us to maintain the premises, provide insurance, pay taxes and pay for all utilities. See the table below for a summary of owned and leased beds operated by the Company.

Not applicable.

Diversicare Healthcare Services, Inc. provides long-term care services to nursing center patients in nine states, primarily in the Southeast, Midwest and Southwest. Our 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, we offer a variety of comprehensive rehabilitation services as well as nutritional support services. As of December 31, 2020, our continuing operations consist of 61 nursing centers with 7,250 licensed skilled nursing beds and 397 assisted-living and other residential beds. We own 15 and lease 46 of our nursing centers included in continuing operations. The Company's continuing operations include centers in Alabama, Indiana, Kansas, Mississippi, Missouri, Ohio, Tennessee, and Texas.

As a result of the COVID-19 pandemic, federal and state governments have passed legislation, promulgated regulations, and taken other administrative actions intended to assist healthcare providers in providing care to COVID-19 and other patients during the public health emergency and to address public health needs. These measures include temporary relaxation of conditions of participation for healthcare providers, relaxation of licensure requirements for healthcare professionals, relaxation of privacy restrictions for telehealth remote communications, promoting use of telehealth by expanding the scope of services for which reimbursement is available, and limited waivers of fraud and abuse laws for activities related to COVID-19 during the public health emergency period. They also include requirements for skilled nursing centers to report to public health authorities, residents and their representatives when residents, and staff are confirmed as having or are being investigated for having COVID-19.

We are working with federal, state, and local health authorities to respond to the COVID-19 pandemic and are taking measures to try to limit the spread of the virus. For example, we have implemented screening protocols for staff, residents, and visitors. CMS requires nursing homes in states with positive testing rates above a certain threshold to test all staff on a weekly basis. Although we are implementing considerable safety measures, caring for COVID-19 patients has associated risks. In addition, we have experienced, and may continue to experience supply chain disruptions, including delays and price increases in equipment, pharmaceuticals, and medical supplies. Staffing, equipment, and pharmaceutical and medical supplies shortages may impact our ability to admit and treat patients. We have incurred, and may continue to incur, increased expenses arising from the COVID-19 pandemic. We have also experienced reduced occupancy in our centers, in part due to perceived risks by patients and family members of residential care and their perception of restrictions such as limited visitation policies, a reduction in patients released to nursing homes from hospitals and other healthcare facilities, and a general reluctance to seek medical care or interface with the healthcare system during the pandemic or for an undetermined period of time. Occupancy may also be affected by the data each nursing home is required to report, including the number of confirmed and suspected cases of COVID-19 and resident deaths related to COVID-19, which is made publicly available through the CDC National Healthcare Safety Network.

The Company is closely monitoring and evaluating the impact of the COVID-19 pandemic on all aspects of its business. We have identified team members and patients who have tested positive for COVID-19 at a select number of our centers, and we have incurred increases in the costs of caring for the patients and residents in those centers. The Company incurred an additional $21.2 million in labor expenses, $4.7 million of supplies expenses, $6.0 million of employee testing expenses and $0.5 million of travel expenses related to the COVID-19 pandemic for the twelve months ended December 31, 2020. The Company has also experienced reduced occupancy at its centers and has incurred additional expenditures preparing our centers for potential outbreaks. The Company has an interdisciplinary team monitoring and keeping apprised of the latest information about the virus and its prevalence. The Company has implemented precautionary measures and response protocols to minimize the spread of the virus, following guidance from the CDC, but the Company nevertheless expects additional cases of the virus will occur at these and other facilities.

One of the primary sources of relief for healthcare providers is the CARES Act, an economic stimulus package signed into law on March 27, 2020, which included, among other things, modifications to the limitation on business interest expense and net

operating loss provisions relative to the payment of Federal income taxes, allows an optional payment deferral of the employer's portion of Social Security taxes that are otherwise due through December 31, 2020. These provisions of the CARES Act were effective after the date of enactment and also include the appropriation of stimulus funds to healthcare providers. The PPPHCE Act and the CAA, both expansions of the CARES Act that include additional emergency appropriations, were signed into law on April 24, 2020 and December 27, 2020, respectively. In total, the CARES Act, the PPPHCE Act, and the CAA include $178 billion of funding to be distributed through the PHSSEF to eligible providers, including public entities and Medicare- and/or Medicaid-enrolled providers. PHSSEF payments are intended to financially assist healthcare providers with lost revenues and healthcare-related expenses incurred in response to the COVID-19 pandemic. As long as the recipient has sufficient COVID-19 attributable expenses and lost revenues between January 1, 2020 and June 30, 2021 and complies with certain terms and conditions, the PHSSEF payments are not required to be repaid. The terms and conditions include, among other things, complying with reporting requirements, limitations on balance billing and restrictions against using PHSSEF funds to reimburse expenses or losses that other sources are obligated to reimburse.

