Diversicare Healthcare Services (DVCR) 10-Q2021 Q3 Quarterly report

On August 26, 2021, Diversicare Healthcare Services, Inc. (together with its subsidiaries, “Diversicare” or the “Company”) entered into an Agreement and Plan of Merger with DAC Acquisition LLC, a Delaware limited liability company (“Parent”), and DVCR Acquisition Corporation, a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”), relating to the proposed acquisition of the Company by Parent. The merger agreement provides that, upon the terms and subject to the conditions set forth therein, Merger Sub will be merged with and into the Company (the “Merger”) with the Company continuing as the surviving corporation in the Merger as a direct, wholly-owned subsidiary of Parent. Upon completion of the Merger, the Company will cease to be a publicly traded company and each share of Company common stock issued and outstanding immediately prior to the effective time of the Merger (other than (i) shares of Company common stock held by the Company as treasury stock or owned by Parent or Merger Sub and (ii) shares of Company common stock held by stockholders who have properly and validly exercised their statutory rights of appraisal in respect of such shares) will be automatically converted into the right to receive cash in an amount equal to $10.10 per share, net of applicable withholding taxes and without interest thereon.

The closing of the Merger is subject to various closing conditions, each of which is more fully described in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on August 27, 2021 and the Company’s definitive proxy statement on Schedule 14A filed with the SEC on October 20, 2021.

The completion of the Merger is subject to the satisfaction or waiver of certain customary conditions, including, among others: (i) the adoption of the merger agreement by the Company’s stockholders as of the October 5, 2021 record date; (ii) the absence of any temporary restraining order, preliminary or permanent injunction or other order preventing the consummation of the Merger issued by any Governmental Entity of competent jurisdiction; (iii) termination or expiration of any waiting periods applicable to the consummation of the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; (iv) the representations and warranties of the parties being true and correct subject to certain materiality qualifications and all covenants of the parties having been complied with in all material respects; and (v) the absence of a Company Material Adverse Effect on the Company. The Merger is not subject to any approval by the stockholders of Parent and Parent's obligations under the merger agreement are guaranteed by Ephram Lahasky and MED Healthcare Partners LLC. Parent may terminate the merger agreement upon payment of a termination fee of approximately $4.2 million. The merger agreement further provides that upon termination of the merger agreement by the Company or Parent upon specified conditions, the Company will be required to pay Parent a termination fee of approximately $2.1 million. On October 20, 2021, the Company filed the proxy statement relating to the Merger and the special meeting of stockholders, which the Company intends to hold on November 18, 2021.

Unless stated otherwise, any forward-looking information contained in this report does not take into account or give any effect to the impact of the proposed Merger.

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

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

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

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

Diversicare Healthcare Services, Inc. (together with its subsidiaries, “Diversicare” or the “Company”) provides long-term care services to nursing center patients in 8 states, primarily in the Southeast, Midwest, and Southwest. The Company’s centers provide a range of health care services to their patients and residents that include nursing, personal care, and social services. Additionally, the Company’s nursing centers also offer a variety of comprehensive rehabilitation services, as well as nutritional support services. The Company's continuing operations include centers in Alabama, Indiana, Kansas, Mississippi, Missouri, Ohio, Tennessee, and Texas.

As of September 30, 2021, the Company’s continuing operations consist of 61 nursing centers with 7,250 licensed nursing beds. The Company owns 15 and leases 46 of its nursing centers. Our nursing centers range in size from 50 to 320 licensed nursing beds. The licensed nursing bed count does not include 397 licensed assisted and residential living beds.

In January 2020, the Secretary of U.S. Department of Health and Human Services (“HHS”) declared a national public health emergency due to a novel coronavirus. In March 2020, the World Health Organization categorized COVID-19, a disease caused by this coronavirus (“COVID-19”), as a pandemic. According to the Centers for Disease Control and Prevention (“CDC”), older adults and people with certain underlying medical conditions are at higher risk for serious illness from COVID-19. The CDC has identified nursing home populations as being at high risk of being affected by pathogens like COVID-19 as a result of the congregate nature of nursing homes and the resident population served.

