ENSG 3.31.12 10Q
Table of Contents

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2012.
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from                      to                     .
Commission file number: 001-33757
__________________________
THE ENSIGN GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)
Delaware
33-0861263
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
27101 Puerta Real, Suite 450
Mission Viejo, CA 92691
(Address of Principal Executive Offices and Zip Code)
(949) 487-9500
(Registrant’s Telephone Number, Including Area Code)
N/A
(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)
_____________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
As of April 30, 2012, 21,342,085 shares of the registrant’s common stock were outstanding.
 
 
 
 
 



THE ENSIGN GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2012
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

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Part I. Financial Information

Item 1.        Financial Statements
THE ENSIGN GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par values)
(Unaudited)
 
March 31,
2012
 
December 31,
2011
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
32,618

 
$
29,584

Accounts receivable—less allowance for doubtful accounts of $12,794 and $12,782 at March 31, 2012 and December 31, 2011, respectively
94,050

 
86,311

Prepaid income taxes
246

 
5,882

Prepaid expenses and other current assets
7,373

 
7,667

Deferred tax asset—current
8,676

 
11,195

Total current assets
142,963

 
140,639

Property and equipment, net
410,773

 
403,862

Insurance subsidiary deposits and investments
17,168

 
16,752

Escrow deposits
2,940

 
175

Deferred tax asset
4,380

 
3,514

Restricted and other assets
11,975

 
10,418

Intangible assets, net
5,197

 
2,321

Goodwill
19,901

 
17,177

Other indefinite-lived intangibles
9,911

 
1,481

Total assets
$
625,208

 
$
596,339

Liabilities and equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
16,603

 
$
21,169

Accrued wages and related liabilities
33,565

 
41,958

Accrued self-insurance liabilities—current
12,946

 
12,369

Other accrued liabilities
16,912

 
18,577

Current maturities of long-term debt
7,028

 
6,314

Total current liabilities
87,054

 
100,387

Long-term debt—less current maturities
195,826

 
181,556

Accrued self-insurance liabilities—less current portion
32,942

 
31,904

Fair value of interest rate swap
2,150

 
2,143

Deferred rent and other long-term liabilities
3,206

 
2,864

Total liabilities
321,178

 
318,854

 
 
 
 
Commitments and contingencies (Note 16)

 

Temporary equity - redeemable noncontrolling interest
11,581

 

Equity:
 
 
 
Ensign Group, Inc. stockholders' equity:
 
 
 
Common stock; $0.001 par value; 75,000 shares authorized; 21,703 and 21,327 shares issued and outstanding at March 31, 2012, respectively, and 21,575 and 21,179 shares issued and outstanding at December 31, 2011, respectively
22

 
22

Additional paid-in capital
80,552

 
77,257

Retained earnings
215,685

 
204,073

Common stock in treasury, at cost, 376 and 396 shares at March 31, 2012 and December 31, 2011, respectively
(2,439
)
 
(2,559
)
Accumulated other comprehensive loss
(1,313
)
 
(1,308
)
Total Ensign Group, Inc. stockholders' equity
292,507

 
277,485

Non-controlling interest
(58
)
 

Total equity
292,449

 
277,485

Total liabilities and equity
$
625,208

 
$
596,339

See accompanying notes to condensed consolidated financial statements.

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Table of Contents

THE ENSIGN GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)

 
Three Months Ended
March 31,
 
2012
 
2011
Revenue
$
202,160

 
$
182,943

Expense:
 
 
 
Cost of services (exclusive of facility rent, general and administrative expense and depreciation and amortization shown separately below)
160,829

 
143,155

Facility rent—cost of services
3,321

 
3,616

General and administrative expense
7,697

 
7,401

Depreciation and amortization
6,924

 
5,059

Total expenses
178,771

 
159,231

Income from operations
23,389

 
23,712

Other income (expense):
 
 
 
Interest expense
(2,925
)
 
(2,727
)
Interest income
51

 
55

Other expense, net
(2,874
)
 
(2,672
)
Income before provision for income taxes
20,515

 
21,040

Provision for income taxes
7,687

 
8,294

Net income
12,828

 
12,746

Less: net income (loss) attributable to noncontrolling interest
(76
)
 

Net income attributable to The Ensign Group, Inc.
$
12,904

 
$
12,746

Net income per share:
 
 
 
Basic
$
0.61

 
$
0.61

Diluted
$
0.59

 
$
0.59

Weighted average common shares outstanding:
 
 
 
Basic
21,251

 
20,854

Diluted
21,796

 
21,516

See accompanying notes to condensed consolidated financial statements.