Recipients of more than ten thousand dollars in PHSSEF funds will be required to submit reports to HHS that include information about their expenses and lost revenues and use of the PHSSEF funds. Although registration for the reporting portal has been opened, HHS has not yet opened the portal for reporting or finalized a deadline for submission of the initial report. HHS continues to update guidance regarding post-payment reporting requirements and "frequently asked questions" that provide some additional details and examples related to how recipients should calculate their COVID-19 attributable expenses and lost revenues for purposes of PHSSEF reporting. Ultimately, to the extent that reports submitted by a recipient do not demonstrate sufficient healthcare related lost revenues and expenses attributable to COVID-19 (as those terms are defined by HHS), the recipient may have to repay any excess funds received.

During the year ended December 31, 2020, we received $47.2 million from the PHSSEF. We also applied for additional Phase 3 General Distribution PHSSEF payments; however, we do not know whether we will ultimately receive additional payments. Due to the recent enactment of the CARES Act and related legislation and evolving guidance, there is still a high degree of uncertainty surrounding their implementation. We are closely tracking our use of the funds received from PHSSEF in order to demonstrate compliance with the terms and conditions, including applicable reporting requirements. The Company is still evaluating the most recent guidance; however, the Company currently anticipates, but cannot guarantee, that it will have sufficient COVID-19 attributable expenses and lost revenues to retain the PHSSEF payments it has received to date. The Company will not be able to determine the amount of used funds until the reporting rules are finalized by the federal government, and the Company knows the full extent of its COVID-19 attributable expenses and lost revenues. The Company can offer no assurance that it will be in compliance with all requirements related to retaining the PHSSEF payments received under the CARES Act and related legislation. If we fail to appropriately comply with all of the terms and conditions or do not have sufficient expenses and lost revenues (as defined by these programs), the Company may be required to repay some or all of these amounts, which could have a material adverse impact. Infection control incentive payments may be used only for certain infection control expenses, and payments are determined based on reporting done through CASPER. However, these payments remain subject to audit by HHS and the Company cannot assure that it will not be required to repay some or all of the amounts received.

The Company is continuing to evaluate and consider the potential impact that the COVID-19 public health emergency may have on its liquidity, financial condition and results of operations due to numerous uncertainties. We also continue to assess the potential impact of the CARES Act, the PPPHCE Act, and other stimulus measures, if any, as well as the impact of other laws, regulations, and guidance related to COVID-19 on our business, results of operations, financial condition and cash flows. Given the uncertainty as to the duration and severity of the COVID-19 pandemic, it could have a material adverse effect on the Company's future results of operations, financial condition and liquidity.

We identified several key strategic objectives to increase shareholder value through improved operations and business development. These strategic operating initiatives include: improving our facilities’ quality metrics, improving skilled mix in our nursing centers, improving our average Medicare rate, maintaining Electronic Medical Records to improve Medicaid

capture, and completing strategic acquisitions and divestitures. We have experienced success in these initiatives and expect to continue to build on these improvements.

One of our key performance indicators is skilled mix. We believe that our skilled mix is an important indicator of our success in attracting high-acuity patients because it represents the percentage of our patients who are reimbursed by Medicare, managed care and other skilled payors, for whom we receive higher reimbursement rates. Our strategic operating initiatives of improving our skilled mix and our average Medicare rate required investing in nursing and clinical care to treat more acute patients along with nursing center-based marketing representatives to attract these patients. These initiatives developed referral and Managed Care relationships that have attracted and are expected to continue to attract payor sources for patients covered by Medicare and Managed Care. The Company's skilled mix for the years ended December 31, 2020 and 2019 was 15.9% and 13.9%, respectively. For the past several years, census and skilled mix trends have been affected by healthcare reforms resulting in lower lengths of stay among our skilled patient population and lower admissions caused by initiatives among acute care providers, managed care payors and conveners to divert certain skilled nursing referrals to home health or other community-based care settings.

