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 Interim 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, 2022 (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. 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. 33 Table of Contents 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, our wholly owned captive insurance subsidiary and our captive real estate investment trust (REIT) called Standard Bearer Healthcare REIT, Inc. (Standard Bearer) 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, the captive insurance subsidiary or Standard Bearer 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 Interim Financial Statements included in this Quarterly Report. Overview We are a provider of health care services across the post-acute care continuum. We engage in the operation, 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 September 30, 2023, we offered skilled nursing, senior living and rehabilitative care services through 295 skilled nursing and senior living facilities. Our real estate portfolio includes 112 owned real estate properties, which includes 82 facilities operated and managed by us, 30 operations leased to and operated by third party operators, and the Service Center location. Of the 30 real estate operations leased to third party operators, one senior living facility is located on the same real estate property as a skilled nursing facility that we own and operate. The following table summarizes our affiliated facilities and operational skilled nursing beds and senior living units by ownership status as of September 30, 2023: Owned and Operated Leased (with a Purchase Option) Leased (without a Purchase Option) Total for Facilities Operated Number of facilities 82 11 202 295 Percentage of total 27.8 % 3.7 % 68.5 % 100.0 % Operational skilled nursing beds 8,128 1,145 21,196 30,469 Percentage of total 26.7 % 3.8 % 69.5 % 100.0 % Senior living units 1,682 178 1,143 3,003 Percentage of total 56.0 % 5.9 % 38.1 % 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 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 and our captive real estate trust owns and operates our real estate portfolio. Our captive real estate investment trust, Standard Bearer, owns and manages our real estate business. References herein to the consolidated “Company” and “its” assets and activities, as well as the use of the terms “we,” “us,” “our” and similar terms in this Quarterly Report, 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 Operational Update — On May 11, 2023, the United States Department of Health and Human Services (HHS) ended the public health emergency (PHE). Our primary focus has always been and continues to be the health and safety of our patients, residents, employees and their respective families. Even with the end of the PHE, we continue to implement new measures and maintain existing ones to provide the safest possible environment within our sites of service, taking into consideration the vulnerable nature of our patients. 34 Table of Contents We continue to execute on key initiatives to rebuild occupancy lost due to the pandemic. Our combined Same Facilities and Transitioning Facilities occupancy is 79.2%, which represents a 2.9% increase compared to the prior year quarter and is closer to our pre-pandemic occupancy levels, which was 80.1% in March 2020. As we shift to an endemic, we anticipate the return of our seasonal occupancy and skilled mix. Throughout most of our history, our seasonality trends for skilled nursing occupancy and skilled mix typically included the greatest growth during the first and fourth quarters and softening in the second and third quarters. The seasonal impact coupled with certain Emergency Waivers expiring have contributed to shift our acuity towards pre-pandemic levels. Nevertheless, the innovative approaches and strategic partnerships developed during the pandemic have supported our occupancy improvements and continue to enable us to gain additional market share. These key initiatives together with our dedication to our cultural and operational fundamentals resulted in a strong third quarter. We receive state relief funding from various states, including healthcare relief funding under the American Rescue Plan Act (ARPA), increases in the Federal Medical Assistance Percentage (FMAP) under the Families First Coronavirus Response Act (FFCRA) and other state specific relief programs. We use this funding, which reimburses the recipient, for healthcare and labor related patient care services and expenses that are attributable to the COVID-19 pandemic. The end of the PHE created a gradual phase down of the temporary increase in FMAP funding until it is completely phased out at the end of 2023. State specific approaches have been developed including various states having increased their base rates to account for increases in expenses in the post-pandemic environment. During the three and nine months ended September 30, 2023, we recognized $10.3 million and $55.1 million, respectively, of combined state relief funding as revenue. During the three and nine months ended September 30, 2022, we recognized $21.4 million and $63.5 million, respectively, of combined state relief funding as revenue. Common Stock Repurchase Program — On August 29, 2023, the Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $20.0 million of our common stock under the program for a period of approximately 12 months from September 1, 2023. We did not repurchase any shares during the third quarter of 2023. 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 September 30, 2023: 35 Table of Contents TX CA AZ UT CO WA ID SC NE IA KS NV WI Total Number of operated facilities Skilled nursing operations 77 67 30 18 19 15 11 9 4 4 — 2 2 258 Senior living operations 1 — 1 2 5 1 — — 1 — — — — 11 Campuses (1) 4 3 5 1 1 — 1 — 2 2 7 — — 26 Number of owned and operated facilities Skilled nursing properties 18 10 9 7 5 4 5 5 1 — — — 2 66 Senior living communities 1 — — — 3 — — — 1 — — — — 5 Campuses (1) 2 1 4 — — — — — — — 4 — — 11 Number of operated beds/units Operational skilled nursing beds 9,856 6,764 4,517 1,976 1,986 1,436 999 1,126 413 368 570 358 100 30,469 Senior living units 509 197 735 163 723 98 21 — 313 31 213 — — 3,003 Number of owned and operated beds/units Owned skilled nursing beds 2,279 1,185 1,596 669 457 413 468 544 88 — 329 — 100 8,128 Owned Senior living units 443 42 335 — 459 — — — 274 — 129 — — 1,682 Real estate properties leased to third party (2) Skilled nursing and senior living properties 6 2 1 — — 1 — — — — — 1 19 30 (1) Campuses represent facilities that offer both skilled nursing and senior living services. (2) Excludes three subleases to third parties in California. During the nine months ended September 30, 2023, we expanded our operations through long-term leases, with the addition of 24 stand-alone skilled nursing operations. Of these additions, Standard Bearer acquired the real estate of three of the stand-alone skilled nursing operations, which were leased back to Ensign affiliated entities. These new operations added a total of 2,340 operational skilled nursing beds to be operated by our affiliated operating subsidiaries. We also invested in new ancillary services that are complementary to our existing businesses. Additionally, Standard Bearer acquired the real estate of one campus operation, which is leased to a third party operator. Subsequent to September 30, 2023, we expanded our operations through a long-term lease, with the addition of one stand-alone skilled nursing operation. This new operation added 45 operational skilled nursing beds to be operated by our affiliated operating subsidiaries. For further discussion of our real estate properties and expansions, see Note 6 and 7, Standard Bearer and Operation Expansions in the Notes to the Interim Financial Statements . Key Performance Indicators We manage the fiscal aspects of our business by monitoring key performance indicators that affect our financial performance. Revenue associated with these metrics is generated based on contractually agreed-upon amounts or rate, excluding the estimates of variable consideration under the revenue recognition standard, Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 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. 36 Table of Contents • 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 state relief funding, which includes ARPA, FFCRA and other state relief programs. • 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 September 30, Nine Months Ended September 30, Skilled Mix: 2023 2022 2023 2022 Days 29.1 % 31.6 % 30.7 % 32.1 % Revenue 48.4 % 51.6 % 50.6 % 52.3 % 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 beds in a skilled nursing facility that are actually operational and available for occupancy may be less than the total official licensed bed capacity. This sometimes occurs due to the permanent dedication of bed space to alternative purposes, such as enhanced therapy treatment space or other desirable uses calculated to improve service offerings and/or operational efficiencies in a facility. In some cases, three- and four-bed wards have been reduced to two-bed rooms for resident comfort, and larger wards have been reduced to conform to changes in Medicare requirements. These beds are seldom expected to be placed back into service. We believe that reporting occupancy based on operational beds is consistent with industry practices and provides a more useful measure of actual occupancy performance from period to period. The following table summarizes our overall occupancy statistics for skilled nursing operations for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, Occupancy for skilled services: 2023 2022 2023 2022 Operational beds at end of period 30,469 26,630 30,469 26,630 Available patient days 2,778,007 2,440,900 8,128,137 7,047,179 Actual patient days 2,190,540 1,846,699 6,363,107 5,287,690 Occupancy percentage (based on operational beds) 78.9 % 75.7 % 78.3 % 75.0 % 37 Table of Contents Segments We have two reportable segments: (1) skilled services, which includes the operation of skilled nursing facilities and rehabilitation therapy services and (2) Standard Bearer, which is comprised of select properties owned by us through our captive REIT and leased to skilled nursing and senior living operations, including our own operating subsidiaries and third-party operators. We also reported an “all other” category that includes operating results from our senior living operations, mobile diagnostics, transportation, other real estate and other ancillary operations. These 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. Revenue Sources The following table sets forth our total service revenue by payor source generated by our skilled services segment and our "All Other" category and as a percentage of total revenue for the periods indicated (dollars in thousands): Three Months Ended September 30, Skilled Services All Other (3) Total Service Revenue 2023 2022 2023 2022 2023 2022 Medicaid (1) $ 367,079 $ 295,927 $ 7,759 $ 6,688 $ 374,838 $ 302,615 Medicare 237,531 211,104 — — 237,531 211,104 Medicaid-skilled 62,452 50,643 — — 62,452 50,643 Subtotal 667,062 557,674 7,759 6,688 674,821 564,362 Managed care 170,747 132,663 — — 170,747 132,663 Private and other (2) 65,158 48,981 24,598 19,877 89,756 68,858 TOTAL SERVICE REVENUE $ 902,967 $ 739,318 $ 32,357 $ 26,565 $ 935,324 $ 765,883 Three Months Ended September 30, Skilled Services All Other (3) Total Service Revenue 2023 2022 2023 2022 2023 2022 Medicaid (1) 40.7 % 40.0 % 24.0 % 25.2 % 40.1 % 39.5 % Medicare 26.3 28.6 — — 25.4 27.6 Medicaid-skilled 6.9 6.8 — — 6.6 6.6 Subtotal 73.9 75.4 24.0 25.2 72.1 73.7 Managed care 18.9 17.9 — — 18.3 17.3 Private and other (2) 7.2 6.7 76.0 74.8 9.6 9.0 TOTAL SERVICE REVENUE 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % (1) Medicaid payor includes revenue for senior living operations and revenue related to state relief funding. (2) Private and other payors in our "all other" category includes revenue from senior living operations and all payors generated in our other ancillary operations. (3) All Other incorporates intercompany eliminations. Nine Months Ended September 30, Skilled Services All Other (3) Total Service Revenue 2023 2022 2023 2022 2023 2022 Medicaid (1) $ 1,052,904 $ 845,341 $ 21,979 $ 17,750 $ 1,074,883 $ 863,091 Medicare 733,335 610,009 — — 733,335 610,009 Medicaid-skilled 182,394 146,355 — — 182,394 146,355 Subtotal 1,968,633 1,601,705 21,979 17,750 1,990,612 1,619,455 Managed care 488,511 389,036 — — 488,511 389,036 Private and other (2) 180,946 137,826 73,274 57,069 254,220 194,895 TOTAL SERVICE REVENUE $ 2,638,090 $ 2,128,567 $ 95,253 $ 74,819 $ 2,733,343 $ 2,203,386 38 Table of Contents Nine Months Ended September 30, Skilled Services All Other (3) Total Service Revenue 2023 2022 2023 2022 2023 2022 Medicaid (1) 39.9 % 39.7 % 23.1 % 23.7 % 39.3 % 39.2 % Medicare 27.8 28.7 — — 26.8 27.7 Medicaid-skilled 6.9 6.8 — — 6.7 6.6 Subtotal 74.6 75.2 23.1 23.7 72.8 73.5 Managed care 18.5 18.3 — — 17.9 17.7 Private and other (2) 6.9 6.5 76.9 76.3 9.3 8.8 TOTAL SERVICE REVENUE 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % (1) Medicaid payor includes revenue for senior living operations and revenue related to state relief funding. (2) Private and other payors in our "all other" category includes revenue from senior living operations and all payors generated in our other ancillary operations. (3) All Other incorporates intercompany eliminations. Skilled Services Within our skilled nursing operations, we generate revenue from Medicaid, private pay, managed care and Medicare payors. We believe that our skilled mix, which we define as the number of days Medicare, managed care and other skilled patients are receiving services at our skilled nursing operations divided by the total number of days patients are receiving services at our skilled nursing operations, from all payor sources (less days from senior living services) for any given period, is an important indicator of our success in attracting high-acuity patients because it represents the percentage of our patients who are reimbursed by Medicare, managed care and other skilled payors, for whom we receive higher reimbursement rates. We are participating in supplemental payment programs in various states that provide supplemental Medicaid payments for skilled nursing facilities that are licensed to non-state government-owned entities such as city and county hospital districts. Numerous operating subsidiaries entered into transactions with various 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. Standard Bearer We generate rental revenue primarily by leasing post-acute care properties that 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 September 30, 2023, our real estate portfolio within Standard Bearer is comprised of 107 real estate properties. Of these properties, 78 are leased to affiliated skilled nursing facilities wholly owned and managed by us and 30 are leased to facilities wholly owned and managed by third party operators. During the three and nine months ended September 30, 2023, we generated rental revenues of $21.0 million and $60.6 million, respectively, of which $17.0 million and $49.0 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 certain of 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 Estimates Our Interim Financial Statements included in this report have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of these financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, cash flows, revenues and expenses, and related disclosure of contingent assets and liabilities. See Item 2., Management’s Discussion and Analysis of Financial Condition and Results of Operations , in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 for further discussion of critical accounting estimates. There were no material changes to our critical accounting policies with which the estimates are developed since December 31, 2022. 