The Centers for Medicare & Medicaid Services (“CMS”) and the CDC have issued guidance to state and local governments and long-term care facilities to help mitigate the spread of COVID-19. For example, CMS has issued guidance that has gradually relaxed nursing home visitation restrictions that were imposed in 2020, while emphasizing the importance of infection prevention practices. To help nursing homes and other providers respond to and contain the spread of COVID-19, CMS has also issued temporary emergency blanket waivers to various government healthcare program requirements. For example, through the end of the public health emergency declaration, CMS is waiving the requirement for a three-day hospital stay prior to Medicare Part A coverage of skilled nursing facility benefits, which allows Medicare beneficiaries that require a new or changed skilled level of care to receive that care under Medicare Part A from a skilled nursing facility without satisfying the hospital stay requirement (sometimes referred to as “skilled in place”). CMS continues to review the need for the waivers and has announced early termination of some waivers as the pandemic and nursing home practices have evolved. In addition, CMS has announced COVID-19 reporting requirements and focused infection control surveys intended to assess long-term care facility compliance with infection control requirements in connection with the COVID-19 pandemic. CDC guidance includes infection prevention and control practices intended to protect both nursing home residents and healthcare personnel.

On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) which includes, among other things, modifications to the limitation on business interest expense and net operating loss provisions relative to the payment of federal income taxes and allows an optional payment deferral of the employer's portion of Social Security taxes that were 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 Medicare and Medicaid providers. The Paycheck Protection Program and Health Care Enhancement Act ("PPPHCE Act"), enacted on April 24, 2020, the Consolidated Appropriations Act, 2021 ("CAA"), enacted December 27, 2020, and American Rescue Plan Act of 2021 ("ARPA"), enacted on March 11, 2021, provide for additional emergency appropriations for COVID-19 response.

Together, the CARES Act and other enacted legislation, authorize funding to healthcare entities to be distributed through the Public Health and Social Services Emergency Fund ("PHSSEF"), also known as the Provider Relief Fund. Payments from PHSSEF, as made to providers through general and targeted distributions, are intended to compensate providers for lost revenues and healthcare-related expenses attributable to the COVID-19 pandemic only. As long as the recipient has sufficient COVID-19 attributable expenses and lost revenues, as defined by the PHSSEF and complies with certain terms and conditions, these payments are not required to be repaid. The terms and conditions include, among others, requirements to comply with certain reporting requirements, limitations on balance billing and restrictions against using PHSSEF funds to reimburse expenses or losses that have been reimbursed from other sources or that other sources are obligated to reimburse. The CAA provides that targeted distribution payments made to an eligible entity may be allocated by the entity's parent organization among its subsidiary eligible health care providers and the entity receiving the targeted distribution payments remains responsible for reporting obligations. As of September 30, 2021, the Company has utilized the funds it received from the PHSSEF to compensate for COVID-19 attributable lost revenues and pay for permissible expenses, including but not limited to

increased wages and increased costs for personal protective equipment, infection control supplies, and COVID-19 testing, and the Company has not refunded any of the funds received from the PHSSEF. The Company’s remaining deferred COVID-19 funds relate to distributions from the Nursing Home Infection Control, described below.

The CARES Act and other enacted legislation authorized additional relief funding to skilled nursing facilities and nursing homes in the form of Nursing Home Infection Control distributions, with a fixed ten thousand dollars distributed for each facility and variable distributions based on number of beds. The legislation also provides for infection control quality incentive payments to skilled nursing facilities and nursing homes based on certain performance measures tied to COVID-19 infections and mortalities. These payments were calculated based on monthly performance periods running from September through December 2020, with the total available bonus payment for each performance period determined in part based on data reported via Certification and Survey Provider Enhanced Reports ("CASPER"). The terms and conditions for this distribution limit use of payments to certain infection control expenses. In June 2021, HHS clarified that the reporting requirements and time period for use of funds applicable to general PHSSEF funds also apply to these Nursing Home Infection Control distributions.