As another part of our strategic operating initiatives, all of our nursing centers utilize EMR to improve Medicaid acuity capture, primarily in our states where the Medicaid payments are acuity based. By using EMR, we have increased our average Medicaid rate despite rate cuts in certain acuity based states by accurate and timely capture of care delivery.

Our strategic operating initiatives include a renewed focus on completing strategic acquisitions and divestitures. We continue to pursue and investigate opportunities to acquire or lease new centers, focusing primarily on opportunities within our existing geographic areas of operation. As part of our strategic efforts, we have also performed thorough analysis on our existing centers in order to determine whether continuing operations within certain markets or regions is in line with the short-term and long-term strategy of the business. Additionally, we have expanded our participation in certain state sponsored quality incentive programs that reward providers for achievement of certain quality measures.

On December 1, 2020, the Company entered into an agreement with Omega to transfer operations of the facility located in Florida to another operator. The agreement effectively amended the Master Lease to remove this center, reduced the annual rent expense, and released the Company from any further obligations arising under the Master Lease with respect to the Florida facility.

Effective November 1, 2020, the Company entered into agreements with a third party therapy company to outsource the therapy services that were previously provided by the Company through its wholly owned subsidiary Diversicare Therapy Services. The outsourced services include all physical, occupational, and speech therapy provided to patients of the Company's facilities. The contracts are for a three year term, absent termination for cause by either party. The third party provider has extensive expertise in providing therapy, and the Company believes that the therapy company's expertise in this area will benefit our patients and result in an overall operational cost savings for the Company.

On December 1, 2018, the Company sold three Kentucky properties for a purchase price of $18.7 million, which are collectively referred to as the "Kentucky Properties." On August 30, 2019, the Company terminated operations of ten centers in Kentucky and concurrently transferred operations to a new operator. These ten centers are collectively referred to as the "Kentucky Centers." The sale of the Kentucky Properties and the termination of operations at the Kentucky Centers are referred to collectively as the "Kentucky Exit." As a result of the Kentucky Exit, the Company no longer operates any skilled nursing centers in the State of Kentucky. The Kentucky Exit represents a strategic shift that has (or will have) a major effect on the Company's operations and financial results. In accordance with ASC 205, the Company's discontinued operating results have been reclassified on the face of the income statement and footnotes to reflect the discontinued status of these operations. Refer to Note 4, "Discontinued Operations" to the consolidated financial statements.

During 2019, the Company expanded its participation in the Texas Quality Incentive Program as administered by the Texas Health and Human Services Commission. QIPP provides supplemental Medicaid payments for skilled nursing centers that achieve certain quality measures. The Company previously had one of its Texas skilled nursing centers participating in the QIPP. During April 2019, the Company enrolled an additional eleven of its Texas skilled nursing centers in the program, such that twelve of the Company’s centers participate in the QIPP effective September 1, 2019. To allow four of these centers to meet the QIPP participation requirements, the Company entered into a transaction with a Texas medical district already participating in the QIPP, providing for the transfer of the related provider licenses from the Company to the medical district. The Company’s operating subsidiary retained the management of the centers on behalf of the medical district. In response to the

COVID-19 pandemic, the Texas Health and Human Services Commission waived some of the performance and reporting requirements for QIPP effective March 1, 2020 for the remainder of state fiscal year 2021.

On October 1, 2018, the Company entered into a new Master Lease Agreement (the "Omega Master Lease") with Omega Healthcare Investors ("Omega") to lease 34 centers currently owned by Omega and operated by Diversicare. The old Master Lease with Omega provided for its operation of 23 skilled nursing centers in Texas, Kentucky, Alabama, Tennessee, Florida, and Ohio. Additionally, Diversicare operated 11 centers owned by Omega under separate leases in Missouri, Kentucky, Indiana, and Ohio. The Omega Master Lease entered into by Diversicare and the Lessor consolidated the leases for all 34 centers under one new master lease. The Lease has an initial term of twelve years with two optional 10 year extensions. The Omega Master Lease has a common date of annual lease fixed escalators of 2.15% beginning on October 1, 2019. The Omega Master Lease was subsequently amended on August 30, 2019 when the Company terminated operations of ten centers in Kentucky and concurrently transferred operations to a new operator. The agreement effectively amended the Omega Master Lease to remove the ten Kentucky facilities, reduce the annual rent expense, and release the Company from any further obligations arising under the Omega Master Lease with respect to the Kentucky facilities. The remaining Omega Master Lease terms remain unchanged with an initial term of twelve years and two optional 10-year extensions. The annual lease fixed escalator remains at 2.15% beginning on October 1, 2019.