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THE ENSIGN GROUP, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2012
 
2011
Net income
$
12,828

 
$
12,746

Other comprehensive loss, net of tax:
 
 
 
Net unrealized loss on interest rate swap, net of tax of $2 for the three months ended March 31, 2012.
(5
)
 

Comprehensive income
12,823

 
12,746

Less: net income (loss) attributable to noncontrolling interest
(76
)
 

Comprehensive income attributable to The Ensign Group, Inc.
$
12,899

 
$
12,746


See accompanying notes to consolidated financial statements.


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THE ENSIGN GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Three Months Ended
March 31,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income
$
12,828

 
$
12,746

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
6,924

 
5,059

Amortization of deferred financing fees and debt discount
203

 
168

Deferred income taxes
1,653

 
294

Provision for doubtful accounts
1,812

 
2,227

Stock-based compensation
831

 
831

Excess tax benefit from share based compensation
(398
)
 
(441
)
Loss (gain) on disposition of property and equipment
9

 
(3
)
Change in operating assets and liabilities
 
 
 
Accounts receivable
(9,532
)
 
(9,264
)
Prepaid income taxes
5,636

 
1,333

Prepaid expenses and other current assets
306

 
502

Insurance subsidiary deposits and investments
(416
)
 
607

Accounts payable
(6,395
)
 
1,236

Accrued wages and related liabilities
(8,393
)
 
(4,186
)
Income taxes payable

 
6,592

Other accrued liabilities
(1,583
)
 
(119
)
Accrued self-insurance
1,621

 
1,396

Deferred rent liability
212

 
(289
)
Net cash provided by operating activities
5,318

 
18,689

Cash flows from investing activities:
 
 
 
Purchase of property and equipment
(7,025
)
 
(9,001
)
Cash payment for business acquisitions
(7,043
)
 
(37,074
)
Cash payment for asset acquisitions

 
(7,339
)
Escrow deposits
(2,940
)
 

Escrow deposits used to fund business acquisitions
175

 
14,422

Cash proceeds from the sale of property and equipment
29

 
51

Restricted and other assets
(1,517
)
 
(278
)
Net cash used in investing activities
(18,321
)
 
(39,219
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of debt
21,525

 

Payments on long term debt
(6,571
)
 
(715
)
Issuance of treasury stock upon exercise of options
120

 
103

Issuance of common stock upon exercise of options
2,067

 
775

Dividends paid
(1,283
)
 
(1,150
)
Excess tax benefit from share based compensation
398

 
441

Payments of deferred financing costs
(219
)
 
(39
)
Net cash provided by (used in) financing activities
16,037

 
(585
)
Net increase (decrease) in cash and cash equivalents
3,034

 
(21,115
)
Cash and cash equivalents beginning of period
29,584

 
72,088

Cash and cash equivalents end of period
$
32,618

 
$
50,973

Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
3,096

 
$
2,900

Income taxes
$

 
$
7,870

Non-cash financing and investing activity:
 
 
 

Acquisition of redeemable noncontrolling interest
$
11,600

 
$

Accrued capital expenditures
$
1,829

 
$
895

See accompanying notes to condensed consolidated financial statements.

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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in thousands, except per share data)
(Unaudited)

