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 Quarterly 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, 2020 (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 Quarterly Report on Form 10-Q, 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 Quarterly Report on Form 10-Q and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock. This Quarterly Report on Form 10-Q contains "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, which include, but are not limited to our expected future financial position, results of operations, cash flows, financing plans, business strategy, budgets, capital expenditures, competitive positions, growth opportunities, and 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, our business and operations for 2021 continue to be impacted by the COVID-19 pandemic. Because of the unprecedented nature of the pandemic, we are unable to predict the full extent and duration of the financial impact of COVID-19 on our business, financial condition and results of operations. Our actual results could differ materially 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 Quarterly Report on Form 10-Q. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q, 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, "Ensign," "Company," “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 "Ensign," "Company," “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. Overview We are a provider of health care services across the post-acute care continuum, engaged in the ownership, acquisition, development and leasing of skilled nursing, senior living and other healthcare-related properties, and other ancillary businesses located in Arizona, California, Colorado, Idaho, Iowa, Kansas, Nebraska, Nevada, South Carolina, Texas, Utah, Washington and Wisconsin. Our operating subsidiaries, each of which strives to be the operation of choice in the community it serves, provide a broad spectrum of skilled nursing, senior living and other ancillary services. As of June 30, 2021, we offered skilled nursing, senior living and rehabilitative care services through 240 skilled nursing and senior living facilities. Of the 240 facilities, we operated 175 facilities under long-term lease arrangements, and have options to purchase 11 of those 175 facilities. Our real estate portfolio includes 95 owned real estate properties, which included 65 facilities operated and managed by us, 31 senior living operations leased to and operated by The Pennant Group, Inc., or Pennant, as part of the spin-off transaction that occurred in October 2019 (Spin-Off), and the Service Center location. Of the 31 real estate operations leased to Pennant, two senior living operations are located on the same real estate properties as skilled nursing facilities that the Company owns and operates. 33 Table of Contents The following table summarizes our affiliated facilities and operational skilled nursing beds and senior living units by ownership status as of June 30, 2021: Owned and Operated Leased (with a Purchase Option) Leased (without a Purchase Option) Total for Facilities Operated Number of facilities 65 11 164 240 Percentage of total 27.1 % 4.6 % 68.3 % 100.0 % Operational skilled nursing beds 6,417 1,145 16,924 24,486 Percentage of total 26.2 % 4.7 % 69.1 % 100.0 % Senior living units 1,445 178 605 2,228 Percentage of total 64.9 % 8.0 % 27.1 % 100.0 % Ensign 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 (or 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 Annual Report, 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 Update — We are continuing to closely monitor the impact of the global COVID-19 pandemic on our business and are taking proactive steps designed to protect the health and safety of our residents and employees and to maintain business continuity. As the vaccines became more accessible in all 50 states, we began to see a significant decline in COVID-19 cases in our affiliated operations as we worked diligently to vaccinate all of our willing residents and staff. 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. As the vaccine distribution commenced and infection rates began to decline, our occupancy rates started to recover in the first quarter of 2021 and continued throughout the second quarter of 2021. The improvements in occupancy were due to our operations developing innovative approaches to confront the occupancy declines, including strategic partnerships with upstream and downstream continuum partners and increasing clinical competencies to treat high-acuity patients, including those that are COVID-19 positive. Additionally, we have seen increases in hospital volumes for surgeries. Some operations added COVID-19 wings, while others became COVID-19 dedicated facilities, enabling an important offloading of strained hospital capacity. Even with COVID-19 demands waning, the partnerships developed during the pandemic will continue to benefit us into the future. As a result of our local, one operation at a time approach, our Same Facilities and Transitioning Facility occupancy rebounded by 2.1% and 3.0%, respectively, during the second quarter of 2021 compared to the fourth quarter of 2020, and 1.7% and 1.5%, respectively, compared to the first quarter of 2021. By strengthening existing partnerships, creating new partnerships and most importantly, demonstrating clinical capabilities and favorable outcomes, our census has continued to stabilize. We believe our operations are primed to rebuild occupancies and continue to gain additional market share as a result of relationships with acute care providers and other health care partners. During the three and six months ended June 30, 2021, we received approximately $2.4 million and $11.5 million, respectively, in provider relief fund distributions (Provider Relief Fund) from the Coronavirus Aid, Relief and Economic Security Act of 2020 (the CARES Act) from the federal government. To date, we have returned all Provider Relief Funds that we received. Further, in March 2021, we repaid the remaining $102.0 million of Medicare Accelerated and Advance Payment Program funds. 34 Table of Contents During the three and six months ended June 30, 2021, we received an additional $16.8 million and $32.4 million, respectively, in state relief funding and recognized $16.7 million and $33.2 million, respectively, as revenue, of which $5.8 million and $6.5 million were classified as unapplied state funding included in our liabilities as of June 30, 2021 and December 31, 2020, respectively. See Note 3, COVID-19 Update in the Notes to the Condensed Consolidated Financial Statements. 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. We recorded $48.3 million of deferred payments of social security taxes as a liability in 2020, of which $24.2 million will be paid out in the fourth quarter of 2021 and the remaining liabilities in 2022. Until the COVID-19 pandemic has been resolved as a public health crisis, it has the potential to cause further and more severe disruption of the global and national economies. Despite these challenges, we believe we are well-positioned to operate effectively in the current environment. Our forecasted metrics may be modified as the pace of the recovery in our volumes and related activity become clearer over the coming months. We continue to focus 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. Facility Information The following table sets forth the location of our operated and owned facilities by type as well as the number of beds and units located at operated and owned facilities as of June 30, 2021: TX CA AZ UT CO WA ID NE IA SC WI NV KS Total Number of operated facilities Skilled nursing operations 60 50 29 18 14 13 10 4 4 4 2 1 — 209 Senior living operations 1 — — 2 5 — — 1 — — — — — 9 Campuses (1) 4 1 3 1 1 — 1 2 2 — — — 7 22 Number of operated beds/units Operational skilled nursing beds 7,787 5,080 4,203 1,991 1,294 1,227 904 413 368 426 100 92 601 24,486 Senior living units 505 65 315 165 619 — 21 301 31 — — — 206 2,228 Number of owned and operated facilities Skilled nursing properties 15 6 7 7 4 2 5 1 — 4 2 — — 53 Senior living communities 1 — — — 3 — — 1 — — — — — 5 Campuses (1) 2 — 3 — — — — — — — — — 2 7 Number of owned and operated beds/units Owned skilled nursing beds 1,938 691 1,264 684 348 204 454 88 — 426 100 — 220 6,417 Owned Senior living units 439 — 315 — 355 — — 262 — — — — 74 1,445 (1) Campuses represent facilities that offer both skilled nursing and senior living services. During the six months ended June 30, 2021, we expanded our operations through a combination of long-term leases and a real estate purchase with the addition of twelve stand-alone skilled nursing operations. Of these additions, one is related to a purchase of owned property, further expanding our real estate portfolio. These new operations added a total of 1,263 operational skilled nursing beds operated by our affiliated operating subsidiaries. For further discussion of our acquisitions, see Note 8, Operation Expansions in the Notes to the Condensed Consolidated Financial Statements . 35 Table of Contents 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: 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. 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 June 30, Six Months Ended June 30, Skilled Mix: 2021 2020 2021 2020 Days 30.9 % 29.7 % 32.6 % 29.5 % Revenue 51.4 % 51.4 % 53.5 % 50.8 % Occupancy — We define occupancy derived from our 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. 