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

The following table summarizes the Diversicare statements of continuing operations for the years ended December 31, 2020 and 2019, and sets forth this data as a percentage of "Patient revenues, net" for the same year:

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

The Company has professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. Effective July 1, 2013, the Company established a wholly-owned, consolidated offshore limited purpose insurance subsidiary, SHC Risk Carriers, Inc. (“SHC”), which has issued a policy insuring claims made against all of the Company's nursing centers in Florida and Tennessee, several of the Company’s nursing centers in Alabama, Ohio, and Texas and several of the Company's prior nursing centers in Kentucky for claims prior to the transfer of such operation. The insurance coverage provided for these centers under the SHC policy include coverage limits of $1.0 million per medical incident with a sublimit per center of $3.0 million and total annual aggregate policy limits of $5.0 million. All other centers within the Company’s portfolio are covered through various commercial insurance policies which provide coverage limits of $1.0 million per claim and have sublimits of $3.0 million per center, with varying aggregate policy limits and deductibles. The deductibles for these policies vary in amount and are covered through the insurance subsidiary.

Because our actual liability for existing and anticipated professional liability and general liability claims will exceed our limited insurance coverage, we have recorded total liabilities for reported professional liability claims and estimates for incurred but unreported claims of $24.7 million and $1.0 million of estimated insurance recovery receivables as of December 31, 2020, including $3.5 million for settlements that are expected to be paid in 2021, estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, and estimates of related legal costs incurred and expected to be incurred. All losses are projected on an undiscounted basis. The payments due under the government settlement agreement are not included in this reserve.

The Company evaluates the adequacy of this liability on a quarterly basis. Semi-annually, the Company retains a third-party actuarial firm to assist in the evaluation of this reserve. Since May 2012, the actuary has assisted management in the preparation of the appropriate accrual for incurred but not reported general and professional liability claims based on data furnished as of May 31 and November 30 of each year. The actuary primarily utilizes historical data regarding the frequency and cost of the Company's past claims over a multi-year period, industry data and information regarding the number of occupied beds to develop its estimates of the Company's ultimate professional liability cost for current periods.

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

The Company's cash expenditures for self-insured professional liability costs from continuing operations were $5.5 million and $4.6 million for the years ended December 31, 2020 and 2019, respectively.

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

Professional liability costs are material to our financial position, and changes in estimates, as well as differences between estimates and the ultimate amount of loss, may cause a material fluctuation in our reported results of operations. Our professional liability expense was $8.3 million and $7.0 million for the years ended December 31, 2020 and 2019, respectively. These amounts are material in relation to our reported income (loss) from continuing operations for the related periods of $6.5 million and $(27.5) million, respectively. The total liability recorded at December 31, 2020 was $24.7 million, compared to current assets of $97.3 million and total assets of $439.9 million.

With respect to workers' compensation insurance, substantially all of our employees are covered under either a prefunded deductible policy or state-sponsored programs. We have been and remain a non-subscriber to the Texas workers' compensation system and are, therefore, completely self-insured for employee injuries with respect to our Texas operations. For the period from July 1, 2008 through December 31, 2020, we are covered by a prefunded deductible policy. Under this policy, we are self-insured for the first $0.5 million per claim, subject to an aggregate maximum of $3.0 million. We fund a loss fund account with the insurer to pay for claims below the deductible. We account for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred.

We are self-insured for health insurance benefits for certain employees and dependents for amounts up to $0.2 million per individual annually. We provide reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate, based on known claims and estimates of unknown claims based on historical information. The differences between actual settlements and reserves are included in expense in the period finalized. Our reserves for health insurance benefits can fluctuate materially from one year to the next depending on the number of significant health issues of our covered employees and their dependents.