1. DESCRIPTION OF BUSINESS

The Company - The Ensign Group, Inc., through its subsidiaries (collectively, Ensign or the Company), provides skilled nursing and rehabilitative care services through the operation of 104 facilities, five home health and three hospice operations as of March 31, 2012, located in Arizona, California, Colorado, Idaho, Iowa, Nebraska, Nevada, Oregon, Texas, Utah and Washington. The Company's facilities, each of which strives to be the facility of choice in the community it serves, provide a broad spectrum of skilled nursing, assisted living, home health and hospice services, including physical, occupational and speech therapies, and other rehabilitative and healthcare services, for both long-term residents and short-stay rehabilitation patients. The Company recently entered into a joint venture to develop and operate urgent care facilities and related businesses. These walk-in clinics will offer daily access to healthcare for minor injuries and illnesses, including x-ray and lab services, all from convenient neighborhood locations with no appointments. The Company's facilities have a collective capacity of approximately 11,800 operational skilled nursing, assisted living and independent living beds. As of March 31, 2012, the Company owned 79 of its 104 facilities and operated an additional 25 facilities through long-term lease arrangements, and had options to purchase five of those 25 facilities.
The Ensign Group, Inc. is a holding company with no direct operating assets, employees or revenue. All of the Company’s skilled nursing, assisted living and home health and hospice operations are operated by separate, wholly-owned, independent subsidiaries, each of which has its own management, employees and assets. One of the Company’s wholly-owned subsidiaries, referred to as the Service Center, provides 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. The Company also has a wholly-owned captive insurance subsidiary (the Captive) that provides some claims-made coverage to the Company’s operating subsidiaries for general and professional liability, as well as coverage for certain workers’ compensation insurance liabilities.
Like the Company’s facilities, the Service Center and the Captive are operated by separate, wholly-owned, independent subsidiaries that have their own management, employees and assets. References herein to the consolidated “Company” and “its” assets and activities, as well as the use of the terms “we,” “us,” “our” and similar verbiage in this quarterly report is not meant to imply that The Ensign Group, Inc. has direct operating assets, employees or revenue, or that any of the facilities, the Service Center or the Captive are operated by the same entity.
Other Information — The accompanying condensed consolidated financial statements as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 (collectively, the Interim Financial Statements), are unaudited. Certain information and footnote disclosures normally included in annual consolidated financial statements have been condensed or omitted, as permitted under applicable rules and regulations. Readers of the Interim Financial Statements should refer to the Company’s audited consolidated statements and notes thereto for the year ended December 31, 2011 which are included in the Company’s annual report on Form 10-K, File No. 001-33757 (the Annual Report) filed with the Securities and Exchange Commission (the SEC). Management believes that the Interim Financial Statements reflect all adjustments which are of a normal and recurring nature necessary to present fairly the Company’s financial position and results of operations in all material respects. The results of operations presented in the Interim Financial Statements are not necessarily representative of operations for the entire year.


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying Interim Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company is the sole member or shareholder of various consolidated limited liability companies and corporations; each established to operate various acquired skilled nursing, assisted living facilities, and home health and hospice operations. Additionally, our Interim Financial Statements include accounts of our majority owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. The Company presents noncontrolling interest within the equity section of its condensed consolidated balance sheets. Noncontrolling interest that is redeemable at the option of the minority shareholder is presented outside of permanent equity in the mezzanine section as temporary equity in the Company's consolidated balance sheets. The Company presents the amount of consolidated net income that is attributable to The Ensign Group, Inc. and the noncontrolling interest in its condensed consolidated statements of income.

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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Estimates and Assumptions — The preparation of Interim Financial Statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. The most significant estimates in the Company’s Financial Statements relate to revenue, allowance for doubtful accounts, intangible assets and goodwill, impairment of long-lived assets, general and professional liability, worker’s compensation, and healthcare claims included in accrued self-insurance liabilities, interest rate swaps, and income taxes. Actual results could differ from those estimates.

Business Segments — The Company has a single reportable segment — long-term care services, which includes the operation of skilled nursing and assisted living facilities, home health, hospice, urgent care and related ancillary services. The Company’s single reportable segment is made up of several individual operating segments grouped together principally based on their geographical locations within the United States. Based on the similar economic and other characteristics of each of the operating segments, management believes the Company meets the criteria for aggregating its operating segments into a single reportable segment.