36 Table of Contents The following table summarizes our overall occupancy statistics for skilled nursing operations for the periods indicated: Three Months Ended June 30, Six Months Ended June 30, Occupancy for skilled services: 2021 2020 2021 2020 Operational beds at end of period 24,486 22,907 24,486 22,907 Available patient days 2,200,536 2,084,261 4,322,632 4,154,993 Actual patient days 1,599,707 1,530,286 3,109,307 3,173,676 Occupancy percentage (based on operational beds) 72.7 % 73.4 % 71.9 % 76.4 % Segments In the fourth quarter of fiscal year 2020, we began reporting the results of our real estate portfolio as a new segment as we continue to expand our real estate investment strategy. We have two reportable segments: (1) skilled services, which includes the operation of skilled nursing facilities and rehabilitation therapy services and (2) real estate, which is comprised of properties owned by us and leased to skilled nursing and assisted living operations, including our own operating subsidiaries and third party operators, and are subject to triple-net long-term leases. Prior to this new segment structure, we had one reportable segment, skilled services. We also reported an “all other” category that includes operating results from our senior living operations, mobile diagnostics, transportation and other ancillary operations. Our senior living, mobile diagnostics, transportation and other ancillary operations businesses are neither significant individually nor in aggregate and therefore do not constitute a reportable segment. Our Chief Executive Officer, who is our chief operating decision maker, or CODM, reviews financial information at the operating segment level. We have presented our segment results in this Quarterly Report on Form 10-Q on a comparative basis to conform to the new segment structure. Revenue Sources The following table sets forth our total service revenue by payor source generated by our skilled services and our "Other" category and as a percentage of total revenue for the periods indicated (dollars in thousands): Three Months Ended June 30, Skilled Services Other (1) Total Service Revenue 2021 2020 2021 2020 2021 2020 Medicaid (2) $ 247,671 $ 222,924 $ 3,784 $ 3,194 $ 251,455 $ 226,118 Medicare 170,008 175,044 — — 170,008 175,044 Medicaid-skilled 42,740 36,385 — — 42,740 36,385 Subtotal 460,419 434,353 3,784 3,194 464,203 437,547 Managed care 112,963 82,316 — — 112,963 82,316 Private and other 39,500 40,008 17,943 21,208 57,443 61,216 Total service revenue $ 612,882 $ 556,677 $ 21,727 $ 24,402 $ 634,609 $ 581,079 37 Table of Contents Three Months Ended June 30, Skilled Services Other (1) Total Service Revenue 2021 2020 2021 2020 2021 2020 Medicaid (2) 40.4 % 40.0 % 17.4 % 13.1 % 39.6 % 38.9 % Medicare 27.7 31.4 — — 26.8 30.1 Medicaid-skilled 7.0 6.6 — — 6.7 6.3 Subtotal 75.1 78.0 17.4 13.1 73.1 75.3 Managed care 18.4 14.8 — — 17.8 14.2 Private and other 6.5 7.2 82.6 86.9 9.1 10.5 Total service 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 senior living operations and all payors generated in our other ancillary operations. (2) Medicaid payor includes revenue for senior living operations and revenue related to FMAP. Six Months Ended June 30, Skilled Services Other (1) Total Service Revenue 2021 2020 2021 2020 2021 2020 Medicaid (2) $ 475,412 $ 443,893 $ 7,401 $ 6,421 $ 482,813 $ 450,314 Medicare 360,311 330,628 — — 360,311 330,628 Medicaid-skilled 82,733 72,394 — — 82,733 72,394 Subtotal 918,456 846,915 7,401 6,421 925,857 853,336 Managed care 221,308 184,345 — — 221,308 184,345 Private and other 74,154 83,721 36,566 45,628 110,720 129,349 Total service revenue $ 1,213,918 $ 1,114,981 $ 43,967 $ 52,049 $ 1,257,885 $ 1,167,030 Six Months Ended June 30, Skilled Services Other (1) Total Service Revenue 2021 2020 2021 2020 2021 2020 Medicaid (2) 39.2 % 39.8 % 16.8 % 12.3 % 38.4 % 38.6 % Medicare 29.7 29.6 — — 28.6 28.3 Medicaid-skilled 6.8 6.6 — — 6.6 6.2 Subtotal 75.7 76.0 16.8 12.3 73.6 73.1 Managed care 18.2 16.5 — — 17.6 15.8 Private and other 6.1 7.5 83.2 87.7 8.8 11.1 Total service 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 senior living operations and all payors generated in our other ancillary operations. (2) Medicaid payor includes revenue for senior living operations and revenue related to FMAP. In addition to the service revenue above, our rental revenue derived from triple-net lease arrangements with third parties is $3,927 and $7,904, respectively, for the three and six months ended June 30, 2021 and $3,620 and $7,282, respectively, for the three and six months ended June 30, 2020. 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. 38 Table of Contents 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. Real Estate We generate rental revenue primarily by leasing post-acute care properties we acquired to healthcare operators under triple-net lease arrangements, whereby the tenant is solely responsible for the costs related to the property, including property taxes, insurance, and maintenance and repair costs, subject to certain exceptions. As of June 30, 2021, our real estate portfolio was comprised of 95 real estate properties. Of these properties, 65 are leased to affiliated skilled nursing facilities wholly-owned and managed by us, 31 are leased to senior living operations wholly-owned and managed by Pennant, and our Service Center property, which is leased to our Service Center and numerous third parties for commercial office space. Of the 31 real estate operations leased to Pennant, two senior living operations are located on the same real estate properties as skilled nursing facilities that the Company owns and operates. During the three and six months ended June 30, 2021, we generated rental revenues of $16.0 million and $31.9 million, of which $12.1 million and $24.0 million, respectively, was derived from affiliated wholly-owned healthcare operators, and therefore eliminated in consolidation. 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. 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 condensed 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 Notes to 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; • 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. 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. 39 Table of Contents 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, the Centers for Medicare and Medicaid Services (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. 40 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 revenue, 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, and workplace protection for healthcare staff. 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 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 monetary penalties 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 each such matter when 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. Coronavirus In an effort to promote efficient care delivery and to decrease the spread of COVID-19, federal, state and local regulators have both implemented new regulations and waived certain existing regulations, including those set forth below. Temporary suspension of certain patient coverage criteria and documentation and care requirements - The Coronavirus Aid, Relief, and Economic Security Act of 2020 (the CARES Act) and a series of temporary waivers and guidance issued by CMS suspended various Medicare patient coverage criteria to ensure patients continue to have adequate access to care, notwithstanding the burdens placed on healthcare providers as related to the COVID-19 pandemic. Many of these regulatory waivers were issued pursuant to Section 1135 of the Social Security Act, which authorizes the HHS Secretary to temporarily waive or modify Medicare and Medicaid requirements for affected health care providers and facilities following the declaration of a public health emergency (Section 1135 Waivers). HHS also waived requirements specific to skilled nursing facilities pursuant to its authority under Section 1812(f) of the Social Security Act (Section 1812(f) Waiver, and together with the Section 1135 Waivers, the Emergency Waivers). While many of the Emergency Waivers are expected to last throughout the duration of the COVID-19 public health emergency, CMS ended several Emergency Waivers that were no longer needed effective May 10, 2021. 41 Table of Contents Examples of requirements that were waived due to 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 from the community or from other states to allow healthcare systems to provide clinical and workforce support where needed; (3) increasing access to telehealth and corresponding reimbursement through Medicare to ensure patients have access to healthcare while remaining 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 remain waived or are otherwise not being enforced during the public health emergency. We believe these regulatory actions could contribute to changes in skilled mix potentially impacting the timing, amount or duration, which may have been different without the existence of the waivers. 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. In addition, CMS is re-prioritizing scheduled program audits and contract-level Risk Adjustment Data Validation audits for Medicare Advantage (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 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 reviews 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 Contractors (SMRC) reviews and Recovery Audit Contractors (RAC). CMS authorized MACs 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 program for Medicare beneficiaries who are residents of the skilled nursing facilities that meet the skill-in-place criteria, foregoing the usual three-day qualifying hospital stay. As patients qualify for skill-in-place for Medicare Part A stays, we could see a decrease in long-term care Medicare Part B programs. 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. While the CMS guidance issued in March 2020 directed that facilities severely restrict visitation, through the course of the Pandemic, CMS has subsequently provided guidance that broadens visitation. 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. Some of these states were also publicly reporting COVID-19 outbreaks in facilities. 