No impairment of long lived assets was recognized during 2020 and 2019. If our estimates or assumptions with respect to an asset change in the future, we may be required to record impairment charges for our assets.

Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities at tax rates in effect when such temporary differences are expected to reverse. We generally expect to fully utilize our deferred tax assets; however, when necessary, we record a valuation allowance to reduce our net deferred tax assets to the amount that is more likely than not to be realized.

In determining the need for a valuation allowance or the need for and magnitude of liabilities for uncertain tax positions, we make certain estimates and assumptions. These estimates and assumptions are based on, among other things, knowledge of operations, markets, historical trends and likely future changes and, when appropriate, the opinions of advisors with knowledge and expertise in certain fields. Due to certain risks associated with our estimates and assumptions, actual results could differ.

We have employment agreements with certain members of management that provide for the payment to these members of amounts up to two times their annual salary in the event of a termination without cause, a constructive discharge (as defined), or upon a change of control of the Company (as defined). The maximum contingent liability under these agreements is approximately $1.5 million as of December 31, 2020. The terms of such agreements are for one year and automatically renew for one year if not terminated by us or the employee.

As discussed in the overview at the beginning of Management's Discussion and Analysis of Financial Condition and Results of Operations, we have completed certain divestitures, acquisitions and entered several new lease agreements. We have reclassified our Consolidated Financial Statements to present certain divestitures as discontinued operations for all periods presented. The following discussion only relates to our continuing operations.

During the year ended December 31, 2020, we received $47.2 million of provider relief from the CARES Act, PPHCE Act, and the Families First Coronavirus Response Act. We recognized $19.8 million of the provider relief funds during the year ended December 31, 2020, which is classified as "Other Operating Income" in the Company's results of operations. We also recognized $4.0 million of grant funds from states, which is included in "Other Operating Income" in the Company's results of operations for the year ended December 31, 2020. The Medicare stimulus funds that we recognized during the year were used to offset healthcare-related expenses and lost revenues attributable to COVID-19. Increased healthcare related expenses included but were not limited to increased wages and increased costs of personal protective equipment, testing and other supplies. Refer to Note 2, "COVID-19 Pandemic to the consolidated financial statements for further discussion.

Operating expense increased to $389.2 million in 2020 from $380.9 million in 2019. Operating expense increased to 81.8% of patient revenue in 2020, compared to 80.2% of patient revenue in 2019.

The primary driver for the increase in operating expense was incremental healthcare-related expenses attributable to COVID-19 of $32.3 million. Such expenses included increased labor expenses and increased cost for personal protective equipment, testing, food and certain other supplies. Excluding the COVID-19 related impacts, we benefited from our cost saving initiatives including decreased wages of $14.4 million. Additionally, our nursing and ancillary and health insurance costs decreased by $4.9 million, and $2.3 million, respectively.

Lease expense increased to $54.0 million in 2020 from $53.0 million in 2019, an increase of $1.0 million, or 1.9%. The increase in lease expense was due to rent increases resulting from the amendment to the Lease with Omega Healthcare Investors in conjunction with the Kentucky Exit as well as annual rent escalation provisions.

Professional liability expense was $8.3 million in 2020 compared to $7.0 million in 2019, an increase of $1.3 million, or 18.8%. Our cash expenditures for professional liability costs, including the State of Kentucky, were $5.5 million and $4.6 million for 2020 and 2019, respectively. Professional liability expense and cash expenditures fluctuate from year to year based respectively on the results of our third-party professional liability actuarial studies, the premium costs of purchased insurance, and on the costs incurred in defending and settling existing claims. See “Liquidity and Capital Resources” for further discussion of the accrual for professional liability.

In June 2019, the Company and the U.S. Department of Justice reached an agreement in principle on the financial terms of a settlement regarding a civil investigative demand. In anticipation of the execution of final agreements and payment of a settlement amount of $9.5 million, the Company recorded an additional contingent liability related to the DOJ investigation of $3.1 million during the twelve months ended December 31, 2019 to increase our previously estimated and recorded liability related to this investigation. Refer to Note 12, "Commitments and Contingencies" to the consolidated financial statements for further discussion.