Fair Value of Financial Instruments — The Company’s financial instruments consist principally of cash and cash equivalents, debt security investments, interest rate swap agreements, accounts receivable, insurance subsidiary deposits, accounts payable and borrowings. The Company believes all of the financial instruments’ recorded values approximate fair values because of their nature or respective short durations. The interest rate swap is carried at fair value on the balance sheet. The Company’s fixed-rate debt instruments do not actively trade in an established market. The fair values of this debt are estimated by discounting the principal and interest payments at rates available to the Company for debt with similar terms and maturities. See further discussion of debt security investments in Note 4 Fair Value Measurements.
Revenue Recognition — The Company recognizes revenue when the following four conditions have been met: (i) there is persuasive evidence that an arrangement exists; (ii) delivery has occurred or service has been rendered; (iii) the price is fixed or determinable; and (iv) collection is reasonably assured. The Company's revenue is derived primarily from providing long-term healthcare services to residents and is recognized on the date services are provided at amounts billable to individual residents. For residents under reimbursement arrangements with third-party payors, including Medicaid, Medicare and private insurers, revenue is recorded based on contractually agreed-upon amounts on a per patient, daily basis.
Revenue from the Medicare and Medicaid programs accounted for 73.8% and 75.6% of the Company’s revenue for the three months ended March 31, 2012, and 2011, respectively. The Company records revenue from these governmental and managed care programs as services are performed at their expected net realizable amounts under these programs. The Company’s revenue from governmental and managed care programs is subject to audit and retroactive adjustment by governmental and third-party agencies. Consistent with healthcare industry accounting practices, any changes to these governmental revenue estimates are recorded in the period the change or adjustment becomes known based on final settlement. The Company recorded retroactive adjustments that increased revenue by $317 and $546 for the three months ended March 31, 2012 and 2011, respectively.
The Company’s service specific revenue recognition policies are as follows:
Skilled Nursing Revenue
The Company’s revenue is derived primarily from providing long-term healthcare services to residents and is recognized on the date services are provided at amounts billable to individual residents. For residents under reimbursement arrangements with third-party payors, including Medicaid, Medicare and private insurers, revenue is recorded based on contractually agreed-upon amounts on a per patient, daily basis. The Company records revenue from private pay patients, at the agreed upon rate, as services are performed.
Home Health and Hospice Revenue Recognition
Episodic Based Revenue —Net service revenue is typically recorded on a 60-day episode payment rate. The Company makes adjustments to revenue on completed episodes to reflect differences between estimated and actual payment amounts, an inability to obtain appropriate billing documentation or authorizations acceptable to the payor and other reasons unrelated to credit risk. The Company records an estimate for the impact of such payment adjustments based on its historical experience. In addition to revenue recognized on completed episodes, the Company also recognizes a portion of revenue associated with episodes in progress. Episodes in progress are 60-day episodes of care that begin during the reporting period, but were not completed as of the end of the period. The Company estimates this revenue on a monthly basis based upon historical trends. The primary factors underlying this estimate are the number of episodes in progress at the end of the reporting period, expected Medicare revenue per episode and the Company's estimate of the average percentage complete based on days completed of the episode of care.

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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Non-episodic Based Revenue — Revenue is recorded on an accrual basis based upon the date of service at amounts equal to our established or estimated per-visit rates, as applicable.
Hospice Revenue — Revenue is recorded on an accrual basis based upon the date of service at amounts equal to the estimated payment rates. The estimated payment rates are daily rates for each of the levels of care we deliver. The Company makes adjustments to revenue for an inability to obtain appropriate billing documentation or authorizations acceptable to the payor and other reasons unrelated to credit risk. The Company estimates the impact of these adjustments based on its historical experience, which primarily includes historical collection rates on Medicare claims, and records it during the period services are rendered as an estimated revenue adjustment and as a reduction to its outstanding patient accounts receivable. Additionally, as Medicare hospice revenue is subject to an inpatient cap limit and an overall payment cap, the Company monitors its provider numbers and estimates amounts due back to Medicare if a cap has been exceeded. The Company records these adjustments as a reduction to revenue and increases other accrued liabilities.
Accounts Receivable and Allowance for Doubtful Accounts — Accounts receivable consist primarily of amounts due from Medicare and Medicaid programs, other government programs, managed care health plans and private payor sources. Estimated provisions for doubtful accounts are recorded to the extent it is probable that a portion or all of a particular account will not be collected.
In evaluating the collectability of accounts receivable, the Company considers a number of factors, including the age of the accounts, changes in collection patterns, the composition of patient accounts by payor type and the status of ongoing disputes with third-party payors. On an annual basis, the historical collection percentages are reviewed by payor and by state and are updated to reflect the recent collection experience of the Company. In order to determine the appropriate reserve rate percentages which ultimately establish the allowance, the Company analyzes historical cash collection patterns by payor and by state. The percentages applied to the aged receivable balances are based on the Company’s historical experience and time limits, if any, for managed care, Medicare, Medicaid and other payors. The Company periodically refines its estimates of the allowance for doubtful accounts based on experience with the estimation process and changes in circumstances.
Equity Investment — The Company's majority-owned subsidiary has a non-marketable equity investment which is accounted for under the equity method. The investment is initially recorded at cost and the Company will adjust the carrying amount for its share of the earnings or losses of the investee after the date of investment. The investment is evaluated periodically for impairment. If it is determined that a decline of the investment is other than temporary, then the investment basis would be written down to fair value and the write-down would be included in earnings as a loss.
Property and Equipment — Property and equipment are initially recorded at their historical cost. Repairs and maintenance are expensed as incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the depreciable assets (ranging from three to 30 years). Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the remaining lease term.
Impairment of Long-Lived Assets — The Company reviews the carrying value of long-lived assets that are held and used in the Company’s operations for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is determined based upon expected undiscounted future net cash flows from the operations to which the assets relate, utilizing management’s best estimate, appropriate assumptions, and projections at the time. If the carrying value is determined to be unrecoverable from future operating cash flows, the asset is deemed impaired and an impairment loss would be recognized to the extent the carrying value exceeded the estimated fair value of the asset. The Company estimates the fair value of assets based on the estimated future discounted cash flows of the asset. Management has evaluated its long-lived assets and has not identified any impairment during the three months ended March 31, 2012 or 2011.
Intangible Assets and Goodwill — Definite-lived intangible assets consist primarily of favorable lease, lease acquisition costs, patient base, facility trade names and franchise relationships. Favorable leases and lease acquisition costs are amortized over the life of the lease of the facility, typically ranging from ten to 20 years. Patient base is amortized over a period of four to eight months, depending on the classification of the patients and the level of occupancy in a new acquisition on the acquisition date. Trade names at facilities are amortized over 30 years and franchise relationships are amortized over 25 years.
The Company's indefinite-lived intangible assets consist of trade names and home health and hospice Medicare licenses. The Company tests indefinite-lived intangible assets for impairment on an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount of the intangible asset may not be recoverable.