Recipients of more than ten thousand dollars in PHSSEF funds, including Nursing Home Infection Control distributions, are required to submit reports to HHS that include information about their expenses and lost revenues and use of the PHSSEF funds through an online portal that opened on July 1, 2021. The timelines for reporting on the use of PHSSEF funds depend on the time periods during which the funds were received, such that a series of reports will be required. We have reported our use of the PHSSEF funds we received between April 10, 2020 and June 30, 2020 in accordance with the Post-Payment Notices of Reporting Requirements guidance. HHS continues to update guidance regarding post-payment reporting requirements that provide additional details and examples related to how recipients should calculate their COVID-19 attributable expenses, lost revenues and infection control expenses for purposes of PHSSEF reporting. Ultimately, to the extent that reports submitted by a recipient do not demonstrate sufficient healthcare related lost revenues, expenses attributable to COVID-19 or infection control expenses (as those terms are defined by HHS), the recipient may have to repay any excess funds received.

On September 10, 2021, HHS announced additional funding available for health care providers affected by the COVID-19 pandemic. The Phase 4 General Distribution PHSSEF payments will be based on providers' lost revenues and expenses between July 1, 2020, and March 31, 2021. We also recently applied for funding under Phase 4 of the PHSSEF and the American Rescue Plan Rural funding program; however, we do not know whether we will ultimately receive additional payments under these distributions. The Company currently anticipates, but cannot guarantee, that it will have sufficient COVID-19 attributable expenses and lost revenues to retain the PPSSEF payments it has received to date, or sufficient infection control expenses to retain the Nursing Home Infection Control distributions it has received to date. The Company does not yet know the full extent of its COVID-19 attributable expenses and lost revenues. The Company will not be able to determine the amount of used funds until the form, process and reporting rules are finalized by the federal government. There also can be no assurance that the PHSSEF funds will ultimately be enough to reimburse the Company for the full extent of its COVID-19 attributable expenses and losses.

As a result of the COVID-19 pandemic, we have experienced and may continue to experience price increases in equipment, pharmaceuticals, and medical supplies due to increased demand and limited availability for certain items. Staffing, equipment, pharmaceutical and medical supplies and vaccine 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, particularly in the form of increased labor costs, testing and the increased costs of personal protective equipment, food and infection control supplies. Refer to Note 4, "COVID-19 Pandemic" for further information.

There have been cases of COVID-19 at our centers. We have experienced and may continue to experience 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 (which have been relaxed pursuant to CMS guidance), 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 interim consolidated financial statements for the three and nine month periods ended September 30, 2021 and 2020, included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP") have been condensed or omitted pursuant to such rules and regulations. In the opinion of management of the Company, the accompanying interim consolidated financial statements reflect all normal, recurring adjustments necessary to present fairly the Company’s financial position at September 30, 2021, the results of operations and changes in shareholders' deficit for the three and nine month

periods ended September 30, 2021 and 2020 and cash flows for the nine month periods ended September 30, 2021 and 2020. The Company’s balance sheet information at December 31, 2020, was derived from its audited consolidated financial statements as of December 31, 2020.

The results of operations for the three and nine month periods ended September 30, 2021 and 2020 are not necessarily indicative of the operating results that may be expected for a full year. These interim consolidated financial statements should be read in connection with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

Additionally, the Company has received Medicaid stimulus funds, which are recognized in accordance with ASC 606. Refer to Note 5, "Revenue Recognition and Accounts Receivable" to the interim consolidated financial statements included in this report for additional information.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The new guidance intends to improve financial reporting by requiring timelier recognition of credit losses on loans and other financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other such commitments. This update requires that financial statement assets measured at an amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. This standard is effective for smaller reporting companies for the fiscal year beginning after December 15, 2022 with early adoption permitted. The Company is in the initial stages of evaluating the impact from the adoption of this new standard on the consolidated financial statements and related disclosures.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The new guidance contains practical expedients for reference rate reform related activities that impact debt, leases, derivatives and other contracts. The guidance in ASU No. 2020-04 is optional and may be elected over time as reference rate reform activities occur. During the first quarter of 2020, the Company elected to apply the hedge accounting expedients related to probability and the assessments of effectiveness for future LIBOR-indexed cash flows to assume that the index upon which future hedged transactions will be based matches the index on the corresponding derivatives. Application of these expedients preserves the presentation of derivatives consistent with past presentation. The amendments in the ASU are effective for all entities as of March 12, 2020 through December 31, 2022. The Company continues to evaluate changes in the market and may apply other elections, as applicable, in the future as allowed under ASU No. 2020-04.