General and administrative expenses were approximately $27.7 million in 2020 compared to $28.0 million in 2019, a decrease of $0.3 million, or 1.1%. The fluctuation is due to a decrease in legal fees, travel expenses, consulting fees and postage of $1.3 million, $0.6 million, $0.3 million and $0.3 million, respectively. This was slightly offset by an increase in labor expense of $1.8 million and $0.5 million of legal and consulting fees related to the Company's debt refinance in October 2020.

Depreciation and amortization expense remained consistent at $9.1 million in 2020 and in 2019.

In connection with the Company's debt refinance that took place in October 2020, the Company recorded a write off of deferred financing costs of $0.2 million in 2020. See Note 8, "Long-Term Debt, Interest Rate Swap and Finance Lease Obligations" to the consolidated financial statements included in this report for additional information.

Interest expense has decreased to $5.0 million in 2020 compared to $6.0 million in 2019, a decrease of $1.0 million. The decrease was due to a decrease in the outstanding borrowings on our loan facilities.

As a result of the above, continuing operations reported income before taxes of $6.0 million in 2020, as compared to a loss before taxes of $11.8 million in 2019. The benefit for income taxes was $0.5 million in 2020, resulting in an effective rate of 8.9%. The provision for income taxes was $15.7 million in 2019, resulting in an effective rate of 133.2%. The fluctuation is attributable to a full valuation allowance of $18.9 million in 2019. The basic and diluted income per common share from continuing operations were $0.99 and $0.97 in 2020, respectively, compared to a basic and diluted loss per common share from continuing operations of $4.25 in 2019.

Since the end of the year, there have been additional cases of COVID-19 at some of our centers. The Company has continued to experience reduced occupancy and increased healthcare-related expenses attributable to COVID-19 at its centers in the form of increased wages and increased cost of personal protective equipment, food and certain other supplies. The Company expects such increased expenses to continue throughout 2021.

The Company is closely monitoring the impact of the COVID-19 pandemic on all aspects of its business. While the Company incurred significant disruptions during the twelve months ended December 31, 2020 from the COVID-19 pandemic, it is unable to fully predict the impact that the COVID-19 pandemic will have on its liquidity, financial condition and results of operations due to numerous uncertainties. As a result of the COVID-19 pandemic, we have recognized less revenue and increased healthcare-related expenses; however, we have also received additional stimulus funds through the CARES Act, PPPHCE Act, and the Families First Coronavirus Response Act during the twelve months ended December 31, 2020, which have been used and are expected to continue to be used to mitigate the impact of the reduced revenues and increased operating expenses, and any cash flow or liquidity impacts therefrom. The increased operating expenses include increased wages and the increased cost of personal protective equipment, infection control supplies, food and dietary supplies. Refer to Note 2, "COVID-19 Pandemic."

Our primary source of liquidity is the net cash flows provided by the operating activities of our centers in addition to provider relief funds received. These internally generated cash flows are used to service existing debt obligations, fund required capital expenditures as well as provide cash flows for investing opportunities. In determining priorities for our cash flow, we evaluate alternatives available to us and select the ones that we believe will most benefit us over the long term. Options for our cash include, but are not limited to, capital improvements, acquisitions, and payment of existing debt obligations, as well as initiatives to improve nursing center performance. We review these potential uses and align them to our cash flows with a goal of achieving long-term success.

Net cash provided by operating activities of continuing operations totaled $48.2 million and $12.3 million in 2020 and 2019, respectively. The primary drivers for the increase in cash provided by operating activities between 2020 and 2019 are income from continuing operations and federal stimulus that was received during the twelve months ended December 31, 2020 through the CARES Act and PPPHCE. As of December 31, 2020 the Company had $25.9 million remaining federal stimulus funds. These funds are required to be used to offset lost revenues and increased expenses that both resulted from the COVID-19 pandemic. Such increased expenses include but are not limited to increased costs for personal protective equipment, employee testing and other supplies. Operating activities of discontinued operations used cash of $1.4 million and $7.0 million in 2020 and 2019, respectively.

Our cash expenditures related to professional liability claims were $5.5 million and $4.6 million for 2020 and 2019, respectively. Although we work diligently to limit the cash required to settle and defend professional liability claims, a significant judgment entered against us in one or more legal actions could have a material adverse impact on our cash flows and could result in our being unable to meet all of our cash needs as they become due.