39 Table of Contents Industry Trends The post-acute care industry has evolved to meet the growing demand for post-acute and custodial healthcare services generated by an aging population, increasing life expectancies and the trend toward shifting patient care to lower cost settings. The industry has evolved in recent years, which we believe has led to a number of favorable improvements in the industry, as described below: • Shift of Patient Care to Lower Cost Alternatives — The growth of the senior population in the U.S. continues to increase healthcare costs, often faster than the available funding from government-sponsored healthcare programs. In response, federal and state governments have adopted cost-containment measures that encourage the treatment of patients in more cost-effective settings such as skilled nursing facilities, for which the staffing requirements and associated costs are often significantly lower than acute care hospitals and other post-acute care settings. As a result, skilled nursing facilities are generally serving a larger population of higher-acuity patients than in the past. • Significant Acquisition and Consolidation Opportunities — The skilled nursing industry is large and highly fragmented, characterized predominantly by numerous local and regional providers. Due to the increasing demands from hospitals and insurance carriers to implement sophisticated and expensive reporting systems, we believe this fragmentation provides us with significant acquisition and consolidation opportunities. • Improving Supply and Demand Balance — The number of skilled nursing facilities has declined modestly over the past several years. We expect that the supply and demand balance in the skilled nursing industry will continue to improve due to the shift of patient care to lower cost settings, an aging population and increasing life expectancies. • Increased Demand Driven by Aging Populations — As seniors account for an increasing percentage of the total U.S. population, we believe the demand for skilled nursing and senior living services will continue to increase. According to the census projection released by the U.S. Census Bureau in early 2020, between 2016 and 2030, the number of individuals over 65 years old is projected to be one of the fastest growing segments of the United States population, growing from 15% 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 (FFS) 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 business operations. Our independent operating subsidiaries that provide healthcare services are subject to federal, state and local laws relating to, among other things, licensure, quality and adequacy of care, physical plant requirements, life safety, personnel and operating policies. In addition, these same subsidiaries are subject to federal and state laws that govern billing and reimbursement, relationships with vendors, business relationships with physicians and workplace protection for healthcare staff. Such laws include (but are not limited to) the Anti-Kickback Statute (AKS), the federal False Claims Act (FCA), the Stark Law and state corporate practice of medicine statutes. Governmental and other authorities periodically inspect the skilled nursing facilities (SNFs), senior living facilities and the outpatient rehabilitation agencies of our independent operating subsidiaries to verify continued compliance with applicable regulations and standards. The operations must pass these inspections to remain licensed under state laws and to comply with Medicare and Medicaid provider agreements and applicable Conditions of Participation. The operations can only participate in these third-party payment programs if inspections by regulatory authorities reveal that the operations are in substantial compliance with applicable state and federal requirements. In the ordinary course of business, federal or state regulatory authorities may issue notices to the operations alleging deficiencies in certain regulatory practices, which may require corrective action to regain and maintain compliance. In some cases, federal or state regulators may impose other remedies including imposition of civil monetary penalties, temporary payment bans, loss of certification as a provider in the Medicare or Medicaid program, or revocation of a state operating license. We believe that the regulatory environment surrounding the healthcare industry subjects providers to intense scrutiny. In the ordinary course of business, providers are subject to inquiries, investigations and audits by federal and state agencies related to compliance with participation and payment rules under government payment programs. These inquiries may originate from HHS, Office of the Inspector General (OIG), state Medicaid agencies, state Attorney Generals, local and state ombudsman offices and CMS Recovery Audit Contractors, among other agencies. In response to the inquiries, investigations and audits, federal and state agencies 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 prior to surveyor visits, Medicare and Medicaid payment bans and terminations from those programs, which may be temporary or permanent in nature. We vigorously contest each such regulatory outcome 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 operations. Proposed, Anticipated and Recently Issued Rulemaking and Administrative Actions The federal government, through CMS rulemaking, Presidential executive actions or Congressional legislation, and state and local governments have recently released the following proposed rulemaking or administrative actions that may have an impact on our independent operating SNFs or assisted living facilities: Biden-Harris Administration's Nursing Home Care Priorities — The Biden-Harris Administration is seeking reform around reimbursement, staffing levels, standards of care, increased transparency and public disclosure of ownership, and enhanced civil remedies as a means of enforcement against those facilities that do not satisfy CMS’s standards. Proposed rules based on these directives have already been published in 2023, including those highlighted below and observers expect additional rules to be issued this year and in the future. Final rules will follow publication of these proposed rules after a notice-and-comment period required by law. Proposed Rule over Ownership Transparency — On February 13, 2023, CMS issued a proposed rule that, if finalized and implemented, would require SNFs to disclose certain information regarding their ownership and managerial relationships. The proposed rule would require disclosure to include the identity of any person or legal entity that: (1) exercises financial, operational, or managerial control over any facility or part of a facility, or provides services to a facility that include its policies and procedures or cash management services; (2) leases or subleases real property to the facility, or owns 5% or more of the real property’s total value; and (3) provides any management or administrative services (or consults regarding the same), or provides accounting or financial services to the SNF. A final rule concerning this subject has not yet been published. This proposed rule is different from, and farther-reaching than, the disclosure of Medicare-collected nursing facility ownership that has been published on the Nursing Home Compare website since April of 2022. 41 Table of Contents Certain states have adopted laws reflecting their concerns regarding ownership transparency. For example, in July 2023, Iowa adopted laws requiring disclosure of ownership information not previously required for licensure to promote transparency. Additionally, in July of 2023, the California Department of Health Care Access and Information of the California Health and Human Services Agency issued a notice of proposed rulemaking containing regulations that would implement financial and ownership transparency requirements for California-licensed SNFs that are required by California law passed in 2021. Federal Legislation — On March 9, 2023, the home and community-based services (HCBS) Access Act was introduced to expand access to and resources available for HCBS. This bill provides Medicaid funding to individuals who provide direct home- and community-based care to adults over the age of 60 or people who have disabilities. This bill also provides financial resources for the training of these direct care providers, who are intended to provide services to the elderly or disabled that range from advocacy and community integration to transportation and daily assistance tasks ranging from bathing and laundry to meal preparation and housekeeping. As of the date of filing, no further action has been taken on the HCBS Access Act since its introduction and referral to the aforementioned committees. State Legislation — Many states in which our independent operating subsidiaries operate have introduced or passed legislation that would create or change laws and regulations related to our business and industry. In the past, California had proposed a law on direct care spending requirements that may have affected our business and SNFs operating within that state. These proposals had included requirements for healthcare facilities certified by CMS, including SNFs, to report all annual revenues to the State of California by June 30 of each year and certify that a stated percentage of all non-Medicare revenues should be used for direct patient-related services, including staffing and operational costs. On October 13, 2023, the California Governor signed into law a bill which impacts the minimum wages of healthcare workers. Effective June 1, 2024, the law raises the minimum wage for California healthcare employees and sets a new salary threshold for those who are considered exempt healthcare employees. The bill only becomes effective for SNFs if a patient care minimum spending requirement bill is also passed. We anticipate that a minimum spending bill will be proposed in the near future. Final Rule Fiscal Year 2024 Skilled Nursing Facility Prospective Payment System (SNF PPS) — On July 31, 2023, CMS published its final rule updating the Medicare payment rates within the SNF PPS for FY 2024 (SNF PPS FY 2024 Final Rule). The SNF PPS FY 2024 Final Rule modifies the SNF Quality Reporting Program (QRP) and the SNF Value-Based Purchasing (VBP) Program. The SNF PPS FY 2024 Final Rule finalized the rates to be paid in the 2024 fiscal year. The SNF PPS FY 2024 Final Rule increases the Medicare payment rate aggregate net market basket by 4.0%. The increase includes a 6.4% net market basket update to the payment rates of 3.0%, plus a 3.6% market basket forecast error adjustment, less a 0.2% productivity adjustment, as well as a negative 2.3% in the FY 2024 SNF PPS rates due to the second phase of the Patient Driven Payment Model (PDPM) parity adjustment recalibration. The net effect of these changes is expected to be an overall 4.0% increase in payments to SNFs in FY 2024. This final rule also updates the SNF QRP for FY 2024 and future years, including the adoption of two new quality reporting measures, modification of one measure and removal of three measures resulting in public reporting of four QRP measures. Additionally, the SNF PPS FY 2024 Final Rule makes changes to the SNF VBP Program. Specifically, this final rule adopts four new measures: the nursing staff turnover measure, the discharge function score measure, the long stay hospitalization measure per 1,000 resident days and the percent of residents experiencing one or more falls with a major injury (long stay); the existing SNF 30-day all-cause readmission measure (SNFRM) is replaced with the SNF within stay potentially preventable readmissions (SNF WS PPR) measure beginning in FY 2028. SNF PPS FY 2024 Final Rule adopted the Nursing Staff Turnover (NST) measure for the SNF VBP program beginning with the FY 2026 program year. This is a structural measure that has been collected and publicly reported on Care Compare, and the measure assesses the stability of the staffing within a SNF using nursing staff turnover. The NST measure uses facility-reported, electronic data from CMS’ Payroll-Based Journal (PBJ) system to calculate annual turnover rates for nursing staff, including RNs, LPNs, and nurse assistants. Facilities would begin reporting this measure in FY 2024, with payment effects beginning in FY 2026. The NST measure looks at six consecutive quarters of data. It starts with a baseline quarter and the first two quarters of the performance period to identify eligible employees. Then, it uses the next four quarters to find the number of employment spells that ended in turnover. Finally, it checks data from the sixth quarter to identify gaps in days worked that began in the last 60 days of the fifth quarter used for the measure. The measure score is then calculated by comparing the total number of eligible employees with 60-day gaps in working during the specified periods. 42 Table of Contents Biden-Harris Administration Executive Order — In April of 2023, President Biden signed an executive order seeking to increase access to affordable, high-quality long-term care for adults who are older or disabled. This executive order articulated the Biden-Harris Administration’s policy to enable families to have access to affordable, high-quality care for older or disabled family members, and to support the workforce of individuals who would provide such care, including through adequate wages and the ability to unionize. This executive order directed HHS and CMS to take steps to use existing funding and resources to connect home- and community-based workers with education and training opportunities and to create greater opportunities for workers in those fields to obtain health insurance and retirement benefits. Proposed CMS Minimum Staffing Mandate — On September 1, 2023, CMS issued its proposed rule that would establish minimum staffing standards for long-term care facilities. As a proposed rule, the comment period for this regulation is open for 60 days from the date of this proposed rule’s publication. This proposed rule contains three primary staffing proposals: 1) minimum staffing standards of 0.55 hours per resident per day (HPRD) for registered nurses (RNs) and 2.45 HPRD for nurse aids (NAs); 2) a requirement to have a RN on-site 24 hours per day, seven days per week; and 3) requirements for enhanced facility assessments. The proposed rule features a staggered implementation of these requirements, including a possible hardship exemption for select facilities. As this is a proposed rule, CMS has requested and received stakeholder feedback on all components of this regulation so that these comments may be considered prior to CMS's publication of a final rule. Additionally, the proposed rule would increase the reporting and transparency of Medicaid payments made to a facility for its direct care, including state-level reporting requirements and provisions for states and CMS to make public information about payments made to long-term care facilities. Facility self-assessments would also be enhanced under this proposed rule. CMS proposes that the facility self-assessment be updated on the issue of staffing to contain or clarify: 1) that facilities must use evidence-based methods when planning for resident care, including accommodation of behavioral health needs; 2) requiring facilities to use the self-assessment to assess the specific needs of each resident, with adjustments made for changes in the resident population; 3) requiring that facilities include the input of staff, including leadership, management, nurse staff and other direct care providers who render other services to residents; 4) requiring that the staffing plan maximize recruitment and retention of staff in a manner consistent with the President’s April 2023 Executive Order on increasing access to high-quality care and supporting caregivers. A hardship exemption for CMS’s proposed minimum staffing standards is also set forth in the proposed rule. Long-term care facilities could qualify for a temporary hardship exemption from new minimum staffing ratios upon meeting specific criteria that demonstrate: 1) workforce unavailability based on an absence of providers relative to individuals in the age group of recipients within a specific geographic location; 2) a facility’s good faith efforts to hire and retain staff through a recruitment and retention plan; and 3) a financial commitment to staffing by documenting the total annual amount spent on direct care staff. A survey would be required to assess the residents’ health and safety before CMS would consider granting such a hardship exemption. Any facility that received a hardship exemption from the minimum staffing requirement would have this exemption noted on the Care Compare website rating skilled nursing facilities. Further, facilities would not be eligible to receive an exemption if they: 1) failed to submit their data to the payroll-based journal system; 2) have been identified as a special focus facility; or 3) have been identified at any time within the preceding 12 months as having insufficient staffing that was either at a widespread or pattern level with resulting actual harm to residents, or receiving an immediate jeopardy citation regarding insufficient staffing. Even after receiving an exemption, a facility would still be required to maintain sufficient staff around-the-clock to provide care and monitor resident health. If finalized, this proposed rule would have a staggered and phased implementation over a period of three years, with the phases differentiated between rural and non-rural facilities. For facilities in urban areas, the final rule’s facility assessment requirements would become effective within 60 days of the final rule’s publication, with the proposed rule’s round-the-clock on-site RN requirement becoming effective two years after the final rule’s publication; and the above-referenced minimum staffing of 0.55 HPRD for RNs and 2.45 HPRD for NAs would take effect three years after the final rule’s publication. For rural facilities, the final rule’s facility assessment requirements would still become effective within 60 days of the final rule’s publication but the proposed rule’s round-the-clock on-site RN requirement would become effective three years after the final rule’s publication, and the above-referenced minimum staffing of 0.55 HPRD for RNs and 2.45 HPRD for NAs would take effect five years after the final rule’s publication. This minimum staffing proposed rule also seeks further information from stakeholders regarding alternative policies for establishing minimum nurse staffing standards. In particular, CMS seeks comment on an alternative total nurse staffing standard of 3.48 HPRD (among other alternatives), which would include minimum individual standards of 0.55 HPRD for RNs and 2.45 HPRD for NAs, in addition to other nurse staffing as needed to attain a total of 3.48 HPRD across all nurse types. CMS also seeks stakeholder comments regarding the benefits and trade-offs of using different standards, evidence, or methodologies used by states that have adopted minimum nursing standards to inform its own standard-setting. 43 Table of Contents Coronavirus In March of 2020, in an effort to promote efficient care delivery and to decrease the spread of COVID-19, federal, state and local regulators implemented new regulations and waived, (in some cases temporarily), certain existing regulations, including those discussed below. These new regulations and waivers of the other regulations expired on May 11, 2023. Temporary suspension of certain patient coverage criteria and documentation and care requirements — CMS issued a series of temporary waivers, rules, and guidance, suspending various Medicare patient coverage criteria as it related to the COVID-19 pandemic to ensure patients continued to have adequate access to care, notwithstanding the burdens placed on healthcare providers HHS also waived requirements specific to SNFs. During this time, CMS also suspended and reduced the priority of standard audit activities in order to focus on patient care. While all of these waivers expired with the termination of the PHE on May 11, 2023, others were terminated at various points in 2021 and 2022 during the PHE. Certain rules, such as requirements for COVID-19 reporting, testing, and vaccination remained in place through the end of the PHE. Testing requirements — Beginning in April 2020, authorities in several states in which our independent operating subsidiaries are located began to mandate widespread COVID-19 testing at all SNFs and assisted living facilities based on guidance from the Centers for Disease Control and Prevention (CDC). During the PHE, CMS issued revised parameters for testing, requiring routine testing of only unvaccinated staff and then further revised its guidance in September of 2022 to specify only symptomatic individuals and their close contacts, (including staff and residents), should be tested for COVID-19. On June 5, 2023, CMS published a final rule containing changes to COVID-19 vaccination, reporting, testing, and other requirements (Omnibus Final Rule), which takes effect 60 days after publication and ended the COVID-19 testing and reporting requirements for SNFs and assisted living facilities imposed during the PHE. All of the federal, state and local government vaccines mandates have been rescinded since the end of the PHE. Changes to Medicaid Reimbursement — In March of 2020, the Families First Coronavirus Relief Act (FFCRA) provided a 6.2% increase to the Federal Medicaid Assistance Percentage (FMAP) during the PHE. The FFCRA also imposed conditions restricting the disenrollment and standards for re-enrolling Medicaid beneficiaries to promote continuous care of beneficiaries during the PHE. The Consolidated Appropriations Act of 2023 (CAA 2023) amended these Medicaid enrollment protections and increased FMAP funding provided in the FFCRA. In the first quarter of 2023, the FMAP increase CMS provides to the states remained elevated by 6.2%, but this amount decreased to 5% for April through June 2023, 2.5% for July through September 2023, and 1.5% for October through December 2023 before tapering to 0% by the end of 2023. The ultimate amount of Medicaid funding provided from each state will vary substantially based on each state's policies. Under the CAA 2023, states were allowed to begin disenrolling Medicaid beneficiaries and resuming Medicaid eligibility determinations beginning on April 1, 2023 upon satisfying conditions that include reviewing Medicaid beneficiaries' eligibility and have begun doing so. On August 30, 2023, CMS advised all 50 states in a letter to their respective Medicaid administrators to observe federal Medicaid regulations in making these redeterminations, including requirements to make eligibility determinations on an individual basis rather than a per-household basis. CMS has worked with 12 states regarding their respective redetermination and disenrollment processes, and previously paused policy in six states. As a result of this activity, the redetermination and disenrollment period that began on April 1, 2023 has not proceeded as rapidly as some may have expected. Medicare Medicare presently accounts for approximately 27.8% 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. 44 Table of Contents Patient-Driven Payment Model (PDPM) The SNF PPS Rule became effective October 1, 2019. The SNF PPS Rule included 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 PDPM, which utilizes clinically relevant factors for determining Medicare payment by using 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 SNFs' resources that do not vary depending on resident characteristics. PDPM replaces the existing methodology, and is intended to achieve 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. Under the SNF PPS PDPM system, the payment to SNFs and nursing homes is based heavily on the patient’s condition rather than the specific services provided by each SNF. Skilled Nursing Facility - Quality Reporting Program (SNF QRP) The Improving Medicare Post-Acute Care Transformation Act of 2014 (IMPACT Act) provided data reporting requirements for certain Post-Acute-Care (PAC) providers. If a SNF does not submit required quality data as required by the IMPACT Act, its payment rates are reduced by 2.0% for each such fiscal year, which may result in payment rates for a fiscal year being less than the preceding fiscal year. The SNF QRP standardized patient assessment data elements. The SNF QRP applies to freestanding SNFs, SNFs affiliated with acute care facilities and all non-critical access hospital swing-bed rural hospitals. These data elements are the subject of frequent change and adjustment. CMS's rulemaking often identifies new data elements to be reported. In July of 2022, CMS announced revisions to calculating its five-star ratings for the Nursing Home Compare website. Under this new calculation, points are assigned to a SNF based on its performance across six measures: (1) case-mix adjusted total nurse staffing levels (including registered nurses, licensed practical nurses, and nursing aides), measured by hours per resident per day; (2) case-mix adjusted registered nurse staffing levels, measured by hours per resident per day; (3) case-mix adjusted total nurse staffing levels (including registered nurses, licensed practical nurses, and nursing aides), measured by hours per resident day on the weekend; (4) total nurse turnover, defined as the percentage of nursing staff that left the nursing home over a 12-month period; (5) registered nurse turnover, defined as the percentage of registered nursing staff that left the nursing home over a 12-month period; and (6) administrator turnover, defined as the percentage of administrators that left the nursing home over a 12-month period. These six measures will be measured on a quarterly basis. These six new measures were included in the five-star rating in October 2022. In addition, CMS also implemented a planned increase to the quality measure reporting thresholds, increasing each threshold by one-half of the average improvement of quality measure scores since CMS last set quality measure thresholds. Going forward, CMS plans to implement similar rating threshold increases every six months. On July 29, 2022, CMS announced the adoption of a process measure for influenza vaccination coverage among healthcare personnel within SNFs. This measure will be determined by the percentage of SNF healthcare personnel who receive an influenza vaccine any time from when it first becomes available through March 31 of the following year. SNFs began submitting this data on October 1, 2022. On July 31, 2023, CMS published the SNF PPS FY 2024 Final Rule, which included changes to the SNF QRP, including adopting, removing and modifying specific measures. The final rule also includes policy changes and the public reporting of four measures. The final rule adopts the Discharge Function Score (DC Function) measure, which determines the functional condition of residents by examining the proportion of SNF residents who achieve or surpass a projected discharge functionality score. The assessment includes consideration of mobility and self-care, utilizing data from the Minimum Data Set (MDS). The DC Function will replace the current process and is scheduled to go into effect for the FY 2025 SNF QRP. CMS will adopt two measures for the SNF QRP starting in FY 2026. First, CMS will raise the Data Completion Thresholds for the MDS. SNFs must report required quality measure data and standardized resident assessment data gathered using the MDS for at least 90% of the assessments they submit to CMS. SNFs who fail to meet this requirement will be subject to a 2% reduction on their applicable fiscal year payment starting in FY 2026. Second, CMS will adopt the Patient/Resident COVID-19 Vaccine metric. This metric highlights the number of patient stays in which SNF patients received the COVID-19 vaccine. 45 Table of Contents The SNF PPS FY 2024 Final Rule also modifies the SNF QRP’s Healthcare Professional (HCP) Covid Vaccine Measure. The measure will track the proportion of healthcare staff vaccinated for COVID-19 and have kept their vaccination status current per the CDC recommendations. Previously, SNFs were only obligated to disclose whether their healthcare workers had completed the initial vaccination series for COVID-19. Now, there is an added requirement to report the total count of healthcare employees who have maintained their COVID-19 vaccination status in line with CDC recommendations. The SNF PPS FY 2024 Final Rule also removed the Application of Functional Assessment/Care Plan measures from the SNF QRP. CMS stated the decision stemmed from two primary reasons: first, the consistently high-performance levels among SNFs make it challenging for CMS to identify significant advancements; and second, the DC Function measure aligns more closely with the preferred functional outcomes for residents. Medicare Annual Payment Rule CMS is required to calculate an annual Medicare market-basket update to the payment rates. On July 31, 2023, CMS issued the SNF PPS FY 2024 Final Rule, which will result in a net increase of 4.0% in Medicare payments to SNFs in fiscal year 2024. This increase results from the 6.4% net market basket update to the payment rates, which is based on a 3.0% SNF market basket increase plus a 3.6% market basket forecast error adjustment, less a 0.2% productivity adjustment and a negative 2.3% adjustment as a result of the recalibrated parity adjustment. On July 29, 2022, CMS issued a final rule for fiscal year 2023 that increased the Medicare payment rates to aggregate net market basket by 2.7%. The increase results from the 5.1% update to the market basket, which is based on a 3.9% current year market basket increase plus a 1.5% market basket error adjustment, less a 0.3% productivity adjustment and a negative 2.3% adjustment as a result of the recalibrated parity adjustment. The recalibrated parity adjustment is being phased in at a rate of 2.3% per year on both the SNF PPS FY 2024 and FY 2023 Final Rules. Sequestration of Medicare Rates The Budget Control Act of 2011 requires a mandatory, across the board reduction in federal spending, called a sequestration. Medicare FFS claims with dates of service or dates of discharge on or after April 1, 2013 incur a 2.0% reduction in Medicare payments through at least 2023, unless Congress takes further action. Under the CARES Act, there was a temporary suspension of the 2.0% reduction of Medicare claim reimbursements as a result of the COVID-19 pandemic which lasted until June 2022. Under the CAA 2023, a further 4% cut to Medicare spending that would have been required under the Statutory Pay-As-You-Go Act of 2010 (PAYGO) was waived for fiscal years 2023 and 2024. Instead, the CAA 2023 deferred any further Medicare sequestration under PAYGO until fiscal year 2025. The CAA 2023 also offset planned Medicare sequestrations that would have been as high as 4.0% and instead maintained fee schedule cuts of approximately 2%. Skilled Nursing Facility Value-Based Purchasing (SNF-VBP) Program The SNF-VBP Program rewards SNFs 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 SNFs using the SNF-VBP Program. The program also introduced 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. CMS uses regulations to specify how it measures the performance for SNFs as well as the data that SNFs are to report to CMS. The deadlines for baseline period quality measure quarterly reporting and performance periods and standards began in the 2023 program year. The final rule for the fiscal year 2023 SNF PPS also provided for SNF-VBP program expansion beyond the use of its single, all-cause hospital readmission measure to determine payment, with the inclusion of measures in fiscal year 2026 for SNF healthcare associated infections requiring hospitalization (SNF HAI) and total nursing hours per resident day measures and in fiscal year 2027, the discharge to community post-acute care measure for SNFs, which assess the rate of successful discharges to the community from a SNF setting. 46 Table of Contents The SNF PPS FY 2024 Final Rule elected to replace the SNFRM measure with the SNF WS PPR measure beginning in the FY 2028 program year. The potentially preventable readmission (PPR) measure assesses the risk-standardized rate of unplanned and potentially avoidable readmissions during SNF stays for Medicare fee-for-service beneficiaries. The new SNF WS PPR measure refines the original Skilled Nursing Facility 30-Day Potentially Preventable Readmission (SNFPPR) measure, which followed the requirements of the Protecting Access to Medicare Act (PAMA) of 2014. The refinement in the SNF WS PPR measure shifts the observation window from a fixed 30-day post-hospital discharge to the duration of the SNF stay. Moreover, the time gap allowed between the prior inpatient discharge and the SNF admission has been extended from one day to 30 days. These changes, based on feedback from expert panels and a 2015 partnership, better align the measure with the IMPACT Act's provisions and enhance the reliability of tracking preventable readmissions. Additionally, the SNF WS PPR measure's calculations use two years of Medicare claims data to generate a provider-specific risk-standardized readmission rate. 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), physical therapy (PT) services and a separate annual cap for occupational therapy (OT) services. The Bipartisan Budget Act of 2018 (BBA) establishes coding modifier requirements to obtain payments beyond certain payment thresholds, discussed below and reaffirms the specific $3,000 claim audit threshold requirements for Medicare Administrative Contractors. For PT and SLP combined the threshold for coding modifier requirements was $2,230 for CY 2023 with the same threshold for OT services. The KX modifier is added to medical claims to indicate the providing clinician attests that the services corresponding to that claim were medically necessary and that the justification for those services is contained within the patient’s medical records. This modifier is intended for use where the services will exceed the threshold for those services set by the BBA and updated by annual fee schedule rules, yet are still appropriate and medically necessary, and thus should be compensated by Medicare. Consistent with CMS’s “Patients over Paperwork” initiative, the agency has also been moving toward eliminating burdensome claims-based functional reporting requirements. Beginning in 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, removing a coding burden caused by requirements for additional documentation and claim modifier coding. On November 1, 2022, CMS issued the calendar year 2023 PFS, resulting in a PFS conversion factor of $33.06, a decrease of $1.55 from the calendar year 2022 PFS conversion factor of $34.61. This is a 4.45% cut to the conversion factor for calendar year 2023. Additionally, 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. Through the end of coverage year 2024, certain of our Part B services provided through telehealth will still qualify for Medicare reimbursement based on flexibility first provided under the Emergency Waivers, which added physical therapy, occupational therapy and speech-language pathology to the list of approved telehealth Providers for the Medicare Part B programs provided by a SNF. During the PHE, CMS added certain PT and OT services to the list of Medicare-covered telehealth services on a temporary basis, some of which were made permanent for use and new codes were added for PT, OT, or SLP telehealth services—including some “sometimes therapy” codes that were not subject to MPPR. The CAA 2023 extended certain, but not all, telehealth flexibilities until December 31, 2024, allowing certain telehealth flexibilities to continue after the PHE's expiration. On February 13, 2023, CMS extended the use of these codes for telehealth through the end of CY 2023. On July 13, 2023, CMS issued the proposed CY 2024 PFS. Under this proposed rule, overall payment rates for Medicare Part B services are to be reduced by 1.25% compared to calendar year 2023. Additionally, acts of Congress may affect the ultimate conversion factor and amounts paid under Medicare for the Company’s services, as the CY 2023 PFS final rule reimbursement rates were scheduled to be lower than those that took effect until Congress passed spending legislation that reduced the amount of spending cut from CY 2022 to CY 2023. 47 Table of Contents The proposed CY 2024 PFS contains provisions to make payments when physicians and certain non-physician practitioners, such as physician assistants, nurse practitioners, physical therapists, occupational therapists and clinical psychologists, involve caregivers in implementing an individualized plan of treatment or therapy. The purpose of this proposed provision is to incentivize the training of caregivers and provide additional funds to offset the costs of training these caregivers through participation in licensed healthcare providers’ course of care for patients and residents. The proposed CY 2024 PFS also solicits information regarding changing the requirements for supervision of physical therapist assistants and occupational therapist assistants in private practice from “direct” supervision to broader “general” supervision. The comments and data CMS receives from this request for information may affect the rate of reimbursement for PT and OT services in the future and may affect the desirability and utilization of physical therapy assistants and occupational therapy assistants for certain patient services. Additionally, the proposed CY 2024 PFS would add certain health maintenance and well-being coaching to the services for which Medicare will reimburse telehealth services through December 31, 2024. This proposed rule also proposes adding risk assessments for social determinants of health to the list of telehealth services Medicare will reimburse on a permanent basis. Programs of All-Inclusive Care for the Elderly The requirements under the Programs of All-Inclusive Care for the Elderly (PACE) provide greater operational flexibility and update information under the Medicare and Medicaid programs, including leniency in compliance with program requirements during and after a 3-year trial period and relieving restrictions placed on the team that assesses and provides for the needs of each PACE participant. Further, non-physician primary care providers can provide certain services in place of primary care physicians. On February 1, 2023, CMS issued its final rule, which takes effect on April 3, 2023, requiring the collection of data by Medicare Advantage organizations and their service providers and the submission of data to CMS for risk adjustment data validation (RADV) audits. The purpose of these RADV audits is to maintain the accuracy of risk-adjusted payments made to Medicare Advantage organizations. Decisions Regarding Skilled Nursing Facility Payment Reimbursement rates and rules are subject to frequent change that historically, 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 influenced by budgetary or political pressures, may materially adversely affect the rates at which Medicare reimburses us for our services. 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 other reimbursement rates, see Part II, Item 1A Risk Factors under the headings Risks Related to Our Business and Industry. Patient Protection and Affordable Care Act Various healthcare reform provisions became law upon enactment of 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. The Inflation Reduction Act of 2022 (IRA), which continued and expanded certain provisions of the ACA, extended the premium subsidies paid by the federal government, until the end of 2024, resulting in subsidies being available to offset or reduce the costs of private health insurance policies for qualifying individuals. This may aid older patients in obtaining or keeping their health insurance in order to pay for long-term care services. The CAA 2023 revised the funds available to fund Medicare in 2023 and deferred the PAYGO sequestration of Medicare expenses, resulting in the CY 2023 PFS increasing its conversion factor from $33.06 to more than $33.89. 48 Table of Contents The 2024 presidential election may significantly alter the current regulatory framework and impact our business and the health care industry, including any further extensions or expansions of certain ACA provisions, namely recent rulemaking activity regarding ACA Section 1557's anti-discrimination provisions. We continually monitor these developments so we can respond to the changing regulatory environment impacting our business. Requirements of Participation CMS has requirements that providers, including SNFs, must meet in order to participate in the Medicare and Medicaid Programs. Some of these requirements can be burdensome and costly. One such requirement of participation in the Medicare and Medicaid programs involves limitations around the use of pre-dispute, binding arbitration agreements by SNFs. CMS has issued guidance and direction around arbitration that must be satisfied for any agreement to be enforceable and which may result in adverse consequences for our business if not followed. Congress has routinely introduced, but not passed, legislation addressing the issue of arbitration agreements used by SNFs. While legislative action is possible in the future, federal regulations and state/federal laws remain our primary source of authority over the use of pre-dispute binding arbitration agreements. On June 29, 2022, CMS announced updated guidance for Phase 2 and 3 of the Requirements of Participation. CMS distributed these updates to surveyors and state agencies in order to, among other things, enhance responses to resident complaints and reported incidents. This guidance focuses on the following topics: (1) resident abuse and neglect (including reporting of abuse); (2) admission, transfer and discharge; (3) mental health and substance abuse disorders; (4) nurse staffing and reporting of payroll to evaluate staffing sufficiency; (5) residents’ rights (including visitation); (6) potential inaccurate diagnoses or assessments; (7) prescription and use of pharmaceuticals, including psychotropics and drugs that act like psychotropics; (8) infection prevention and control; (9) arbitration of disputes between facilities and residents; (10) psychosocial outcomes and related severity; and (11) the timeliness and completion of state investigations to improve consistency in the application of standards among various states. On July 29, 2022, CMS updated the Medicare Requirements of Participation for SNFs, which includes the modification of requirements associated with a facility's physical environment to minimize unnecessary renovation expenses in order to avoid closure of SNFs due to the related expense. CMS "grandfathered" certain facilities and will allow SNFs that were participating in Medicare before July 5, 2016 and that previously used the Fire Safety Evaluation System (FSES) to continue using the 2001 FSES mandatory values when determining compliance with applicable standards. CMS also updated the Requirements of Participation to revise existing qualification requirements for directors of food and nutrition services in SNFs, while "grandfathering" in directors with two or more years of experience and certain minimum training in food safety so they may continue in that role without satisfying further educational requirements. On February 17, 2023, CMS revised the survey resources that CMS and state surveyors use in evaluating SNFs’ compliance with federal Requirements for Participation. This revision incorporated the recent changes to CMS’ focused infection control survey item, which CMS had removed in favor of standard infection control survey measures. These changes were made to the most recent revision of long-term care facility survey documents that CMS had last revised in October of 2022. These updates provided more information for state surveyors to utilize when evaluating SNFs’ compliance with the Medicare Requirements of Participation, as well as included guidance for facilities on operationalizing compliance with these requirements based on how surveyors would measure and evaluate facility performance. 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 Balanced Budget Act of 1997 expanded the penalties for healthcare fraud. Additionally, 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 FCA clarifies that if an item or service is provided in violation of the AKS, the claim submitted for those items or services is a false claim that may be prosecuted under the FCA as a false claim. 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. The Biden-Harris Administration has also signaled an increasing focus on nursing home performance and the reimbursement nursing homes receive from federal healthcare payment programs. Many states also have a false claim prohibition that mirrors or closely tracks the federal FCA. 49 Table of Contents Federal law also provides that the 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. CMS can recover overpayments from health care providers up to six years following the year in which payment was made. In 2021, the OIG released the result of an audit finding that Medicare overpaid millions of dollars for chronic care management (CCM) services. The OIG's 2021 report found that in calendar years 2017 and 2018, Medicare overpaid millions of dollars in CCM claims. In 2022, the OIG released an audit revealing that CMS had not collected $226 million, or 45%, of identified overpayments within that period, potentially affecting SNFs. These investigatory actions by OIG demonstrate its increased scrutiny into post-hospital SNF care provided to beneficiaries and may encourage additional oversight or stricter compliance standards. In 2023, representatives of the DOJ speaking at certain industry events, including the American Health Law Association’s Fraud and Compliance Forum, have indicated that its healthcare enforcement trends would emphasize opioid prescribing, Medicare Advantage and managed care plan fraud, and COVID-19 related fraud, including under various relief programs available during and in conjunction with the pandemic. 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. Over time our overall patient mix has consistently shifted to higher-acuity in most facilities we operate. We also use specialized care-delivery software that assists our caregivers in more accurately capturing and recording services in order to, among other things, increase reimbursement to levels appropriate for the care actually delivered. These efforts may place us under greater scrutiny with the OIG, CMS, our fiscal intermediaries, recovery audit contractors and others. Federal Healthcare Reform Five-Star Quality Reporting Metrics — The Quality Payment Program (QPP) was created under the Medicare Access and Children's Health Insurance Program (CHIP) Reauthorization Act of 2015. This program was based on the Merit-based Incentive Payment System (MIPS) or the use of Alternative Payment Models (APM), which relied on quality data CMS gathered and evaluated using the Five-Star Quality Rating system, which includes a rating of one to five in various categories. These categories include (but are not limited to) the results of surveys conducted by state inspectors, other health inspection outcomes, staffing, spending, readmissions and stay durations; the data collected and its weighting in determining a rating on a scale of one to five stars is subject to periodic and ongoing revision, re-balancing and adjustment by CMS to reflect market conditions and CMS’s priorities in patient care. Since 2020, CMS’s measurement of the data reported by providers, including SNFs, has become more competitive and resulted in a reduction of four- and five-star rankings available under CMS’s Five-Star Quality Rating system. The Five-Star Quality reporting system for nursing homes is displayed on CMS's consumer-based Nursing Home Compare website, along with a consumer alert icon next to nursing homes that have been cited for incidents of abuse, neglect, or exploitation on the Nursing Home Compare website. The Nursing Home Compare website is updated monthly with CMS’s refresh of survey inspection results on that website. Additionally, in April of 2022, the Nursing Home Compare website began publishing the ownership information for Medicare-enrolled nursing facilities based on disclosures made to CMS from 2016 through 2022 due to mergers, acquisitions, or other changes in ownership, to allow for the identification of common ownership of nursing facilities. In addition, the Five Star Quality Ratings incorporated staffing data such as staff tenure and SNF weekend staffing beginning with the October 2022 refresh of the Nursing Home Compare website. In January of 2023, CMS updated the Nursing Home Five-Star Quality Rating System’s Technical Users’ Guide. As explained in the latest update to this guide, CMS will be auditing schizophrenia coding within the MDS reported to CMS, with adjustments to quality ratings based on any inaccuracies in this schizophrenia-related data. Additionally, CMS will not display citations that a facility has informally disputed on the Nursing Home Compare website, although the outcome of such citations will only be included in the calculation of a facility’s star rating once the dispute is completed and the underlying survey considered final. In July 2023, CMS revised the nursing-home level exclusion criteria used on the administrator turnover measure, adding information regarding its calculation of the staff turnover measure and publishing an updated ratings table, which identifies the points needed for each nursing facility to obtain certain star ratings within its state. Only 10% of nursing facilities can receive a five-star rating in the state where it operates. 50 Table of Contents In September 2023, CMS announced that it will update the staffing level case-mix adjustment methodology and freeze four of the quality measures used in the Nursing Home Five-Star Quality Rating System beginning with the April 2024 refresh of the Nursing Home Compare website’s data. This freeze is implemented to accommodate changes to the MDS so that information that will be added to the MDS can be gathered. For three months, until the July 2024 refresh of the Nursing Home Compare website rankings, CMS will freeze the staffing level measures for all SNFs. Beginning with the July 2024 refresh, CMS will change the staffing case-mix adjustment methodology to a model based on PDPM, which is discussed above. The Nursing Home Compare website will then begin posting staffing level measures that use this PDPM methodology. To incentivize SNFs to submit accurate staffing data, CMS will revise the staffing methodology to penalize SNFs that fail to submit staffing data, or submit erroneous data, by awarding them the lowest possible score for those measures beginning in April of 2024. State Legislation Concerning Nursing Home Supervision — California passed into law a bill which changes the limitations, or “caps,” on non-economic damages that can be awarded in medical negligence cases filed against healthcare providers (including skilled nursing and long-term care facilities). Beginning on January 1, 2023, non-economic damages (i.e. pain and suffering) available to plaintiffs suing healthcare providers in medical malpractice and professional negligence cases increased from $0.25 million to $0.35 million, and will then increase over the following ten years up to a $0.75 million cap. Once the limit reaches $0.75 million, a 2% annual inflationary adjustment will attach beginning on January 1, 2034. In wrongful death cases that arise from claims of medical malpractice and professional negligence, the cap on non-economic damages increased from $0.25 million to $0.50 million on January 1, 2023, and increase every year thereafter for ten years until the cap on non-economic damages in such cases is $1.0 million; thereafter, this cap will also be subject to an annual 2% increase. The caps are separate as to each claim, meaning that there is one cap for negligence and one cap for wrongful death. The new limits on non-economic damages apply prospectively to lawsuits filed on and after January 1, 2023. On September 27, 2022, California’s Governor signed into law the Skilled Nursing Facility Ownership and Management Reform Act of 2022. This law increases the oversight authority of the California Department of Public Health, and changes several provisions regarding SNF licensing in the State of California. This includes eliminating previous regulatory provisions that permitted SNFs to operate in advance of receiving their formal license from the State. This law also requires SNF license applicants to disclose additional information in connection with a license application and evaluates more data regarding the applicant’s prior operations, including prior citations, CMS sanctions and legal proceedings against the applicant or other facilities owned or managed by the applicant before issuing a license. United States Supreme Court Decisions – On June 8, 2023, the United States Supreme Court issued its opinion in Health and Hospital Corporation of Marion County, Indiana (HHC) v. Talevski, which pertained to claims of mistreatment in a nursing home. The nursing home was publicly owned by the government county where it operated, rather than privately owned. The question before the Supreme Court was whether the Nursing Home Reform Act, passed as part of the Omnibus Budget Reconciliation Act of 1987, gave Talevski the right to sue HHC for a violation of his civil rights under 42 U.S.C. § 1983, a specific statute that allows for claims against persons who act for and on behalf of any government entity. The Supreme Court held that Talevski’s civil rights claim against HHC could proceed. While the facts of this case are of limited precedential value to our independent operating subsidiaries, which are not owned by and do not act on behalf of any government entity, this decision may draw wider public interest into claims against SNFs and assisted living facilities generally. Monitoring Compliance in Our Facilities Governmental agencies and other authorities periodically inspect our independent operating facilities to assess compliance with various standards, rules and regulations, with potential fines, sanctions and other penalties for noncompliance. Unannounced surveys or inspections generally occur at least annually and may also follow a government agency's receipt of a complaint about a facility. Facilities must pass these inspections to maintain 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 provider contracts with managed care clients at many facilities. From time to time, our independent operating subsidiaries, like others in the healthcare industry, may receive notices from federal and state regulatory agencies of an alleged failure to substantially comply with applicable standards, rules or regulations. These notices may require corrective action, may impose civil monetary penalties for noncompliance, and may threaten or impose other operating restrictions on SNFs such as admission holds, provisional skilled nursing license, or increased staffing requirements. If our independent operating subsidiaries fail to comply with these directives or otherwise fail to comply substantially with licensure and certification laws, rules and regulations, the facility could lose its certification as a Medicare or Medicaid provider, or lose its license permitting operation in the State. 51 Table of Contents Facilities with otherwise acceptable regulatory histories generally are given an opportunity to correct deficiencies and continue their participation in the Medicare and Medicaid programs by a certain date, usually within six months of inspection; however, 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, may not be 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 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 acquisition by our independent operating subsidiaries and that develop new deficiencies after acquisition 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 or sustained quality of care problems through the special focus facility (SFF) initiative. 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 a defined period of time. On October 21, 2022, CMS issued a Memorandum identifying the changes it intends to make in connection with the oversight of those facilities that fall under the SFF Program, including increased penalties for SFFs that fail to improve their performance upon further inspection by CMS, increasing the standards SFFs must meet to graduate from the SFF program, maintaining heightened oversight of any SFF for a period of three years after it graduates and increasing the technical assistance CMS provides to SFFs. 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, leaving operators with the task of deciding whether to continue accepting patients after the potential denial of payment date--risking the retroactive denial of revenue. Some of our independent operating subsidiaries have been or will be in denial of payment status due to findings of continued regulatory deficiencies, resulting in an actual loss of revenue associated with patients admitted after the denial of payment date. Additional sanctions could ensue and, if imposed, could include 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 surveyors. 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. 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 and between healthcare providers, such as the federal and state anti-kickback laws, the Stark laws, and various state anti-referral laws. The Social Security Act 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 Social Security Act. 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 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 on a case-by-case basis based upon all facts and circumstances and risk increased scrutiny and possible sanctions by enforcement authorities. 52 Table of Contents Violations of the Social Security Act can result in inflation-adjusted criminal penalties of more than $0.1 million and ten years imprisonment. It can also result in inflation-adjusted civil monetary penalties of more than $0.1 million per violation and an assessment of up to three times the total amount of remuneration offered, paid, solicited, or received. It 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 our independent operating subsidiaries operate have adopted or are considering similar legislative proposals, some of which extend beyond that state's e-Medicaid program, to prohibit the payment or receipt of remuneration for the referral of patients regardless of the source of payment for the care. Additionally, the "Stark Law" of the Social Security Act 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, in relevant part, inpatient and outpatient hospital services, PT, OT, SLP, durable medical equipment, prosthetics, orthotics and supplies, diagnostic imaging, 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 disallowed from seeking payment under the Medicare or Medicaid programs or from collecting from the patient or other payor. Statutory and regulatory exceptions and exemptions to this exist and have specific rules that must be followed to qualify for such exception or exemption. 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. 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 Health care providers are also subject to laws and regulations enacted to protect the confidentiality of patient health information and patients' right to access such 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 and our independent operating subsidiaries have established policies and procedures to comply with HIPAA privacy and security requirements and our independent operating subsidiaries have adopted and implemented HIPAA compliance plans, which we believe comply with the HIPAA privacy and security regulations, which impose significant costs for ongoing compliance activities. There are numerous other laws and legislative and regulatory initiatives at the federal and state levels addressing privacy and security concerns. Our independent operating subsidiaries are also subject to any federal or state privacy-related laws that are more restrictive than the privacy regulations issued under HIPAA. 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. On February 3, 2023, the DOJ’s Antitrust Division withdrew its support for three policies that had been jointly created by the DOJ and the Federal Trade Commission (FTC) in 1993, 1996, and 2011, announcing instead, without providing further alternative guidance, that the DOJ would take a case-by-case enforcement approach to evaluate conduct in the healthcare industry, citing that the previous policies were outdated and overly permissive. Similarly, on July 14, 2023, the FTC withdrew two antitrust policy statements related to enforcement in healthcare markets. Moving forward, the FTC will evaluate mergers and conduct in healthcare markets on a case-by-case basis using principles of antitrust enforcement and competition policy. 53 Table of Contents On July 19, 2023, the DOJ and FTC released a draft joint statement of antitrust policy that outlines 13 guidelines to be used when determining if a merger is unlawfully anticompetitive under antitrust laws. These guidelines cover various aspects of antitrust enforcement relevant to SNF and senior living facilities, such as market concentration, competition between firms, risk of coordination, elimination of potential entrants, control of products or services, vertical mergers, dominant positions, trends toward concentration, series of multiple acquisitions, multi-sided platforms, competing buyers, partial ownership or minority interests and overall impact on competition. The draft joint statement also includes detailed sections on the application of the guidelines, defining relevant markets and approaches to rebuttal evidence. These proposed statements are not exhaustive and the DOJ and FTC may focus on one or multiple guidelines depending on the specific circumstances of each merger. These proposed general statements of antitrust policy, once finalized, may be a prelude to a new joint statement of healthcare antitrust policy of the DOJ and FTC, with the agencies’ finalized general statements providing insight into whether healthcare-specific statements will be issued. This development and potential new guidance regarding DOJ and FTC antitrust policy increases risk and uncertainty regarding transactions that may be subject to criminal and civil enforcement by federal and state agencies, as well as by private litigants. Americans with Disabilities Act Our independent operating subsidiaries must also comply with the ADA, and similar state and local laws to the extent that the 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 the independent operating subsidiaries continue to assess their facilities relative to ADA compliance and make appropriate modifications as needed. Real Estate Investment Trust (REIT) Qualification We elected for Standard Bearer to be taxed as a REIT for U.S. federal income tax purposes beginning with its taxable year ended December 31, 2022. Standard Bearer's qualification as a REIT will depend upon its ability to meet, on a continuing basis, various complex requirements under the Internal Revenue Code, relating to, among other things, the sources of its gross income, the composition and value of its assets, distribution levels to its shareholders and the concentration of ownership of its capital stock. We believe that Standard Bearer is organized in conformity with the requirements for qualification and taxation as a REIT under the Code and that its manner of operation has and will enable it to continue to meet the requirements for qualification and taxation as a REIT. REGULATIONS SPECIFIC TO SENIOR LIVING COMMUNITIES As previously mentioned, senior living services revenue (approximately 2.1% of total revenue) is primarily derived from private pay residents, with a small portion of senior living revenue derived from Medicaid funds. Thus, some of the regulations discussed above applicable to Medicaid providers, also apply 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. As rates paid to senior living community operators are generally lower than rates paid to SNF 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 SNFs. States that administer Medicaid programs for services in senior living communities are responsible for monitoring the participating communities and, as a result of the growth of senior living in recent years, these states have adopted licensing standards applicable to senior living communities. CMS has continued to commence 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 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 and the pressure to enforce those laws by federal and state authorities continues to grow as well. In order to operate our businesses, we and our independent operating subsidiaries must comply with myriad federal, state and local laws from healthcare including provisions regarding patient safety, staffing, and prescription drugs to environmental issues. Changes in the law or new interpretations of existing laws may have an adverse impact on our methods and costs of doing business. 54 Table of Contents 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. Our total revenue for the three months ended September 30, 2023 increased $170.8 million, or 22.2%, while our diluted GAAP earnings per share grew by 12.1%, from $0.99 to $1.11, compared to the three months ended September 30, 2022. Throughout 2023, we have continued to make progress on targeted initiatives related to increasing occupancy in our facilities, attracting and developing our people and acquiring new skilled nursing operations and integrating them with our proven cultural and operational principals. Our combined Same Facilities and Transitioning Facilities occupancy increased by 2.9% compared to the three months ended September 30, 2022. As our census continues to return to pre-pandemic levels, we anticipate a return to our historical seasonality trends, which typically result in higher occupancy and skilled mix during the first and fourth quarters and softening in the second and third quarters. See Recent Activities for our operational update. During the nine months ended September 30, 2023, we added 24 new operations, which included 17 operations in California. These California facilities include a group of highly skilled team members who will further our mission of dignifying long term care. We continue to work diligently with existing and recently acquired operations so that each can reach its full clinical and financial potential. Our strength remains in our operating model, which empowers each operator to form their own market-specific strategy and adjust to the needs of their local medical communities, including methods for attracting new healthcare professionals into our workforce and retaining and developing existing staff. Despite continued labor pressures, there are positive trends on both turnover and agency usage in some of our markets. The following table sets forth details of operating results for our revenue, expenses and earnings, and their respective components, as a percentage of total revenue for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 REVENUE: Service revenue 99.4 % 99.5 % 99.4 % 99.4 % Rental revenue 0.6 0.5 0.6 0.6 TOTAL REVENUE 100.0 % 100.0 % 100.0 % 100.0 % Expenses: Cost of services 78.8 78.1 78.6 77.7 Rent—cost of services 5.4 5.1 5.3 5.0 General and administrative expense 5.4 5.1 5.7 5.2 Depreciation and amortization 1.9 2.1 1.9 2.1 TOTAL EXPENSES 91.5 90.4 91.5 90.0 Income from operations 8.5 9.6 8.5 10.0 Other income (expense): Interest expense (0.2) (0.2) (0.2) (0.3) Other income (expense) 0.4 — 0.5 (0.2) Other income (expense), net 0.2 (0.2) 0.3 (0.5) Income before provision for income taxes 8.7 9.4 8.8 9.5 Provision for income taxes 1.9 2.1 2.0 2.1 NET INCOME 6.8 7.3 6.8 7.4 Less: net income attributable to noncontrolling interests — — — — Net income attributable to The Ensign Group, Inc. 6.8 % 7.3 % 6.8 % 7.4 % 55 Table of Contents Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 SEGMENT INCOME (1) (In thousands) Skilled services $ 117,816 $ 101,750 $ 348,169 $ 302,272 Standard Bearer (2) 7,165 6,941 21,517 20,679 NON-GAAP FINANCIAL MEASURES: PERFORMANCE METRICS Adjusted EBT 92,091 78,964 266,906 230,922 EBITDA 98,133 90,165 285,376 267,181 Adjusted EBITDA 108,044 96,588 310,620 285,413 FFO for Standard Bearer 13,594 12,502 40,045 36,477 VALUATION METRICS Adjusted EBITDAR $ 158,401 $ 457,374 (1) Segment income represents operating results of the reportable segments excluding gain and loss on sale of assets, real estate insurance recoveries and losses, impairment charges and provision for income taxes. Included in segment income for Standard Bearer are expenses for intercompany management fees between Standard Bearer and the Service Center and intercompany interest expense. Segment income is reconciled to the Condensed Consolidated Statement of Income in Note 8, Business Segments in Notes to Interim Financial Statements of this Quarterly Report on Form 10-Q. (2) Standard Bearer segment income includes rental revenue from Ensign affiliated tenants and expenses. The following discussion includes references to Adjusted EBT, 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. 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 other income (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 other 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. 56 Table of Contents 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 interest expense, or the cash requirements necessary to service interest or principal payments, on our debt; • they do not reflect rent expenses, which are necessary to operate our leased operations, in the case of Adjusted EBITDAR; • they do not reflect any income tax payments we may be required to make; • although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and do not reflect any cash requirements for such replacements; and • other companies in our industry may calculate these measures differently than we do, which may limit their usefulness as comparative measures. We compensate for these limitations by using them only to supplement net income on a basis prepared in accordance with GAAP in order to provide a more complete understanding of the factors and trends affecting our business. Management strongly encourages investors to review our consolidated financial statements in their entirety and to not rely on any single financial measure. Because these Non-GAAP Financial Measures are not standardized, it may not be possible to compare these financial measures with other companies’ Non-GAAP financial measures having the same or similar names. These Non-GAAP Financial Measures should not be considered a substitute for, nor superior to, financial results and measures determined or calculated in accordance with GAAP. We strongly urge you to review the reconciliation of income from operations to the Non-GAAP Financial Measures in the table below, along with our Interim Financial Statements and related notes included elsewhere in this document. We use the following Non-GAAP financial measures that we believe are useful to investors as key valuation and operating performance measures: PERFORMANCE MEASURES Adjusted EBT We adjust income before provision for income taxes (Adjusted EBT) 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 EBT. We believe that the presentation of Adjusted EBT, when combined with income before provision for income taxes and GAAP net income attributable to The Ensign Group, Inc., is beneficial to an investor’s complete understanding of our operating performance. We use this performance measure as an indicator of business performance, as well as for operational planning, decision-making purposes and to determine compensation in our executive compensation plan. Adjusted EBT is income before provision for income taxes adjusted for non-core business items, which for the reported periods includes, to the extent applicable: • stock-based compensation expense; • legal costs and adjustments; • gain on business interruption of recoveries and sale of assets; • write-off of deferred financing fees; • acquisition related costs; • costs incurred related to new systems implementation; and 57 Table of Contents • depreciation and amortization of patient base intangible assets. 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) other income (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 the same non-core business items as listed in Adjusted EBT, except for depreciation and amortization of patient base intangible assets and write-off of deferred financing fees. Funds from Operations (FFO) We consider FFO to be a useful supplemental measure of the operating performance of Standard Bearer. 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 consist of Standard Bearer segment income, excluding depreciation and amortization related to real estate, gains or losses from the sale of real estate, insurance recoveries related to real estate and impairment of depreciable real estate assets. 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, and is therefore presented only for the current period. 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. 58 Table of Contents The table below reconciles income before provision for income taxes to Adjusted EBT for the periods presented: Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Consolidated statements of income data: (In thousands) Income before provision for income taxes $ 82,045 $ 72,455 $ 241,480 $ 211,638 Stock-based compensation expense 7,237 5,898 22,691 16,681 Legal costs and adjustments (a) 2,783 859 1,965 4,485 Gain on business interruption recoveries and sale of assets (259) (900) (1,009) (3,467) Write-off of deferred financing fees (b) — — — 566 Acquisition related costs (c) 150 245 722 416 Costs incurred related to new systems implementation — 321 875 390 Depreciation and amortization - patient base (d) 135 86 182 213 ADJUSTED EBT $ 92,091 $ 78,964 $ 266,906 $ 230,922 (a) Legal costs incurred in connection with the medical directors related matter. Legal adjustments relate to findings attributable to our ancillary services subsidiary, which includes the portion attributable to non-controlling interests. (b) Represents the write-off of deferred financing fees associated with the amendment of the credit facility. (c) Costs incurred to acquire operations that are not capitalizable. (d) Included in depreciation and amortization are amortization expenses related to patient base intangible assets at newly acquired skilled nursing and senior living facilities. The table below reconciles net income to EBITDA, Adjusted EBITDA and Adjusted EBITDAR for the periods presented: Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Consolidated statements of income data: (In thousands) Net income $ 63,968 $ 56,242 $ 188,027 $ 164,133 Less: net income (loss) attributable to noncontrolling interests 105 63 319 (77) Add: Other (income) expense, net (2,253) 1,832 (8,939) 9,991 Provision for income taxes 18,077 16,213 53,453 47,505 Depreciation and amortization 18,446 15,941 53,154 45,475 EBITDA $ 98,133 $ 90,165 $ 285,376 $ 267,181 Stock-based compensation expense 7,237 5,898 22,691 16,681 Legal costs and adjustments (a) 2,783 859 1,965 4,212 Gain on business interruption recoveries and sale of assets (259) (900) (1,009) (3,467) Acquisition related costs (b) 150 245 722 416 Costs incurred related to new systems implementation — 321 875 390 ADJUSTED EBITDA $ 108,044 $ 96,588 $ 310,620 $ 285,413 Rent—cost of services 50,357 38,907 146,754 111,897 ADJUSTED EBITDAR $ 158,401 $ 457,374 (a) Legal costs incurred in connection with the medical directors related matter. Legal adjustments relate to findings attributable to our ancillary services subsidiary, which excludes the portion attributable to non-controlling interests. (b) Costs incurred to acquire operations that are not capitalizable. 59 Table of Contents Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022 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 September 30, 2023 Skilled services Standard Bearer All Other Eliminations Consolidated Total Revenue $ 902,967 $ 20,980 $ 39,124 $ (22,280) $ 940,791 Total expenses, including other income, net 785,151 13,815 82,060 (22,280) 858,746 Segment income (loss) 117,816 7,165 (42,936) — 82,045 Income before provision for income taxes $ 82,045 Three Months Ended September 30, 2022 Skilled services Standard Bearer All Other Eliminations Consolidated Total Revenue $ 739,318 $ 18,732 $ 31,844 $ (19,889) $ 770,005 Total expenses, including other income, net 637,568 11,791 68,880 (19,889) 698,350 Segment income (loss) 101,750 6,941 (37,036) — 71,655 Gain on sale of assets, net — — — — 800 Income before provision for income taxes $ 72,455 Our total revenue increased by $170.8 million, or 22.2%, compared to the three months ended September 30, 2022. The increase in revenue was driven by an increase in occupancy from Medicaid non-skilled services as well as the impact of acquisitions. Total revenue from operations acquired on or subsequent to October 1, 2022 increased our consolidated service revenue by $117.3 million during the three months ended September 30, 2023, when compared to the same period in 2022. These increases were offset by a decline in state relief funds. We recorded $10.3 million of state relief revenue in the third quarter of 2023 compared to $21.4 million in the same period in 2022. 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 September 30, 2023 and 2022: Three Months Ended September 30, 2023 2022 Change % Change TOTAL FACILITY RESULTS: (Dollars in thousands) Skilled services revenue $ 902,967 $ 739,318 $ 163,649 22.1 % Number of facilities at period end 258 222 36 16.2 % Number of campuses at period end* 26 26 — — % Actual patient days 2,190,540 1,846,699 343,841 18.6 % Occupancy percentage — Operational beds 78.9 % 75.7 % 3.2 % Skilled mix by nursing days 29.1 % 31.6 % (2.5) % Skilled mix by nursing revenue 48.4 % 51.6 % (3.2) % 60 Table of Contents Three Months Ended September 30, 2023 2022 Change % Change SAME FACILITY RESULTS: (1) (Dollars in thousands) Skilled services revenue $ 692,257 $ 649,690 $ 42,567 6.6 % Number of facilities at period end 189 189 — — % Number of campuses at period end* 24 24 — — % Actual patient days 1,660,683 1,596,942 63,741 4.0 % Occupancy percentage — Operational beds 79.5 % 76.6 % 2.9 % Skilled mix by nursing days 30.7 % 33.0 % (2.3) % Skilled mix by nursing revenue 49.8 % 53.1 % (3.3) % Three Months Ended September 30, 2023 2022 Change % Change TRANSITIONING FACILITY RESULTS: (2) (Dollars in thousands) Skilled services revenue $ 62,979 $ 59,773 $ 3,206 5.4 % Number of facilities at period end 22 22 — — % Number of campuses at period end* 1 1 — — % Actual patient days 165,645 158,856 6,789 4.3 % Occupancy percentage — Operational beds 76.2 % 73.5 % 2.7 % Skilled mix by nursing days 20.0 % 23.1 % (3.1) % Skilled mix by nursing revenue 36.1 % 40.5 % (4.4) % Three Months Ended September 30, 2023 2022 Change % Change RECENTLY ACQUIRED FACILITY RESULTS: (3) (Dollars in thousands) Skilled services revenue $ 147,731 $ 29,855 $ 117,876 NM Number of facilities at period end 47 11 36 NM Number of campuses at period end* 1 1 — NM Actual patient days 364,212 90,901 273,311 NM Occupancy percentage — Operational beds 77.4 % 65.6 % NM Skilled mix by nursing days 26.1 % 22.6 % NM Skilled mix by nursing revenue 46.9 % 39.3 % NM * Campus represents a facility that offers both skilled nursing and senior living services. Revenue and expenses related to skilled nursing and senior living services have been allocated and recorded in the respective operating segment. (1) Same Facility results represent all facilities purchased prior to January 1, 2020. (2) Transitioning Facility results represent all facilities purchased from January 1, 2020 to December 31, 2021. (3) Recently Acquired Facility (Acquisitions) results represent all facilities purchased on or subsequent to January 1, 2022. Skilled services revenue increased by $163.6 million, or 22.1%, compared to the three months ended September 30, 2022. The increases in skilled services revenue were across all payer types including increases in Medicaid revenue of $83.0 million, or 23.9%, Medicare revenue of $26.4 million, or 12.5%, managed care revenue of $38.1 million, or 28.7% and private revenue of $16.1 million, or 33.0%. The increase in skilled services revenue was primarily driven by strong performance across our skilled services operations as our occupancy continued to recover in the third quarter of 2023, as well as the favorable impact of skilled census from our recent acquisitions. Our consolidated occupancy increased by 3.2% during the three months ended September 30, 2023 compared to the same period in 2022. As our census continues to return to pre-pandemic levels, we anticipate a return to our historical seasonality trends, which typically result in higher occupancy and skilled mix during the first and fourth quarters and softening in the second and third quarters. See Recent Activities for our operational update. 61 Table of Contents Revenue in our Same Facilities increased by $42.6 million, or 6.6% due to increased occupancy and a shift to higher Medicaid and private census. Our diligent efforts to strengthen our partnerships with various managed care organizations, hospitals and the local communities we operate in increased our managed care days by 6.9% and managed care revenue per patient day by 6.6%, resulting in an increase in managed care revenue of 15.9%. In addition, Medicaid revenue increased by $30.7 million or 10.3%, mainly from the increase in days and Medicaid revenue per patient day. With the ending of the PHE, we experienced a decrease in acuity due to the return of seasonal trends. Revenue generated by our Transitioning Facilities increased by $3.2 million, or 5.4%, primarily due to improved occupancy growth and an increase in revenue per patient day. Our Medicaid days and private days increased by 9.0% and 5.6%, respectively, demonstrating our ability to focus on increasing occupancy across various payer types. We experienced a decrease in Medicare revenue and skilled days as our normal seasonality returns in the post-pandemic environment. Skilled services revenue generated by Recently Acquired Facilities increased by $117.9 million compared to the three months ended September 30, 2022 . We acquired 36 operations between October 1, 2022 and September 30, 2023 across six states. In the future, if we acquire additional turnaround or start-up operations, we expect to see lower occupancy rates and skilled mix and these metrics are expected to vary from period to period based upon the maturity of the facilities within our portfolio. Historically, we have generally experienced lower occupancy rates and lower skilled mix at Recently Acquired Facilities and therefore, we anticipate generally lower overall occupancy during years of growth. Included in our metrics for Recently Acquired Facilities are 17 facilities we acquired that are mature and have higher occupancy rates, higher skilled mix days and higher skilled mix revenue than our typical acquisitions. The following table reflects the change in skilled nursing average daily revenue rates by payor source, excluding services that are not covered by the daily rate (1) : Three Months Ended September 30, Same Facility Transitioning Acquisitions Total 2023 2022 2023 2022 2023 2022 2023 2022 SKILLED NURSING AVERAGE DAILY REVENUE RATES: Medicare $ 721.35 $ 684.58 $ 699.44 $ 669.29 $ 800.93 $ 652.66 $ 735.66 $ 682.41 Managed care 544.85 511.35 539.53 487.16 560.44 422.21 546.36 508.13 Other skilled 584.77 566.00 518.59 514.55 433.72 425.91 562.61 552.31 Total skilled revenue 615.02 593.71 612.82 587.23 663.54 510.11 622.12 590.36 Medicaid 277.82 258.54 274.44 262.17 263.95 236.02 275.09 257.57 Private and other payors 263.19 251.48 251.08 244.55 267.56 180.79 262.97 248.01 Total skilled nursing revenue $ 379.79 $ 368.27 $ 339.42 $ 335.24 $ 368.46 $ 293.23 $ 374.85 $ 361.74 (1) These rates exclude state relief funding . Our Medicare daily rates at Same Facilities and Transitioning Facilities increased by 5.4% and 4.5%, respectively, compared to the three months ended September 30, 2022. The increase is attributable to the 2.7% net market basket increase that became effective in October 2022. In addition, we have seen a shift to higher acuity patients. Our average Medicaid rates increased 6.8% 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. 62 Table of Contents The following tables set forth our percentage of skilled nursing patient revenue and days by payor source: Three Months Ended September 30, Same Facility Transitioning Acquisitions Total 2023 2022 2023 2022 2023 2022 2023 2022 PERCENTAGE OF SKILLED NURSING REVENUE Medicare 20.8 % 26.1 % 19.6 % 24.6 % 28.9 % 18.9 % 22.0 % 25.7 % Managed care 20.2 19.0 12.7 11.9 13.2 7.9 18.6 18.0 Other skilled 8.8 8.0 3.8 4.0 4.8 12.5 7.8 7.9 Skilled Mix 49.8 53.1 36.1 40.5 46.9 39.3 48.4 51.6 Private and other payors 7.9 7.2 8.7 8.4 8.2 5.2 8.0 7.2 Medicaid 42.3 39.7 55.2 51.1 44.9 55.5 43.6 41.2 TOTAL SKILLED NURSING 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Three Months Ended September 30, Same Facility Transitioning Acquisitions Total 2023 2022 2023 2022 2023 2022 2023 2022 PERCENTAGE OF SKILLED NURSING DAYS Medicare 10.9 % 14.0 % 9.5 % 12.3 % 13.3 % 8.5 % 11.2 % 13.6 % Managed care 14.1 13.7 8.0 8.2 8.7 5.5 12.7 12.8 Other skilled 5.7 5.3 2.5 2.6 4.1 8.6 5.2 5.2 Skilled Mix 30.7 33.0 20.0 23.1 26.1 22.6 29.1 31.6 Private and other payors 11.5 10.5 11.8 11.6 11.2 8.5 11.5 10.5 Medicaid 57.8 56.5 68.2 65.3 62.7 68.9 59.4 57.9 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 September 30, Change 2023 2022 $ % Cost of service $ 713,290 $ 579,199 $ 134,091 23.2 % Revenue percentage 79.0 % 78.3 % 0.7 % Cost of services related to our skilled services segment increased by $134.1 million, or 23.2%. Cost of services as a percentage of revenue increased to 79.0% from 78.3% due to costs related to new acquisitions, increase in professional liabilities reserves and higher staffing expenses as a result of the challenging labor environment. The increase in wages and benefits is offset by the decrease in contract labor usage as we made progress on retention and hiring. Standard Bearer Three Months Ended September 30, Change 2023 2022 $ % (Dollars in thousands) Rental revenue generated from third-party tenants $ 4,004 $ 3,708 $ 296 8.0 % Rental revenue generated from Ensign affiliated operations 16,976 15,024 1,952 13.0 TOTAL RENTAL REVENUE $ 20,980 $ 18,732 $ 2,248 12.0 % Segment income 7,165 6,941 224 3.2 Depreciation and amortization 6,429 5,561 868 15.6 FFO $ 13,594 $ 12,502 $ 1,092 8.7 % 63 Table of Contents Rental revenue — Our rental revenue, including revenue generated from our affiliated facilities, increased by $2.2 million, or 12.0%, to $21.0 million, compared to the three months ended September 30, 2022. The increase in revenue is primarily attributable to six real estate purchases, as well as annual rent increases since the three months ended September 30, 2022. FFO — Our FFO increased by $1.1 million, or 8.7%, to $13.6 million, compared to the three months ended September 30, 2022. The increase in rental revenue of $2.2 million is offset by increases in interest expense of $1.1 million associated with the intercompany agreements between Standard Bearer and the Service Center. All Other Revenue Our other revenue increased by $7.3 million, or 22.9%, to $39.1 million, compared to the three months ended September 30, 2022. Other revenue for 2023 includes senior living revenue of $18.9 million, revenue from other ancillary services of $17.3 million and rental income of $2.9 million. The increase in other revenue is primarily attributable to our other ancillary services. Consolidated Financial Expenses Rent-cost of services — Our rent-cost of services as a percentage of total revenue increased by 0.3% to 5.4%, primarily due to lease obligations acquired as part of our 31 operational expansions with long-term leases since the three months ended September 30, 2022. General and administrative expense — General and administrative expense increased $11.9 million or 30.3%, to $51.1 million. General and administrative expense as a percentage of revenue increased by 0.3% to 5.4%. This increase was primarily due to increased legal costs and headcount due to acquisition activities. Excluding the legal costs, general and administrative expense as a percentage of revenue remained consistent at 5.1%. Depreciation and amortization — Depreciation and amortization expense increased $2.5 million, or 15.7%, to $18.4 million. This increase was primarily related to the additional depreciation and amortization incurred as a result of our newly acquired operations and capital expenditures. Depreciation and amortization decreased 0.2%, to 1.9%, as a percentage of revenue. Other income (expense), net — Other income (expense), net as a percentage of revenue increased by 0.4%. Other income primarily includes interest income from our investments offset by interest expense related to our debt. Additionally our deferred investment program incurs gains or losses depending on market performance. During the three months ended September 30, 2023 and 2022, the deferred compensation investment program had a loss of $1.4 million and $1.1 million, respectively. There is an offsetting reduction in expense allocated between cost of services and general and administrative expenses. Provision for income taxes — Our effective tax rate was 22.0% for the three months ended September 30, 2023, compared to 22.4% for the same period in 2022. 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 including non-deductible compensation. See Note 14, Income Taxes , in the Notes to the Interim Financial Statements for further discussion. Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022 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. Nine Months Ended September 30, 2023 Skilled Services Standard Bearer All Other Eliminations Consolidated Total revenue $ 2,638,090 $ 60,611 $ 114,574 $ (64,298) $ 2,748,977 Total expenses, including other expense, net 2,289,921 39,094 242,680 (64,298) 2,507,397 Segment income (loss) 348,169 21,517 (128,106) — 241,580 Loss on real estate insurance recoveries (100) Income before provision for income taxes $ 241,480 64 Table of Contents Nine Months Ended September 30, 2022 Skilled Services Standard Bearer All Other Eliminations Consolidated Total revenue $ 2,128,567 $ 53,523 $ 89,793 $ (55,947) $ 2,215,936 Total expenses, including other expense, net 1,826,295 32,844 204,373 (55,947) 2,007,565 Segment income (loss) 302,272 20,679 (114,580) — 208,371 Gain from sale of real estate 3,267 Income before provision for income taxes $ 211,638 Our total revenue increased $533.0 million, or 24.1%, compared to the nine months ended September 30, 2022. The increase in revenue was primarily driven by an increase in occupancy and patient days from our skilled services operations and the impact of acquisitions. Total revenue from operations acquired on or subsequent to October 1, 2022 increased our consolidated service revenue by $300.1 million during the nine months ended September 30, 2023, when compared to the same period in 2022. In addition, we recorded $55.1 million of state relief revenue during the nine months ended September 30, 2023 compared to $63.5 million in 2022, which directly correlated to the additional COVID-19 related labor 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 nine months ended September 30, 2023 and 2022: Nine Months Ended September 30, 2023 2022 Change % Change TOTAL FACILITY RESULTS: (Dollars in thousands) Skilled services revenue $ 2,638,090 2,128,567 $ 509,523 23.9 % Number of facilities at period end 258 222 36 16.2 % Number of campuses at period end* 26 26 — — % Actual patient days 6,363,107 5,287,690 1,075,417 20.3 % Occupancy percentage — Operational beds 78.3 % 75.0 % 3.3 % Skilled mix by nursing days 30.7 % 32.1 % (1.4) % Skilled mix by nursing revenue 50.6 % 52.3 % (1.7) % Nine Months Ended September 30, 2023 2022 Change % Change SAME FACILITY RESULTS: (1) (Dollars in thousands) Skilled services revenue $ 2,058,291 $ 1,909,387 $ 148,904 7.8 % Number of facilities at period end 189 189 — — % Number of campuses at period end* 24 24 — — % Actual patient days 4,895,304 4,680,168 215,136 4.6 % Occupancy percentage — Operational beds 78.9 % 75.5 % 3.4 % Skilled mix by nursing days 32.2 % 33.1 % (0.9) % Skilled mix by nursing revenue 51.8 % 53.4 % (1.6) % 65 Table of Contents Nine Months Ended September 30, 2023 2022 Change % Change TRANSITIONING FACILITY RESULTS: (2) (Dollars in thousands) Skilled services revenue $ 186,948 $ 171,428 $ 15,520 9.1 % Number of facilities at period end 22 22 — — % Number of campuses at period end* 1 1 — — % Actual patient days 489,310 462,848 26,462 5.7 % Occupancy percentage — Operational beds 76.0 % 72.1 % 3.9 % Skilled mix by nursing days 21.8 % 23.4 % (1.6) % Skilled mix by nursing revenue 38.9 % 41.8 % (2.9) % Nine Months Ended September 30, 2023 2022 Change % Change RECENTLY ACQUIRED FACILITY RESULTS: (3) (Dollars in thousands) Skilled services revenue $ 392,851 $ 47,752 $ 345,099 NM Number of facilities at period end 47 11 36 NM Number of campuses at period end* 1 1 — NM Actual patient days 978,493 144,674 833,819 NM Occupancy percentage — Operational beds 76.4 % 69.1 % NM Skilled mix by nursing days 27.5 % 28.0 % NM Skilled mix by nursing revenue 49.7 % 45.8 % NM * Campus represents a facility that offers both skilled nursing and senior living services. Revenue and expenses related to skilled nursing and senior living services have been allocated and recorded in the respective operating segment. (1) Same Facility results represent all facilities purchased prior to January 1, 2020. (2) Transitioning Facility results represent all facilities purchased from January 1, 2020 to December 31, 2021. (3) Recently Acquired Facility (Acquisitions) results represent all facilities purchased on or subsequent to January 1, 2022. Skilled services revenue increased $509.5 million, or 23.9%, compared to the nine months ended September 30, 2022. The increases in skilled services revenue were across all payer types including increases in M edicaid revenue of $243.6 million, or 24.6%, Medicare revenue of $123.3 million, or 20.2%, managed care revenue of $99.5 million, or 25.6% and private revenue of $43.1 million, or 31.3%. The increase in skilled services revenue was primarily driven by strong performance across our existing skilled services operations as our census continued to recover during the first nine months of 2023, continued growth in skilled census and the impact of acquisitions. Our consolidated occupancy increased by 3.3% during the nine months ended September 30, 2023 compared to the same period in 2022. Revenue in our Same Facilities increased $148.9 million, or 7.8%, compared to the same period in 2022, due to increases in occupancy and revenue per patient day. Our diligent efforts to strengthen our partnership with various managed care organizations, hospitals and the local communities we operate in, increased our managed care revenue by $49.5 million, or 13.6%, mainly due to increases in managed care days of 8.2% and revenue per patient day of 4.2%. In addition, Medicaid revenue increased by $87.3 million or 10.0%, mainly from the increases in Medicaid days and revenue per patient day. Revenue generated by our Transitioning Facilities increased $15.5 million, or 9.1%, primarily due to improved occupancy growth and an increase in revenue per patient day. Our private days, Medicaid days and managed care skilled days increased by 11.4%, 7.3% and 4.2%, respectively, demonstrating our ability to focus on increasing occupancy across payer types. Skilled services revenue generated by Recently Acquired Facilities increased by approximately $345.1 million compared to the nine months ended September 30, 2022. The increases were primarily due to the expansion of 36 operations between October 1, 2022 and September 30, 2023 across six states. 66 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 and lower skilled mix at Recently Acquired Facilities and therefore, we anticipate generally lower overall occupancy during years of growth. Included in our metrics for Recently Acquired Facilities are 17 facilities we acquired that are mature and have higher occupancy rates, higher skilled mix days and higher skilled mix revenue than our typical acquisitions. The following table reflects the change in skilled nursing average daily revenue rates by payor source, excluding services that are not covered by the daily rate (1) : Nine Months Ended September 30, Same Facility Transitioning Acquisitions Total 2023 2022 2023 2022 2023 2022 2023 2022 SKILLED NURSING AVERAGE DAILY REVENUE RATES Medicare $ 715.73 $ 690.28 $ 688.45 $ 666.01 $ 776.42 $ 673.95 $ 724.85 $ 688.09 Managed care 530.73 509.18 527.77 492.19 548.39 439.40 532.41 507.32 Other skilled 594.85 570.37 522.06 533.80 468.14 428.56 576.60 558.30 Total skilled revenue 612.20 595.47 608.25 589.74 659.01 498.57 618.43 592.79 Medicaid 273.04 258.77 268.26 250.64 251.06 234.47 269.05 257.20 Private and other payors 263.13 249.86 253.81 249.37 260.58 181.23 261.99 248.66 Total skilled nursing revenue $ 381.33 $ 369.26 $ 340.74 $ 329.84 $ 364.26 $ 305.09 $ 375.58 $ 364.06 (1) These rates exclude state relief funding and include sequestration reversal of 1% for the second quarter in 2022 and 2% for the first quarter of 2022. Our Medicare daily rates at Same Facilities and Transitioning Facilities increased by 3.7% and 3.4%, respectively, compared to the nine months ended September 30, 2022. The increase is attributable to the 2.7% net market basket increase that became effective in October 2022, offset by the phased reinstatement of the sequestration. During the nine months ended September 30, 2022, Medicare daily rates included three months of sequestration suspension of 1%, three months of sequestration suspension of 2% and three months of no sequestration suspension. In addition, we have seen a shift to higher acuity patients. Our average Medicaid rates increased 4.6% 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: Nine Months Ended September 30, Same Facility Transitioning Acquisitions Total 2023 2022 2023 2022 2023 2022 2023 2022 PERCENTAGE OF SKILLED NURSING REVENUE Medicare 23.0 % 26.2 % 22.3 % 25.3 % 31.4 % 17.0 % 24.2 % 25.9 % Managed care 20.1 19.2 12.7 12.4 13.1 9.3 18.5 18.4 Other skilled 8.7 8.0 3.9 4.1 5.2 19.5 7.9 8.0 Skilled mix 51.8 53.4 38.9 41.8 49.7 45.8 50.6 52.3 Private and other payors 7.5 7.0 8.5 8.2 7.9 3.8 7.6 7.0 Medicaid 40.7 39.6 52.6 50.0 42.4 50.4 41.8 40.7 TOTAL SKILLED NURSING 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 67 Table of Contents Nine Months Ended September 30, Same Facility Transitioning Acquisitions Total 2023 2022 2023 2022 2023 2022 2023 2022 PERCENTAGE OF SKILLED NURSING DAYS Medicare 12.3 % 14.0 % 11.0 % 12.5 % 14.8 % 7.7 % 12.6 % 13.7 % Managed care 14.4 13.9 8.2 8.3 8.7 6.5 13.1 13.2 Other skilled 5.5 5.2 2.6 2.6 4.0 13.8 5.0 5.2 Skilled mix 32.2 33.1 21.8 23.4 27.5 28.0 30.7 32.1 Private and other payors 10.9 10.4 11.4 10.8 11.0 6.4 10.9 10.3 Medicaid 56.9 56.5 66.8 65.8 61.5 65.6 58.4 57.6 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): Nine Months Ended September 30, Change 2023 2022 $ % Cost of service $ 2,081,107 $ 1,658,124 $ 422,983 25.5 % Revenue percentage 78.9 % 77.9 % 1.0 % Cost of services related to our skilled services segment increased by $423.0 million, or 25.5%. Cost of services as a percentage of revenue increased to 78.9% from 77.9%, due to costs related to new acquisitions, increase in professional liabilities reserves and higher wage expenses as a result of the labor shortage environment, resulting in additional overtime, benefits and bonuses to our staff. Standard Bearer Nine Months Ended September 30, Change 2023 2022 $ % (Dollars in thousands) Rental revenue generated from third-party tenants $ 11,576 $ 11,180 $ 396 3.5 % Rental revenue generated from Ensign affiliated operations 49,035 42,343 6,692 15.8 TOTAL RENTAL REVENUE $ 60,611 $ 53,523 $ 7,088 13.2 % Segment income 21,517 20,679 838 4.1 Depreciation and amortization 18,528 15,798 2,730 17.3 FFO $ 40,045 $ 36,477 $ 3,568 9.8 % Rental revenue — Our rental revenue, including revenue generated from our affiliated facilities, increased by $7.1 million, or 13.2%, to $60.6 million, compared to the nine months ended September 30, 2022. The increase in revenue is primarily attributable to six real estate purchases as well as annual rent increases since the nine months ended September 30, 2022. FFO — Our FFO increased by $3.6 million, or 9.8%, to $40.0 million, compared to the nine months ended September 30, 2022. The increase in rental revenue of $7.1 million is offset by increases in interest expense of $3.0 million associated with the intercompany agreements between Standard Bearer and the Service Center. 68 Table of Contents All Other Revenue Our other revenue increased by $24.8 million, or 27.6%, to $114.6 million, compared to the nine months ended September 30, 2022. Other revenue for 2023 includes senior living revenue of $56.4 million, revenue from other ancillary services of $49.9 million and rental income of $8.3 million. The increase in other revenue is primarily attributable to our other ancillary services as well as senior living operations' starting to rebound from COVID-19. Consolidated Financial Expenses Rent-cost of services — Our rent-cost of services as a percentage of total revenue increased by 0.3% to 5.3%, primarily due to lease obligations acquired as part of our 31 operational expansions with long-term leases since the nine months ended September 30, 2022. General and administrative expense — General and administrative expense increased $40.4 million or 34.8%, to $156.4 million. General and administrative expense as a percentage of revenue increased by 0.5% to 5.7%. This increase was primarily due to increases in legal costs, system implementation costs, bonuses due to enhanced performance and headcount due to acquisition activity. Excluding the legal costs, general and administrative expense as a percentage of revenue decreased 0.1%. Depreciation and amortization — Depreciation and amortization expense increased $7.7 million, or 16.9%, to $53.2 million. This increase was primarily related to the additional depreciation and amortization incurred as a result of our newly acquired operations and capital expenditures. Depreciation and amortization decreased 0.2%, to 1.9%, as a percentage of revenue. Other income (expense), net — Other income (expense), net as a percentage of revenue increased by 0.8%. Other income primarily includes interest income from our investments offset by interest expense related to our debt. Additionally, our deferred investment program may incur gains or losses depending on market performance. During the nine months ended September 30, 2023, the deferred compensation investment program had a gain of $1.1 million. During the nine months ended September 30, 2022, the deferred compensation investment program had a loss of $5.7 million. There is an equal offsetting reduction in expense allocated between cost of services and general and administrative expenses. Provision for income taxes — Our effective tax rate was 22.1% for the nine months ended September 30, 2023, compared to 22.4% for the same period in 2022. 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, including non-deductible compensation. See Note 14, Income Taxes , in the Interim 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 September 30, 2023 is impacted by cash generated from strong operational performance and increased acquisition and share repurchase activities. The U.S. Internal Revenue Service and California have provided disaster-area tax relief for the deferral of federal and California estimated tax payments until the fourth quarter of 2023. As of the third quarter of 2023, the Company has deferred approximately $50.0 million of 2023 federal and California estimated tax payments. The Company subsequently made an estimated tax payment of $69.4 million in October of 2023 for federal and California taxes that had been incurred through the third quarter of 2023. Historically, we have primarily financed the majority of our acquisitions through mortgages on our properties, our Credit Facility and cash generated from operations. Cash paid to fund acquisitions was $54.0 million and $90.4 million for the nine months ended September 30, 2023 and 2022, respectively. Total capital expenditures for property and equipment were $77.4 million and $59.7 million for the nine months ended September 30, 2023 and 2022, respectively. We currently have approximately $100.0 million budgeted for renovation projects in 2023. We believe our current cash balances, our cash flow from operations and the amounts available for borrowing 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. 69 Table of Contents Our cash and cash equivalents as of September 30, 2023 consisted of bank term deposits, money market funds and U.S. Treasury bill related investments. In addition, as of September 30, 2023, we held investments of approximately $103.3 million. We believe our investments that were in an unrealized loss position as of September 30, 2023 do not require an allowance for expected credit losses, nor has any event occurred subsequent to that date that would indicate so. As mentioned above, our primary source 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 September 30, 2023, along with projected operating cash flows and available financing, will support our normal business operations for the foreseeable future. On August 29, 2023, the Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $20.0 million of our common stock under the program for a period of approximately 12 months from September 1, 2023. Under this program, we are authorized to repurchase our issued and outstanding common shares from time to time in open-market and privately negotiated transactions and block trades in accordance with federal securities laws. The share repurchase program does not obligate us to acquire any specific number of shares. We did not purchase any shares pursuant to this stock repurchase program during the three months ended September 30, 2023. The following table presents selected data from our condensed consolidated statement of cash flows for the periods presented: Nine Months Ended September 30, 2023 2022 NET CASH PROVIDED BY/(USED IN): (In thousands) Operating activities $ 291,397 $ 222,337 Investing activities (137,754) (143,771) Financing activities (2,043) (31,903) Net increase in cash and cash equivalents 151,600 46,663 Cash and cash equivalents beginning of period 316,270 262,201 Cash and cash equivalents at end of period $ 467,870 $ 308,864 Operating Activities Cash provided by operating activities is net income adjusted for certain non-cash items and changes in operating assets and liabilities. The $69.1 million increase in cash provided by operating activities for the nine months ended September 30, 2023 compared to the same period in 2022 w as primarily due to higher net income offset by changes in working capital. Changes in working capital were driven by deferral of income tax payments of $55.5 million and accrued wages offset by timing of accounts receivable collections. Investing Activities Investing cash flows consist primarily of capital expenditures, investment activities, insurance proceeds and cash used for acquisitions. The $6.0 million decrease in cash used in investing activities for the nine months ended September 30, 2023 compared to the same period in 2022, was primarily due to a decrease in cash used for operational expansions of $36.4 million offset by an increase in cash used for capital expenditures of $17.6 million and investments of $4.8 million. In addition, in the prior year, we had cash proceeds from the sale of fixed assets and insurance proceeds of $8.6 million that did not recur in current year. Financing Activities Financing cash flows consist primarily of payment of dividends to stockholders, issuance and repayment of short-term and long-term debt, payment for share repurchases and sale of subsidiary shares. 70 Table of Contents The $29.9 million decrease in cash used in financing activities for the nine months ended September 30, 2023 compared to the same period in 2022, was primarily due to $29.9 million of share repurchases as part of our stock repurchase program in 2022. Credit Facility with a Lending Consortium Arranged by Truist We maintain a revolving credit facility with Truist Securities (Truist) (the Credit Facility) with availability up to $600.0 million in aggregate principal amount. The maturity date of the Credit Facility is April 8, 2027. Borrowings are supported by a lending consortium arranged by Truist. The interest rates applicable to loans under the Credit Facility are, at our option, equal to either a base rate plus a margin ranging from 0.25% to 1.25% per annum or SOFR plus a margin range from 1.25% to 2.25% per annum, based on the Consolidated Total Net Debt to Consolidated EBITDA ratio (as defined in the credit agreement). In addition, there is a commitment fee on the unused portion of the commitments that ranges from 0.20% to 0.40% per annum, depending on the Consolidated Total Net Debt to Consolidated EBITDA ratio. Mortgage Loans and Promissory Note As of September 30, 2023, 23 of our subsidiaries have mortgage loans insured with HUD for an aggregate amount of $151.1 million, which subjects these subsidiaries to HUD oversight and periodic inspections. The mortgage loans bear effective interest rates at a range of 3.1% to 4.2%, including fixed interest rates at a range of 2.4% to 3.3% per annum. In addition to the interest rate, we incur other fees for HUD placement, including but not limited to audit fees. 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, during the first three years, the prepayment fee is 10.0%, and is reduced by 3.0% in the fourth year of the loan, and reduced by 1.0% per year for years five through ten of the loan. There is no prepayment penalty after year ten. The terms for all the mortgage loans are 25 to 35 years. In addition to the HUD mortgage loans, one of our subsidiaries has a promissory note that bears a fixed interest rate of 5.3% per annum and has a term of 12 years. The 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 As of September 30, 2023, 213 of our facilities are under long-term lease arrangements, of which 96 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 97 facilities leased from CareTrust include an option to purchase that we can exercise starting on December 1, 2024. 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. Eighty of our affiliated facilities, excluding the facilities that are operated under the Master Leases from CareTrust, are operated under 13 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. 71 Table of Contents U.S. Department of Justice Civil Investigative Demand On May 31, 2018, we received a Civil Investigative Demand (CID) from the U.S. Department of Justice (DOJ) stating that it was investigating whether there had been a violation of the FCA and/or the AKS with respect to the relationships between certain of our independently operated skilled nursing facilities and persons who serve or have served as medical directors. We have fully cooperated with the DOJ and promptly responded to its requests for information. In April 2020, we were advised that the DOJ declined to intervene in any subsequent action filed in connection with the subject matter of this investigation. Despite the decision of the DOJ to decline to participate in litigation based on the subject matter of its previously issued CID, the involved qui tam relator has moved forward with the lawsuit. We are vigorously defending this lawsuit, but expects the costs of defense to be significant given the nature of the allegations and the date range contemplated by the complaint. As a general matter, our independent operating entities have established and maintain policies and procedures to promote compliance with the FCA, the AKS, and other applicable regulatory requirements. 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, supply expenses and capital expenditures 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. There can be no assurance that we will be able to anticipate fully or otherwise respond to any future inflationary pressures.