As of September 30, 2021, the Company has received $51,607 from the PHSSEF. The Company recognized $2,344 and $9,563 as income for the three month periods ended September 30, 2021 and 2020, respectively, and $21,335 and $14,711 for the nine months ended September 30, 2021 and 2020, respectively, which is reflected in "other operating income" in the Company's results of operations. For the nine months ended September 30, 2021 and 2020, the Company utilized $954 and $898, respectively, of these stimulus dollars to fund capital improvements to prevent the spread of COVID-19. The remaining

stimulus funds of $8,174 and $25,900 as of September 30, 2021 and December 31, 2020, respectively, are classified as "deferred income" on the consolidated balance sheet.

The Nursing Home Infection Control Distributions, which also include infection control quality incentive payments, are subject to terms and conditions that require recipients to use the funds for infection control expenses. HHS issued guidance in June 2021 that set forth deadlines for using and reporting on the use of PHSSEF funds, including Nursing Home Infection Control Distributions, which depend on the time periods in which the PHSSEF funds were received.

The Company recognized $877 of grant funds from states, which is included in "other operating income" in the Company's results of operations for the nine month period ended September 30, 2021. Additionally, the Families First Coronavirus Response Act provided states with a temporary increase in the regular federal matching rate, or federal medical assistance percentage, used to determine the federal government's share of the cost of covered services in state Medicaid programs, provided the states agreed to certain conditions such as not imposing cost-sharing requirements for COVID-19-related testing and treatment. The Company recognized $5,038 and $6,645 for the three month periods ended September 30, 2021 and 2020, respectively, of Medicaid and Hospice dollars related to this temporary increase in the federal matching rate, which related to patient services rendered and is reflected in "patient revenues, net" in the Company's results of operations. The Company recognized $14,909 and $11,709, for the nine month periods ended September 30, 2021 and 2020, respectively, of Medicaid and Hospice dollars, which related to patient services rendered and is reflected in "patient revenues, net" in the Company's results of operations.

The CARES Act and other stimulus legislation also include other provisions offering financial relief, for example lifting the Medicare sequestration from May 1, 2020 through December 31, 2021, which would have otherwise reduced payments to Medicare providers by 2% as required by the Budget Control Act of 2011 (but also extending sequestration through 2030). For the three month periods ended September 30, 2021 and 2020, the suspension of the Medicare sequestration positively impacted net patient revenues by $644 and $724, respectively, and $2,004 and $1,031 for the nine month periods ended September 30, 2021 and 2020, respectively. However, in addition to providing funding for healthcare providers, the ARPA increases the federal budget deficit in a manner that triggers an additional statutorily mandated sequestration under the Pay-As-You-Go Act of 2010 ("PAYGO Act"). As a result, absent congressional action, Medicare spending will be reduced by up to 4% in FY 2022, to begin to take effect in January 2022, in addition to the existing sequestration requirements of the Budget Control Act of 2011.

The Company incurred an additional $6,018 and $8,241 of labor expense for the three month periods ended September 30, 2021 and 2020, respectively, and $1,152 and $4,430 for testing and the increased costs of personal protective equipment, food and infection control supplies related to the COVID-19 pandemic for the three month period ended September 30, 2021 and 2020, respectively. The Company incurred an additional $19,847 and $11,349 of labor expense for the nine month periods ended September 30, 2021 and 2020, respectively, and $5,731 and $5,642 for testing and the increased costs of personal protective equipment, food and infection control supplies related to the COVID-19 pandemic for the nine month periods ended September 30, 2021 and 2020, respectively. These expenses are reflected in "operating expense" in the Company's results of operations for the three and nine month periods ended September 30, 2021.