Investing activities of continuing operations used cash of $5.6 million and $5.0 million in 2020 and 2019, respectively. The cash used for investing activities represents capital expenditures for improvements to our centers and purchases of clinical equipment to assist with fighting and slowing the spread of COVID-19.

Net cash used in financing activities of continuing operations were $13.1 million and $0.3 million in 2020 and 2019, respectively. During 2020, the Company used surplus cash to repay $13.1 million net of outstanding borrowings on our loan facilities.

The Company has professional liability insurance coverage for its nursing centers that, based on historical claims experience, is likely to be substantially less than the claims that are expected to be incurred. Effective July 1, 2013, the Company established a wholly-owned, consolidated offshore limited purpose insurance subsidiary, SHC, which has issued a policy insuring claims made against all of the Company's nursing centers in Florida and Tennessee, and several of the Company’s nursing centers in Alabama, Kentucky, Ohio, and Texas. The insurance coverage provided for these centers under the SHC policy include coverage limits of $1.0 million or $3.0 million per medical incident with a sublimit per center of $3.0 million and total annual aggregate policy limits of $5.0 million. All other centers within the Company’s portfolio are covered through various commercial insurance policies which provide coverage limits of $1.0 million per claim and have sublimits of $3.0 million per center, with varying aggregate policy limits and deductibles. The deductibles for these policies are covered through the insurance subsidiary.

As of December 31, 2020, we have recorded total liabilities for reported professional liability claims and estimates for incurred, but unreported claims of $24.7 million. Our calculation of this estimated liability is based on the Company's best estimates of the likelihood of adverse judgments with respect to any asserted claim; however, a significant judgment could be entered

against us in one or more of these legal actions, and such a judgment could have a material adverse impact on our financial position and cash flows.

The Company maintains a credit facility with a syndicate of banks. The Company originally entered into the credit facility in May 2013, and subsequently amended the facility. As of December 31, 2019, the credit facility consisted of a mortgage loan $67.5 million, an acquisition loan with a borrowing capacity of $12.5 million, a revolver with a borrowing capacity of $40.3 million and an affiliated revolver with a borrowing capacity of $2.0 million.

On October 14, 2020, the Company executed an Amended and Restated Credit Agreement (the "Credit Agreement") with a syndicate of banks, which consists of a $62.0 million mortgage loan subsequently amended ("Amended Mortgage Loan"), a $36.0 million revolver subsequently amended ("Amended Revolver") and a $2.0 million affiliated revolver amended ("Amended Affiliated Revolver"). The Amended Mortgage Loan, Amended Revolver and Amended Affiliated Revolver have a 3-year maturity through September 30, 2023. The Amended Mortgage Loan has a term of 3 years, with principal and interest payable monthly based on a 25-year amortization. Interest on the term loan facility is based on LIBOR plus 4.0% with a 1.0% floor. The Amended Mortgage Loan balance was $61.1 million as of December 31, 2020 with an interest rate of 5.0%. The Amended Mortgage Loan consolidated the mortgage and acquisition loans. The Amended Mortgage Loan is secured by 15 owned nursing centers, related equipment and a lien on the accounts receivable of these centers. The Amended Mortgage Loan, the Amended Revolver and the Amended Affiliated Revolver are cross-collateralized and cross-defaulted. The Company’s Amended Revolver and Amended Affiliated Revolver have an interest rate of LIBOR plus 4.0% and are secured by accounts receivable and are subject to limits on the maximum amount of loans that can be outstanding under the revolver based on borrowing base restrictions.

As of December 31, 2020, we had $61.6 million of outstanding long-term debt and capital lease obligations. The $61.6 million total includes $0.5 million in capital lease obligations.

As of December 31, 2020, the Company did not have any borrowings outstanding under its revolvers compared to $15.0 million outstanding as of December 31, 2019. The Company has 4 letters of credit with a total value of $12.4 million outstanding as of December 31, 2020. Considering the balance of eligible accounts receivable, the letters of credit, the amounts outstanding under the revolvers and the maximum loan amount of $28.8 million, the balance available for borrowing under the revolvers was $16.4 million at December 31, 2020.