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% and 10%; and twice weekly testing if the county positivity rate exceeds 10%. On April 27, 2021, CMS again issued revised parameters for testing, specifying that the requirement for routine testing of staff applies only to those staff members that are unvaccinated - fully vaccinated staff do not have to be routinely tested. The routine 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, regardless of vaccination status, 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 repeat 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 or are enforcing testing mandates under existing or expanded workplace safety regulations. Non-compliance with state or federal mandates may result in imposition of fines or other administrative action. 42 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 National Health Safety Network no less than weekly, which is made publicly available on a dedicated website. 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 resident/family/representative 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. Effective May 21, 2021, CMS published an interim final ruling requiring long-term care facilities to report weekly COVID-19 vaccination data of both residents and staff to the CDC National Healthcare Safety Network. Facilities are also required to provide residents and staff with vaccine education and offer vaccines, when available, to residents and staff. CMS may initiate enforcement activities and assess civil monetary penalties for not meeting any of these COVID-19 reporting requirements. We do not believe these reporting requirements will have a material impact on our Condensed Consolidated Financial Statements. Effective June 11, 2021, HHS revised the Post-Payment Notice of Reporting Requirements which are applicable to recipients of Provider Relief Funds. The revised requirements provide additional information on the data elements that recipients are required to report as part of the post-payment reporting process, as well as the timing of such reporting. 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 (and subsequently updated in January 2021), 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. Federal COVID-19 Vaccination Program — On December 11, 2020, the U.S. Food and Drug Administration (FDA) issued the first emergency use authorization (EUA) for the Pfizer-BioNTech vaccine for the prevention of COVID-19, followed by the second EUA for the use of the Moderna COVID-19 vaccine on December 28, 2020, and the third EUA for the Johnson & Johnson vaccine on February 27, 2021. Vaccine distribution is now widespread in all 50 states. Medicare Medicare presently accounts for approximately 29.7% of our skilled nursing services revenue year-to-date, 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 became effective October 1, 2019. The SNF PPS Rule includes a new case-mix model that focuses on the patient’s condition (clinically relevant factors) and resulting care needs, 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, occupational therapy, speech language pathology, nursing and social services and non-therapy ancillary services. 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. 43 Table of Contents PDPM replaces the existing case-mix classification methodology, Resource Utilization Groups, Version 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 facilities per diem payments to reflect varying costs throughout the stay, through the physician therapy, occupational therapy and non-therapy ancillary services components. In addition, PDPM is intended to reduce paperwork requirements for performing patient assessments. Under the 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 each such 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 (fiscal year 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 SNF QRP reporting requirements effective until June 30, 2020. This effectively gave 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 CMS is required 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 increased 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. On April 8, 2021, CMS issued a proposed rule for fiscal year 2022 that updates the Medicare payment rates and the quality programs for skilled nursing facilities. Under the proposed rule, which would become effective October 1, 2021, the aggregate net market basket rate is expected to increase by 1.3%, for fiscal year 2022. This estimated increase is attributable to a 2.3% market basket increase factor with a 0.8% point reduction for forecast error adjustment and a 0.2% point reduction for multifactor productivity adjustment. On April 12, 2021, CMS revealed its intent to recalibrate PDPM’s parity adjustment up to 5.0% based on the prior year aggregate spending under the new model. The reimbursement change, if proposed and finalized, could adversely impact our reimbursement rates. 44 Table of Contents 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. On December 27, 2020, the Consolidated Appropriations Act further suspended the 2.0% payment adjustment through March 31, 2021. On April 14, 2021, Congress extended the suspension of the 2.0% payment adjustment through December 31, 2021. To pay for the change, Congress would increase the sequester cuts by one year to fiscal year 2030. 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 fiscal year 2020 SNF PPS Rules estimate the 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. The fiscal year 2021 SNF PPS rule updated the deadlines for baseline period quality measure quarterly reporting and announced performance periods and standards for the fiscal year 2023 program year, but otherwise made no changes to the measures, scoring or payment policies. In the fiscal year 2022 program, CMS proposed changes to account for COVID-19 impacting readmission rates and SNF admissions during the performance periods of fiscal year 2020. These proposed changes would impact the SNF-VBP rate adjustment. 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 occupational therapy (OT) services. These caps were implemented under the authority of the Balanced Budget Amendments of 1997. These amounts were previously associated with the financial limitation amounts. The Bipartisan Budget Act of 2018 (BBA) repealed those caps while retaining and adding additional limitations to ensure appropriate therapy services. This policy does not limit the amount of medically necessary Medicare Part B therapy services a beneficiary may receive. The BBA establishes coding modifier requirements to obtain payments beyond the updated KX modifier thresholds, discussed below, and reaffirms the specific $3,000 claim audit threshold requirements for the Medicare Administrative Contractors. For PT and SLP combined the threshold for coding modifier requirements is $2,110 for 2021, compared to $2,080 for 2020. The threshold is the same for OT services. 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 increases the amount of time that therapists can spend with their patients. Effective January 1, 2021, CMS rescinded 21 problematic National Correct Coding Initiative edits impacting outpatient therapy services, including services furnished under Medicare Part B primarily related to PT and OT services. These code edits were previously implemented on October 1, 2020 and required additional documentation and claim modifier coding burden when procedure codes representing many PT or OT evaluation codes or treatment codes performed under a PT, OT, or SLP plan of care was billed on the same date. This additional burden is no longer required. On November 1, 2019, CMS issued the calendar year 2020 Physician Fee Schedule (PFS) 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 BBA, 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. 45 Table of Contents On December 1, 2020, CMS issued the calendar year 2021 PFS Final Rule, which reduced the conversion factor (i.e. the number by which CMS determine all current procedural terminology code payments) by 10.2%. These changes lowered the reimbursement rate for therapy Medicare Part B specialty providers, specific to our industry by 9% for PT and OT and by 6% for SLP Codes. The Consolidated Appropriations Act of 2021 (CAA, also referred to as The Omnibus Appropriations Law) was signed into law on December 27, 2020. The CAA includes three components relevant to the Medicare Part B PFS. First, the CAA incorporates a rate relief of approximately 3.75% for fiscal year 2021. Additionally, the CAA incorporates a freeze to the payment for the physician add-on code for three years which would effectively create relief on the initial cuts through 2023. Finally, the relief calls for the 2% sequester to not be applied to the Medicare Part B program for the first quarter of 2021. CMS incorporated the first and second components of the CAA relief into the fiscal year 2021 PFS files which were published on January 5, 2021. While the 2021 PFS Final Rule reduced the fiscal year 2021 factor to $32.4085 (calendar year conversion factor was $36.0896), subsequently, the CAA restored part of the reductions resulting in the final fiscal year 2021 conversion factor of $34.8931. This conversion factor rate does not include the 2% sequester which will also qualify as temporary relief for the first quarter of 2021. On July 13, 2021, CMS issued the calendar year 2022 PFS proposed rule, which proposes to implement the portion of the BBA requiring the use of new modifiers to allow CMS to identify and make payments at 85% of the otherwise applicable Part B payment amount for PT and OT services furnished in whole or in part by PT and OT assistants. Other changes in the proposed rule, including reducing the conversion factor by 3.89%, will have the effect of lowering the reimbursement rate for Part B therapy services specific to our industry by approximately 2%, if implemented. 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 through the end of the public health emergency. Subsequently, the calendar year 2021 PFS Final Rule added certain of these PT and OT services to the list of Medicare telehealth services on a temporary basis through the end of the calendar year in which the COVID-19 public health emergency ends. 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. Under the calendar year 2022 PFS proposed rule, these telehealth services would continue to be included on the Medicare telehealth services list until the end of calendar year 2023. Pursuant to the Emergency Waivers, CMS allowed 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, which is currently in effect through October 18, 2021. The PFS Final Rule also increased the frequency limitation on nursing facility telehealth visits from once every 30 days to once every fourteen days. Our facilities are utilizing this waiver as physicians elect to provide telehealth visits to Medicare Part B beneficiaries residing in the skilled nursing facility. On December 31, 2020, CMS announced the annual update to the list of codes that describe Medicare Part B outpatient therapy services, effective January 1, 2021. Several existing and new codes introduced during the COVID-19 public health emergency impacting skilled nursing facilities providers for use under physical therapy, occupational therapy, or speech-language pathology plans of care were recently made permanent including several telehealth codes. CMS designated all these new HCPCS/CPT codes as “sometimes therapy,” to permit physicians and certain non-physician practitioners, including nurse practitioners, physician assistants, and clinical nurse specialists, to render these services outside a therapy plan of care when appropriate. “Sometimes Therapy” codes will not have the MPPR applied. 46 Table of Contents 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 On February 20, 2020, CMS published a proposed rule which would modernize requirements for the Preadmission Screening and Resident Review 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 Medicare 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. 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 I, 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 former Presidential administration have resulted in significant changes in legislation, regulation, implementation of Medicare, Medicaid, and government policy. The recent 2020 Presidential and Congressional elections may 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. 47 Table of Contents 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, 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 expressly inform the resident or his/her representative of the right not to sign the agreement as a condition of admission. 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 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 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. Civil monetary penalties 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 three-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. 48 Table of Contents Federal Healthcare Reform In 2015, CMS released a final rule addressing, among other things, implementation of certain provisions of Medicare Access and CHIP Reauthorization Act of 2015, which changes the way physicians are paid who participate in Medicare through implementation of the Quality Payment Program. Quality Payment Program creates two tracks for physician payment: (1) the Merit-Based Incentive Payment System (MIPS) that streamlines multiple quality programs; and (2) Alternative Payment Models that give bonus payments for participation in eligible Alternative Payment Models. The final rule also excluded services furnished in skilled nursing facilities from the definition of primary care services for purposes of the Shared Savings Program. The Five-Star Quality Rating system includes a rating of one to five in various categories including the use of antipsychotics in calculating the star ratings, modified calculations for staffing levels, reflect higher standards for nursing homes to achieve a high rating on the quality measure dimension, 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 the COVID-19 pandemic, a temporary freeze of Skilled Nursing Facilities Quality Reporting Program data, Staffing Data, and Health Inspection data on the Nursing Home Compare website to account for the suspended reporting and inspection obligations due to the COVID-19 pandemic. 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. In April 2020, CMS began increasing quality measure thresholds by 50% of the average rate of improvement of QM scores every six months. 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. 49 Table of Contents 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 inspections conducted as part of the Nursing Home Five Star Quality Rating System, results of inspections conducted on or after March 4, 2020 were not used to calculate a nursing home’s health inspection star ratings. CMS resumed calculating nursing homes' health inspection ratings on January 27, 2021. In addition, beginning on July 29, 2020, data used to calculate staffing measures in the Five Star Quality ratings system for the first and second quarters of 2020 was frozen based upon the waiver of the requirement for facilities to submit staffing data through the PBJ system. This waiver ended in June 2020 for the third and fourth quarters of 2020, and staffing data was reflected in the Five Star ratings January 2021. Another impact of the COVID-19 pandemic to the Nursing Home Five-Star Quality Rating System is CMS’s decision to make submission of the minimum data set assessment data optional for the fourth quarter of 2019 and excepted for the first and second quarters of 2020. Due to the gap in reported data, CMS did not include the two quality measures that are based on the minimum data set assessment-based data in its quality measure ratings in January 2021. 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 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 (SFF) 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 SFF 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. SFFs receive 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. 50 Table of Contents 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. 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 (Anti-Kickback Statute) 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 Anti-Kickback Statute can result in criminal penalties of up to $100,000 and ten years imprisonment. Violations of the Anti-Kickback Statute 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 Statute may also result in an individual's or organization's exclusion from future participation in 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. 51 Table of Contents Additionally, 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 and home health 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 are not eligible for payment by federal healthcare programs and must be repaid to Medicare or Medicaid, any other third-party payor, and the patient. Violations of the Stark Law may result in the imposition of civil monetary penalties, including, treble damages. Individuals and organizations may also be excluded from participation in federal healthcare programs for Stark Law violations. 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. 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, including the Health Information Technology for Economic and Clinical Health (HITECH) Act which governs our use and disclosure of protected health information of patients. 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 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. Healthcare entities are also required to afford patients with certain rights of access to their health information under HIPAA and the 21st Century Cures Act (Cures Act). Recently, the Office of Civil Rights, the agency responsible for HIPAA enforcement, has targeted investigative and enforcement efforts on violations of patients’ rights of access, imposing significant fines for violations largely initiated from patient complaints. The Office of the National Coordinator for Health Information Technology can also investigate and impose separate penalties for information blocking violations under the Cures Act. 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. Americans with Disabilities Act Our facilities must also comply with the American with Disabilities Act (ADA), and similar state and local laws to the extent that such facilities are "public accommodations" as defined in those laws. The obligation to comply with the ADA and other similar laws is an ongoing obligation, and we continue to assess our facilities and make appropriate modifications. 52 Table of Contents 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 1.9% 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 facility-based 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, the ADA, and safety and health standards set by the Occupational Safety and Health Administration. Changes in the law or new interpretations of existing laws may have an adverse impact on our methods and costs of doing business. 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. As vaccines continue to become more readily available and COVID-19 cases are declining in the communities we serve, we began to see a recovery in our census during the first quarter of 2021 and our improved occupancy levels continued into the second quarter of 2021. As a result, we continue to experience healthy growth and achieve record revenue and net income. Our total revenue for the quarter increased $53.8 million, or 9.2% while our diluted GAAP earning per share grew by 19.2%, from $0.73 to $0.87, compared to the second quarter in 2020. Revenue from our skilled services collectively increased by 10.1%. See Recent Activities for further information. Our one operation at a time approach demonstrates our affiliated operators focus on clinical results and operational fundamentals. We have also strengthened our collection process and 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 cash generated from strong performance resulted in strong financial success in the quarter. 53 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 June 30, Six Months Ended June 30, 2021 2020 2021 2020 Revenue: Service revenue 99.4 % 99.4 % 99.4 % 99.4 % Rental revenue 0.6 0.6 0.6 0.6 Total revenue 100.0 % 100.0 % 100.0 % 100.0 % Expense: Cost of services 76.4 77.3 76.7 77.2 Rent—cost of services 5.4 5.6 5.4 5.5 General and administrative expense 5.8 5.4 5.5 5.4 Depreciation and amortization 2.2 2.3 2.2 2.3 Total expenses 89.8 90.6 89.8 90.4 Income from operations 10.2 9.4 10.2 9.6 Other income (expense): Interest expense (0.3) (0.4) (0.3) (0.5) Interest and other income 0.2 0.2 0.1 0.2 Other expense, net (0.1) (0.2) (0.2) (0.3) Income before provision for income taxes 10.1 9.2 10.0 9.3 Provision for income taxes 2.2 2.3 2.1 2.2 Net income 7.9 6.9 7.9 7.1 Less: net income attributable to noncontrolling interests 0.2 0.1 0.1 0.1 Net income attributable to The Ensign Group, Inc. 7.7 % 6.8 % 7.8 % 7.0 % Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 Segment Income (1) (In thousands) Skilled services $ 90,010 $ 78,302 $ 178,941 $ 158,893 Real estate (2) $ 8,891 $ 7,794 $ 17,712 $ 14,119 Non-GAAP Financial Measures: Performance Metrics EBITDA $ 77,491 $ 68,599 $ 154,198 $ 138,759 Adjusted EBITDA $ 82,523 $ 72,383 $ 163,402 $ 146,191 FFO for real estate segment $ 13,675 $ 12,381 $ 27,189 $ 23,221 Valuation Metric Adjusted EBITDAR $ 116,978 $ 231,275 (1) Segment income represents operating results of the reportable segments excluding gain and loss on sale of assets, impairment charges and provision for income taxes. Segment income is reconciled to the Condensed Consolidated Statement of Income in Note 7, Business Segments in Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q. (2) Real estate segment income includes rental revenue from Ensign affiliated tenants and related expenses. The following discussion includes references to EBITDA, Adjusted EBITDA, Adjusted EBITDAR and Funds from Operations (FFO) which are non-GAAP financial measures (collectively, the Non-GAAP Financial Measures). Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other provisions of the Securities 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. 54 Table of Contents We believe the presentation of certain 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 the 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 use certain 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. Despite the importance of these measures in analyzing our underlying business, designing incentive compensation and for our goal setting, the Non-GAAP Financial Measures have no standardized meaning defined by GAAP. Therefore, certain of 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 condensed 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 condensed consolidated financial statements and related notes included elsewhere in this document. 55 Table of Contents We use the following Non-GAAP financial measures that we believe are useful to investors as key valuation and operating performance measures: 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; • costs incurred related to real estate due diligence; • costs incurred related to new systems implementation; • gain on sale of assets; and • acquisition related costs. Funds from Operations (FFO) We consider FFO to be a useful supplemental measure of the operating performance of our real estate segment. Historical cost accounting for real estate assets in accordance with U.S. GAAP implicitly assumes that the value of real estate assets diminishes predictably over time as evidenced by the provision for depreciation. However, since real estate values have historically risen or fallen with market conditions, many real estate investors and analysts have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient. In response, the National Association of Real Estate Investment Trusts (NAREIT) created FFO as a supplemental measure of operating performance for REITs, which excludes historical cost depreciation from net income. We define (in accordance with the definition used by NAREIT) FFO to mean net income attributable to common stockholders (NICS), computed in accordance with U.S. GAAP, excluding gains (or losses) from sales of real estate and impairment of depreciable real estate assets and including depreciation and amortization related to real estate to earnings. 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. 56 Table of Contents 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. The table below reconciles net income to EBITDA, Adjusted EBITDA and Adjusted EBITDAR for the periods presented: Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 Consolidated statements of income data: (In thousands) Net income $ 50,583 $ 40,688 $ 100,420 $ 81,890 Less: net income attributable to noncontrolling interests 1,158 440 1,789 793 Add: Interest expense, net 513 1,211 1,406 4,178 Provision for income taxes 13,758 13,535 26,707 26,159 Depreciation and amortization 13,795 13,605 27,454 27,325 EBITDA $ 77,491 $ 68,599 $ 154,198 $ 138,759 Stock-based compensation expense 4,633 3,528 8,687 6,763 Results related to operations not at full capacity(a) — 197 584 539 Gain on sale of assets — — (540) — Costs incurred related to real estate due diligence 171 — 171 — Acquisition related costs(b) 152 34 188 83 Costs incurred related to new systems implementation 76 — 76 — Rent related to items above — 25 38 47 Adjusted EBITDA $ 82,523 $ 72,383 $ 163,402 $ 146,191 Rent—cost of services 34,455 32,484 67,911 64,814 Less: rent related to items above — (25) (38) (47) Adjusted rent 34,455 32,459 67,873 64,767 Adjusted EBITDAR $ 116,978 $ 231,275 (a) Represents results of operations not at full capacity during the period presented. (b) Costs incurred to acquire operations which are not capitalizable. Three Months Ended June 30, 2021 Compared to the Three Months Ended June 30, 2020 The following table sets forth details of operating results for our revenue and earnings, and their respective components, by our reportable segment for the periods indicated: Three Months Ended June 30, 2021 Skilled services Real estate All Other Eliminations Consolidated Total revenue 612,882 16,031 21,727 (12,104) $ 638,536 Total expenses, including other expense, net 522,872 7,140 56,287 (12,104) 574,195 Segment income (loss) 90,010 8,891 (34,560) — 64,341 Income before provision for income taxes $ 64,341 Three Months Ended June 30, 2020 Skilled services Real estate All Other Eliminations Consolidated Total revenue $ 556,677 $ 15,009 $ 24,402 $ (11,389) $ 584,699 Total expenses, including other expense, net 478,375 7,215 56,275 (11,389) 530,476 Segment income (loss) 78,302 7,794 (31,873) — 54,223 Income before provision for income taxes $ 54,223 Our total revenue increased $53.8 million, or 9.2%, compared to the three months ended June 30, 2020. The increase in revenue was primarily driven by an increase in our skilled mix days and revenue per patient day from our skilled services operations, along with the impact of acquisitions. Total revenue from operations acquired on or subsequent to January 1, 2020 increased our consolidated revenue by $27.9 million during the three months ended June 30, 2021, when compared to the same period in 2020. In addition, we recorded $16.7 million of state relief revenue in the second quarter of 2021 compared to $12.4 million in the same period in 2020, which correlated directly to the additional COVID-19 related expenses incurred. All state relief revenue is included in Medicaid revenue. Skilled Services Revenue The following table presents the skilled services revenue and key performance metrics by category during the three months ended June 30, 2021 and 2020: Three Months Ended June 30, 2021 2020 Change % Change Total Facility Results: (Dollars in thousands) Skilled services revenue $ 612,882 $ 556,677 $ 56,205 10.1 % Number of facilities at period end 209 195 14 7.2 % Number of campuses at period end* 22 21 1 4.8 % Actual patient days 1,599,707 1,530,286 69,421 4.5 % Occupancy percentage — Operational beds 72.7 % 73.4 % (0.7) % Skilled mix by nursing days 30.9 % 29.7 % 1.2 % Skilled mix by nursing revenue 51.4 % 51.4 % — % Three Months Ended June 30, 2021 2020 Change % Change Same Facility Results(1): (Dollars in thousands) Skilled services revenue $ 492,510 $ 468,023 $ 24,487 5.2 % Number of facilities at period end 165 165 — — % Number of campuses at period end* 15 15 — — % Actual patient days 1,264,220 1,262,224 1,996 0.2 % Occupancy percentage — Operational beds 73.9 % 73.9 % — % Skilled mix by nursing days 32.4 % 31.0 % 1.4 % Skilled mix by nursing revenue 53.2 % 52.8 % 0.4 % 57 Table of Contents Three Months Ended June 30, 2021 2020 Change % Change Transitioning Facility Results(2): (Dollars in thousands) Skilled services revenue $ 88,617 $ 83,356 $ 5,261 6.3 % Number of facilities at period end 27 27 — — % Number of campuses at period end* 6 6 — — % Actual patient days 243,576 250,988 (7,412) (3.0) % Occupancy percentage — Operational beds 68.4 % 70.9 % (2.5) % Skilled mix by nursing days 26.9 % 24.0 % 2.9 % Skilled mix by nursing revenue 46.3 % 44.6 % 1.7 % Three Months Ended June 30, 2021 2020 Change % Change Recently Acquired Facility Results(3): (Dollars in thousands) Skilled services revenue $ 31,755 $ 5,298 $ 26,457 NM Number of facilities at period end 17 3 14 NM Number of campuses at period end* 1 — 1 NM Actual patient days 91,911 17,074 74,837 NM Occupancy percentage — Operational beds 68.4 % 76.0 % NM Skilled mix by nursing days 19.8 % 15.9 % NM Skilled mix by nursing revenue 37.0 % 30.0 % 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. In the second quarter of 2021, we converted a campus into a skilled nursing facility. (1) Same Facility results represent all facilities purchased prior to January 1, 2018. (2) Transitioning Facility results represent all facilities purchased from January 1, 2018 to December 31, 2019. (3) Recently Acquired Facility (Acquisitions) results represent all facilities purchased on or subsequent to January 1, 2020. Skilled services revenue increased $56.2 million, or 10.1%, compared to the three months ended June 30, 2020. Of the $56.2 million increase, Medicaid custodial revenue increased $24.7 million, or 11.1%, Medicaid skilled revenue increased $6.4 million, or 17.5%, and managed care revenue increased by $30.6 million, or 37.2%. This is partially offset by the decreases in Medicare revenue of $5.0 million , or 2.9%, and private and other revenue of $0.5 million, or 1.3%. The increase in revenue was primarily driven by strong performance across our skilled services operations. The negative impact of COVID-19 on our census started in March 2020 and continues in 2021. Our consolidated occupancy decreased by 0.7%, which includes operations acquired at lower occupancy compared to the same period in the prior year. The impact of the decline in occupancy was offset by the increase in skilled mix days due to a shift toward high acuity patients. Revenue in our Same Facilities increased $24.5 million, or 5.2% due to higher patient acuity, skilled days and total patient days. Our skilled days increased by 4.7%, which resulted in an increase in skilled mix revenue of $9.7 million . Managed care skilled days increased by 33.9% coupled with an increase from our revenue daily rate of 1.8%, resulting in an increase in Managed Care revenue of $23.4 million. Medicaid custodial and private patient census days decreased due to COVID-19. This was offset by an increase in our Medicaid daily rate of 5.2% as a result of our successful participation in the quality improvement programs and the supplemental programs in various states. Revenue generated by our Transitioning Facilities increased $5.3 million , or 6.3% , primarily due to an increase in our skilled mix days compared to the three months ended June 30, 2020, demonstrating our ability to transition these healthcare operations toward higher acuity patients. The acuity gains were partially offset by the decline in occupancy of non-skilled patient days. Skilled services revenue generated by facilities purchased on or subsequent to January 1, 2020 (Recently Acquired Facilities) increased by approximately $26.5 million compared to the three months ended June 30, 2020 . We acquired fifteen operations between July 1, 2020 and June 30, 2021 across five states. 58 Table of Contents 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 June 30, Same Facility Transitioning Acquisitions Total 2021 2020 2021 2020 2021 2020 2021 2020 Skilled Nursing Average Daily Revenue Rates: Medicare $ 687.38 $ 665.84 $ 671.78 $ 639.97 $ 670.62 $ 574.22 $ 684.33 $ 661.05 Managed care 505.69 496.84 476.54 474.06 481.12 391.39 501.06 493.10 Other skilled 541.80 537.80 419.22 356.73 512.71 — 530.17 530.57 Total skilled revenue 584.52 587.36 559.34 565.08 582.65 534.44 581.11 584.08 Medicaid 248.71 236.36 238.66 223.11 242.40 236.81 246.65 234.02 Private and other payors 236.86 232.60 236.12 216.52 259.37 234.86 238.06 229.76 Total skilled nursing revenue $ 356.45 $ 344.87 $ 324.54 $ 304.46 $ 311.41 $ 283.93 $ 349.00 $ 337.55 (1) These rates exclude additional FMAP we recognized and include sequestration reversal of 2%. Our Medicare daily rates at Same Facilities and Transitioning Facilities increased by 3.2% and 5.0%, respectively, compared to the three months ended June 30, 2020. The increase is attributable to the 2.2% net market basket increase that became effective in October 2020 coupled with our continued shift towards higher acuity patients. Included in revenue for the three months ended June 30, 2021 is the result of the temporary suspension of the 2% Medicare sequestration, which started on May 1, 2020 and was extended through December 31, 2021. Our average Medicaid rates increased 5.4% 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 state relief 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. The following tables set forth our percentage of skilled nursing patient revenue and days by payor source: Three Months Ended June 30, Same Facility Transitioning Acquisitions Total 2021 2020 2021 2020 2021 2020 2021 2020 Percentage of Skilled Nursing Revenue: Medicare 24.9 % 29.5 % 25.3 % 29.4 % 21.3 % 25.2 % 24.8 % 29.5 % Managed care 19.5 14.8 17.2 13.9 8.8 4.8 18.6 14.6 Other skilled 8.8 8.5 3.8 1.3 6.9 — 8.0 7.3 Skilled mix 53.2 52.8 46.3 44.6 37.0 30.0 51.4 51.4 Private and other payors 6.8 7.5 7.8 8.7 8.7 13.1 7.0 7.7 Medicaid 40.0 39.7 45.9 46.7 54.3 56.9 41.6 40.9 Total skilled nursing 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 59 Table of Contents Three Months Ended June 30, Same Facility Transitioning Acquisitions Total 2021 2020 2021 2020 2021 2020 2021 2020 Percentage of Skilled Nursing Days: Medicare 12.9 % 15.3 % 12.2 % 14.0 % 9.9 % 12.5 % 12.6 % 15.1 % Managed care 13.7 10.3 11.7 8.9 5.7 3.4 13.0 10.0 Other skilled 5.8 5.4 3.0 1.1 4.2 — 5.3 4.6 Skilled mix 32.4 31.0 26.9 24.0 19.8 15.9 30.9 29.7 Private and other payors 10.3 11.0 10.8 12.3 10.4 15.9 10.3 11.3 Medicaid 57.3 58.0 62.3 63.7 69.8 68.2 58.8 59.0 Total skilled nursing 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Cost of Services The following table sets forth total cost of services for our Skilled services segment for the periods indicated (dollars in thousands): Three Months Ended June 30, Change 2021 2020 $ % Cost of service $ 472,217 $ 431,048 $ 41,169 9.6 % Revenue percentage 77.0 % 77.4 % (0.4) % Cost of services related to our Skilled services segment increased $41.2 million, or 9.6%, primarily due to additional costs related to new acquisitions, which accounted for $20.7 million of the increase to cost of services. Cost of services as a percentage of revenue decreased to 77.0% from 77.4%, a decrease of 0.4%. We experienced a decrease in cost associated with operational improvements. Real Estate Segment Three Months Ended June 30, Change 2021 2020 $ % (In thousands) Rental revenue generated from third-party tenants $ 3,927 $ 3,620 $ 307 8.5 % Rental revenue generated from Ensign affiliated operations 12,104 11,389 715 6.3 Total rental revenue $ 16,031 $ 15,009 $ 1,022 6.8 % Segment income 8,891 7,794 1,097 14.1 Depreciation and amortization 4,784 4,587 197 4.3 FFO $ 13,675 $ 12,381 $ 1,294 10.5 % Rental revenue. Our rental revenue, including revenue generated from our affiliated facilities, increased by $1.0 million, or 6.8%, to $16.0 million, compared to the three months ended June 30, 2020. The increase in revenue is primarily attributable to acquisitions and CPI increases. FFO. Our FFO increased $1.3 million, or 10.5% to $13.7 million, compared to the three months ended June 30, 2020. The increase in FFO is primarily related to the increase in rental revenue and the decrease in interest expense. 60 Table of Contents All Other Service Revenue Our other revenue decreased by $2.7 million, or 11.0%, to $21.7 million, compared to the three months ended June 30, 2020. Other revenue for 2021 includes senior living revenue of $12.0 million and revenue from other ancillary services of $9.7 million. The decrease in other revenue is due to the impact of COVID-19, which negatively impacted services in our other ancillary services. Consolidated Financial Expenses Rent — cost of services. Our rent — cost of services as a percentage of total revenue decreased by 0.2% to 5.4%, primarily due the growth in revenue outpacing the increase in rent expense. General and administrative expense — General and administrative expense increased $5.5 million or 17.4%, to $36.9 million. This increase was primarily due to increases in wages and benefits due to enhanced performance and growth. General and administrative expense as a percentage of revenue increased by 0.4% to 5.8%. Depreciation and amortization — Depreciation and amortization expense increased $0.2 million, or 1.4%, 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 0.1%, to 2.2%, as a percentage of revenue. Other expense, net — Other expense, net as a percentage of revenue decreased by 0.1%, to 0.1%. Other expense primarily includes interest expense related to debt. Provision for income taxes — Our effective tax rate was 21.4% for the three months ended June 30, 2021, compared to 25.0% for the same period in 2020. The effective tax rate for both periods is driven by the impact of excess tax benefits from stock-based compensation, partially offset by non-deductible expenses. The 2021 reporting period had a larger excess tax benefit from stock-based compensation compared to 2020. See Note 14, Income Taxes , in the Notes to the Condensed Consolidated Financial Statements for further discussion. Six Months Ended June 30, 2021 Compared to the Six Months Ended June 30, 2020 The following table sets forth details of operating results for our revenue and earnings, and their respective components, by our reportable segment for the periods indicated: Six Months Ended June 30, 2021 Skilled services Real estate All Other Eliminations Consolidated Total revenue $ 1,213,918 $ 31,910 $ 43,967 $ (24,006) $ 1,265,789 Total expenses, including other expense, net 1,034,977 14,198 113,933 (24,006) 1,139,102 Segment income (loss) 178,941 17,712 (69,966) — 126,687 Gain from sale of real estate (1) 440 Income before provision for income taxes $ 127,127 (1) Gain from sale of real estate includes gains or losses from the sale of real estate, insurance recoveries and impairment charges from operations. Six Months Ended June 30, 2020 Skilled services Real estate All Other Eliminations Consolidated Total revenue $ 1,114,981 $ 29,953 $ 52,049 $ (22,671) $ 1,174,312 Total expenses, including other expense, net 956,088 15,834 117,012 (22,671) 1,066,263 Segment income (loss) 158,893 14,119 (64,963) — 108,049 Income before provision for income taxes $ 108,049 61 Table of Contents Our total revenue increased $91.5 million, or 7.8%, compared to the six months ended June 30, 2020. The increase in revenue was primarily driven by an increase in our skilled service segment and the increase in skilled mix days and revenue per patient day from our skilled services operations, along with the impact of acquisitions. Total revenue from operations acquired on or subsequent to January 1, 2020 increased our consolidated revenue by $46.9 million during the six months ended June 30, 2021, when compared to the same period in 2020. In addition, we recorded $33.2 million of state relief revenue during the first half of 2021 compared to $13.1 million in 2020, which correlated directly to the additional COVID-19 related expenses incurred. All state relief revenue is included in Medicaid revenue. Skilled Services Segment Revenue The following table presents the skilled services revenue and key performance metrics by category during the six months ended June 30, 2021 and 2020: Six Months Ended June 30, 2021 2020 Change % Change Total Facility Results: (Dollars in thousands) Skilled services revenue $ 1,213,918 1,114,981 $ 98,937 8.9 % Number of facilities at period end 209 195 14 7.2 % Number of campuses at period end* 22 21 1 4.8 % Actual patient days 3,109,307 3,173,676 (64,369) (2.0) % Occupancy percentage — Operational beds 71.9 % 76.4 % (4.5) % Skilled mix by nursing days 32.6 % 29.5 % 3.1 % Skilled mix by nursing revenue 53.5 % 50.8 % 2.7 % Six Months Ended June 30, 2021 2020 Change % Change Same Facility Results(1): (Dollars in thousands) Skilled services revenue $ 984,300 $ 944,919 $ 39,381 4.2 % Number of facilities at period end 165 165 — — % Number of campuses at period end* 15 15 — — % Actual patient days 2,483,913 2,634,027 (150,114) (5.7) % Occupancy percentage — Operational beds 73.1 % 77.1 % (4.0) % Skilled mix by nursing days 33.9 % 31.0 % 2.9 % Skilled mix by nursing revenue 54.9 % 52.5 % 2.4 % Six Months Ended June 30, 2021 2020 Change % Change Transitioning Facility Results(2): (Dollars in thousands) Skilled services revenue $ 177,642 $ 162,383 $ 15,259 9.4 % Number of facilities at period end 27 27 — — % Number of campuses at period end* 6 6 — — % Actual patient days 479,244 514,329 (35,085) (6.8) % Occupancy percentage — Operational beds 67.6 % 72.8 % (5.2) % Skilled mix by nursing days 28.7 % 22.3 % 6.4 % Skilled mix by nursing revenue 48.8 % 41.7 % 7.1 % 62 Table of Contents Six Months Ended June 30, 2021 2020 Change % Change Recently Acquired Facility Results(3): (Dollars in thousands) Skilled services revenue $ 51,976 $ 7,679 $ 44,297 NM Number of facilities at period end 17 3 14 NM Number of campuses at period end* 1 — 1 NM Actual patient days 146,150 25,320 120,830 NM Occupancy percentage — Operational beds 67.8 % 75.2 % NM Skilled mix by nursing days 22.9 % 16.6 % NM Skilled mix by nursing revenue 41.9 % 30.5 % 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. In the first half of 2021, we converted two campuses into two skilled nursing facilities. (1) Same Facility results represent all facilities purchased prior to January 1, 2018. (2) Transitioning Facility results represent all facilities purchased from January 1, 2018 to December 31, 2019. (3) Recently Acquired Facility (Acquisitions) results represent all facilities purchased on or subsequent to January 1, 2020. S killed services revenue increased $98.9 million, or 8.9%, compared to the six months ended June 30, 2020. Of the $98.9 million increase, Managed care revenue increased $37.0 million, or 20.1%, Medicare revenue increased $29.7 million, or 9.0%, Medicaid custodial revenue increased $31.5 million , or 7.1% and Medicaid skilled revenue increased $10.3 million , or 14.3%. This is partially offset by the decrease in private and other revenue of $9.6 million , or 11.4%. The increase in revenue was primarily driven by strong performance across our skilled services operations. The negative impact of COVID-19 on our census started in March 2020 and continues in 2021. Our consolidated occupancy decreased by 4.5%, which includes operations acquired at lower occupancy, compared to the same period in the prior year. The impact of the decline in occupancy was offset by the increase in skilled mix days due to a shift toward high acuity patients. Revenue in our Same Facilities increased $39.4 million, or 4.2% due to greater patient acuity and skilled days, even while occupancy declined by 4.0%, due to COVID-19. The decline in our occupancy is mainly in our non-skilled patient days, which was offset by the shift toward high acuity patients. Total revenue for Same Facilities included $26.8 million and $11.0 million of Medicaid revenue related to state relief funding for the six months ended June 30, 2021 and 2020, respectively. The revenue increase was driven by higher skilled mix from managed care coupled with higher Medicare revenue, all of which was partially offset by Medicaid and private revenue decrease. Revenue generated by our Transitioning Facilities increased $15.3 million, or 9.4%, primarily due to increases in our daily rate and skilled mix days compared to the six months ended June 30, 2020 , demonstrating our ability to transition these healthcare operations that were acquired two and three years ago. In addition, we experienced a shift toward higher acuity patients, as demonstrated by increased census in all skilled payors . Our skilled days increased by 19.8% , coupled with an increase from our skilled mix revenue daily rate of 3.6%. Skilled services revenue generated by facilities purchased on or subsequent to January 1, 2020 (Recently Acquired Facilities) increased by approximately $44.3 million compared to the six months ended June 30, 2020. We acquired fifteen operations between July 1, 2020 and June 30, 2021 across five states. In the future, if we acquire additional facilities that are underperforming and need to be turned around or invest in 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 and lower skilled mix at Recently Acquired Facilities and therefore, we anticipate generally lower overall occupancy during years of growth. 63 Table of Contents 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) : Six Months Ended June 30, Same Facility Transitioning Acquisitions Total 2021 2020 2021 2020 2021 2020 2021 2020 Skilled Nursing Average Daily Revenue Rates: Medicare $ 689.79 $ 664.78 $ 675.46 $ 634.74 $ 702.48 $ 551.59 $ 688.12 $ 659.51 Managed care 505.52 485.29 480.65 456.52 436.73 401.35 500.60 481.46 Other skilled 544.03 530.55 410.61 338.52 512.75 — 531.74 522.09 Total skilled revenue 589.97 573.61 568.53 549.01 592.65 517.00 587.15 570.34 Medicaid 250.01 233.78 240.10 221.07 241.82 235.53 247.95 231.54 Private and other payors 238.07 233.28 238.89 217.76 253.90 232.05 238.98 230.38 Total skilled nursing revenue $ 364.03 $ 339.15 $ 334.18 $ 293.79 $ 323.27 $ 281.70 $ 357.51 $ 331.33 (1) These rates exclude additional FMAP we recognized and include sequestration reversal of 2%. Our Medicare daily rates at Same Facilities and Transitioning Facilities increased by 3.8% and 6.4%, respectively, compared to the six months ended June 30, 2020. The increase is attributable to the 2.2% net market basket increase that became effective in October 2020 coupled with our continued shift towards higher acuity patients. Included in revenue for the six months ended June 30, 2021 is the result of the temporary suspension of the 2% Medicare sequestration, which started on May 1, 2020 and was extended through December 31, 2021. Our average Medicaid rates increased 7.1% 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 state relief revenue we recorded. Payor Sources as a Percentage of Skilled Nursing Services. We use our skilled mix as a measure of the quality of reimbursements we receive at our affiliated skilled nursing facilities over various periods. The following tables set forth our percentage of skilled nursing patient revenue and days by payor source: Six Months Ended June 30, Same Facility Transitioning Acquisitions Total 2021 2020 2021 2020 2021 2020 2021 2020 Percentage of Skilled Nursing Revenue: Medicare 27.2 % 27.3 % 28.2 % 26.8 % 26.0 % 25.1 % 27.3 % 27.2 % Managed care 19.2 16.9 17.3 13.5 7.8 5.4 18.5 16.3 Other skilled 8.5 8.3 3.3 1.4 8.1 — 7.7 7.3 Skilled mix 54.9 52.5 48.8 41.7 41.9 30.5 53.5 50.8 Private and other payors 6.4 7.5 7.4 9.6 8.0 15.7 6.5 7.9 Medicaid 38.7 40.0 43.8 48.7 50.1 53.8 40.0 41.3 Total skilled nursing 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 64 Table of Contents Six Months Ended June 30, Same Facility Transitioning Acquisitions Total 2021 2020 2021 2020 2021 2020 2021 2020 Percentage of Skilled Nursing Days: Medicare 14.3 % 13.9 % 13.9 % 12.4 % 12.0 % 12.8 % 14.2 % 13.7 % Managed care 13.9 11.8 12.0 8.7 5.8 3.8 13.2 11.2 Other skilled 5.7 5.3 2.8 1.2 5.1 — 5.2 4.6 Skilled mix 33.9 31.0 28.7 22.3 22.9 16.6 32.6 29.5 Private and other payors 9.7 11.0 10.4 13.0 10.2 19.1 9.8 11.4 Medicaid 56.4 58.0 60.9 64.7 66.9 64.3 57.6 59.1 Total skilled nursing 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Cost of Services The following table sets forth total cost of services for our skilled services segment for the periods indicated (dollars in thousands): Six Months Ended June 30, Change 2021 2020 $ % Cost of service $ 935,177 $ 861,587 $ 73,590 8.5 % Revenue percentage 77.0 % 77.3 % (0.3) % Cost of services related to our skilled services segment increased $73.6 million, or 8.5%, due primarily to additional costs at new acquisitions, which accounted for $34.1 million of the increase. Cost of services as a percentage of revenue decreased to 77.0% from 77.3%, a decrease of 0.3%. We experienced a decrease in cost associated with operational improvements. Real Estate Segment Six Months Ended June 30, Change 2021 2020 $ % Rental revenue generated from third-party tenants $ 7,904 $ 7,282 $ 622 8.5 % Rental revenue generated from Ensign affiliated operations 24,006 22,671 1,335 5.9 Total rental revenue $ 31,910 $ 29,953 $ 1,957 6.5 % Segment income 17,712 14,119 3,593 25.4 Depreciation and amortization 9,477 9,102 375 4.1 FFO $ 27,189 $ 23,221 $ 3,968 17.1 % Rental revenue. Our rental revenue, including revenue generated from our affiliated facilities, increased by $2.0 million, or 6.5% to $31.9 million, compared to the six months ended June 30, 2020. The increase in revenue is primarily attributable to acquisitions and CPI increases. FFO. Our FFO increased $4.0 million, or 17.1% to $27.2 million, compared to the six months ended June 30, 2020. The increase in FFO is primarily related to the increase in rental revenue and the decrease in interest expense. All Other Service Revenue Our other revenue decreased by $8.1 million, or 15.5% to $44.0 million, compared to the six months ended June 30, 2020. Other revenue for 2021 includes senior living revenue of $23.8 million and revenue from other ancillary services of $20.2 million. The decrease in other revenue is due to the impact of COVID-19, which negatively impacted services in our other ancillary services. 65 Table of Contents Consolidated Financial Expenses Rent — cost of services. Our rent — cost of services as a percentage of total revenue decreased by 0.1% to 5.4%, primarily due to the growth in revenue outpacing the increase in rent expense. General and administrative expense. General and administrative expense increased $7.5 million or 11.8%, to $71.2 million. This increase was primarily due to increases in wages and benefits due to enhanced performance and growth. General and administrative expense increased by 0.1% to 5.5%, as a percentage of revenue. Depreciation and amortization . Depreciation and amortization expense increased $0.1 million, or 0.5%, to $27.5 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 0.1%, to 2.2%, as a percentage of revenue. Other expense, net. Other expense, net as a percentage of revenue decreased by 0.1%, to 0.2%. Other expense primarily includes interest expense related to borrowings under our Credit Facility. As there was no outstanding debt under the Credit Facility, interest expense decreased. Provision for income taxes. Our effective tax rate was 21.0% for the six months ended June 30, 2021, compared to 24.2% for the same period in 2020. The effective tax rate for both periods is driven by the impact of excess tax benefits from stock-based compensation, partially offset by non-deductible expenses. The 2021 reporting period had a larger excess tax benefit from stock-based compensation compared to 2020. See Note 14, Income Taxes , in the Notes to the 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 Credit Facility. Our liquidity as of June 30, 2021 is impacted by cash generated from strong operational performance and the repayment of Medicare Accelerated and Advance Payment Program funds. Historically, we have primarily financed the majority of our acquisitions through the financing of our operating subsidiaries through mortgages, our Credit Facility, and cash generated from operations. Total capital expenditures for property and equipment were $33.8 million and $27.1 million for the six months ended June 30, 2021 and 2020, respectively. We currently have approximately $65.0 million budgeted for renovation projects for 2021. 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 June 30, 2021 consisted of bank term deposits, money market funds and U.S. Treasury bill related investments. In addition, as of June 30, 2021, we held debt security investments of approximately $48.9 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 June 30, 2021 were not other-than-temporarily impaired, nor has any event occurred subsequent to that date that would indicate any other-than-temporary impairment. As mentioned above, our primary sources of cash is 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 June 30, 2021, along with projected operating cash flows and available financing, will support our normal business operations for the foreseeable future. 66 Table of Contents The following table presents selected data from our condensed consolidated statement of cash flows for the periods presented: Six Months Ended June 30, 2021 2020 Net cash provided by/(used in): (In thousands) Operating activities $ 108,397 $ 174,138 Investing activities (40,862) (28,326) Financing activities (105,686) (3,249) Net (decrease)/increase in cash and cash equivalents (38,151) 142,563 Cash and cash equivalents beginning of period 236,562 59,175 Cash and cash equivalents at end of period $ 198,411 $ 201,738 Operating Activities Cash provided by operating activities is net income adjusted for certain non-cash items and changes in operating assets and liabilities. The $65.7 million decrease in cash provided by operating activities for the six months ended June 30, 2021 compared to the same period in 2020, w as primarily due to changes in working capital partially offset by higher net income. Changes in working capital was driven by timing of accounts receivable collections, prepayment of income taxes, timing of prepaid expenses and other assets and accrued wages and related liabilities, which are partially offset by the timing of accounts payable payments. Investing Activities Investing cash flows consist primarily of capital expenditures, investment activities, insurance proceeds and cash used for acquisitions. The $12.5 million increase in cash used in investing activities for the six months ended June 30, 2021 compared to the same period in 2020, was primarily due to an increase in cash used for acquisitions of $11.2 million, coupled with an increase in capital expenditures of $6.7 million, which is partially offset by an increase in cash from insurance proceeds of $6.7 million. Financing Activities Financing cash flows consist primarily of payment of dividends to stockholders, issuance and repayment of short-term and long-term debt, repayment of the Medicare Accelerated and Advance Payment Program funds and sale of shares of common stock through employee equity incentive plans. The $102.4 million increase in cash used in financing activities for the six months ended June 30, 2021 compared to the same period in 2020, was primarily due to the repayment of the Medicare Accelerated and Advance Payment Program funds of $102.0 million. 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 $350.0 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. 67 Table of Contents Mortgage Loans and Promissory Notes As of June 30, 2021, 19 of our subsidiaries have mortgage loans insured with HUD for an aggregate amount of $112.9 million, which subjects these subsidiaries to HUD oversight and periodic inspections. The mortgage loans bear effective interest rates range of 2.8% to 4.2%, including fixed interest rates range of 2.6% to 3.3% 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 5.0% and 5.3% per annum and the term of the notes are 10 months and twelve years, 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 fiscal year of 2021, 164 of our facilities are under long-term lease arrangements, of which 92 of the operations are under nine triple-net Master Leases and one stand-alone lease with CareTrust REIT, Inc. (CareTrust). 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. Additionally, four of the 93 facilities leased from CareTrust include an option to purchase that we can exercise starting on December 1, 2024. In the second quarter of 2021, the Company added four operations and extended the term for one of the Master Leases for an additional 15 years. As a result, the total lease liabilities and right-of-use assets increased by $54.7 million to reflect the new lease obligation. 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-three 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. 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 through 2018, 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 through 2018, 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 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. 68 Table of Contents 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 December 2019, the FASB issued Accounting Standards Update (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. We adopted this standard on January 1, 2021 and determined there was no material impact 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. We adopted this standard on January 1, 2021 and determined there was no material impact on our condensed consolidated financial statements. Accounting Standards Recently Issued but Not Yet Adopted by the Company 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 reference rates which are expected to replace LIBOR reference rates. 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. 69 Table of Contents In November 2020, the SEC issued final rules 33-10890 and 34-90459 “ Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information ,” which modernizes and simplifies certain disclosure requirements of Regulation S-K. Certain key rule amendments eliminate the requirement to disclose Selected Financial Data; Selected Quarterly Financial Data, with certain exceptions; the impact of inflation and changing prices, provided the impact is not material; off-balance sheet arrangements in tabular form; and the aggregate amount of contractual obligations in tabular form. The final rules also amended various aspects of Item 303, “ Management’s Discussion and Analysis of Financial Condition and Results of Operations ,” among others. The final rules are effective for all registration statements, annual reports and quarterly reports filed on or after August 9, 2021, with early adoption permitted. We are currently evaluating the impact of the disclosure changes in our annual and quarterly reports. In July 2021, the FASB issued ASU 2021-05 “ Lessors—Certain Leases with Variable Lease Payments (Topic 842), ” which amends the lessor classification guidance to introduce additional criteria when classifying leases with variable lease payments that do not depend on a reference index or a rate. This guidance is effective for annual periods beginning after December 15, 2021, which will be our fiscal year 2022, with early adoption permitted. We have not yet determined the effect of the ASU on our results of operations, financial condition or cash flows. Off-Balance Sheet Arrangements As of June 30, 2021, we had approximately $7.6 million on our Credit Facility of borrowing capacity pledged as collateral to secure outstanding letters of credit.