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 all of our centers, and we have incurred an increase in the costs of caring for the team members, patients, and residents in those centers. The Company has also experienced reduced occupancy at its centers and has incurred additional expenditures preparing its centers for potential outbreaks and maintaining the healthcare delivery capacity of its centers. While we have experienced reduced occupancy and increased expenses, we received additional PHSSEF and other stimulus funds during 2020 and 2021, which have been used, and are expected to continue to be used to mitigate the impact of COVID-19 derived lost revenues associated with the reduced occupancy as well as increased expenses, and any cash flow or liquidity impacts therefrom.

The Company has an interdisciplinary team monitoring and staying up to date on the latest information about COVID-19. The Company understands that President Biden has tasked CMS with issuing guidance and/or promulgating setting forth vaccine requirements for certain employees that may be applicable to the Company, and the Company intends to fully comply with that guidance. The Company has implemented precautionary measures and response protocols to minimize the spread of COVID-19, following the current guidance from CMS, the CDC, and state and local governments. The Company also intends to fully comply with the forthcoming Occupational Safety and Health Administration ("OSHA") Emergency Temporary Standard ("ETS") as applicable. Nevertheless, the Company expects additional COVID-19 cases will occur at its centers. The Company is continuing to evaluate and consider the potential impact that COVID-19 may have on its liquidity, financial condition and results of operations due to numerous uncertainties, including the duration of the COVID-19 pandemic and the timing, availability and adoption of effective medical treatment and vaccines. These and other factors relating to the COVID-19 pandemic could have a material adverse effect on the Company's future results of operations, financial condition and liquidity.

The Company's revenue is derived from providing quality healthcare services to its patients. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. The promise to provide quality care is accounted for as a single performance obligation satisfied at a point in time, when those services are rendered on a daily basis.

The Company performed analyses using the application of the portfolio approach as a practical expedient to group patient contracts with similar characteristics, such that revenue for a given portfolio would not be materially different than if it were evaluated on a contract-by-contract basis. These analyses incorporated consideration of reimbursements at varying rates from Medicaid, Medicare, Managed Care, Private Pay, Assisted Living, Hospice, and Veterans for services provided in each corresponding state. It was determined that the contracts are not materially different for the following groups: Medicaid, Medicare, Managed Care and Private Pay and other (Assisted Living, Hospice and Veterans).

In accordance with ASC 606, the Company recognized $4,516 and $522 of Medicaid and Hospice stimulus dollars, respectively, for the three month period ended September 30, 2021, compared to $6,327 and $318 of Medicaid and Hospice stimulus dollars, respectively, for the three month period ended September 30, 2020. The Company recognized $13,775 and $1,134 of Medicaid and Hospice stimulus dollars, respectively, for the nine month period ended September 30, 2021, compared to $11,709 and $1,089 of Medicaid and Hospice stimulus dollars, respectively, for the nine month period ended September 30, 2020. The Medicaid and Hospice stimulus dollars are reflected as patient revenues in the Company's results of operations and in the table below. Refer to Note 4, "COVID-19 Pandemic" for more information. The following table summarizes revenue from contracts with customers by payor source from continuing operations for the periods presented (dollar amounts in thousands):

Accounts receivable from continuing operations as of September 30, 2021 and December 31, 2020 are summarized in the following table:

In February 2021, the Company entered into an interest rate cap agreement with a member of the bank syndicate as the counterparty. The Company entered into the interest rate cap agreement to mitigate the variable interest rate risk associated with its outstanding mortgage borrowings.

The Company designated the interest rate cap as a cash flow hedge, and the effective portion of the hedge is reflected as a component of other comprehensive income. The interest rate cap has the same maturity date as the Amended Mortgage Loan and has an amortizing notional amount that was $60,127 as of September 30, 2021. The interest rate cap agreement requires the counterparty to pay the Company an amount equal to the applicable notional amount multiplied by the rate by which the LIBOR index exceeds a 1% strike rate during the period.

The Company assesses the effectiveness of the interest rate cap on a quarterly basis and at September 30, 2021, the Company has determined that the interest rate cap was effective. Accordingly, the gain or loss related to the change in fair value of the interest rate cap is recorded in Accumulated Other Comprehensive Income and subsequently reclassified into interest expense in the same period during which the hedged forecasted transaction affects earnings. The fair value of the interest rate cap of $54 at September 30, 2021 was included in other noncurrent assets on the Company's Consolidated Balance Sheets.

In conjunction with the refinancing of its outstanding borrowings during October 2020, the Company terminated its interest rate swap. Following the termination, $90 was recorded in other comprehensive income and was reclassified as an adjustment to earnings over the remaining term of the original hedge. Of this amount, $38 was recorded as a decrease to retained earnings for the nine months ended September 30, 2021.

As of September 30, 2021, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the balance sheets as of September 30, 2021 and December 31, 2020.

The table below presents the effect of cash flow hedge accounting on Accumulated Other Comprehensive Income for the nine months ended September 30, 2021 and September 30, 2020.

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, offshore limited purpose insurance subsidiary, SHC Risk Carriers, Inc. (“SHC”), to replace some of the expiring commercial policies. SHC covers losses up to specified limits per occurrence. All of the Company's nursing centers in Tennessee are now covered under the captive insurance policies along with many of the nursing centers in Alabama, Ohio and Texas, as well as those previously operated by the Company in Kentucky and Florida. The insurance coverage provided for these centers under the SHC policy provides coverage limits of at least $1,000 per medical incident with a sublimit per center of $3,000 and total annual aggregate policy limits of $5,000. All other centers within the Company's portfolio are covered through

various commercial insurance policies which provide similar coverage limits per medical incident, per location, and on an aggregate basis for covered centers. The deductibles for these policies are covered through the insurance subsidiary.

Because the Company’s actual liability for existing and anticipated professional liability and general liability claims will likely exceed the Company’s limited insurance coverage, the Company has recorded total liabilities for reported and estimated future claims of $23,928 and $24,744 as of September 30, 2021 and December 31, 2020, respectively. This accrual includes estimates of liability for incurred but not reported claims, estimates of liability for reported but unresolved claims, actual liabilities related to settlements, including settlements to be paid over time, and estimates of legal costs related to these claims. All losses are projected on an undiscounted basis and are presented without regard to any potential insurance recoveries. Amounts are added to the accrual for estimates of anticipated liability for claims incurred during each period, and amounts are deducted from the accrual for settlements paid on existing claims during each period.

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. The actuary assists 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, the Company obtains reports of asserted claims and lawsuits incurred. These reports, which are provided by the Company’s insurers and a third-party claims administrator, contain information relevant to the actual expense already incurred with each claim as well as the third-party administrator’s estimate of the anticipated total cost of the claim. This information is reviewed by the Company quarterly and provided to the actuary semi-annually. Based on the Company’s evaluation of the actual claims information obtained, the semi-annual estimates received from the third-party actuary, the amounts paid and committed for settlements of claims 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. Any increase in the accrual decreases results of operations in the period and any reduction in the accrual increases results of operations during the period.

As of September 30, 2021, the Company is engaged in 77 professional liability lawsuits. NaN lawsuits are currently scheduled for trial or arbitration during the next twelve months, and it is expected that additional cases will be set for trial or hearing. The Company’s cash expenditures for self-insured professional liability costs were $4,991 and $5,136 for the nine months ended September 30, 2021 and 2020, respectively.

The Company follows the accounting guidance in ASC Topic 954 that clarifies that a health care entity should not net insurance recoveries against a related professional liability claim and that the amount of the claim liability should be determined without consideration of insurance recoveries. Accordingly, the estimated insurance recovery receivables are included within "Self-insurance receivables" on the Consolidated Balance Sheet. As of September 30, 2021 and December 31, 2020 there are estimated insurance recovery receivables of $328 and $1,025 in "Self-insurance receivables", respectively.

Although the Company adjusts its accrual for professional and general liability claims on a quarterly basis and retains a third-party actuarial firm semi-annually to assist management in estimating the appropriate accrual, professional and general liability claims are inherently uncertain, and the liability associated with anticipated claims is very difficult to estimate. Any potential claims or settlements related to COVID-19 are uncertain at this time. Professional liability cases have a long cycle from the date of an incident to the date a case is resolved, and final determination of the Company’s actual liability for claims incurred in any given period is a process that takes years. As a result, the Company’s actual liabilities may vary significantly from the accrual, and the amount of the accrual has and may continue to fluctuate by a material amount in any given period. Each change in the amount of this accrual will directly affect the Company’s reported earnings and financial position for the period in which the change in accrual is made.

In February 2020, we entered into a settlement agreement with the U.S. Department of Justice and the State of Tennessee of actions alleging violations of the federal False Claims Act in connection with our provision of therapy and the completion of certain resident admission forms. This settlement resolved an investigation that had begun in 2012 and covers the time period from January 1, 2010 through December 31, 2015. This agreement requires annual payments for a period of five years ending

in February 2025 and also requires a contingent payment in the event the Company sells any of its owned facilities during the five-year payment period. Relative to the settlement agreement, the Company paid $1,000 and $500 during the first quarter of 2021 and 2020, respectively. As of September 30, 2021 and December 31, 2020, the Company has $8,000 and $9,000 outstanding related to the settlement agreement, respectively. Of the outstanding balance related to the settlement agreement, $1,000 is reflected as "Other current liabilities" and the remaining $7,000 and $8,000 is reflected as "Government settlement accrual" on the Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020, respectively. Failure to timely make any of these payments could result in rescission of the settlement and result in the government having a very large claim against us, including penalties, and/or make us ineligible to participate in certain government funded healthcare programs, any of which could in turn significantly harm our business and financial condition.

In conjunction with the settlement of the government investigation related to our therapy practices, we entered into a corporate integrity agreement ("CIA") with the Office of the Inspector General of CMS. The CIA has a term of five years and imposes material burdens on the Company, its officers and directors to take actions designed to ensure compliance with applicable healthcare laws, including requirements to maintain specific compliance positions within the Company, to report any non-compliance with the terms of the CIA, to return any overpayments received, to submit annual reports and for an annual audit of submitted claims by an independent review organization. The CIA sets forth penalties for non-compliance by the Company with the terms of the agreement, including possible exclusion from federally funded healthcare programs for material violations of the agreement.

With respect to workers’ compensation insurance, substantially all of the Company’s employees are covered under either a prefunded deductible policy or state-sponsored programs. The Company has been and remains a non-subscriber to the Texas workers’ compensation system and, therefore, is completely self-insured for employee injuries with respect to its Texas operations. From the period from July 1, 2008 through September 30, 2021, the Company is covered by a prefunded deductible policy. Under this prefunded policy, the Company is self-insured for the first $500 per claim, subject to an aggregate maximum of $3,000. The Company funds a loss fund account with the insurer to pay for claims below the deductible. The Company accounts for premium expense under this policy based on its estimate of the level of claims subject to the policy deductibles expected to be incurred. The liability for workers’ compensation claims was $1,185 and $1,039 at September 30, 2021 and December 31, 2020, respectively. The Company has a non-current receivable for workers’ compensation policies covering previous years of $2,637 and $2,050 which is included in "other noncurrent assets" on the Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020, respectively. The non-current receivable is a function of payments paid to the Company’s insurance carrier in excess of the estimated level of claims expected to be incurred. Any potential claims or settlements related to COVID-19 are uncertain at this time.

As of September 30, 2021, the Company is self-insured for health insurance benefits for certain employees and dependents for amounts up to $200 per individual annually. The Company provides reserves for the settlement of outstanding self-insured health claims at amounts believed to be adequate. The liability for reported claims and estimates for incurred but unreported claims was $1,444 and $2,358 at September 30, 2021 and December 31, 2020, respectively. The differences between actual settlements and reserves are included in expense in the period finalized. Any potential claims or settlements related to COVID-19 are uncertain at this time.

In June 2008, the Company adopted the Advocat Inc. 2008 Stock Purchase Plan for Key Personnel (“Stock Purchase Plan”). The Stock Purchase Plan provides for the granting of rights to purchase shares of the Company's common stock to directors and officers. The Stock Purchase Plan allows participants to elect to utilize a specified portion of base salary, annual cash bonus, or director compensation to purchase restricted shares or restricted share units (“RSU's”) at 85% of the quoted market price of a share of the Company's common stock on the date of purchase. The restriction period under the Stock Purchase Plan is generally two years from the date of purchase and during which the shares will have the rights to receive dividends, however, the restricted share certificates will not be delivered to the shareholder and the shares cannot be sold, assigned or disposed of during the restriction period. In June 2016, our shareholders approved an amendment to the Stock Purchase Plan to increase the number of shares of our common stock authorized under the Plan from 150 shares to 350 shares. No grants can be made under the Stock Purchase Plan after April 25, 2028.

In April 2010, the Compensation Committee of the Board of Directors adopted the 2010 Long-Term Incentive Plan (“2010 Plan”), followed by approval by the Company's shareholders in June 2010. The 2010 Plan allows the Company to issue stock appreciation rights, stock options and other share and cash based awards. In June 2017, our shareholders approved an amendment to the 2010 Plan to increase the number of shares of our common stock authorized under the 2010 Plan from 380 shares to 680 shares. In June 2021, our shareholders approved an amendment to the 2010 Plan to increase the number of shares

of our common stock authorized under the 2010 Plan from 680 shares to 980 shares. No grants can be made under the 2010 Plan after May 31, 2027.

During the nine months ended September 30, 2021 and 2020, the Compensation Committee of the Board of Directors approved grants totaling approximately 106 and 198 shares of restricted common stock, respectively, to certain employees and members of the Board of Directors. The fair value of restricted shares is determined as the quoted market price of the underlying common shares at the date of the grant. The restricted shares typically vest one-third on the first, second and third anniversaries of the grant date. Unvested shares may not be sold or transferred. During the vesting period, dividends accrue on the restricted shares, but are paid in additional shares of common stock upon vesting, subject to the vesting provisions of the underlying restricted shares. The restricted shares are entitled to the same voting rights as other common shares. On March 13, 2020, the Compensation Committee of the Board of Directors approved the grant of 100 shares of common stock to the Company's Chief Executive Officer, as a one-time bonus in lieu of a 2020 salary increase and as recognition for completing the settlement with the Office of the Inspector General and the disposition of all of the Company's facilities in the State of Kentucky. The stock was fully vested on the date of the grant, and the grant date fair value of which was expensed during the quarter ended March 31, 2020.

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

Upon vesting of equity awards, all restrictions are removed. Our policy is to account for forfeitures of share-based compensation awards as they occur.

Summarized activity of the equity compensation plans is presented below:

The SOSARs and Options were valued and recorded in the same manner, and, other than amounts that may be settled pursuant to employment agreements with certain members of management, will be settled with issuance of new stock for the difference between the market price on the date of exercise and the exercise price. The Company estimated the total recognized and unrecognized compensation related to SOSARs and stock options using the Black-Scholes-Merton equity grant valuation model.

The following table summarizes information regarding stock options and SOSAR grants outstanding as of September 30, 2021:

Stock-based compensation expense is non-cash and is included as a component of general and administrative expense or operating expense based upon the classification of cash compensation paid to the related employees. The Company recorded total stock-based compensation expense of $288 and $491 in the nine month periods ended September 30, 2021 and 2020, respectively.

As of September 30, 2021, the Company has a valuation allowance in the amount of $18,860. The Company will continue to periodically assess the realizability of its future deferred tax assets.