Our lending agreements contain various financial covenants, the most restrictive of which relate to debt service coverage ratios. We are in compliance with all such covenants for the period ending December 31, 2020.

Our calculated compliance with financial covenants is presented below:

Net accounts receivable attributable to patient services of continuing operations totaled $53.7 million at December 31, 2020 compared to $60.5 million at December 31, 2019, representing approximately 49 days and 54 days revenue in accounts receivable, respectively. The decrease in net accounts receivable was driven by decreased census relative to the COVID-19 pandemic as well as improved cash collections. We continue to evaluate and implement additional procedures to strengthen our collection efforts and reduce the incidence of uncollectible accounts.

The chief market risk factor affecting our financial condition and operating results is interest rate risk. As of December 31, 2020, we had outstanding borrowings of approximately $61.1 million, which were subject to variable interest rates.

Not applicable.

Diversicare, with the participation of our principal executive and financial officers, has evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of December 31, 2020. Based on this evaluation, the principal executive and financial officers have determined that such disclosure controls and procedures are effective to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2020. Management reviewed the results of its assessment with our Audit Committee.

We implemented certain changes to our accounting processes and control activities related to the COVID-19 pandemic, specifically for identifying, capturing and recording all COVID-19 expenses, calculating lost revenue and recognizing stimulus revenue and other operating income. We continue to assess the potential impact of COVID-19 to our control environment and make changes as necessary.

Other than the items described above, there have been no changes to our internal control over financial reporting during the fiscal year ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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

future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

None.

Information concerning our Directors, Executive Officers and Corporate Governance is incorporated herein by reference to our definitive proxy statement for our 2021 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

Information concerning Executive Compensation is incorporated herein by reference to our definitive proxy statement for our 2021 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

Information concerning Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters is incorporated herein by reference to our definitive proxy statement for our 2021 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

Information concerning Certain Relationships and Related Transactions, and Director Independence is incorporated herein by reference to our definitive proxy statement for our 2021 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

Information concerning the fees and services provided by our principal accountant is incorporated herein by reference to our definitive proxy statement for our 2021 Annual Meeting of Shareholders, which we will file within 120 days of the end of the fiscal year to which this Report relates.

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

The exhibits filed as part of this Report on Form 10-K are listed in the Exhibit Index below.

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

As described in Note 12 to the consolidated financial statements, the Company recorded a reserve for reported and estimated future self-insured professional and general liability claims of $24.7 million as of December 31, 2020. This reserve included estimates of liabilities for incurred but not reported claims, estimates of liabilities for reported but unresolved claims, actual liabilities related to settlements, including settlements to be paid over time, and estimates of legal costs related to these claims. Semi-annually, the Company engages a third-party actuary to assist management in the evaluation of this reserve.

We identified the determination of the reserve for reported and estimated future self-insured professional and general liability claims as a critical audit matter. Determination of the reserve includes: (i) judgments made by management when assessing claims, especially those which extend beyond a year, including assumptions related to anticipated total cost of the claims, (ii) assumptions developed by the third-party actuary for the current-year reserves and incurred but not reported estimates, and (iii) an assessment of the completeness and accuracy of the underlying data used in the estimation process including claims incurred and claims settlements. Auditing these

aspects of the reserve involved especially challenging auditor judgment due to the nature and extent of audit effort required to address these matters, including the specialized skills and knowledge needed.

The primary procedures we performed to address this critical audit matter included:

As described in Note 2 to the consolidated financial statements, during the year ended December 31, 2020, the Company received $47.2 million in cash distributed from the Public Health and Social Services Emergency Fund, also known as the Provider Relief Fund, as a result of the COVID-19 pandemic. During 2020, the Company recognized $19.8 million in “other operating income” in the Company’s results of operations for the year ended December 31, 2020 and utilized $1.5 million of these funds for capital improvements to prevent the spread of COVID-19. The remaining stimulus funds of $25.9 million as of December 31, 2020 are classified as "deferred income" on the consolidated balance sheet.

We identified the recognition of income related to the Provider Relief Fund as a critical audit matter. Significant auditor judgment was involved in evaluating the Company’s interpretation of applicable guidance and regulations used in determining the amount and supportability of income recognized, including a judgmental assessment of associated terms and conditions.

The primary procedures we performed to address this critical audit matter included: