ENSIGN GROUP, INC 10-Q

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the condensed consolidated financial statements and accompanying notes, which appear elsewhere in this Quarterly Report on Form 10-Q. We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with the Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K for the year ended December 31, 2019 (Annual Report), which discusses our business and related risks in greater detail, as well as subsequent reports we may file from time to time on Form 10-Q and Form 8-K, for additional information. The section entitled “Risk Factors” contained in Part II, Item 1A of this Report, and similar discussions in our other SEC filings, also describe some of the important risk factors that may affect our business, financial condition, results of operations and/or liquidity. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock. This Report contains "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, which include, but are not limited to the Company’s expected future financial position, results of operations, cash flows, financing plans, business strategy, budgets, capital expenditures, competitive positions, growth opportunities, plans and objectives of management. Forward-looking statements can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similar expressions, and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Additionally, many of these risks and uncertainties are currently amplified by and in the future may be amplified by, the COVID-19 outbreak. The developments with respect to the spread of COVID-19 and its impacts have been occurring rapidly and because of the unprecedented nature of the pandemic, we are unable to predict the full extent and duration of the adverse financial impact of COVID-19 on our business, financial condition and results of operations. While we are not able to estimate the full impact of the COVID-19 outbreak on our financial condition and future results of operations, we expect that this situation will have an adverse effect on our reported results in the future. Our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section “Risk Factors” contained in Part II, Item 1A of this Report. These forward-looking statements speak only as of the date of this Report, and are based on our current expectations, estimates and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, except as otherwise required by law. As used in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the words, “we,” “our” and “us” refer to The Ensign Group, Inc. and its consolidated subsidiaries. All of our affiliated operations, the Service Center and the Captive are operated by separate, wholly-owned, independent subsidiaries that have their own management, employees and assets. The use of “we,” “us,” “our” and similar verbiage in this Quarterly Report on Form 10-Q is not meant to imply that any of our affiliated operations, the Service Center or the Captive are operated by the same entity. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and related notes included the Annual Report. 37 Table of Contents Overview We are a provider of health care services across the post-acute care continuum, as well as other ancillary businesses located in Arizona, California, Colorado, Idaho, Iowa, Kansas, Massachusetts, Nebraska, Nevada, South Carolina, Texas, Utah, Washington and Wisconsin. Our operating subsidiaries, each of which strives to be the service of choice in the community it serves, provide a broad spectrum of skilled nursing, senior living and other ancillary services. As of September 30, 2020, we offered skilled nursing, senior living and rehabilitative care services through 226 skilled nursing and senior living facilities. Of the 226 facilities, we operated 163 facilities under long-term lease arrangements, and have options to purchase 11 of those 163 facilities. We owned an additional 93 real estate properties, which included 63 facilities operated and managed by us, 31 senior living operations leased to The Pennant Group, Inc. as part of the Spin-Off (defined below), and the Service Center location. Of those 31 senior living operations, two are located on the same real estate properties as the skilled nursing facilities. The following table summarizes our affiliated facilities and operational skilled nursing beds and senior living units by ownership status as of September 30, 2020: Owned and Operated Leased (with a Purchase Option) Leased (without a Purchase Option) Total for Facilities Operated Number of facilities 63 11 152 226 Percentage of total 27.9 % 4.9 % 67.2 % 100.0 % Operational skilled nursing beds 6,193 1,145 15,653 22,991 Percentage of total 26.9 % 5.0 % 68.1 % 100.0 % Senior living units 1,470 178 606 2,254 Percentage of total 65.2 % 7.9 % 26.9 % 100.0 % The Ensign Group, Inc. (collectively, Ensign or the Company) is a holding company with no direct operating assets, employees or revenues. Our operating subsidiaries are operated by separate, independent entities, each of which has its own management, employees and assets. In addition, certain of our wholly owned subsidiaries, referred to collectively as the Service Center, provide centralized accounting, payroll, human resources, information technology, legal, risk management and other centralized services to the other operating subsidiaries through contractual relationships with such subsidiaries. We also have a wholly owned captive insurance subsidiary (the Captive) that provides some claims-made coverage to our operating subsidiaries for general and professional liability, as well as coverage for certain workers’ compensation insurance liabilities. References herein to the consolidated “Company” and “its” assets and activities, as well as the use of the terms “we,” “us,” “our” and similar terms in this Quarterly Report on Form 10-Q, are not meant to imply, nor should they be construed as meaning, that The Ensign Group, Inc. has direct operating assets, employees or revenue, or that any of the subsidiaries are operated by The Ensign Group. Recent Activities Coronavirus - The outbreak of the coronavirus disease (COVID-19), which was declared a global pandemic by the World Health Organization (WHO) on March 11, 2020, and the related responses by public health and governmental authorities to contain and combat its outbreak and spread, continues to spread and disrupt healthcare operations across the United States, including the markets in which we operate. The rapid spread of the virus has led to the implementation of various responses, including federal, state and local government-imposed quarantines, shelter-in-place mandates, sweeping restrictions on travel, and substantial changes to selected protocol within the healthcare system across the United States. Additionally, the Centers for Disease Control and Prevention (CDC) has stated that older adults are at a higher risk for serious illness and death from COVID-19. The extent to which COVID-19 impacts our operations will depend on future developments which continue to remain highly uncertain and cannot be predicted with confidence, including the duration of the outbreak, additional or modified government actions, new information which may emerge concerning the severity of COVID-19 and the actions taken to contain COVID-19 or treat its impact, among others. In response to the pandemic, federal and state agencies have been evolving and in some cases, relaxing enforcement requirements, trending toward granting healthcare providers with flexibility to prioritize resident care over stringent adherence to regulatory compliance. 38 Table of Contents Our primary focus throughout the COVID-19 pandemic has remained ensuring the health and safety of our patients, residents, employees, and their respective families. We continue to implement measures necessary to provide the safest possible environment within our sites of service taking into consideration the vulnerable nature of our patients and the unique exposure risks of our staff. The CDC has stated that older adults, such as our patients, are at a higher risk for serious illness and death from COVID-19 due to the higher prevalence of chronic medical conditions. In addition, our employees are at higher risk of contracting or spreading the disease when caring for patients due to the nature of the work environment. Consistent with CDC guidelines and recommendations applicable to nursing facilities, we implemented new infection control policies and practices to prevent the introduction of COVID-19 into our facilities and to control the spread of COVID-19 within communities. These changing guidelines include visitor policies, screening and testing employees and others permitted to enter the building, restricted communal dining, and reducing or restricting activities programming and optional therapies. Upon confirmation of a positive COVID-19 exposure at a facility, we follow CDC and local healthcare guidance to minimize further exposure, including implementing personal protection protocols, restricting new admissions, and cohorting and isolating patients. Due to the vulnerable nature of our patients, we continue to adhere to CDC infection prevention guidelines at our facilities, even as federal, state, and local stay-at-home and social distancing orders and recommendations have relaxed. Notwithstanding these protocols and our other response efforts, the virus will likely continue to be introduced to and transmitted within certain facilities due to the highly transmissible nature of the virus. The full financial impact of COVID-19 depends upon numerous factors, including the nature and duration of the COVID-19 pandemic (such as geographic concentration of virus, rate of spread, and duration), access and costs of staffing, testing and supplies, legal and regulatory matters and stimulus funding and other measures intended to mitigate the clinical and financial harm of the pandemic and the spread of it in the communities we serve. While the operating environment for healthcare providers is continuously changing during this pandemic, the safety and well-being of our patients and employees remains our top priority. Although the ultimate impact of the COVID-19 pandemic remains uncertain, we can offer the following observations regarding the impact of COVID-19 on our operations, as well as significant regulatory and legislative relief initiatives. Occupancy Prior to COVID-19, we were exhibiting consistent growth in our occupancy and skilled mix. However, following the introduction of COVID-19 into the U.S., our operations have experienced declines in occupancy as a result of local government-imposed quarantines, including shelter-in-place mandates, sweeping restrictions on travel, and substantial restrictions and changes to protocol within the healthcare system across the U.S., including temporary limitations on certain medical procedures, which limited the number of patients in the hospital that needed skilled nursing services. The introduction of the virus into our operations is typically contemporaneous with the virus’ impact in each community in which we operate. Our operations are located in 14 states and range from metropolitan, suburban and rural communities. The prevalence of the virus varies dramatically by state, within the same state or within the same county. Accordingly, the impact on each of our operations has also varied widely. Our first location to have a confirmed positive COVID-19 patient and staff member was in the state of Washington, which was one of the first states to have confirmed COVID-19 cases in the United States. Accordingly, our Washington locations were impacted beginning in mid-February. As the weeks continued, and as reported and confirmed cases of COVID-19 infections in the United States increased, we also began experiencing an impact on our revenues and expenses throughout the organization. As of October 14, 2020, our 217 affiliated skilled nursing operations across 13 states had 207 confirmed COVID-19 patients in-house. Also, as of October 14, 2020, eight operations had over 20 COVID-19 positive cases, 48 operations had less than 20 cases and 161 operations had no confirmed cases of COVID-19 in house. The vast majority of COVID-19 positive patients at our operations have recovered and returned home. We experienced an increase in COVID-19 cases in our facilities in correlation with the trends occurring in the local community, that as the number of cases increases in the community overall, such as in parts of Texas, Arizona and California, those trends also impact skilled nursing operations in those areas. We expect to continue to see new positive cases in some of our operations as the virus continues to impact each community, as testing mandates have been enacted and we enter into colder months in many of our markets. 39 Table of Contents Beginning in mid-Febr uary and continuing through the third quarter, we've seen a decrease in the number of patients due to a number of factors related to the spread of COVID-19, including lower overall patient flow into the acute-care setting. In response to the pandemic, many acute care hospitals took affirmative steps to prepare for an increase of COVID-19 and critical care patients, and imposed admission restrictions due to the need to preserve personal protective equipment and a heightened anxiety among patients and caregivers regarding the risk of exposure to COVID-19. Occupancy was also impacted by decisions of our operating subsidiaries to limit new admissions into their operations due to the risks and uncertainties surrounding the potential spread of the virus by individuals that had either tested positive for COVID-19, were symptomatic of COVID-19 but had not yet been tested positive due to a shortage of tests, or that were asymptomatic of COVID-19 but had an unknown status and were potentially positive and contagio us. On March 13, 2020, President Trump issued a national emergency declaration in connection with the COVID-19 pandemic. Following the State of Emergency declarations, California was the first state to have a shelter-in-place order, which was subsequently followed by similar orders in the remaining states. Starting in June, as states began lifting stay-at-home restrictions, many of the communities in which we operate experienced an overall increase in COVID-19 cases. As the prevalence of COVID-19 increased in the communities we serve, we experienced an increase in COVID-19 cases in our operations, particularly in Texas, Arizona and California. The increase in COVID-19 cases also have a direct impact on skilled nursing operations in those communities in the quarter, resulting in a decrease in occupancy and, in many cases, a higher skilled mix. More specifically, during the quarter combined Same Facilities and Transitioning Facilities occupancy declined by 2.4% and skilled mix increased by 2.9 %, both from second quarter as the pandemic worsened in many of its key states. However, from mid-July to mid-September, our census remained flat with a slight decrease in skilled mix days. Towards the end of the quarter and into October as the number of elective care/non-urgent procedures and surgeries normalized and the number of COVID-19 cases in the communities stabilized, we experienced an increase in our occupancy and skilled mix days. Specifically, between mid-September to mid-October, combined Same Facilities and Transitioning Facilities occupancy increased by approximately 1.0% and skilled mix increased by 4.0%, respectively. The number of admissions continued to progressively increase through the quarter, demonstrating that the flow of patients has improved as certain markets have begun to loosen restrictions on admissions and as the sentiment towards high quality post-acute care providers has continued to improve. As COVID-19 has progressed and spread throughout the community we serve, our local operations and caregivers have been serving higher acuity patients who have or have been suspected of having COVID-19. The surge of COVID-19 positive patients, or patients suspected to have been exposed to COVID-19, has resulted in an increase in the number of patients requiring skilled services, which we are able to serve through skilled-in-place (SIP) precautions and procedures. In addition, patients that are not COVID-19 positive or suspected to be COVID-19 positive but require skilled services and qualify to be cared for under the SIP precautions and procedures, have remained in our facilities instead of moving to the hospitals first. This not only allows hospitals to maintain open acute care beds for COVID-19 patients and other highly acute patients, but it also limits the risks involved with moving patients back and forth from one care setting to another. Accordingly, our skilled mix days have substantially recovered, reaching levels similar to pre-COVID-19. Legislative and Regulatory Relief In March 2020, the federal government began to undertake numerous legislative and regulatory initiatives designed to provide relief to the healthcare industry during the COVID-19 pandemic. These initiatives include: • Temporary suspension of Medicare sequestration - The Coronavirus Aid, Relief, and Economic Security Act of 2020 (the CARES Act) temporarily suspended the automatic 2% reduction of Medicare claim reimbursements for the period of May 1, 2020 through December 31, 2020. The suspension of the Medicare sequestration increased our revenue by approximately $3.9 million and $6.5 million during the three and nine months ended September 30, 2020, respectively. The magnitude of the positive impact will depend on the continued impact of the virus on our census and skilled mix through the remainder of the year. • Relief funds for healthcare providers - The CARES Act also authorized the Department of Health and Human Services (HHS) to distribute relief fund grants to healthcare providers “to support healthcare-related expenses or lost revenue attributable to COVID-19”. HHS has made several rounds of automatic distributions to providers based upon a variety of factors. Providers have also been able to apply for additional funding. To keep the funds, HHS requires providers to submit an attestation accepting certain terms and conditions; providers who are unwilling to accept the terms must return the funds. Our operations began automatically receiving relief fund payments in April 2020. During the first half of the year, we received approximately $108.8 million in relief distributions, which we returned in full in July 2020. 40 Table of Contents In July 2020, HHS announced that a new $5.0 billion Provider Relief Fund distribution to be used to protect residents of nursing homes and long-term care facilities from the impact of COVID-19. This funding will include four separate distributions: 1. $2.5 billion of the Nursing Home Infection Control Relief is distributed to be used primarily for testing. We received $23.3 million of the funds in the third quarter of 2020 and have reflected these as a liability. We currently intend to repay the entirety of this distribution, but have not yet begun the repayment process. 2. HHS has announced that it intends to issue another round of Provider Relief Funds to SNFs that pass two gateway qualification tests based upon a facility’s COVID-19 infection and mortality rates. To qualify, facilities must demonstrate COVID-19 infection rates below the rate of infection in the counties they are located and demonstrate mortality rates below nationally established performance thresholds for nursing home residents infected with COVID-19. Facilities that qualify during each of the monthly performance periods, running from September 2020 through December 2020, will be eligible for additional funds based upon their aggregate performance on these infection and mortality measures. To date, we have not received additional funding related to this distribution. 3. $250 million of the funds is to be allocated for distribution to “COVID only” facilities. 4. $250 million of the funds will be part of a program for providers that partner with outside groups. See Note 3, COVID-19 Update in the Notes to Condensed Consolidated Financial Statements. • Increase in Federal Medical Assistance Percent (FMAP) - The Family First Coronavirus Response Act provides a 6.2% increase to FMAP. The Act permits states to retroactively increase the Medicaid rates to January 1, 2020. Depending on the state, the FMAP funding will terminate either when the national emergency status is lifted, at the end of the quarter when the national emergency status is lifted or sometime between. During the three and nine months ended September 30, 2020 we recognized $11.7 million and $24.8 million of FMAP reimbursement relief, respectively. The temporary increase on FMAP and the timing of payments has and will continue to vary substantially dependent on the state. • Temporary suspension of certain patient coverage criteria and documentation and care requirements - The CARES Act and a series of temporary waivers and guidance issued by the Centers for Medicare and Medicaid Services (CMS) suspend various Medicare patient coverage criteria, as well as, certain documentation and care requirements. These accommodations are intended to ensure patients have adequate access to care notwithstanding the burdens placed on healthcare providers due to the COVID-19 pandemic. These regulatory actions have and will continue to contribute to an increase in census volumes and skilled mix, that may not otherwise occur. • Medicare Accelerated and Advance Payment Program - The CARES Act expands the Medicare Accelerated and Advance Payment Program to ensure providers and suppliers have the resources needed to combat the pandemic. Our operations began to receive advances in April 2020. We have retained $100.7 million through the Medicare Accelerated and Advance Payment Program through September 30, 2020. The repayment obligations associated with these payments begin one year from the date the accelerated or advance payment was issued. We also paid a portion of the funds back in July 2020. For further discussion, see Note 3, COVID-19 Update in the Notes to Condensed Consolidated Financial Statements. • Deferral of Taxes - The CARES Act also provides for deferred payment of the employer portion of social security taxes through the end of 2020, with 50% of the deferred amount due by December 31, 2021 and the remaining 50% due by December 31, 2022. The U.S. Treasury Department and Internal Revenue Service also allowed corporate taxpayers to defer their estimated federal income taxes for the first and second quarters of 2020 to July 15, 2020. We paid these estimated amounts in the third quarter. 41 Table of Contents Net revenue Our net revenues for the three and nine months ended September 30, 2020 were impacted by COVID-19 as we experienced revenue loss due to a decline in occupancy, which was partially offset by our skilled mix changes. As part of the healthcare community, we have been actively participating in ensuring our patients receive necessary services. CMS has authorized these services through skilled in place (SIP) programs. These programs are designed to allow skilled nursing providers to provide skilled services to higher acuity patients, while allowing hospitals to have increased capacity to care for critical care patients (including COVID-19 positive patients) and limiting the risks related to moving patients between care settings in the midst of a pandemic. In addition, the FMAP program has been designed to enhance the reimbursements to provide additional funding to cover COVID-19 related expenses in selected states. We recorded FMAP revenue of $11.7 million and $24.8 million for the three and nine months ended September 30, 2020, which correlates directly to the additional COVID-19 related expenses we incurred. Operating Expenses We have and continued to experience increased operating expenses during the period impacted by COVID-19 due to the higher utilization, cost and type of personal protective equipment, testing for COVID-19 as well as increased purchasing of other medical supplies and cleaning and sanitization materials. In addition, we have and expect to continue to have increases in labor costs on a per patient basis. In response, we have reduced spending on non-essential supplies, travel costs and all other discretionary items, slowing non-essential capital expenditure projects and temporarily instituted wage reductions and hiring freezes for non-clinical staff. The hiring freeze and wage reductions were lifted in June 2020. Overall The exact timing and pace of the recovery is uncertain given the impact of the pandemic on the overall U.S. and global economy. While we are uncertain as to the duration of our lower census due to the COVID-19 pandemic, we expect the adverse impact to recover as we see increases in hospital volumes and elective surgeries and decrease of COVID-19 case in each of the respective communities we serve. Our forecasted measures may be modified as the pace of the recovery in our volumes become clearer over the coming months. We are focused on navigating the challenges presented by COVID-19 through utilizing the infrastructure of our local operational approach. Each location is partnering with its local leaders and community outreach to ensure the operations are well equipped to deliver quality care. Consistent with previous hurdles, our local leaders are adjusting their operation to meet the clinical and financial challenges, including utilizing the expertise of our Service Center resources to implement best practices. Common Stock Repurchase Program - As approved by the Board of Directors on March 4, 2020 and March 13, 2020, we entered into two separate stock repurchase programs pursuant to which we were authorized to repurchase up to $20.0 million and $5.0 million, respectively, of our common stock under the programs for a period of approximately 12 months each. During the three months ended March 31, 2020, we repurchased 0.5 million and 0.2 million shares of our common stock for a total of $20.0 million and $5.0 million under the March 4, 2020 and March 13, 2020 repurchase programs, respectively. These repurchase programs expired upon the repurchase of the full authorized amount under the two plans. The stock repurchases were supported with funds from our ordinary operations and took place prior to the passage of The CARES Act, which was passed by Congress and signed into law by President Trump on March 27, 2020. Currently, we have no active repurchase plans and do not intend to approve another repurchase plan. As we enter a period of economic uncertainty, we are taking steps to manage our expenses and preserve our cash. We believe our current cash management strategy is appropriate at this time and will consider approving stock repurchase programs in the future after we gain additional visibility into our cash flows and how to best utilize those funds. Spin-Off of Subsidiaries On October 1, 2019, we completed the separation of our transitional and skilled nursing services, home health and hospice operations and substantially all of our senior living operations into two separate, publicly traded companies: • Ensign, which includes skilled nursing and senior living services, physical, occupational and speech therapies and other rehabilitative and healthcare services, post-acute-related new business ventures and real estate investments; and • The Pennant Group, Inc. (Pennant), which is a holding company of operating subsidiaries that provide home health, hospice and senior living services. 42 Table of Contents We completed the separation through a tax-free distribution of substantially all of the outstanding shares of common stock of Pennant to Ensign stockholders on a pro rata basis (the Spin-Off). We transferred to Pennant net assets of 63 home health, hospice and home care agencies and 52 senior living communities. We retained ownership of all the real estate, which includes 29 of the 52 senior living operations that were contributed to Pennant. These assets are leased to Pennant on a triple-net basis. Pennant affiliates are responsible for all costs at the properties, including property taxes, insurance and maintenance and repair costs. Annual rental income generated from the leases with Pennant is $14.0 million. Pennant's remaining 23 senior living operations are leasing the underlying real estate from unrelated third parties. As part of the Spin-Off, we amended the Master Leases with CareTrust and other third-party lease agreements. These amendments terminate the leases related to the operations that transferred to Pennant and modified the rental payments and lease terms of the operations that remained with Ensign. The net impact of the lease termination and modification of the senior living properties is a reduction in annual rent expense of approximately $23.0 million. We entered into several agreements with Pennant in connection with the Spin-off, including a transition services agreement (TSA), separation and distribution agreement, tax matters agreement and employee matters agreement. Pursuant to the TSA, Ensign and Pennant and our respective subsidiaries agreed to provide various services to each other on an interim, transitional basis. Services being provided by us include, among others, certain finance, information technology human resources, employee benefits and other administrative services. The services generally commenced on October 1, 2019 and will terminate on or before September 30, 2021. Revenue to Ensign under the TSA was not material during the three and nine months ended September 30, 2020. Immediately after the Spin-Off, we ceased to consolidate our home health and hospice operations and the senior living operations that were contributed to Pennant into our financial results. As a result, the consolidated financial statements included in this Quarterly Report on Form 10-Q and related financial information reflect the Pennant operations, assets and liabilities, and cash flows as discontinued operations for 2019 financial periods presented. In the fourth quarter of 2019 and subsequent to the Spin-Off, we have one reportable segment, transitional and skilled services, which includes the operation of skilled nursing facilities. Prior to the separation of Pennant, we had three reportable segments. See Note 4, Spin-Off of Subsidiaries , in the notes to condensed consolidated financial statements for further detail. On October 1, 2019, in connection with the Spin-Off, we entered into the Credit Facility, with a revolving line of credit of up to $350.0 million in aggregate principal amount. The maturity date of the Credit Facility is October 1, 2024. Borrowings are supported by a lending consortium arranged by Truist. In connection with the amendment, we also terminated the term loan under the prior credit facility. Acquisition History The following table sets forth the location of our facilities and the number of operational beds and units located at our facilities as of September 30, 2020: TX CA AZ UT CO WA ID NE IA SC WI NV KS Total Number of facilities Skilled nursing operations 55 47 29 18 11 9 9 4 4 4 2 1 — 193 Senior living communities 1 — — 2 5 — — 1 — — — — — 9 Campuses (1) 5 1 3 1 1 — 2 2 2 — — — 7 24 Number of operational beds/units Operational skilled nursing beds 7,331 4,783 4,197 1,958 972 841 904 413 368 426 100 92 606 22,991 Senior living units 514 65 315 165 620 — 37 301 31 — — — 206 2,254 (1) Campus represents a facility that offers both skilled nursing and senior living services. 43 Table of Contents During the nine months ended September 30, 2020, we expanded our operations through a combination of long-term leases and real estate purchases, with the addition of three stand-alone skilled nursing operations, one stand-alone independent living operation and one campus operation. These new operations added a total of 303 operational skilled nursing beds and 298 operational senior living units operated by our affiliated operating subsidiaries. The aggregate purchase price for these acquisitions during the nine months ended September 30, 2020 was $23.1 million. During the first quarter of 2020, we entered into a long-term lease agreement to transfer two senior living operations to Pennant. Our affiliated operations retained ownership of the real estate for these two senior living communities. For further discussion of our acquisitions, see Note 9, Acquisitions in the Notes to Condensed Consolidated Financial Statements. Key Performance Indicators We manage the fiscal aspects of our business by monitoring key performance indicators that affect our financial performance. Revenue associated with these metrics is generated based on contractually agreed-upon amounts or rate, excluding the estimates of variable consideration under the revenue recognition standard, ASC 606. These indicators and their definitions include the following: Transitional and Skilled Services • Routine revenue. Routine revenue is generated by the contracted daily rate charged for all contractually inclusive skilled nursing services. The inclusion of therapy and other ancillary treatments varies by payor source and by contract. Services provided outside of the routine contractual agreement are recorded separately as ancillary revenue, including Medicare Part B therapy services, and are not included in the routine revenue definition. • Skilled revenue. The amount of routine revenue generated from patients in the skilled nursing facilities who are receiving higher levels of care under Medicare, managed care, Medicaid, or other skilled reimbursement programs. The other skilled patients who are included in this population represent very high acuity patients who are receiving high levels of nursing and ancillary services which are reimbursed by payors other than Medicare or managed care. Skilled revenue excludes any revenue generated from our senior living services. • Skilled mix . The amount of our skilled revenue as a percentage of our total skilled nursing routine revenue. Skilled mix (in days) represents the number of days our Medicare, managed care, or other skilled patients are receiving skilled nursing services at the skilled nursing facilities divided by the total number of days patients from all payor sources are receiving skilled nursing services at the skilled nursing facilities for any given period. • Average daily rates. The routine revenue by payor source for a period at the skilled nursing facilities divided by actual patient days for that revenue source for that given period. These rates exclude additional FMAP payments we recognized as part of The Family First Coronavirus Response Act. • Occupancy percentage (operational beds). The total number of patients occupying a bed in a skilled nursing facility as a percentage of the beds in a facility which are available for occupancy during the measurement period. • Number of facilities and operational beds. The total number of skilled nursing facilities that we own or operate and the total number of operational beds associated with these facilities. Skilled Mix. Like most skilled nursing providers, we measure both patient days and revenue by payor. Medicare, managed care and other skilled patients, whom we refer to as high acuity patients, typically require a higher level of skilled nursing and rehabilitative care. Accordingly, Medicare and managed care reimbursement rates are typically higher than from other payors. In most states, Medicaid reimbursement rates are generally the lowest of all payor types. Changes in the payor mix can significantly affect our revenue and profitability. 44 Table of Contents The following table summarizes our overall skilled mix from our skilled nursing services for the periods indicated as a percentage of our total skilled nursing routine revenue and as a percentage of total skilled nursing patient days: Three Months Ended September 30, Nine Months Ended September 30, Skilled Mix: 2020 2019 2020 2019 Days 32.8 % 28.5 % 30.6 % 29.1 % Revenue 53.9 % 47.8 % 51.8 % 48.7 % Occupancy . We define occupancy derived from our transitional and skilled services as the ratio of actual patient days (one patient day equals one patient occupying one bed for one day) during any measurement period to the number of beds in facilities which are available for occupancy during the measurement period. The number of licensed beds in a skilled nursing facility that are actually operational and available for occupancy may be less than the total official licensed bed capacity. This sometimes occurs due to the permanent dedication of bed space to alternative purposes, such as enhanced therapy treatment space or other desirable uses calculated to improve service offerings and/or operational efficiencies in a facility. In some cases, three- and four-bed wards have been reduced to two-bed rooms for resident comfort, and larger wards have been reduced to conform to changes in Medicare requirements. These beds are seldom expected to be placed back into service. We believe that reporting occupancy based on operational beds is consistent with industry practices and provides a more useful measure of actual occupancy performance from period to period. The following table summarizes our overall occupancy statistics for skilled nursing operations for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, Occupancy for transitional and skilled services: 2020 2019 2020 2019 Operational beds at end of period 22,991 21,080 22,991 21,080 Available patient days 2,113,808 1,921,608 6,268,801 5,549,222 Actual patient days 1,495,285 1,516,697 4,668,961 4,395,864 Occupancy percentage (based on operational beds) 70.7 % 78.9 % 74.5 % 79.2 % Segments We have one reportable segment, transitional and skilled services, which includes the operation of skilled nursing facilities. Our Chief Executive Officer, who is our chief operating decision maker, or CODM, reviews financial information at the operating segment level. We also report an “all other” category that includes revenue from our senior living operations, real estate properties, mobile diagnostics and other ancillary operations. These operations are neither significant individually nor in aggregate and therefore do not constitute a reportable segment. 45 Table of Contents Revenue Sources The following table sets forth our total revenue by payor source generated by our transitional and skilled services and our "Other" category and as a percentage of total revenue for the periods indicated (dollars in thousands): Three Months Ended September 30, Transitional and Skilled Services Other (1) Total 2020 2019 2020 2019 2020 2019 Medicaid $ 218,840 $ 202,665 $ 3,352 $ 3,280 $ 222,192 $ 205,945 Medicare 189,237 119,633 — — 189,237 119,633 Medicaid-skilled 38,232 34,080 — — 38,232 34,080 Subtotal 446,309 356,378 3,352 3,280 449,661 359,658 Managed care 87,648 88,542 — — 87,648 88,542 Private and other 36,427 41,053 25,519 22,856 61,946 63,909 Total revenue $ 570,384 $ 485,973 $ 28,871 $ 26,136 $ 599,255 $ 512,109 Medicaid 38.4 % 41.7 % 11.6 % 12.5 % 37.1 % 40.2 % Medicare 33.1 24.6 — — 31.6 23.4 Medicaid-skilled 6.7 7.0 — — 6.4 6.6 Subtotal 78.2 73.3 11.6 12.5 75.1 70.2 Managed care 15.4 18.2 — — 14.6 17.3 Private and other 6.4 8.5 88.4 87.5 10.3 12.5 Total revenue 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % (1) Private and other payors in our "all other" category includes revenue from rental income, senior living operations and all payors generated in our other ancillary operations. Nine Months Ended September 30, Transitional and Skilled Services Other (1) Total 2020 2019 2020 2019 2020 2019 Medicaid $ 662,733 $ 576,504 $ 9,773 $ 9,718 $ 672,506 $ 586,222 Medicare 519,865 355,141 — — 519,865 355,141 Medicaid-skilled 110,626 96,323 — — 110,626 96,323 Subtotal 1,293,224 1,027,968 9,773 9,718 1,302,997 1,037,686 Managed care 271,993 258,205 — — 271,993 258,205 Private and other 120,351 118,296 78,226 62,146 198,577 180,442 Total revenue $ 1,685,568 $ 1,404,469 $ 87,999 $ 71,864 $ 1,773,567 $ 1,476,333 Medicaid 39.3 % 41.0 % 11.1 % 13.5 % 37.9 % 39.7 % Medicare 30.8 25.3 — — 29.3 24.1 Medicaid-skilled 6.6 6.9 — — 6.3 6.5 Subtotal 76.7 73.2 11.1 13.5 73.5 70.3 Managed care 16.1 18.4 — — 15.3 17.5 Private and other 7.2 8.4 88.9 86.5 11.2 12.2 Total revenue 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % (1) Private and other payors in our "all other" category includes revenue from rental income, senior living operations and all payors generated in our other ancillary operations. 46 Table of Contents Transitional and Skilled Services Within our skilled nursing operations, we generate revenue from Medicaid, private pay, managed care and Medicare payors. We believe that our skilled mix, which we define as the number of days Medicare, managed care and other skilled patients are receiving services at our skilled nursing operations divided by the total number of days patients are receiving services at our skilled nursing operations, from all payor sources (less days from senior living services) for any given period, 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. We are participating in supplemental payment programs in various states that provide supplemental Medicaid payments for skilled nursing facilities that are licensed to non-state government-owned entities such as city and county hospital districts. Several of our operating subsidiaries entered into transactions with several such hospital districts providing for the transfer of the licenses for those skilled nursing facilities to the hospital districts. Each affected operating subsidiary agreement between the hospital district and our subsidiary is terminable by either party to fully restore the prior license status. Other Within our senior living operations, we generate revenue primarily from private pay sources, with a portion earned from Medicaid payors or through other state-specific programs. As part of, and subsequent to, the Spin-Off, we lease 31 of the 93 real estate properties owned by us to Pennant on a triple-net basis. Annual rental income generated from the leases with Pennant is approximately $14.0 million. In addition, we hold majority membership interests in our other ancillary operations. Payment for these services varies and is based upon the service provided. The payment is adjusted for an inability to obtain appropriate billing documentation or authorizations acceptable to the payor and other reasons unrelated to credit risk. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). The preparation of these financial statements and related disclosures requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we review our judgments and estimates, including but not limited to those related to the variable considerations to arrive at the transaction price for revenue recognition, income taxes, intangible assets and loss contingencies. We base our estimates and judgments upon our historical experience, knowledge of current conditions and our belief of what could occur in the future considering available information, including assumptions that we believe to be reasonable under the circumstances. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty, and actual results could differ materially from the amounts reported. While we believe that our estimates, assumptions, and judgments are reasonable, they are based on information available when the estimate was made. Refer to Note 2, Summary of Significant Accounting Policies , within the Condensed Consolidated Financial Statements for further information on our critical accounting estimates and policies, which are as follows: • Revenue recognition - the estimate of variable considerations to arrive at the transaction price, including methods and assumptions used to determine settlements with Medicare and Medicaid payors or retroactive adjustments due to audits and reviews; • Self-insurance - the valuation methods and assumptions used in estimating costs to settle open claims of insureds, as well as an estimate of the cost of insured claims that have been incurred but not reported; • Lease s - the incremental borrowing rate determination; • Acquisition accounting - the assumptions used to allocate the purchase price paid for assets acquired and liabilities assumed in connection with our acquisitions; and • Income taxes - the estimation of valuation allowance or the need for and magnitude of liabilities for uncertain tax position. 47 Table of Contents Industry Trends The post-acute care industry has evolved to meet the growing demand for post-acute and custodial healthcare services generated by an aging population, increasing life expectancies and the trend toward shifting patient care to lower cost settings. The industry has evolved in recent years, which we believe has led to a number of favorable improvements in the industry, as described below: • Shift of Patient Care to Lower Cost Alternatives . The growth of the senior population in the U.S. continues to increase healthcare costs, often faster than the available funding from government-sponsored healthcare programs. In response, federal and state governments have adopted cost-containment measures that encourage the treatment of patients in more cost-effective settings such as skilled nursing facilities, for which the staffing requirements and associated costs are often significantly lower than acute care hospitals and other post-acute care settings. As a result, skilled nursing facilities are generally serving a larger population of higher-acuity patients than in the past. • Significant Acquisition and Consolidation Opportunities . The skilled nursing industry is large and highly fragmented, characterized predominantly by numerous local and regional providers. Due to the increasing demands from hospitals and insurance carriers to implement sophisticated and expensive reporting systems, we believe this fragmentation provides us with significant acquisition and consolidation opportunities. • Improving Supply and Demand Balance . The number of skilled nursing facilities has declined modestly over the past several years. We expect that the supply and demand balance in the skilled nursing industry will continue to improve due to the shift of patient care to lower cost settings, an aging population and increasing life expectancies. • Increased Demand Driven by Aging Populations . As seniors account for an increasing percentage of the total U.S. population, we believe the demand for skilled nursing and senior living services will continue to increase. According to the census projection released by the U.S. Census Bureau in early 2020, between 2016 and 2030, the number of individuals over 65 years old is projected to be one of the fastest growing segments of the United States population, growing from 16% to 21%. The Bureau expects this segment to increase nearly 50% to 73 million, as compared to the total U.S. population which is projected to increase by 10% over that time period. Furthermore, the generation currently retiring has accumulated less savings than prior generations, creating demand for more affordable senior housing and skilled nursing services. As a high-quality provider in lower cost settings, we believe we are well-positioned to benefit from this trend. • Transition to Value-Based Payment Models . In response to rising healthcare spending in the United States, commercial, government and other payors are generally shifting away from fee-for-service payment models towards value-based models, including risk-based payment models that tie financial incentives to quality, efficiency and coordination of care. We believe that patient-centered outcomes driven reimbursement models will continue to grow in prominence. Many of our operations already receive value-based payments, and as valued-based payment systems continue to increase in prominence, it is our view that our strong clinical outcomes will be increasingly rewarded. • Accountable Care Organizations and Reimbursement Reform . A significant goal of U.S. federal health care reform is to transform the delivery of health care by changing reimbursement to reflect and support the quality and safety of care that providers deliver, increase efficiency, and reduce growth in spending. Reimbursement models that provide financial incentives to encourage efficiency, affordability, and high-quality care have been developed and implemented by government and commercial third-party payers. The most prolific of these models, the Accountable Care Organization (ACO) model, incentivizes groups of providers to share in savings that are achieved through the coordination of care and chronic disease management of an assigned patient population. Reimbursement methodology reform includes Value-Based Purchasing (VBP), in which a portion of provider reimbursement is redistributed based on relative performance, or improvement on designated economic, clinical quality, and patient satisfaction metrics. In addition, CMS has implemented Episode-based demonstration, voluntary and mandatory payment initiatives that bundle acute care and post-acute care reimbursement. These bundled payment models incentivize cross-continuum care coordination and include financial and performance accountability for episodes of care. These reimbursement methodologies and similar programs are likely to continue and expand, both in government and commercial health plans. Many of our operations already participate in ACOs. With our focus on quality care and strong clinical outcomes, Ensign is well-positioned to benefit from these outcome-based payment models. We believe the post-acute industry has been and will continue to be impacted by several other trends. The use of long-term care insurance is increasing among seniors as a means of planning for the costs of skilled nursing services. In addition, as a result of increased mobility in society, reduction of average family size, and the increased number of two-wage earner couples, more residents are looking for alternatives outside the family for their care. 48 Table of Contents Government Regulation General Healthcare is an area of extensive and frequent regulatory change. Changes in the law or new interpretations of existing laws may have a significant impact on our revenues, costs and the way we operate our business. Our subsidiaries that provide healthcare services are subject to federal, state and local laws relating to, among other things, licensure, delivery, quality and adequacy of care, physical plant requirements, life safety, personnel and operating policies. In addition, our provider subsidiaries are subject to federal and state laws that govern billing and reimbursement, relationships with vendors and business relationships with physicians. Such laws include the Anti-Kickback Statue, the federal False Claims Act (FCA), the Stark Law and state corporate practice of medicine statutes. Governmental and other authorities periodically inspect our skilled nursing facilities, senior living facilities and outpatient rehabilitation agencies to verify that we continue to comply with the applicable regulations and standards. We must pass these inspections to remain licensed under state laws and to comply with our Medicare and Medicaid provider agreements. We can only participate in these third-party payment programs if inspections by regulatory authorities reveal that our operations are in substantial compliance with applicable requirements. In the ordinary course of business, we may receive notices from federal or state regulatory authorities alleging deficiencies in certain regulatory practices. These statements of deficiency may require us to take corrective action to regain and maintain compliance. In some cases, federal or state regulators may impose other remedies including imposition of civil monetary penalties, temporary payment bans, loss of certification as a provider in the Medicare or Medicaid program, or revocation of a state operating license. We believe that the regulatory environment surrounding the healthcare industry subjects providers to intense scrutiny. In the ordinary course of business, providers are subject to inquiries, investigations and audits by federal and state agencies related to compliance with participation and payment rules under government payment programs. These inquiries may originate from the HHS Office of the Inspector General (OIG) audits, state Medicaid agencies, local and state ombudsman offices and CMS Recovery Audit Contractors, among other agencies. In response to the inquiries, investigations and audits, the federal and state governments continue to impose citations for regulatory deficiencies and other regulatory penalties, including demands for refund of overpayments, expanded Civil Money Penalties (CMPs) that extend over long periods of time and date back to incidents long before surveyor visits, Medicare and Medicaid payment bans and terminations from the Medicare and Medicaid programs. We vigorously contest these matters where appropriate; however, there are significant legal and other expenses involved that consume our financial and personnel resources. Expansion of enforcement activity could adversely affect our business, financial condition or the results of our operations. COVID-19 Temporary suspension of certain patient coverage criteria and documentation and care requirements - The CARES Act and a series of temporary waivers and guidance issued by the CMS suspend various Medicare patient coverage criteria as well as documentation and care requirements to provide regulatory relief to ensure patients continue to have adequate access to care notwithstanding the burdens placed on healthcare providers due to the COVID-19 pandemic. Examples of requirements that have been waived since the COVID-19 emergency declaration include the following: (1) approving temporary expansion sites to ensure that local hospitals and health systems have the capacity to handle a potential surge of COVID-19 patients ( e.g. CMS Hospital Without Walls); (2) removing barriers for physicians, nurses, and other clinicians to be readily hired from the community or from other states to allow healthcare systems to rapidly expands their workforce; (3) increasing access to telehealth and corresponding reimbursement through Medicare to ensure patients have access to healthcare while keeping patients safe at home; (4) expanding in-place COVID-19 testing to allow for more testing at home or in community based settings; and (5) temporarily waiving certain documentation, reporting and audit requirements to allow providers, health care facilities, Medicare Advantage and Part D plans, and states to focus on the provision of care (e.g., Patients Over Paperwork). Many states have also waived regulations to ease regulatory burdens on the healthcare industries. It remains uncertain when federal and state regulators will resume enforcement of those regulations which are waived or otherwise not being enforced during the public health emergency. We believe these regulatory actions could contribute to an increase in skilled mix that may not otherwise occur. 49 Table of Contents Pursuant to the Emergency Waivers, CMS also authorized temporary waivers on medical review requirements, effective March 1, 2020, for the duration of the public health emergency. CMS is also pausing standard medical review activities, including prior authorization and other reviews that require providers to provide certain types of documentation. In addition, CMS is re-prioritizing scheduled program audits and contract-level Risk Adjustment Data Validation audits for MA organizations, Part D sponsors, Medicare-Medicaid Plans, and Programs of All-Inclusive Care for the Elderly organizations. Re-prioritizing these audit activities will allow providers, CMS and the organizations to focus on patient care. In July 2020, CMS updated their COVID-19 Provider Burden Relief Frequently Asked Questions (FAQs) related to claim audit waivers for multiple services. On March 30, 2020, CMS suspended most Medicare Fee-For-Service (FFS) medical review because of the COVID-19 pandemic. This included pre-payment medical reviews conducted by Medicare Administrative Contractors (MACs) under the Targeted Probe and Educate program, and post-payment reviews conducted by the MACs, Supplemental Medical Review Contractor (SMRC) reviews and Recovery Audit Contractor (RAC). CMS expects to resume these audit activities beginning on August 3, 2020, regardless of the status of the public health emergency. All reviews will be conducted in accordance with statutory and regulatory provisions, as well as related billing and coding requirements. Available waivers and flexibilities for the claims selected for review will also be applied. Under the Emergency Waivers, CMS is also allowing skilled nursing facilities to provide a “skill-in-place” (SIP) program for Medicare beneficiaries who are residents of the skilled nursing facilities that meet the SIP criteria, foregoing the usual 3-day qualifying hospital stay. As patients qualify for SIP for Medicare Part A stays, we could see a decrease in long-term care Medicare Part B PT, OT, SLP program. This waiver remains valid for the duration of the COVID-19 public health emergency. On August 24, 2020, CMS released a Medicaid Informational Bulletin providing guidance to states on flexibilities that are available to increase reimbursement for nursing facilities implementing specific infection control practices. Resuming visitation and resident rights. CMS has issued guidance to facilities throughout the public health emergency regarding patients’ rights to visitors. In March 2020, CMS issued guidance that facilities restrict visitation to only compassionate care situations. Then, in May 2020, CMS issued guidance for facilities to follow based upon local phases of reopening. In June 2020, CMS expanded on alternative modes of visitation including outdoor visits, compassionate care situations, and communal activities. Most recently, in September 2020, CMS issued guidance on reasonable ways in which nursing facilities can safely facilitate in-person visitation to address the psychosocial needs of residents. In this guidance, CMS indicated that a facility’s failure to facilitate visitation, without adequate reason related to clinical necessity or resident safety, could result in citations for violating resident rights. Testing requirements Beginning in April 2020, authorities in several states in which we operate began to mandate widespread COVID-19 testing at all nursing home and long-term care facilities. This came after the CDC stated that older adults are at a higher risk for serious illness from the coronavirus and issued updated testing guidelines for nursing homes. On July 22, 2020, CMS announced that nursing homes in states with a 5% or greater positivity rate for COVID-19 will be required to test all nursing home staff each week. On August 26, 2020, CMS issued new parameters for testing, requiring routine monthly testing of all facility staff if the facility’s county positivity rate is less than 5%; weekly testing if the county positivity rate is between 5-10%; and twice weekly testing if the county positivity rate exceeds 10%. These testing requirements are in addition to obligations to screen staff each shift, residents daily, and all persons entering the facility for signs and symptoms of COVID-19. Facilities must test any staff or resident who has signs or symptoms of COVID-19. In the event of a COVID-19 outbreak in the facility, all staff and residents must be tested at regular intervals until testing identifies no new cases of COVID-19 infection among staff or residents for a 14-day period. In addition to CMS's testing mandates, some states have imposed their own testing requirements for residents and staff. Non-compliance with state or federal mandates may result in imposition of fines or other administrative action, including license revocation. 50 Table of Contents Reporting requirements Effective May 8, 2020, CMS published an interim final rule requiring skilled nursing facilities to report information related to COVID-19 cases among facility residents and staff directly to the CDC Health Safety Network no less than weekly. In addition, skilled nursing facilities are required to inform residents, their families and representatives of confirmed or suspected COVID-19 cases in their facilities. This notification is required to take place by 5:00 p.m. (local time) the next calendar day following the occurrence of: (1) a single confirmed infection of COVID-19, or (2) three or more residents or staff with new-onset of respiratory symptoms that occur within 72 hours of one another. CMS is making this data collected under this mandate publicly available on a dedicated website. There could be civil monetary penalties for not meeting these reporting requirements. We do not believe these reporting requirements will have a material impact on our Condensed Consolidated Financial Statements. Survey Activity and Enforcement. On March 20, 2020, CMS announced the initiation of focused infection control surveys intended to assess long-term care facility compliance with infection control requirements in connection with the COVID-19 pandemic. CMS prioritized infection control surveys over annual recertification and complaint surveys at the non-immediate jeopardy level, confirming its commitment to infection prevention and control in the skilled nursing industry. Effective August 17, 2020, CMS provided guidance authorizing resumption of traditional survey activity. On June 1, 2020, CMS introduced an enhanced enforcement program with respect to infection control deficiencies. The program contemplates more significant remedies against facilities with a prior history of infection control deficiencies, and imposes more stringent penalties with deficiencies identified at a higher scope and severity. The spectrum of remedies available to CMS for imposition on skilled nursing facilities in connection with this enhancement includes increased monetary fines, shortened time periods to return to compliance, and other administrative penalties. Independent Commission on Safety and Quality in Nursing Homes. On April 30, 2020, CMS announced that it would be convening an independent commission to conduct comprehensive assessments of nursing home responses to the COVID-19 pandemic. This Commission on Safety and Quality in Nursing Homes (Commission) was intended to identify opportunities for improvement to inform immediate and future actions. On September 16, 2020, the Commission issued its final report and recommendations to CMS. Based upon these recommendations, CMS may implement additional measures to combat COVID-19 in nursing facilities. Medicare Medicare presently accounts for approximately 30.8% of our transitional and skilled nursing services year-to-date revenue, being our second-largest payor. The Medicare program and its reimbursement rates and rules are subject to frequent change. These include statutory and regulatory changes, rate adjustments (including retroactive adjustments), administrative or executive orders and government funding restrictions, all of which may materially adversely affect the rates at which Medicare reimburses us for our services. Budget pressures often lead the federal government to reduce or place limits on reimbursement rates under Medicare. Implementation of these and other types of measures has in the past, and could in the future, result in substantial reductions in our revenue and operating margins. Patient-Driven Payment Model (PDPM) The Skilled Nursing Facility Prospective Payment System (SNF PPS) Rule was effective October 1, 2019. The SNF PPS Rule includes a new case-mix model that focuses on the patient’s condition and resulting care needs (clinically relevant factors), rather than on the volume of care provided, to determine Medicare reimbursement. The case mix-model is called the Patient-Driven Payment Model (PDPM), which utilizes clinically relevant factors for determining Medicare payment by using ICD-10 diagnosis codes and other patient characteristics as the basis for patient classification. PDPM utilizes five case-mix adjusted payment components: physician therapy (PT), occupational therapy (OT), speech language pathology (SLP), nursing and social services (nursing) and non-therapy ancillary services (NTA). It also uses a sixth non-case mix component to cover utilization of skilled nursing facilities resources that do not vary depending on resident characteristics. 51 Table of Contents PDPM replaces the existing case-mix classification methodology, Resource Utilization Groups, Version IV (RUG-IV). The structure of PDPM moves Medicare towards a more value-based, unified post-acute care payment system. For example, PDPM adjusts Medicare payments based on each aspect of a resident’s care, thereby more accurately addressing costs associated with medically complex patients. PDPM also removes therapy minutes as the basis for therapy payment. Finally, PDPM adjusts the skilled nursing facilties per diem payments to reflect varying costs throughout the stay, through the PT, OT and NTA components. In addition, PDPM is intended to reduce paperwork requirements for performing patient assessments. Under the new SNF PPS PDPM system, the payment to skilled nursing facilities and nursing homes is based heavily on the patient’s condition rather than the specific services provided by each skilled nursing facility. Skilled Nursing Facility - Quality Reporting Program (SNF QRP) The Improving Medicare Post-Acute Care Transformation Act of 2014 (IMPACT Act) imposed new data reporting requirements for certain Post-Acute-Care (PAC) providers. The IMPACT Act requires that each skilled nursing facility submit their quality measures data. Beginning with fiscal year 2018, and each subsequent year, if a skilled nursing facility does not submit required quality data, their payment rates are reduced by 2.0% for that fiscal year. Application of the 2.0% reduction may result in payment rates for a fiscal year being less than the preceding fiscal year. In addition, reporting-based reductions to the market basket increase factor will not be cumulative; they will only apply for the fiscal year involved. A skilled nursing facility will receive a notification letter from its Medicare administrator contractor if it was non-compliant with the Quality Reporting Program reporting requirements and is subject to the payment reduction. Updated performance measures mandated for the SNF QRP for fiscal year 2020 were established in the final SNF PPS rule adopted on August 8, 2019 (FY 2020 SNF PPS Rule). The final rule continues implementation of the SNF QRP measures to improve program interoperability, operational quality and safety. Specifically, the rule adopts a number of standardized patient assessment data elements. The SNF QRP applies to freestanding skilled nursing facilities, skilled nursing facilities affiliated with acute care facilities, and all non-critical access hospital swing-bed rural hospitals. Under the SNF QRP, a skilled nursing facility’s annual market basket percentage is reduced by 2.0% if the skilled nursing facility does not submit quality measure data in accordance with thresholds set by the IMPACT Act. Skilled nursing facilities that do not meet the SNF QRP requirements for a program year will receive a notice of non-compliance. Beginning in March 2020, due to the COVID-19 pandemic, CMS issued a temporary suspension of QRP reporting requirements effective until June 30, 2020. This effectively allowed skilled nursing facilities discretion as to whether to report data from the fourth quarter (October 1, 2019 – December 31, 2019), and removed reporting requirements entirely for the first and second quarters of 2020 (January 1, 2020 – June 30, 2020). Skilled nursing facilities were required to resume timely quality data collection and submission of measure and patient assessment data effective June 30, 2020. Medicare Annual Market Basket Current law requires CMS to calculate an annual Medicare market basket update to the payment rates. On July 31, 2020, CMS issued a final rule for fiscal year 2021 that updates the Medicare payment rates and the quality programs for skilled nursing facilities. Under the final rule, effective October 1, 2020, the aggregate payments to skilled nursing facilities increase by 2.2% for fiscal year 2021, compared to fiscal year 2020. This estimated increase is attributable to a 2.2% market basket increase factor with a 0.0% point reduction for multifactor productivity adjustment. Sequestration of Medicare Rates The Budget Control Act of 2011 requires a mandatory, across the board reduction in federal spending, called a sequestration. Medicare Fee-For-Service (FFS) claims with dates of service or dates of discharge on or after April 1, 2013 incur a 2.0% reduction in Medicare payments. All Medicare rate payments and settlements have incurred this mandatory reduction and it will continue to be in place through at least 2023, unless Congress takes further action. In response to COVID-19, the CARES Act temporarily suspended the automatic 2.0% reduction of Medicare claim reimbursements for the period of May 1, 2020 through December 31, 2020. 52 Table of Contents Skilled Nursing Facility Value-Based Purchasing (SNF-VBP) Program The SNF-VBP Program rewards skilled nursing facilities with incentive payments based on the quality of care they provide to Medicare beneficiaries, as measured by a hospital readmissions measure. CMS annually adjusts its payment rules for skilled nursing facilities using the SNF-VBP Program. Effective October 1, 2018, CMS began withholding 2.0% to fund the SNF-VBP incentive payment pool and will redistribute 60% of the withheld payments back to skilled nursing facilities through the program. The FY 2020 SNF PPS Rules estimate an economic impact of the SNF-VBP Program to be a reduction of $213.6 million in aggregate payments to skilled nursing facilities during fiscal year 2020. The Rule also introduced two new quality measures to assess how health information is shared and adopted a number of standardized patient assessment data elements that assess factors such as cognitive function and mental status, special services, and social determinants of health. Part B Rehabilitation Requirements Some of our revenue is paid by the Medicare Part B program under a fee schedule. Part B services are limited with a payment cap by combined speech-language pathology services (SLP) and physical therapy (PT) services and a separate annual cap for OT services. These caps were implemented under the authority of the Balanced Budget Amendments of 1997. For PT and SLP combined, the limit on incurred expenses is $2,080 for 2020 compared to $2,040 in 2019. The cap limit is the same for occupational therapy (OT) services. On multiple occasions during the past two decades, Congress has interceded to suspend the “therapy caps” offering an “exceptions process” so claims in excess of the annualized cap can be processed. The Deficit Reduction Act of 2005 (DRA) added Section 1833(g)(5) of the Social Security Act and directed CMS to develop a process that allows exceptions for Medicare beneficiaries to therapy caps when continued therapy is deemed medically necessary. Specifically, the Middle Class Tax Relief and Job Creation Act of 2012 extended the therapy exceptions process but added a second tier cap mandating manual medical review (MMR) for claims submitted that exceeded $3,700 for PT and SLP services combined and another threshold of $3,700 for OT services. On April 16, 2015, President Obama signed MACRA into law. MACRA authorized payment reforms for physicians and other professional services, including the three rehabilitative therapies, included provisions not only stabilizing the professional fee schedules, but also extending the therapy cap exceptions process through December 31, 2017. On February 9, 2018, the Bipartisan Budget Act of 2018 was signed into law, which provides for the repeal of all therapy caps retroactively to January 1, 2018. The law retained the MMR process for claims over the threshold, but reduced the claim threshold to $3,000. Consistent with CMS’ “Patients over Paperwork” initiative, the agency has also been moving toward eliminating burdensome claims-based functional reporting requirements for Part B therapy services. For example, beginning in January 2019, skilled nursing facilities are no longer required to append selected G-codes or the severity modifiers on outpatient therapy claims. This reduces the reporting burden on therapists providing outpatient services and increase the amount of time that therapists can spend with their patients. On November 1, 2019, CMS issued the calendar year 2020 Physician Fee Schedule Final Rule establishing that therapy assistant claim modifiers will be required starting in calendar year 2020. This rule is consistent with the requirement of the Balanced Budget Act (BBA) of 2018, which requires a 15% payment reduction when a physical therapist assistant (PTA) or occupational therapy assistant (OTA) provides services “in whole or in part” on a given day. While the modifiers are required to be applied to the claims beginning in calendar year 2020, the 15% therapist assistant payment reduction will not be applied until calendar year 2022. The final rule clarified that “in whole or in part” means when 10% or more of the services are provided by a PTA or OTA. The FY 2020 Physician Fee Schedule (PFS), indicates that there will be no decrease in physical and occupational therapy code payments in 2020. However, in the proposed and final FY 2020 PFS, CMS also indicated its intent to make changes to reimbursement rates that would become effective January 1, 2021. The FY 2021 PFS Proposed Rule was released on August 17, 2020, which proposed to reduce the conversion factor (i.e., the number by which CMS determines all current procedural terminology code payments) by 10.61%. These changes, if finalized in the fiscal year 2021 PFS Rule, will effectively lower the reimbursement rate for therapy Medicare Part B specialty providers; specific to our industry, by 9%. 53 Table of Contents The Multiple Procedure Payment Reduction (MPPR) continues at a 50% reduction, which is applied to therapy procedures by reducing payments for practice expense of the second and subsequent procedures when services provided beyond one unit of one procedure are provided on the same day. The implementation of MPPR includes (1) facilities that provide Medicare Part B speech-language pathology, occupational therapy, and physical therapy services and bill under the same provider number; and (2) providers in private practice, including speech-language pathologists, who perform and bill for multiple services in a single day. On May 27, 2020, pursuant to its authority under the Emergency Waivers, CMS added physical therapy, occupational therapy and speech-language pathology to list of approved telehealth Providers for the Medicare Part B programs provided by a skilled nursing facility. This waiver allows the reimbursement of certain HCPCS codes delivered by PT, OT, SLP through telehealth. The reimbursement follows the existing physician fee screen reimbursement through the duration of the public health emergency. These services have been used to provide some services to community based outpatients from our skilled nursing facilities that are eligible through local rules to provide community-based outpatient services. Eligible PT, OT, SLP services delivered through telehealth to long-term care residents, when the local COVID-19 quarantine requirements suggest provision of PT, OT, SLP services through alternative means, are also reimbursed per the waiver. The waivers covering the COVID exceptions, including the provision of telehealth services, will remain in effect through the end of the emergency declaration. Pursuant to the Emergency Waivers, CMS is allowing for the facility to bill an originating site fee to CMS for telehealth services provided to Medicare Part B beneficiary residents of the facility when the services are provided by a physician from an alternate location, effective March 6, 2020 through the end of the public health emergency. Our facilities are utilizing this waiver as physicians elect to provide telehealth visits to Medicare Part B beneficiaries residing in the skilled nursing facility. Programs of All-Inclusive Care for the Elderly CMS issued a final rule on June 3, 2019, which updates the requirements for the Programs of All-Inclusive Care for the Elderly (PACE) under the Medicare and Medicaid programs. The regulation is intended to provide greater operational flexibility, remove redundancies and outdated information and codify existing programs. Such flexibility includes, (i) more lenient standards applicable to the current requirement that the PACE organization be monitored for compliance with the PACE program requirements during and after a 3-year trial period and (ii) relieving certain restrictions placed upon the interdisciplinary team that comprehensively assesses and provides for the individual needs of each PACE participant by allowing one person to fill two roles and permitting secondary participation in the PACE program. Further, non-physician primary care providers can provide certain services in place of primary care physicians. Preadmission Screening and Resident Review (PASRR) On February 20, 2020, CMS published a proposed rule which would modernize requirements for the Preadmission Screening and Resident Review (PASRR) process. This process assesses the needs of individuals with mental illness or intellectual disability that are applying to or residing in Medicaid-certified nursing facilities. The proposed rule, if enacted as currently drafted, would impose additional resident review requirements that are not reflected in current regulations, authorize the use of telehealth, and simplify the list of information that must be collected during evaluations. Decisions Regarding Skilled Nursing Facility Payment It is important to understand the Medicare program and that its reimbursement rates and rules are subject to frequent change. Historically, adjustments to reimbursement under Medicare have had a significant effect on our revenue. The federal government and state governments continue to focus on efforts to curb spending on healthcare programs such as Medicare and Medicaid. We are not able to predict the outcome of the legislative process. We also cannot predict the extent to which proposals will be adopted or, if adopted and implemented, what effect, if any, such proposals and existing new legislation will have on us. Efforts to impose reduced allowances, greater discounts and more stringent cost controls by government and other payors are expected to continue and could adversely affect our business, financial condition and results of operations. 54 Table of Contents These include statutory and regulatory changes, rate adjustments (including retroactive adjustments), administrative or executive orders and government funding restrictions, all of which may materially adversely affect the rates at which Medicare reimburses us for our services. Budget pressures often lead the federal government to reduce or place limits on reimbursement rates under Medicare. Implementation of these and other types of measures has in the past, and could in the future, result in substantial reductions in our revenue and operating margins. For a discussion of historic adjustments and recent changes to the Medicare program and related reimbursement rates, see Part II, Item 1A Risk Factors under the headings Risks Related to Our Business and Industry - “O ur revenue could be impacted by federal and state changes to reimbursement and other aspects of Medicaid and Medicare,” “Our future revenue, financial condition and results of operations could be impacted by continued cost containment pressures on Medicaid spending,” “We may not be fully reimbursed for all services for which each facility bills through consolidated billing, which could adversely affect our revenue, financial condition and results of operations ” and “ Reforms to the U.S. healthcare system will impose new requirements upon us and may lower our reimbursements. ” Patient Protection and Affordable Care Act Various healthcare reform provisions became law upon enactment of the Patient Protection and Affordable Care Act and the Healthcare Education and Reconciliation Act (collectively, the ACA). The reforms contained in the ACA have affected our operating subsidiaries in some manner and are directed in large part at increased quality and cost reductions. Several of the reforms are very significant and could ultimately change the nature of our services, the methods of payment for our services and the underlying regulatory environment. These reforms include modifications to the conditions of qualification for payment, bundling of payments to cover both acute and post-acute care and the imposition of enrollment limitations on new providers. The recent congressional elections in the United States and policies implemented by the current administration have resulted in significant changes in legislation, regulation, implementation of Medicare and/or Medicaid, and government policy, but the upcoming 2020 presidential and congressional elections could significantly alter the current regulatory framework and impact our business and the health care industry. We continually monitor these developments so we can respond to the changing regulatory environment impacting our business. Requirements of Participation CMS has requirements that providers, including skilled nursing facilities and other long-term care (LTC) facilities must meet in order to participate in the Medicare and Medicaid Programs. Some requirements can be burdensome and costly, and in recent years, CMS has modified these requirements. For example, in 2016 CMS instituted new requirements, to be met in three phases. The first phase was effective November 28, 2016, the second phase was effective November 28, 2017 and the third phase became effective November 28, 2019 (despite recent proposals to delay implementation of specific portions of the rule). Additionally, beginning in 2016, skilled nursing facilities were required to comply with emergency preparedness requirements, which requirements have since been strengthened via promulgation of additional rules. Another relevant change is a 2019 final rule that removed the prohibition on the use of pre-dispute, binding arbitration agreements by LTC facilities. The rule imposed specific requirements on the use of these agreements, including requiring the use of plain language in drafting; that facilities post a notice in plain language that describes the policy on the use of agreements for binding arbitration in an area that is visible to residents and visitors; that admission to the facility not be conditioned on the signing of an arbitration agreement; and that the facility explicitly inform the resident or his or her representative of the right not to sign the agreement as a condition of admission. 55 Table of Contents Civil and Criminal Fraud and Abuse Laws and Enforcement Various complex federal and state laws exist which govern a wide array of referrals, relationships and arrangements, and prohibit fraud by healthcare providers. Governmental agencies are devoting increasing attention and resources to such anti-fraud efforts. The Health Insurance Portability and Accountability Act of 1996 (HIPAA), and the Balanced Budget Act of 1997 (BBA) expanded the penalties for healthcare fraud. Additionally, in connection with our involvement with federal healthcare reimbursement programs, the government or those acting on its behalf may bring an action under the False Claims Act (FCA), alleging that a healthcare provider has defrauded the government by submitting a claim for items or services not rendered as claimed, which may include coding errors, billing for services not provided, and submitting false or erroneous cost reports. The Fraud Enforcement and Recovery Act of 2009 (FERA) expanded the scope of the FCA by, among other things, creating liability for knowingly and improperly avoiding repayment of an overpayment received from the government and broadening protections for whistleblowers. The FCA clarifies that if an item or service is provided in violation of the Anti-Kickback Statute, the claim submitted for those items or services is a false claim that may be prosecuted under the FCA as a false claim. CMPs under the FCA range from approximately $11,665 to $23,331 and are adjusted each January for inflation. Under the qui tam or “whistleblower” provisions of the FCA, a private individual with knowledge of fraud may bring a claim on behalf of the federal government and receive a percentage of the federal government’s recovery. Due to these whistleblower incentives, lawsuits have become more frequent. Many states also have a false claim prohibition that mirrors or tracks the federal FCA. Federal law also provides that OIG has the authority to exclude individuals and entities from federally funded health care programs on a number of grounds, including, but not limited to, certain types of criminal offenses, licensure revocations or suspensions, and exclusion from state or other federal healthcare programs. And, CMS can recover overpayments from health care providers up to five years following the year in which payment was made. In November 2019, the OIG released a report of its investigation into overpayments to hospitals that did not comply with Medicare’s post-acute-care transfer policy. Hospitals violating this policy transferred patients to certain post-acute-care settings, such as skilled nursing facilities, but claimed the higher reimbursements associated with discharges to homes. A similar OIG audit report, released in February 2019, focused on improper payments for skilled nursing facility services when the Medicare 3-day inpatient hospital stay requirement was not met. These investigatory actions by OIG demonstrate their increased scrutiny into post-hospital skilled nursing facility care provided to beneficiaries and may encourage additional oversight or stricter compliance standards. On numerous occasions, CMS has indicated its intent to vigilantly monitor overall payments to skilled nursing facilities, paying particular attention to facilities that have high reimbursements for ultra-high therapy, therapy resource utilization groups with higher activities of daily living scores, and long average lengths of stay. The OIG recognizes that there is a strong financial incentive for facilities to bill for higher levels of therapies, even when not needed by patients. We cannot predict the extent to which the OIG's recommendations to CMS will be implemented and, what effect, if any, such proposals would have on us. Our business model, like those of some other for-profit operators, is based in part on seeking out higher-acuity patients whom we believe are generally more profitable, and over time our overall patient mix has consistently shifted to higher-acuity in most facilities we operate. We also use specialized care-delivery software that assists our caregivers in more accurately capturing and recording services in order to, among other things, increase reimbursement to levels appropriate for the care actually delivered. These efforts may place us under greater scrutiny with the OIG, CMS, our fiscal intermediaries, recovery audit contractors and others. Federal Health Care Reform On October 30, 2015, CMS released a final rule addressing, among other things, implementation of certain provisions of MACRA, which changes the way physicians are paid who participate in Medicare through implementation of the Quality Payment Program (QPP). QPP creates two tracks for physician payment: (1) the Merit-Based Incentive Payment System (MIPS) that streamlines multiple quality programs; and (2) Alternative Payment Models (APMs) that give bonus payments for participation in eligible APMs. The current Value-Based Payment Modifier program expired at the end of 2018 (CY 2018 will be the final payment adjustment period under the Value-Based Payment Modifier), with the first MIPS adjustments began in 2019. The October 30, 2015 final rule added measures where gaps exist in the current Physician Quality Reporting System (PQRS), which is used by CMS to track the quality of care provided to Medicare beneficiaries. The final rule also excludes services furnished in skilled nursing facilities from the definition of primary care services for purposes of the Shared Savings Program. The rule may have an impact on our revenue in the future. 56 Table of Contents Additionally, in 2015, CMS began implementing a series of changes to the Five-Star Quality Rating system that have made it more difficult for facilities to achieve the highest ratings. These changes have included, among other things: • In 2015, changes include the use of antipsychotics in calculating the star ratings, modified calculations for staffing levels and reflect higher standards for nursing homes to achieve a high rating on the quality measure dimension. • In 2016, the addition of six new quality measures to the Nursing Home Five-Star Quality Ratings, including the rate of hospitalization, emergency room use, community discharge, improvements in function, independently worsened and anxiety or hypnotic medication among nursing home residents. • In 2018, (i) a freeze of the Health Inspection Five Star Ratings; (ii) the addition of Payroll Based Journals (PBJ) data to calculate the staffing ratings in the Nursing Home Five Star Quality Rating System; and (iii) the addition of two claims data measures: Medicare spending per beneficiary and rate of successful return to home or community from a skilled nursing facility for quality measures. • In 2019, (i) the addition of separate ratings for short stay and long stay care; (ii) changes in staffing thresholds; and (iii) modifications to put more emphasis on registered nurse (RN) staffing, including a set rating for nursing homes that report four or more days in the quarter with no RN on site. • In 2020, in response to COVID-19 pandemic, a freeze of Skilled Nursing Facilities Quality Reporting Program data on the Nursing Home Compare website after the October 2020 refresh until April 2022. CMS predicted that the 2019 changes would result in 47% of all nursing centers to lose stars in their "Quality" ratings, 33% to lose stars in their "Staffing" ratings and some 36% to lose stars in their "Overall" ratings. Unsurprisingly, these changes resulted in a reduction in Ensign’s number of facilities with four or five-star ratings in 2019. Additionally, on October 7, 2019, CMS announced it will begin increasing quality measure thresholds by 50% of the average rate of improvement of QM scores every six months, beginning in April 2020. This means if there is an average rate of improvement of 2%, the quality measure threshold will be raised 1%. This frequent adjustment is intended to avoid larger adjustments to thresholds in the future. However, CMS acknowledges that some facilities may see a decline in their overall five-star rating absent any new inspection information. This change could further affect star ratings across the industry. On April 27, 2016, CMS added six new quality measures to its consumer-based Nursing Home Compare website. These quality measures include the rate of rehospitalization, emergency room use, community discharge, improvements in function, independent worsening of ability to move, and use antianxiety or hypnotic medication among nursing home residents. Beginning in July 2016, CMS incorporated all these measures, except for the antianxiety/hypnotic medication measure, into the calculation of the Nursing Home Five-Star Quality Ratings. In 2018, CMS added PBJ data to be used to calculate the staffing ratings in the Nursing Home Five Star Quality Rating System. In 2019, CMS updated thresholds for assigning stars for both the staffing and quality components of the system and added measures of long-stay hospitalizations and long-stay ED visits were added to the quality measure rating. Since the standards for performance are more difficult to achieve, the number of our 4 and 5-star facilities could be reduced. Additionally, in April of 2019, CMS announced a new framework for informing CMS’s work related to the safety and quality in America’s nursing homes. The approach includes the following pillars: Strengthening Oversight, Enhancing Enforcement, Increasing Transparency, Improving Quality, and Putting Patients over Paperwork. As part of the Transparency Pillar, beginning on October 23, 2019 on the Nursing Home Compare website, CMS began displaying a consumer alert icon next to nursing homes that have been cited for incidents of abuse, neglect, or exploitation. The icon will be updated monthly, at the same time CMS inspection results are updated. In February 2020, CMS announced that part of its Enhancing Enforcement efforts would include improved oversight of state survey agencies (SSA) and revisions to the State Performance Standards System, which is the program used to access SSA performance. In responding to the COVID-19 pandemic, CMS announced a new, targeted inspection plan to focus on urgent patient safety threats and infection control, therefore causing a shift in the number of nursing homes inspected and how the inspections are conducted. As this change would disrupt the inspection domain of the Nursing Home Five Star Quality Rating System, results of inspections conducted on or after March 4, 2020 will not be used to calculate a nursing home’s health inspection star ratings. In addition, on June 25, 2020, CMS announced that beginning July 29, 2020, data used to calculate measures in the Five Star Quality ratings system will be frozen based on the data collection period ending December 31, 2019 so as to exclude data from resident assessments that are impacted by the waiver associated with the public health emergency. 57 Table of Contents Another COVID-19 impact to the Nursing Home Five-Star Quality Rating System is CMS’s decision to make QRP reporting optional for the fourth quarter of 2019 and excepted for the first and second quarters of 2020. Due to the gap in reported QRP data, CMS is freezing the data on the Nursing Home Compare website beginning October 2020 through April 2022. This will impact facilities’ that may have less favorable data in October 2020 from being able to demonstrate improvements on the public-facing website through mid-2022. Monitoring Compliance in Our Facilities Governmental agencies and other authorities periodically inspect our facilities to assess our compliance with various standards, rules and regulations. The robust regulatory and enforcement environment continues to impact healthcare providers, especially in connection with responses to any alleged noncompliance identified in periodic surveys and other inspections by governmental authorities. Unannounced surveys or inspections generally occur at least annually and may also follow a government agency's receipt of a complaint about a facility. We must pass these inspections to maintain our licensure under state law, to obtain or maintain certification under the Medicare and Medicaid programs, to continue participation in the Veterans Administration (VA) program at some facilities, and to comply with our provider contracts with managed care clients at many facilities. From time to time, we, like others in the healthcare industry, may receive notices from federal and state regulatory agencies alleging that we failed to substantially comply with applicable standards, rules or regulations. These notices may require us to take corrective action, may impose civil monetary penalties for noncompliance, and may threaten or impose other operating restrictions on skilled nursing facilities such as admission holds, provisional skilled nursing license or increased staffing requirements. If our facilities fail to comply with these directives or otherwise fail to comply substantially with licensure and certification laws, rules and regulations, we could lose our certification as a Medicare or Medicaid provider, or lose our state licenses to operate the facilities. Facilities with otherwise acceptable regulatory histories generally are normally given an opportunity to correct deficiencies and continue their participation in the Medicare and Medicaid programs by a certain date, usually within nine months, although where denial of payment remedies are asserted, such interim remedies go into effect much sooner. Facilities with deficiencies that immediately jeopardize patient health and safety and those that are classified as poor performing facilities, however, are not generally given an opportunity to correct their deficiencies prior to the imposition of remedies and other enforcement actions. Moreover, facilities with poor regulatory histories continue to be classified by CMS as poor performing facilities notwithstanding any intervening change in ownership, unless the new owner obtains a new Medicare provider agreement instead of assuming the facility's existing agreement. However, new owners (including us, historically) nearly always assume the existing Medicare provider agreement due to the difficulty and time delays generally associated with obtaining new Medicare certifications, especially in previously certified locations with sub-par operating histories. Accordingly, facilities that have poor regulatory histories before we acquire them and that develop new deficiencies after we acquire them are more likely to have sanctions imposed upon them by CMS or state regulators. In addition, CMS has increased its focus on facilities with a history of serious quality of care problems through the special focus facility initiative. A facility's administrators and owners are notified when it is identified as a special focus facility. This information is also provided to the general public. The special focus facility designation is based in part on the facility's compliance history typically dating before our acquisition of the facility. Local state survey agencies recommend to CMS that facilities be placed on special focus status. A special focus facility receives heightened scrutiny and more frequent regulatory surveys. Failure to improve the quality of care can result in fines and termination from participation in Medicare and Medicaid. A facility “graduates” from the program once it demonstrates significant improvements in quality of care that are continued over time. Moreover, sanctions such as denial of payment for new admissions often are scheduled to go into effect before surveyors return to verify compliance. Generally, if the surveyors confirm that the facility is in compliance upon their return, the sanctions never take effect. However, if they determine that the facility is not in compliance, the denial of payment goes into effect retroactive to the date given in the original notice. This possibility sometimes leaves affected operators, including us, with the difficult task of deciding whether to continue accepting patients after the potential denial of payment date, thus risking the retroactive denial of revenue associated with those patients' care if the operators are later found to be out of compliance, or simply refusing admissions from the potential denial of payment date until the facility is actually found to be in compliance. In the past and from time to time, some of our affiliated facilities have been or will be in denial of payment status due to findings of continued regulatory deficiencies, resulting in an actual loss of the revenue associated with the Medicare and Medicaid patients admitted after the denial of payment date. Additional sanctions could ensue and, if imposed, these sanctions, entailing various remedies up to and including decertification. 58 Table of Contents CMS has undertaken several initiatives to increase or intensify Medicaid and Medicare survey and enforcement activities, including federal oversight of state actions. CMS is taking steps to focus more survey and enforcement efforts on facilities with findings of substandard care or repeat violations of Medicaid and Medicare standards, and to identify multi-facility providers with patterns of noncompliance. In addition, HHS has adopted a rule that requires CMS to charge user fees to healthcare facilities cited during regular certification, recertification or substantiated complaint surveys for deficiencies, which require a revisit to assure that corrections have been made. CMS is also increasing its oversight of state survey agencies and requiring state agencies to use enforcement sanctions and remedies more promptly when substandard care or repeat violations are identified, to investigate complaints more promptly, and to survey facilities more consistently. Regulations Regarding Financial Arrangements We are also subject to federal and state laws that regulate financial arrangement by healthcare providers, such as the federal and state anti-kickback laws, the Stark laws, and various state anti-referral laws. The Anti-Kickback Statute, Section 1128B of the Social Security Act (the Anti-Kickback Statute or AKS) prohibits the knowing and willful offer, payment, solicitation, or receipt of any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, to induce the referral of an individual, in return for recommending, or to arrange for, the referral of an individual for any item or service payable under any federal healthcare program, including Medicare or Medicaid. The OIG has issued regulations that create “safe harbors” for certain conduct and business relationships that are deemed protected under the Anti-Kickback Statute. In order to receive safe harbor protection, all of the requirements of a safe harbor must be met. The fact that a given business arrangement does not fall within one of these safe harbors, however, does not render the arrangement per se illegal. Business arrangements of healthcare service providers that fail to satisfy the applicable safe harbor criteria, if investigated, will be evaluated based upon all facts and circumstances and risk increased scrutiny and possible sanctions by enforcement authorities. Violations of the federal anti-kickback laws can result in criminal penalties of up to $100,000 and ten years' imprisonment. Violations of the anti-kickback laws can also result in civil monetary penalties of up to $100,000 per violation and an assessment of up to three times the total amount of remuneration offered, paid, solicited, or received. Violation of the anti-kickback laws may also result in an individual's or organization's exclusion from future participation in Medicare, Medicaid and other state and federal healthcare programs. State Medicaid programs are required to enact an anti-kickback statute. Many states in which we operate have adopted or are considering similar legislative proposals, some of which extend beyond the Medicaid program, to prohibit the payment or receipt of remuneration for the referral of patients regardless of the source of payment for the care. We believe that business practices of providers and financial relationships between providers have become subject to increased scrutiny as healthcare reform efforts continue on the federal and state levels. In addition to these regulations, we may face adverse consequences if we violate the federal Stark laws related to certain Medicare physician referrals. Section 1877 of the Social Security Act, commonly known as the “Stark Law,” provides that a physician may not refer a Medicare or Medicaid patient for a “designated health service” to an entity with which the physician or an immediate family member has a financial relationship unless the financial arrangement meets an exception under the Stark Law or its regulations. Designated health services include inpatient and outpatient hospital services, PT, OT, SLP, durable medical equipment, prosthetics, orthotics and supplies, diagnostic imaging, enteral and parenteral feeding and supplies, home health services, and clinical laboratory services. Under the Stark Law, a “financial relationship” is defined as an ownership or investment interest or a compensation arrangement. If such a financial relationship exists and does not meet a Stark Law exception, the entity is prohibited from submitting or claiming payment under the Medicare or Medicaid programs or from collecting from the patient or other payor. Many of the compensation arrangements exceptions permit referrals if, among other things, the arrangement is set forth in a written agreement signed by the parties, the compensation to be paid is set in advance, is consistent with fair market value and is not determined in a manner that takes into account the volume or value of any referrals or other business generated between the parties. Exceptions may have other requirements. Any funds collected for an item or service resulting from a referral that violates the Stark Law must be repaid to Medicare or Medicaid, any other third-party payor, and the patient. In addition, CMPs, which are adjusted for annual inflation, and treble damages may be imposed for presenting or causing to be presented, a claim for a service rendered in violation of the Stark Law. Many states have enacted healthcare provider referral laws that go beyond physician self-referrals or apply to a greater range of services than just the designated health services under the Stark Law. Any services furnished pursuant to a prohibited referral are not eligible for payment by the Medicare programs, and the provider is prohibited from billing any third party for such services. The Stark laws provide for the imposition of a civil monetary penalty of $15,000 per prohibited claim, and up to $100,000 for knowingly entering into certain prohibited cross-referral schemes, and potential exclusion from Medicare for any person who presents or causes to be presented a bill or claim the person knows or should know is submitted in violation of the Stark laws. 59 Table of Contents Regulations Regarding Patient Record Confidentiality We are also subject to laws and regulations enacted to protect the confidentiality of patient health information. For example, HHS has issued rules pursuant to HIPAA, which relate to the privacy of certain patient information. These rules govern our use and disclosure of protected health information. We have established policies and procedures to comply with HIPAA privacy and security requirements at our affiliated facilities and operating subsidiaries. We maintain a company-wide HIPAA compliance plan, which we believe complies with the HIPAA privacy and security regulations. The HIPAA privacy regulations and security regulations have and will continue to impose significant costs on our facilities in order to comply with these standards. There are numerous other laws and legislative and regulatory initiatives at the federal and state levels addressing privacy and security concerns. Our operations are also subject to any federal or state privacy-related laws that are more restrictive than the privacy regulations issued under HIPAA. These laws vary and could impose additional penalties for privacy and security breaches. Antitrust Laws We are also subject to federal and state antitrust laws. Enforcement of the antitrust laws against healthcare providers is common, and antitrust liability may arise in a wide variety of circumstances, including third party contracting, physician relations, joint venture, merger, affiliation and acquisition activities. In some respects, the application of federal and state antitrust laws to healthcare is still evolving, and enforcement activity by federal and state agencies appears to be increasing. At various times, healthcare providers and insurance and managed care organizations may be subject to an investigation by a governmental agency charged with the enforcement of antitrust laws, or may be subject to administrative or judicial action by a federal or state agency or a private party. Violators of the antitrust laws could be subject to criminal and civil enforcement by federal and state agencies, as well as by private litigants. Regulations Specific to Senior Living Communities As previously mentioned, senior living services revenue is primarily derived from private pay residents, with a small portion of senior living revenue (approximately 0.5% of total revenue) derived from Medicaid funds. Thus, some of the regulations discussed above applicable to Medicaid providers, also apply to senior living. However, the following provides a brief overview of the regulatory framework applicable specifically to senior living. A majority of states provide, or are approved to provide, Medicaid payments for personal care and medical services to some residents in licensed senior living communities under waivers granted by or under Medicaid state plans approved by CMS. State Medicaid programs control costs for senior living and other home and community-based services by various means such as restrictive financial and functional eligibility standards, enrollment limits and waiting lists. Because rates paid to senior living community operators are generally lower than rates paid to skilled nursing facility operators, some states use Medicaid funding of senior living services as a means of lowering the cost of services for residents who may not need the higher level of health services provided in skilled nursing facilities. States that administer Medicaid programs for services in senior living communities are responsible for monitoring the services at, and physical conditions of, the participating communities. As a result of the growth of senior living in recent years, states have adopted licensing standards applicable to assisted living communities. Most state licensing standards apply to senior living communities regardless of whether they accept Medicaid funding. Since 2003, CMS has commenced a series of actions to increase its oversight of state quality assurance programs for senior living communities and has provided guidance and technical assistance to states to improve their ability to monitor and improve the quality of services paid for through Medicaid waiver programs. CMS is encouraging state Medicaid programs to expand their use of home and community-based services as alternatives to institutional services, pursuant to provisions of the ACA, and other authorities, through the use of several programs. The types of laws and statutes affecting the regulatory landscape of the post-acute industry continue to expand. In addition to this changing regulatory environment, federal, state and local officials are increasingly focusing their efforts on the enforcement of these laws. In order to operate our businesses, we must comply with federal, state and local laws relating to licensure, delivery and adequacy of medical care, distribution of pharmaceuticals, equipment, personnel, operating policies, fire prevention, rate-setting, billing and reimbursement, building codes and environmental protection. Additionally, we must also adhere to anti-kickback statues, physician referral laws, and safety and health standards set by the Occupational Safety and Health Administration (OSHA). Changes in the law or new interpretations of existing laws may have an adverse impact on our methods and costs of doing business. 60 Table of Contents Our operating subsidiaries are also subject to various regulations and licensing requirements promulgated by state and local health and social service agencies and other regulatory authorities. Requirements vary from state to state and these requirements can affect, among other things, personnel education and training, patient and personnel records, services, staffing levels, monitoring of patient wellness, patient furnishings, housekeeping services, dietary requirements, emergency plans and procedures, certification and licensing of staff prior to beginning employment, and patient rights. These laws and regulations could limit our ability to expand into new markets and to expand our services and facilities in existing markets. Results of Operations We believe we exist to dignify and transform post-acute care. We set out a strategy to achieve our goal of ensuring our patients are receiving the best possible care through our ability to acquire, integrate and improve our operations. Our results serve as a strong indicator that our strategy is working and our transformation is underway. We experienced healthy census growth during the first two months of 2020, achieving record revenue and net income. However, we experienced sharp declines in census beginning in late March 2020, which was attributable to concerns relating to the COVID-19 pandemic. Our net revenues for the three months ended September 30, 2020 continued to be impacted by COVID-19 as we experience revenue loss from a decline in occupancy which was partially offset by our skilled mix changes. To respond to the COVID-19 pandemic and ease the healthcare system burdens, CMS has waived existing regulatory requirements under the Emergency Waivers a series of temporary waivers and guidance issued by CMS, including a waiver of the requirement to have a three-day stay in a hospital to get Medicare coverage of a skilled nursing stay as well as the authorization of renewed skilled nursing facility coverage without having to start a new benefit period for certain beneficiaries who recently exhausted their skilled nursing facility benefits. As our communities experience surges of COVID-19 cases, our patients' needs have required the use of skilled care, resulting in an increase in Medicare Part A days. In addition, the FMAP program has been designed to enhance the reimbursements to provide additional funding to cover COVID-19 related expenses in selected states. For the three and nine months ended September 30, 2020, we recorded FMAP revenue of $11.7 million and $24.8 million, respectively, which directly offset against COVID-19 related expenses we incurred in those states. See Recent Activities for further information. Our total revenue for the quarter increased $87.1 million, or 17.0% while our diluted continuing operations GAAP earning per share grew more than 97.4%, from $0.39 to $0.77, compared to the third quarter in 2019. Over the past four quarters, we have continued to make progress on initiatives which we established more than two years ago. Including our foundational structure of local operations that are the centers of excellence in the communities they serve. As part of this focus, we have been able to expand our relationships with doctors, hospitals and managed care plans. Revenue from our transitional and skilled services collectively increased by 17.4%. We have also strengthened our collection process as well as identified non-clinical areas where we can manage spending. These operational fundamentals coupled with the reduction of interest expense due to the deferral of payroll tax payments and proceeds from Medicare Accelerated and Advance Payment Program resulted in strong third quarter performance. 61 Table of Contents The following table sets forth details of operating results for our revenue, expenses and earnings, and their respective components, as a percentage of total revenue for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Expense: Cost of services 77.6 80.2 77.3 79.7 Rent—cost of services 5.4 6.2 5.5 6.3 General and administrative expense 5.5 5.0 5.4 5.3 Depreciation and amortization 2.3 2.6 2.3 2.6 Total expenses 90.8 94.0 90.5 93.9 Income from operations 9.2 6.0 9.5 6.1 Other income (expense): Interest expense (0.3) (0.7) (0.4) (0.8) Interest and other income 0.1 0.1 0.1 0.1 Other expense, net (0.2) (0.6) (0.3) (0.7) Income before provision for income taxes 9.0 5.4 9.2 5.4 Provision for income taxes 1.8 1.0 2.1 1.0 Net income from continuing operations 7.2 4.4 7.1 4.4 Net income from discontinued operations, net of tax — 1.0 — 1.3 Net income 7.2 5.4 7.1 5.7 Less: net income attributable to noncontrolling interests in continuing operations — 0.1 0.1 0.1 Net income attributable to noncontrolling interests in discontinued operations — — — — Net income attributable to The Ensign Group, Inc. 7.2 % 5.3 % 7.0 % 5.6 % Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Non-GAAP Financial Measures: (In thousands) Performance Metrics EBITDA from continuing operations (1) $ 68,573 $ 43,814 $ 207,333 $ 126,596 EBITDA total (2) $ 68,573 $ 52,595 $ 207,333 $ 153,479 Adjusted EBITDA from continuing operations (1) $ 72,872 $ 46,160 $ 219,065 $ 135,215 Adjusted EBITDA total (2) $ 72,872 $ 58,484 $ 219,065 $ 172,016 Valuation Metric Adjusted EBITDAR (3) $ 105,351 $ 316,311 (1) EBITDA and Adjusted EBITDA represents results without discontinued operations of the Spin-Off, which occurred on October 1, 2019. (2) EBITDA and Adjusted EBITDA total for 2019 represents results inclusive of discontinued operations. (3) Presented for current year only. 62 Table of Contents The following discussion includes references to EBITDA, Adjusted EBITDA and Adjusted EBITDAR which are non-GAAP financial measures (collectively, Non-GAAP Financial Measures). Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other provisions of the Exchange Act of 1934, as amended (the Exchange Act), define and prescribe the conditions for use of certain non-GAAP financial information. These Non-GAAP Financial Measures are used in addition to and in conjunction with results presented in accordance with GAAP. These Non-GAAP Financial Measures should not be relied upon to the exclusion of GAAP financial measures. These Non-GAAP Financial Measures reflect an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the accompanying reconciliations to corresponding GAAP financial measures, provide a more complete understanding of factors and trends affecting our business. We believe the presentation of Non-GAAP Financial Measures are useful to investors and other external users of our financial statements regarding our results of operations because: • they are widely used by investors and analysts in our industry as a supplemental measure to evaluate the overall performance of companies in our industry without regard to items such as interest expense, net and depreciation and amortization, which can vary substantially from company to company depending on the book value of assets, capital structure and the method by which assets were acquired; and • they help investors evaluate and compare the results of our operations from period to period by removing the impact of our capital structure and asset base from our operating results. We use Non-GAAP Financial Measures: • as measurements of our operating performance to assist us in comparing our operating performance on a consistent basis; • to allocate resources to enhance the financial performance of our business; • to assess the value of a potential acquisition; • to assess the value of a transformed operation's performance; • to evaluate the effectiveness of our operational strategies; and • to compare our operating performance to that of our competitors. We typically use Non-GAAP Financial Measures to compare the operating performance of each operation. These measures are useful in this regard because they do not include such costs as net interest expense, income taxes, depreciation and amortization expense, which may vary from period-to-period depending upon various factors, including the method used to finance operations, the amount of debt that we have incurred, whether an operation is owned or leased, the date of acquisition of a facility or business, and the tax law of the state in which a business unit operates. We also establish compensation programs and bonuses for our leaders that are partially based upon the achievement of Adjusted EBITDAR targets. 63 Table of Contents Despite the importance of these measures in analyzing our underlying business, designing incentive compensation and for our goal setting, Non-GAAP Financial Measures have no standardized meaning defined by GAAP. Therefore, our Non-GAAP Financial Measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for analysis of our results as reported in accordance with GAAP. Some of these limitations are: • they do not reflect our current or future cash requirements for capital expenditures or contractual commitments; • they do not reflect changes in, or cash requirements for, our working capital needs; • they do not reflect the net interest expense, or the cash requirements necessary to service interest or principal payments, on our debt; • they do not reflect rent expenses, which are necessary to operate our leased operations, in the case of Adjusted EBITDAR; • they do not reflect any income tax payments we may be required to make; • although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and do not reflect any cash requirements for such replacements; and • other companies in our industry may calculate these measures differently than we do, which may limit their usefulness as comparative measures. We compensate for these limitations by using them only to supplement net income on a basis prepared in accordance with GAAP in order to provide a more complete understanding of the factors and trends affecting our business. Management strongly encourages investors to review our consolidated financial statements in their entirety and to not rely on any single financial measure. Because these Non-GAAP Financial Measures are not standardized, it may not be possible to compare these financial measures with other companies’ Non-GAAP Financial Measures having the same or similar names. These Non-GAAP Financial Measures should not be considered a substitute for, nor superior to, financial results and measures determined or calculated in accordance with GAAP. We strongly urge you to review the reconciliation of income from operations to the Non-GAAP Financial Measures in the table below, along with our consolidated financial statements and related notes included elsewhere in this document. We use the following Non-GAAP Financial Measures that we believe are useful to investors as key valuation and operating performance measures: 64 Table of Contents PERFORMANCE MEASURES: EBITDA We believe EBITDA is useful to investors in evaluating our operating performance because it helps investors evaluate and compare the results of our operations from period to period by removing the impact of our asset base (depreciation and amortization expense) from our operating results. We calculate EBITDA as net income, adjusted for net losses attributable to noncontrolling interest, before (a) interest expense, net, (b) provision for income taxes, and (c) depreciation and amortization. Adjusted EBITDA We adjust EBITDA when evaluating our performance because we believe that the exclusion of certain additional items described below provides useful supplemental information to investors regarding our ongoing operating performance, in the case of Adjusted EBITDA. We believe that the presentation of Adjusted EBITDA, when combined with EBITDA and GAAP net income attributable to The Ensign Group, Inc., is beneficial to an investor’s complete understanding of our operating performance. Adjusted EBITDA is EBITDA adjusted for non-core business items, which for the reported periods includes, to the extent applicable: • results related to operations not at full capacity; • stock-based compensation expense; • acquisition related costs; and • gain on sale of fixed assets, net of impairment charges. VALUATION MEASURE: Adjusted EBITDAR We use Adjusted EBITDAR as one measure in determining the value of prospective acquisitions. It is also a commonly used measure by our management, research analysts and investors, to compare the enterprise value of different companies in the healthcare industry, without regard to differences in capital structures and leasing arrangements. Adjusted EBITDAR is a financial valuation measure that is not specified in GAAP. This measure is not displayed as a performance measure as it excludes rent expense, which is a normal and recurring operating expense . The adjustments made and previously described in the computation of Adjusted EBITDA are also made when computing Adjusted EBITDAR. We calculate Adjusted EBITDAR by excluding rent-cost of services from Adjusted EBITDA. We believe the use of Adjusted EBITDAR allows the investor to compare operational results of companies who have operating and capital leases. A significant portion of capital lease expenditures are recorded in interest, whereas operating lease expenditures are recorded in rent expense. 65 Table of Contents The table below reconciles net income to EBITDA, Adjusted EBITDA and Adjusted EBITDAR for the periods presented: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Consolidated statements of income data: (In thousands) Net income $ 43,313 $ 27,828 $ 125,202 $ 84,360 Less: net income attributable to noncontrolling interests in continuing operations 253 390 1,045 591 Less: net income from discontinued operations — 5,290 — 19,473 Add: Interest expense, net 890 3,168 5,068 9,656 Provision for income taxes 10,866 5,093 37,026 14,944 Depreciation and amortization 13,757 13,405 41,082 37,700 EBITDA from continuing operations 68,573 43,814 207,333 126,596 EBITDA from discontinued operations(d) — 8,781 — 26,883 EBITDA $ 68,573 $ 52,595 $ 207,333 $ 153,479 Results related to operations not at full capacity(a) 81 555 620 1,184 Stock-based compensation expense 4,173 2,829 10,936 8,215 Acquisition related costs(b) 20 69 104 144 Gain on sale of fixed assets, net of impairment charges(c) — (1,402) — (1,402) Rent related to items above 25 295 72 478 Adjusted EBITDA from continuing operations 72,872 46,160 219,065 135,215 Adjusted EBITDA from discontinued operations(d) — 12,324 — 36,801 Adjusted EBITDA $ 72,872 $ 58,484 $ 219,065 $ 172,016 Rent—cost of services 32,504 31,875 97,318 93,278 Less: rent related to items above (25) (295) (72) (478) Adjusted rent from continuing operations 32,479 31,580 97,246 92,800 Adjusted rent included in discontinued operations — 5,849 — 17,283 Adjusted EBITDAR from continuing operations $ 105,351 $ 316,311 (a) Represents results of operations not at full capacity during the period presented. (b) Costs incurred to acquire operations which are not capitalizable. (c) Gain on sale of fixed assets includes impairment charges of $1.5 million at two of our senior living operations, offset by the gain recognized for the sale of real estate of $2.9 million in the three and nine months ended September 30, 2019. (d) All adjustments included in the table below are presented within net income from discontinued operations, net of tax. Three Months Ended September 30, 2019 Nine Months Ended September 30, 2019 Net income from discontinued operations, net of tax $ 5,290 $ 19,473 Less: net income attributable to noncontrolling interests in discontinued operations 279 629 Add: Interest and other income, net (4) (26) Provision for income taxes 2,860 5,663 Depreciation and amortization 914 2,402 EBITDA from discontinued operations $ 8,781 $ 26,883 Losses related to operations in the start-up phase 59 377 Stock-based compensation expense 149 1,018 Spin-Off transaction costs 3,261 7,909 Acquisition related costs 70 603 Rent related to items above 4 11 Adjusted EBITDA from discontinued operations $ 12,324 $ 36,801 66 Table of Contents Three Months Ended September 30, 2020 Compared to the Three Months Ended September 30, 2019 Revenue Three Months Ended September 30, 2020 2019 $ % $ % (Dollars in thousands) Transitional and skilled services $ 570,384 95.2 % $ 485,973 94.9 % All other (1) 28,871 4.8 26,136 5.1 Total revenue $ 599,255 100.0 % $ 512,109 100.0 % (1) Includes revenue from rental income and services generated from our senior living services, real estate properties and other ancillary services. Our total revenue increased $87.1 million, or 17.0%, compared to the three months ended September 30, 2019. The increase in revenue was primarily driven by an increase in our skilled mix days and revenue per patient day from our transitional and skilled services operations, along with the impact of acquisitions. Total revenue from operations acquired on or subsequent to October 1, 2019 increased our consolidated revenue by $42.4 million during the three months ended September 30, 2020, when compared to the same period in 2019. In addition, we recorded $11.7 million of FMAP revenue, which correlate directly to the additional COVID-19 related expenses incurred. All FMAP revenue is included in Medicaid revenue. Transitional and Skilled Services The following table presents the transitional and skilled services revenue and key performance metrics by category during the three months ended September 30, 2020 and 2019: Three Months Ended September 30, 2020 2019 Change % Change Total Facility Results: (Dollars in thousands) Transitional and skilled revenue $ 570,384 $ 485,973 $ 84,411 17.4 % Number of facilities at period end 193 179 14 7.8 % Number of campuses at period end* 24 22 2 9.1 % Actual patient days 1,495,285 1,516,697 (21,412) (1.4) % Occupancy percentage — Operational beds 70.7 % 78.9 % (8.2) % Skilled mix by nursing days 32.8 % 28.5 % 4.3 % Skilled mix by nursing revenue 53.9 % 47.8 % 6.1 % Three Months Ended September 30, 2020 2019 Change % Change Same Facility Results(1): (Dollars in thousands) Transitional and skilled revenue $ 443,217 $ 411,306 $ 31,911 7.8 % Number of facilities at period end 152 152 — — % Number of campuses at period end* 15 15 — — % Actual patient days 1,138,971 1,267,903 (128,932) (10.2) % Occupancy percentage — Operational beds 71.2 % 79.5 % (8.3) % Skilled mix by nursing days 34.7 % 29.8 % 4.9 % Skilled mix by nursing revenue 56.2 % 49.6 % 6.6 % 67 Table of Contents Three Months Ended September 30, 2020 2019 Change % Change Transitioning Facility Results(2): (Dollars in thousands) Transitional and skilled revenue $ 52,033 $ 46,350 $ 5,683 12.3 % Number of facilities at period end 16 16 — — % Number of campuses at period end* 4 4 — — % Actual patient days 148,732 155,367 (6,635) (4.3) % Occupancy percentage — Operational beds 75.3 % 79.5 % (4.2) % Skilled mix by nursing days 25.1 % 21.2 % 3.9 % Skilled mix by nursing revenue 41.7 % 35.7 % 6.0 % Three Months Ended September 30, 2020 2019 Change % Change Recently Acquired Facility Results(3): (Dollars in thousands) Transitional and skilled revenue $ 75,134 $ 25,570 $ 49,564 NM Number of facilities at period end 25 11 14 NM Number of campuses at period end* 5 3 2 NM Actual patient days 207,582 84,554 123,028 NM Occupancy percentage — Operational beds 65.6 % 71.4 % NM Skilled mix by nursing days 27.7 % 23.5 % NM Skilled mix by nursing revenue 49.1 % 41.3 % NM Three Months Ended September 30, 2020 2019 Change % Change (Dollars in thousands) Facility Closed Results(4): Skilled nursing revenue $ — $ 2,747 $ (2,747) NM Actual patient days — 8,873 (8,873) NM Occupancy percentage — Operational beds — % 64.7 % NM Skilled mix by nursing days — % 19.1 % NM Skilled mix by nursing revenue — % 41.9 % NM * Campus represents a facility that offers both skilled nursing and senior living services. Revenue and expenses related to skilled nursing and senior living services have been allocated and recorded in the respective operating segment. (1) Same Facility results represent all facilities purchased prior to January 1, 2017. (2) Transitioning Facility results represent all facilities purchased from January 1, 2017 to December 31, 2018. (3) Recently Acquired Facility (Acquisitions) results represent all facilities purchased on or subsequent to January 1, 2019. (4) Facility Closed results represents closed operations during the three months ended September 30, 2019, which were excluded from Same Facilities results for the three months ended September 30, 2019 and 2020 for comparison purposes. Transitional and skilled services revenue increased $84.4 million, or 17.4%, compared to the three months ended September 30, 2019. Of the $84.4 million increase, Medicare revenue increased $69.6 million , or 58.2%, Medicaid custodial revenue increased $16.2 million, or 8.0% and Medicaid skilled revenue increased $4.1 million, or 11.9%. Private and other revenue decreased $4.6 million, or 11.3% and managed care revenue decreased by $0.9 million, or 1.0%. 68 Table of Contents Revenue in our Same Facilities increased $31.9 million, or 7.8% due to greater patient acuity and SIP days, even while occupancy and census declined by 8.3% and 10.2%, respectively, due to COVID-19. The decline in our occupancy is mainly in our non-skilled patient days, which is being offset by a shift to higher Medicare census, which also drove up skilled mix days and revenue. Our skilled mix days increased by 4.9% coupled with an increase from our skilled revenue daily rate of 13.2%, which included the impact of 2% sequestration reversal. This resulted in an increase in skilled mix revenue of $36.3 million. We continued to experience decreased Medicaid custodial and private patient census days related to COVID-19 during the second quarter of 2020 that continued into our third quarter. Our Medicaid census decreased by 15.2%, but was offset by an increase in our Medicaid daily rate of 8.8% as a result of our successful participation in the quality improvement programs and the supplemental programs in various states. In addition, included in total revenue for Same Facilities is $8.9 million of Medicaid revenue related to FMAP program. Revenue generated by our Transitioning Facilities increased $5.7 million, or 12.3%, primarily due to an increase of 13.4% in skilled patient days . W e experienced and continued to see a shift in higher patient acuity, resulting in an increase in skilled mix revenue of $4.3 million, or 26.8%, compared to the three months ended September 30, 2019. Transitional and skilled services revenue generated by facilities purchased on or subsequent to January 1, 2019 (Recently Acquired Facilities) increased by approximately $49.6 million compared to the three months ended September 30, 2019 . We acquired 16 operations between October 1, 2019 and September 30, 2020 across four states. In the future, if we acquire additional turnaround or start-up operations, we expect to see lower occupancy rates and skilled mix, and these metrics are expected to vary from period to period based upon the maturity of the facilities within our portfolio. Historically, we have generally experienced lower occupancy rates, lower skilled mix at Recently Acquired Facilities and therefore, we anticipate generally lower overall occupancy during years of growth. The following table reflects the change in skilled nursing average daily revenue rates by payor source, excluding services that are not covered by the daily rate (1) : Three Months Ended September 30, Same Facility Transitioning Acquisitions Total 2020 2019 2020 2019 2020 2019 2020 2019 Skilled Nursing Average Daily Revenue Rates: Medicare $ 664.61 $ 600.96 $ 590.02 $ 530.91 $ 646.90 $ 651.12 $ 656.43 $ 597.82 Managed care 496.14 458.91 477.39 425.49 489.23 432.31 493.78 455.48 Other skilled 542.37 487.87 523.66 472.23 356.09 346.95 535.22 482.68 Total skilled revenue 587.57 519.07 539.37 482.60 587.23 525.84 583.86 517.16 Medicaid 245.99 226.19 257.44 235.48 234.94 229.85 245.54 227.48 Private and other payors 233.83 226.78 234.44 217.99 218.59 229.67 231.77 225.04 Total skilled nursing revenue $ 363.39 $ 314.12 $ 324.76 $ 284.74 $ 330.63 $ 299.45 $ 354.99 $ 310.18 (1) These rates exclude additional FMAP revenue we recognized as part of The Family First Coronavirus Response Act and include sequestration reversal of 2%. Our Medicare daily rates at Same Facilities and Transitioning Facilities increased by 10.6% and 11.1%, respectively, compared to the three months ended September 30, 2019. The increase is attributable to the 2.4% net market basket increase that became effective in October 2019 coupled with our continued shift towards higher acuity patients. Included in revenue for the three months ended September 30, 2020 is the results of the temporary suspension of the 2% Medicare sequestration, which started on May 1, 2020 and will go through December 31, 2020. In addition, our new payment model, PDPM, became effective on October 1, 2019. Our average Medicaid rates increased 7.9% due to state reimbursement increases and our participation in supplemental Medicaid payment programs and quality improvement programs in various states. Medicaid rates exclude the amount of FMAP revenue we recorded. Payor Sources as a Percentage of Skilled Nursing Services. We use our skilled mix as measures of the quality of reimbursements we receive at our affiliated skilled nursing facilities over various periods. 69 Table of Contents The following tables set forth our percentage of skilled nursing patient revenue and days by payor source: Three Months Ended September 30, Same Facility Transitioning Acquisitions Total 2020 2019 2020 2019 2020 2019 2020 2019 Percentage of Skilled Nursing Revenue: Medicare 31.5 % 22.2 % 22.9 % 19.5 % 35.6 % 24.2 % 31.2 % 22.1 % Managed care 15.8 18.9 14.0 12.7 12.3 13.8 15.2 18.0 Other skilled 8.9 8.5 4.8 3.5 1.2 3.3 7.5 7.7 Skilled mix 56.2 49.6 41.7 35.7 49.1 41.3 53.9 47.8 Private and other payors 6.5 8.2 10.7 12.3 7.3 7.3 7.1 8.5 Medicaid 37.3 42.2 47.6 52.0 43.6 51.4 39.0 43.7 Total skilled nursing 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Three Months Ended September 30, Same Facility Transitioning Acquisitions Total 2020 2019 2020 2019 2020 2019 2020 2019 Percentage of Skilled Nursing Days: Medicare 17.2 % 11.5 % 12.6 % 10.5 % 18.2 % 11.2 % 16.9 % 11.4 % Managed care 11.6 12.9 9.5 8.5 8.3 9.6 10.9 12.2 Other skilled 5.9 5.4 3.0 2.2 1.2 2.7 5.0 4.9 Skilled mix 34.7 29.8 25.1 21.2 27.7 23.5 32.8 28.5 Private and other payors 10.3 11.9 14.8 15.6 10.9 9.5 10.8 12.2 Medicaid 55.0 58.3 60.1 63.2 61.4 67.0 56.4 59.3 Total skilled nursing 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Other Our other revenue increased by $2.7 million, or 10.5% to $28.9 million, compared to the three months ended September 30, 2019. Other revenue for the third quarter in 2020 includes senior living revenue of $11.8 million; mobile diagnostics revenue of $6.6 million, medical transportation revenue of $4.9 million and rental and other ancillary operations revenue of $5.6 million. This increase in other revenue is due to acquisitions and rental income from Pennant. Cost of Services The following table sets forth total cost of services for continuing operations of our transitional and skilled services and "All Other" category for the periods indicated (dollars in thousands): Three Months Ended September 30, 2020 2019 Change $ % (1) $ % (1) $ % Transitional and skilled services $ 438,110 76.8 % $ 389,519 80.2 % $ 48,591 12.5 % All other 26,998 93.5 20,997 80.3 6,001 28.6 Total cost of services $ 465,108 77.6 % $ 410,516 80.2 % $ 54,592 13.3 % (1) This represents cost of services as a percentage of revenue. Consolidated cost of services increased $54.6 million, or 13.3%, compared to the three months ended September 30, 2019. Consolidated cost of services as a percentage of revenue decreased by 2.6%. 70 Table of Contents Transitional and Skilled Services Cost of services related to our transitional and skilled services segment increased $48.6 million, or 12.5%, due primarily to additional costs related to COVID-19 related expenses and new acquisitions. Cost of services as a percentage of revenue decreased to 76.8% from 80.2%, a decrease of 3.4%. We experienced an increase in expenses on a per patient day basis related to COVID-19, including wages, supplies and additional ancillary costs. These increases were offset with better collections and lower purchased services expenses. Other Operating Expenses Rent — cost of services. Our rent — cost of services as a percentage of total revenue decreased by 0.8% to 5.4%, primarily due to our recent acquisitions including real estate assets, coupled with the growth in revenue outpacing the increase in rent expense. General and administrative expense. G eneral and administrative expense increased $7.3 million or 28.6%, to $32.8 million. This increase was primarily due to increases in wages and benefits due to enhanced performance and growth. In addition, general and administrative expense as a percentage of revenue increased by 0.5% to 5.5%. Depreciation and amortization . Depreciation and amortization expense increased $0.4 million, or 2.6%, to $13.8 million. This increase was primarily related to the additional depreciation and amortization incurred as a result of our newly acquired operations. Depreciation and amortization decreased 0.3%, to 2.3%, as a percentage of revenue. Other expense, net. Other expense, net as a percentage of revenue decreased by 0.4%, to 0.2%. Other expense primarily includes interest expense related to borrowings under our credit facility. During the quarter, we were able to utilize the proceeds from Medicare Accelerated and Advance Payment Program and deferral of social security taxes to reduce the amount outstanding on our revolving credit facility. The repayment period for the Medicare Accelerated and Advance Payment Program starts in March 2021. Provision for income taxes. Our effective tax rate was 20.1% for the three months ended September 30, 2020, compared to 18.4% for the same period in 2019. The higher effective tax rate is driven by the impact of the tax benefit from stock-based payment awards, offset by non-deductible expenses. See Note 15, Income Taxes , in the Notes to Condensed Consolidated Financial Statements for further discussion. Nine Months Ended September 30, 2020 Compared to the Nine Months Ended September 30, 2019 Revenue Nine Months Ended September 30, 2020 2019 $ % $ % (Dollars in thousands) Transitional and skilled services $ 1,685,568 95.0 % $ 1,404,469 95.1 % All other (1) 87,999 5.0 71,864 4.9 Total revenue $ 1,773,567 100.0 % $ 1,476,333 100.0 % (1) Includes revenue from rental income and services generated from our senior living services, real estate properties and other ancillary services. Our total revenue increased $297.2 million, or 20.1%, compared to the nine months ended September 30, 2019. The increase in revenue was primarily driven by an increase in our skilled mix days and revenue per patient day from transitional and skilled services operations, along with the impact of acquisitions. Total revenue from operations acquired on or subsequent to October 1, 2019 increased our consolidated revenue by $117.3 million during the nine months ended September 30, 2020, when compared to the same period in 2019. In addition, we recorded $24.8 million of FMAP payments received. 71 Table of Contents Transitional and Skilled Services The following table presents the transitional and skilled services revenue and key performance metrics by category during the nine months ended September 30, 2020 and 2019: Nine Months Ended September 30, 2020 2019 Change % Change Total Facility Results: (Dollars in thousands) Transitional and skilled revenue $ 1,685,568 1,404,469 $ 281,099 20.0 % Number of facilities at period end 193 179 14 7.8 % Number of campuses at period end* 24 22 2 9.1 % Actual patient days 4,668,961 4,395,864 273,097 6.2 % Occupancy percentage — Operational beds 74.5 % 79.2 % (4.7) % Skilled mix by nursing days 30.6 % 29.1 % 1.5 % Skilled mix by nursing revenue 51.8 % 48.7 % 3.1 % Nine Months Ended September 30, 2020 2019 Change % Change Same Facility Results(1): (Dollars in thousands) Transitional and skilled revenue $ 1,319,620 $ 1,216,841 $ 102,779 8.4 % Number of facilities at period end 152 152 — — % Number of campuses at period end* 15 15 — — % Actual patient days 3,570,174 3,762,109 (191,935) (5.1) % Occupancy percentage — Operational beds 75.0 % 79.7 % (4.7) % Skilled mix by nursing days 32.5 % 30.4 % 2.1 % Skilled mix by nursing revenue 54.1 % 50.4 % 3.7 % Nine Months Ended September 30, 2020 2019 Change % Change Transitioning Facility Results(2): (Dollars in thousands) Transitional and skilled revenue $ 154,601 $ 136,155 $ 18,446 13.5 % Number of facilities at period end 16 16 — — % Number of campuses at period end* 4 4 — — % Actual patient days 456,714 458,633 (1,919) (0.4) % Occupancy percentage — Operational beds 78.0 % 79.0 % (1.0) % Skilled mix by nursing days 24.8 % 21.9 % 2.9 % Skilled mix by nursing revenue 41.8 % 36.9 % 4.9 % 72 Table of Contents Nine Months Ended September 30, 2020 2019 Change % Change Recently Acquired Facility Results(3): (Dollars in thousands) Transitional and skilled revenue $ 211,347 $ 43,334 $ 168,013 NM Number of facilities at period end 25 11 14 NM Number of campuses at period end* 5 3 2 NM Actual patient days 642,073 148,385 493,688 NM Occupancy percentage — Operational beds 69.5 % 71.6 % NM Skilled mix by nursing days 23.7 % 22.2 % NM Skilled mix by nursing revenue 44.7 % 39.3 % NM Nine Months Ended September 30, 2020 2019 Change % Change (Dollars in thousands) Facility Closed Results(4): Skilled nursing revenue $ — $ 8,139 $ (8,139) NM Actual patient days — 26,737 (26,737) NM Occupancy percentage — Operational beds — % 65.7 % NM Skilled mix by nursing days — % 17.4 % NM Skilled mix by nursing revenue — % 37.5 % NM * Campus represents a facility that offers both skilled nursing and senior living services. Revenue and expenses related to skilled nursing and senior living services have been allocated and recorded in the respective operating segment. (1) Same Facility results represent all facilities purchased prior to January 1, 2017. (2) Transitioning Facility results represent all facilities purchased from January 1, 2017 to December 31, 2018. (3) Recently Acquired Facility (Acquisitions) results represent all facilities purchased on or subsequent to January 1, 2019. (4) Facility Closed results represents closed operations during the nine months ended September 30, 2019, which were excluded from Same Facilities results for the nine months ended September 30, 2019 and 2020 for comparison purposes. Transitional and skilled services revenue increased $281.1 million, or 20.0%, compared to the nine months ended September 30, 2019. Of the $281.1 million increase, Medicare and managed care revenue increased $178.6 million , or 29.1%, Medicaid custodial revenue increased $86.2 million , or 15.0%, Medicaid skilled revenue increased $14.3 million , or 14.8% and private and other revenue increased $2.0 million , or 1.7%. The increase in revenue was primarily driven by strong performance across our transitional and skilled services operations during the first quarter of 2020, which grew first quarter revenue by $109.1 million. We began experiencing the impact of COVID-19 during the second and third quarters, which negatively impacted our census. Our occupancy decreased by 4.7% compared to the same period in prior year. The decline is offset by the increase in skilled mix days due to a shift toward high acuity patients. Revenue in our Same Facilities increased $102.8 million, or 8.4%. The impact of COVID-19 resulted in a decrease in occupancy of 4.7%. The decline in our occupancy is mainly in our non-skilled patient days, which is being offset by the shift toward high acuity patients. Our skilled days increased by 1.6%, coupled with an increase in our skilled revenue daily rate of 11.5%, resulting in an increase in skilled mix revenue of $78.7 million, or 13.3%. We continued to experience decreased Medicaid custodial and private patient days census related to COVID-19 during the second quarter of 2020. Our Medicaid census decreased by 7.0% but is offset by an increase in our Medicaid daily rate of 6.0% as a result of our successful participation in the quality improvement programs and the supplemental programs in various states. In addition, included in total revenue for Same Facilities is $19.3 million of Medicaid revenue related to the FMAP program. 73 Table of Contents Revenue generated by our Transitioning Facilities increased $18.4 million, or 13.5%, primarily due to increases in our daily rate and patient days compared to the nine months ended September 30, 2019 , demonstrating our ability to transition these healthcare operations that were acquired two and three years ago. In addition, we continued to see a shift toward higher acuity patients . Our skilled days increased by 2.9%, coupled with an increase from our skilled mix revenue daily rate of 10.3%. Transitional and skilled services revenue generated by Recently Acquired Facilities increased by approximately $168.0 million compared to the nine months ended September 30, 2019. We acquired 16 operations between October 1, 2019 and September 30, 2020 across four states. In the future, if we acquire additional facilities that are underperforming and need to be turned around or start up-operations, we expect to see lower occupancy rates and skilled mix, and these metrics are expected to vary from period to period based upon the maturity of the facilities within our portfolio. Historically, we have generally experienced lower occupancy rates, lower skilled mix at Recently Acquired Facilities and therefore, we anticipate generally lower overall occupancy during years of growth. The following table reflects the change in skilled nursing average daily revenue rates by payor source, excluding services that are not covered by the daily rate (1) : Nine Months Ended September 30, Same Facility Transitioning Acquisitions Total 2020 2019 2020 2019 2020 2019 2020 2019 Skilled Nursing Average Daily Revenue Rates: Medicare $ 668.14 $ 599.34 $ 591.32 $ 532.09 $ 643.17 $ 633.93 $ 658.38 $ 594.51 Managed care 489.23 456.95 465.22 425.47 470.43 429.89 485.33 453.94 Other skilled 534.44 490.70 509.31 466.05 341.41 346.85 526.54 487.06 Total skilled revenue 579.53 519.87 532.29 482.40 572.14 515.17 574.99 517.24 Medicaid 237.32 223.83 246.69 232.93 221.48 227.80 235.88 225.10 Private and other payors 233.18 228.84 237.79 220.85 213.42 214.28 230.81 226.66 Total skilled nursing revenue $ 348.15 $ 314.75 $ 316.27 $ 285.47 $ 303.66 $ 289.92 $ 338.91 $ 310.71 (1) These rates exclude additional FMAP revenue we recognized as part of The Family First Coronavirus Response Act. Our Medicare daily rates at Same Facilities and Transitioning Facilities increased by 11.5% and 11.1%, respectively, compared to the nine months ended September 30, 2019. Included in revenue for the nine months ended September 30, 2020 is the results of five months of the temporary suspension of the 2% Medicare sequestration, which started on May 1, 2020 and will go through December 31, 2020. In addition, our new payment model, PDPM, became effective on October 1, 2019. Our average Medicaid rates increased 4.8% due to state reimbursement increases and our participation in supplemental Medicaid payment programs and quality improvement programs in various states. Payor Sources as a Percentage of Skilled Nursing Services. We use our skilled mix as measures of the quality of reimbursements we receive at our affiliated skilled nursing facilities over various periods. 74 Table of Contents The following tables set forth our percentage of skilled nursing patient revenue and days by payor source: Nine Months Ended September 30, Same Facility Transitioning Acquisitions Total 2020 2019 2020 2019 2020 2019 2020 2019 Percentage of Skilled Nursing Revenue: Medicare 28.8 % 23.3 % 23.0 % 20.3 % 31.4 % 22.4 % 28.6 % 23.0 % Managed care 16.7 18.9 14.7 13.3 11.9 13.9 15.9 18.1 Other skilled 8.6 8.2 4.1 3.3 1.4 3.0 7.3 7.6 Skilled mix 54.1 50.4 41.8 36.9 44.7 39.3 51.8 48.7 Private and other payors 7.1 8.1 10.8 12.2 8.5 8.0 7.7 8.5 Medicaid 38.8 41.5 47.4 50.9 46.8 52.7 40.5 42.8 Total skilled nursing 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Nine Months Ended September 30, Same Facility Transitioning Acquisitions Total 2020 2019 2020 2019 2020 2019 2020 2019 Percentage of Skilled Nursing Days: Medicare 15.0 % 12.2 % 12.3 % 10.9 % 14.8 % 10.3 % 14.7 % 12.0 % Managed care 11.9 13.0 10.0 8.9 7.7 9.4 11.1 12.4 Other skilled 5.6 5.2 2.5 2.1 1.2 2.5 4.8 4.7 Skilled mix 32.5 30.4 24.8 21.9 23.7 22.2 30.6 29.1 Private and other payors 10.6 11.5 14.5 15.5 12.2 10.6 11.1 12.0 Medicaid 56.9 58.1 60.7 62.6 64.1 67.2 58.3 58.9 Total skilled nursing 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Other Our other revenue increased by $16.1 million, or 22.5% to $88.0 million, compared to the nine months ended September 30, 2019. Other revenue for the nine months ended September 30, 2020 includes senior living revenue of $35.1 million; mobile diagnostics revenue of $21.0 million, medical transportation revenue of $15.6 million and rental and other ancillary operations revenue of $16.3 million. The increase in other revenue is due to acquisitions and rental income from Pennant. Cost of Services The following table sets forth total cost of services for continuing operations of our transitional and skilled services and "All Other" category for the periods indicated (dollars in thousands): Nine Months Ended September 30, 2020 2019 Change $ % (1) $ % (1) $ % Transitional and skilled services $ 1,299,777 77.1 % $ 1,116,828 79.5 % $ 182,949 16.4 % All other 71,601 81.4 60,418 84.1 11,183 18.5 Total cost of services $ 1,371,378 77.3 % $ 1,177,246 79.7 % $ 194,132 16.5 % (1) This represents cost of services as a percentage of revenue. Consolidated cost of services increased $194.1 million, or 16.5% compared to the nine months ended September 30, 2019. Consolidated cost of services as a percentage of revenue decreased by 2.4% to 77.3%. 75 Table of Contents Transitional and Skilled Services Cost of services related to our transitional and skilled services segment increased $182.9 million, or 16.4%, due primarily to additional costs at new acquisitions, which accounted for $118.8 million of the increase, coupled with additional COVID-19 related expenses. Cost of services as a percentage of revenue decreased to 77.1% from 79.5%, a decrease of 2.4%. Other Operating Expenses Rent — cost of services. Our rent — cost of services as a percentage of total revenue decreased by 0.8% to 5.5%, primarily due to our recent acquisitions including real estate assets, coupled with the growth in revenue outpacing the increase in rent expense. General and administrative expense. General and administrative expense increased $17.9 million or 22.7%, to $96.5 million. This increase was primarily due to increases in wages and benefits due to enhanced performance and growth. In addition, general and administrative expense as a percentage of revenue increased by 0.1% to 5.4%. Depreciation and amortization . Depreciation and amortization expense increased $3.4 million, or 9.0%, to $41.1 million. This increase was primarily related to the additional depreciation and amortization incurred as a result of our newly acquired operations. Depreciation and amortization decreased 0.3%, to 2.3%, as a percentage of revenue. Other expense, net. Other expense, net as a percentage of revenue decreased by 0.4%, to 0.3%. Other expense primarily includes interest expense related to borrowings under our credit facility. Interest expense during the second and third quarter of 2020 decreased as we were able to utilize the proceeds from Medicare Accelerated and Advance Payment Program and deferral tax programs to reduce the amount outstanding on our revolving credit facility. Provision for income taxes. Our effective tax rate was 22.8% for the nine months ended September 30, 2020, compared to 18.7% for the same period in 2019. The higher effective tax rate is driven by the impact of the tax benefit from stock-based payment awards. See Note 15, Income Taxes , in the Notes to Condensed Consolidated Financial Statements for further discussion. Liquidity and Capital Resources Our primary sources of liquidity have historically been derived from our cash flows from operations and long-term debt secured by our real property and our revolving credit facilities. Our liquidity as of September 30, 2020 is impacted by cash receipts and payments related to the Provider Relief Funds and Medicare Accelerated and Advance Payment Program. Historically, we have primarily financed the majority of our acquisitions through the financing of our operating subsidiaries through mortgages, our revolving credit facility, and cash generated from operations. Cash paid to fund acquisitions was $9.1 million and $74.5 million for the nine months ended September 30, 2020 and 2019, respectively. Total capital expenditures for property and equipment were $37.8 million and $49.9 million for the nine months ended September 30, 2020 and 2019, respectively. We currently have approximately $47.0 million budgeted for renovation projects for 2020 , which incorporates the temporary suspension of non-essential capital expenditure projects. We believe our current cash balances, our cash flow from operations and the amounts available under our credit facility will be sufficient to cover our operating needs for at least the next 12 months. We may, in the future, seek to raise additional capital to fund growth, capital renovations, operations and other business activities, but such additional capital may not be available on acceptable terms, on a timely basis, or at all. Our cash and cash equivalents as of September 30, 2020 consisted of bank term deposits, money market funds and U.S. Treasury bill related investments. In addition, as of September 30, 2020, we held debt security investments of approximately $49.3 million, which were split between AA, A and BBB rated securities. We believe our debt security investments that were in an unrealized loss position as of September 30, 2020 were not other-than-temporarily impaired, nor has any event occurred subsequent to that date, including the recent developments related to COVID-19, that would indicate any other-than-temporary impairment. 76 Table of Contents As mentioned above, one primary source of cash is generated from our ongoing operations. Our positive cash flows have supported our business and have allowed us to pay regular dividends to our stockholders. We currently anticipate that existing cash and total investments as of September 30, 2020, along with projected operating cash flows and available financing, will support our normal business operations for the foreseeable future. Given the uncertainty in the rapidly changing market and economic conditions related to the COVID-19 outbreak, we will continue to evaluate the nature and extent of the impact to our business and financial position. The following table presents selected data on our continuing operations from our condensed consolidated statement of cash flows for the periods presented: Nine Months Ended September 30, 2020 2019 Net cash provided by/(used in): (In thousands) Continuing operating activities $ 282,161 $ 109,077 Continuing investing activities (48,485) (121,183) Continuing financing activities (117,471) 25,502 Net decrease in cash and cash equivalents from discontinued operations — (83) Net increase in cash and cash equivalents 116,205 13,313 Cash and cash equivalents beginning of period, including cash of discontinued operations 59,175 31,083 Cash and cash equivalents end of period, including cash of discontinued operations $ 175,380 $ 44,396 Less cash of discontinued operations at end of period — 47 Cash and cash equivalents at end of period $ 175,380 $ 44,349 Operating Activities Cash provided by operating activities is net income adjusted for certain non-cash items and changes in operating assets and liabilities. The $173.1 million increase in cash provided by continuing operating activities for the nine months ended September 30, 2020 compared to the same period in 2019 w as primarily due to higher net income and changes in working capital in 2020 compared to 2019. Changes in working capital was driven by deferred payment of the employer portion of social security taxes, strong accounts receivable collections, timing of accrued expenses and accrued wages and related liabilities. Investing Activities Investing cash flows consist primarily of capital expenditures, investment activities and cash used for acquisitions. The decrease in cash used in continuing investing activities for the nine months ended September 30, 2020 compared to the same period in 2019 of $72.7 million was primarily due to a decrease in cash used for acquisitions, net of escrow deposits, of $65.5 million coupled with a decrease in capital expenditures of $12.0 million. Financing Activities Financing cash flows consist primarily of repurchases of common stock, payment of dividends to stockholders, issuance and repayment of short-term and long-term debt, net proceeds from the Medicare Accelerated and Advance Payment Program, Provider Relief Fund, net and sale of shares of common stock through employee equity incentive plans. The decrease in cash provided by continuing financing activities for the nine months ended September 30, 2020 compared to the same period in 2019 of $143.0 million was primarily due to a net debt repayment of $211.7 million in 2020 compared to a net borrowing of $31.5 million in the same period in 2019. Additionally, during the first quarter of 2020 we repurchased $25.0 million of common stock under our authorized common stock repurchase programs. We did not have any repurchases of common stock in 2019. The decreases are offset by net proceeds received under Provider Relief Funds and the Medicare Accelerated and Advance Payment Program of $124.0 million. 77 Table of Contents Credit Facility with a Lending Consortium Arranged by Truist We maintain the Credit Facility with a lending consortium arranged by Truist, which includes a revolving line of credit of up to $350 million in aggregate principal amount. The maturity date of the Credit Facility is October 1, 2024. The interest rates applicable to loans under the Credit Facility are, at the Company's option, equal to either a base rate plus a margin ranging from 0.50% to 1.50% per annum or LIBOR plus a margin range from 1.50% to 2.50% per annum, based on the Consolidated Total Net Debt to Consolidated EBITDA ratio (as defined in the agreement). In addition, we pay a commitment fee on the unused portion of the commitments that ranges from 0.25% to 0.45% per annum, depending on the Consolidated Total Net Debt to Consolidated EBITDA ratio. Mortgage Loans and Promissory Notes As of June 30, 2020, 19 of our subsidiaries are under mortgage loans insured with Department of Housing and Urban Development (HUD) for an aggregate amount of $114.4 million, which subjects these subsidiaries to HUD oversight and periodic inspections. The mortgage loans bear fixed interest rates range of 2.6% to 3.5% per annum. Amounts borrowed under the mortgage loans may be prepaid, subject to prepayment fees of the principal balance on the date of prepayment. For the majority of the loans, the prepayment fee is 10% during the first three years and is reduced by 3% in the fourth year of the loan, and reduced by 1% per year for years five through ten of the loan. There is no prepayment penalty after year ten. The term of the mortgage loans are 25 to 35-years. In addition to the HUD mortgage loans above, we have two promissory notes. The notes bear fixed interest rates of 5.3% and 4.3% per annum and the term of the notes are 12 years and 10 months, respectively. The 12 year note which was used for an acquisition is secured by the real property comprising the facility and the rent, issues and profits thereof, as well as all personal property used in the operation of the facility. Operating Leases During the third quarter of 2020, 163 of our facilities are under long-term lease arrangements, of which 85 of the operations are under the triple-net Master Leases with CareTrust REIT, Inc. (CareTrust). In connection with the Spin-Off, 11 of the original 94 properties were transferred to Pennant. Of the 11 properties, two of the senior living operations are located on the same real estate properties as the skilled nursing facilities. The Master Leases consist of multiple leases, each with its own pool of properties, that have varying maturities and diversity in property geography. Under each master lease, our individual subsidiaries that operate those properties are the tenants and CareTrust's individual subsidiaries that own the properties subject to the Master Leases are the landlords. The rent structure under the Master Leases includes a fixed component, subject to annual escalation equal to the lesser of the percentage change in the Consumer Price Index (but not less than zero) or 2.5%. At our option, we can extend the Master Leases for two or three five-year renewal terms beyond the initial term, on the same terms and conditions. If we elect to renew the term of a Master Lease, the renewal will be effective as to all, but not less than all, of the leased property then subject to the Master Lease. We also lease certain affiliated facilities and our administrative offices under non-cancelable operating leases, most of which have initial lease terms ranging from five to 20 years and is subject to annual escalation equal to the percentage change in the Consumer Price Index with a stated cap percentage. In addition, we lease certain of our equipment under non-cancelable operating leases with initial terms ranging from three to five years. Most of these leases contain renewal options, certain of which involve rent increases. Forty of our affiliated facilities, excluding the facilities that are operated under the Master Leases from CareTrust, are operated under eight separate master lease arrangements. Under these master leases, a breach at a single facility could subject one or more of the other affiliated facilities covered by the same master lease to the same default risk. Failure to comply with Medicare and Medicaid provider requirements is a default under several of our leases, master lease agreements and debt financing instruments. In addition, other potential defaults related to an individual facility may cause a default of an entire master lease portfolio and could trigger cross-default provisions in our outstanding debt arrangements and other leases. With an indivisible lease, it is difficult to restructure the composition of the portfolio or economic terms of the lease without the consent of the landlord. 78 Table of Contents U.S. Department of Justice Civil Investigative Demand On May 31, 2018, we received a Civil Investigative Demand (CID) from the U.S. Department of Justice stating that it is investigating to determine whether we have violated the False Claims Act and/or the Anti-Kickback Statute with respect to the relationships between certain of our skilled nursing facilities and persons who served as medical directors, advisory board participants or other referral sources. The CID covered the period from October 3, 2013 to the present, and was limited in scope to ten of our Southern California skilled nursing facilities. In October 2018, the Department of Justice made an additional request for information covering the period of January 1, 2011 to the present, relating to the same topic. As a general matter, our operating entities maintain policies and procedures to promote compliance with the False Claims Act, the Anti-Kickback Statute, and other applicable regulatory requirements. We have fully cooperated with the U.S. Department of Justice to promptly respond to the requests for information and have recently been advised that the U.S. Department of Justice has declined to intervene in any subsequent action based on or related to the subject matter of this investigation. Inflation We have historically derived a substantial portion of our revenue from the Medicare program. We also derive revenue from state Medicaid and similar reimbursement programs. Payments under these programs generally provide for reimbursement levels that are adjusted for inflation annually based upon the state’s fiscal year for the Medicaid programs and in each October for the Medicare program. These adjustments may not continue in the future, and even if received, such adjustments may not reflect the actual increase in our costs for providing healthcare services. Labor and supply expenses make up a substantial portion of our cost of services. Those expenses can be subject to increase in periods of rising inflation and when labor shortages occur in the marketplace. To date, we have generally been able to implement cost control measures or obtain increases in reimbursement sufficient to offset increases in these expenses. We may not be successful in offsetting future cost increases. Recent Accounting Pronouncements Except for rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws and a limited number of grandfathered standards, the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) is the sole source of authoritative GAAP literature recognized by the FASB and applicable to us. For any new pronouncements announced, we consider whether the new pronouncements could alter previous generally accepted accounting principles and determines whether any new or modified principles will have a material impact on our reported financial position or operations in the near term. The applicability of any standard is subject to the formal review of our financial management and certain standards are under consideration. Recent Accounting Standards Adopted by the Company In August 2018, the FASB issued amended guidance to simplify fair value measurement disclosure requirements. The new provisions eliminate the requirements to disclose (1) transfers between Level 1 and Level 2 of the fair value hierarchy, (2) policies related to valuation processes and the timing of transfers between levels of the fair value hierarchy, and (3) net asset value disclosure of estimates of timing of future liquidity events. The FASB also modified disclosure requirements of Level 3 fair value measurements. We adopted this standard effective January 1, 2020 and determined there was no material impact on our consolidated financial statements. In January 2017, the FASB issued amended authoritative guidance to simplify and reduce the cost and complexity of the goodwill impairment test. The new provisions eliminate step 2 from the goodwill impairment test and shifts the concept of impairment from a measure of loss when comparing the implied fair value of goodwill to its carrying amount to comparing the fair value of a reporting unit with its carrying amount. The FASB also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment or step 2 of the goodwill impairment test. The new guidance does not amend the optional qualitative assessment of goodwill impairment. We adopted this standard effective January 1, 2020 and determined there was no material impact on our consolidated financial statements. In June 2016, the FASB issued Accounting Standards Update (ASU) 2016-13 “ Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ”, which replaces the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected. We adopted this standard effective January 1, 2020 and determined there was no material impact on our consolidated financial statements. 79 Table of Contents Accounting Standards Recently Issued but Not Yet Adopted by the Company In December 2019, the FASB issued ASU 2019-12 "Simplifying the Accounting for Income Taxes (Topic 740)", as part of its simplification initiative to reduce the cost and complexity in accounting for income taxes. ASU 2019-12 removes certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. ASU 2019-12 also amends other aspects of the guidance to help simplify and promote consistent application of GAAP. The guidance is effective for interim and annual periods beginning after December 15, 2020 and we have elected not to early adopt this ASU. We do not expect the adoption of ASU 2019-12 to have a material impact on our financial position, results of operations and liquidity. In February 2020, the FASB issued ASU 2020-04 "Reference Rate Reform (Topic 848)" which provides temporary, optional practical expedients and exceptions to enable a smoother transition to the new reference rates which will replace LIBOR and other reference rates expected to be discontinued. Adoption of the provisions of ASU 2020-04 is optional. The amendments are effective for all entities from the beginning of the interim period that includes the issuance date of the ASU. An entity may elect to apply the amendments prospectively through December 31, 2022. We are currently evaluating the impact of ASU. 2020-04 on our financial position, results of operations and liquidity. In May 2020, the SEC issued Final Rule Release No. 33-10786, “ Amendments to Financial Disclosures about Acquired and Disposed Businesses ” (“SEC Rule 33-10786”), which amends the disclosure requirements applicable to acquisitions and dispositions of businesses. Amendments within SEC Rule 33-10786 primarily impact (1) the tests and thresholds used to determine the significance of acquisitions and dispositions; (2) the form and content of pro forma information required to be disclosed in connection with significant acquisitions and dispositions; (3) acquiree financial statement requirements; and (4) thresholds used to determine the significance of acquisitions and dispositions of real estate operations, and related financial statement requirements, among others. The amendments are effective for all SEC registrants beginning January 1, 2021, with early compliance permitted. We do not expect the amendments to have a material impact on our condensed consolidated financial statements. Off-Balance Sheet Arrangements During the three months ended September 30, 2020, we increased our outstanding letters of credit by $1.8 million to $7.6 million. As of September 30, 2020, we had approximately $7.6 million on our Credit Facility of borrowing capacity pledged as collateral to secure outstanding letters of credit.