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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations. Goodwill is subject to annual testing for impairment. In addition, goodwill is tested for impairment if events occur or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company defines reporting units as the individual facilities. The Company performs its annual test for impairment during the fourth quarter of each year. The Company did not record any impairment charges during the three months ended March 31, 2012 or 2011.
Self-Insurance — The Company is partially self-insured for general and professional liability up to a base amount per claim (the self-insured retention) with an aggregate, one time deductible above this limit. Losses beyond these amounts are insured through third-party policies with coverage limits per occurrence, per location and on an aggregate basis for the Company. For claims made after April 1, 2012, the combined self-insured retention was $500 per claim with an aggregate $1,750 deductible limit. For all facilities, except those located in Colorado, the third-party coverage above these limits was $1,000 per occurrence, $3,000 per facility, with a $10,000 blanket aggregate and an additional state-specific aggregate where required by state law. In Colorado, the third-party coverage above these limits was $1,000 per occurrence and $3,000 per facility, which is independent of the $10,000 blanket aggregate applicable to our other 99 facilities.
The self-insured retention and deductible limits for general and professional liability and worker’s compensation are self-insured through the Captive, the related assets and liabilities of which are included in the accompanying condensed consolidated balance sheets. The Captive is subject to certain statutory requirements as an insurance provider. These requirements include, but are not limited to, maintaining statutory capital. The Company’s policy is to accrue amounts equal to the actuarially estimated costs to settle open claims of insureds, as well as an estimate of the cost of insured claims that have been incurred but not reported. The Company develops information about the size of the ultimate claims based on historical experience, current industry information and actuarial analysis, and evaluates the estimates for claim loss exposure on a quarterly basis. Accrued general liability and professional malpractice liabilities recorded on an undiscounted basis in the accompanying condensed consolidated balance sheets were $29,976 and $29,196 as of March 31, 2012 and December 31, 2011, respectively.
 The Company’s operating subsidiaries are self-insured for workers’ compensation liability in California. To protect itself against loss exposure in California with this policy, the Company has purchased individual stop-loss insurance coverage that insures individual claims that exceed $500 for each claim. In Texas, the operating subsidiaries have elected non-subscriber status for workers’ compensation claims and, effective February 1, 2011, the Company has purchased individual stop-loss coverage that insures individual claims that exceed $750 for each claim. The Company’s operating subsidiaries in other states have third party guaranteed cost coverage. In California and Texas, the Company accrues amounts equal to the estimated costs to settle open claims, as well as an estimate of the cost of claims that have been incurred but not reported. The Company uses actuarial valuations to estimate the liability based on historical experience and industry information. Accrued workers’ compensation liabilities are recorded on an undiscounted basis in the accompanying condensed consolidated balance sheets and were $10,404 and $9,827 as of March 31, 2012 and December 31, 2011, respectively.
The Company provides self-insured medical (including prescription drugs) and dental healthcare benefits to the majority of its employees. The Company is fully liable for all financial and legal aspects of these benefit plans. To protect itself against loss exposure with this policy, the Company has purchased individual stop-loss insurance coverage that insures individual claims that exceed $250 for each covered person with an aggregate individual stop loss deductible of $75. The Company’s accrued liability under these plans recorded on an undiscounted basis in the accompanying condensed consolidated balance sheets was $2,700 and $2,436 at March 31, 2012 and December 31, 2011, respectively.
In addition, in accordance with guidance provided by the Financial Accounting Standards Board (FASB) in August 2010, the Company has recorded an asset and equal liability of $2,808 and $2,814 at March 31, 2012 and December 31, 2011, respectively, in order to present the ultimate costs of malpractice claims and the anticipated insurance recoveries on a gross basis.
The Company believes that adequate provision has been made in the Financial Statements for liabilities that may arise out of patient care, workers’ compensation, healthcare benefits and related services provided to date. The amount of the Company’s reserves was determined based on an estimation process that uses information obtained from both company-specific and industry data. This estimation process requires the Company to continuously monitor and evaluate the life cycle of the claims. Using data obtained from this monitoring and the Company’s assumptions about emerging trends, the Company, with the assistance of an independent actuary, develops information about the size of ultimate claims based on the Company’s historical experience and other available industry information. The most significant assumptions used in the estimation process include determining the trend in costs, the expected cost of claims incurred but not reported and the expected costs to settle or pay damage awards with respect to unpaid claims. The self-insured liabilities are based upon estimates, and while management believes that the estimates of loss are reasonable, the ultimate liability may be in excess of or less than the recorded amounts. Due to the inherent volatility of actuarially determined loss estimates, it is reasonably possible that the Company could experience changes in estimated losses that could be material to net income. If the Company’s actual liability exceeds its estimates of loss, its future earnings, cash flows

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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


and financial condition would be adversely affected.

Income Taxes —Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities at tax rates in effect when such temporary differences are expected to reverse. The Company generally expects to fully utilize its deferred tax assets; however, when necessary, the Company records a valuation allowance to reduce its net deferred tax assets to the amount that is more likely than not to be realized.

For interim reporting purposes, the provision for income taxes is determined based on the estimated annual effective income tax rate applied to pre-tax income, adjusted for certain discrete items occurring during the period. In determining the effective income tax rate for interim financial statements, the Company must consider expected annual income, permanent differences between financial reporting and tax recognition of income or expense and other factors. When the Company takes uncertain income tax positions that do not meet the recognition criteria, it records a liability for underpayment of income taxes and related interest and penalties, if any. In considering the need for and magnitude of a liability for such positions, the Company must consider the potential outcomes from a review of the positions by the taxing authorities.
In determining the need for a valuation allowance, the annual income tax rate for interim periods, or the need for and magnitude of liabilities for uncertain tax positions, the Company makes certain estimates and assumptions. These estimates and assumptions are based on, among other things, knowledge of operations, markets, historical trends and likely future changes and, when appropriate, the opinions of advisors with knowledge and expertise in certain fields. Due to certain risks associated with the Company’s estimates and assumptions, actual results could differ.

Noncontrolling Interest — The noncontrolling interest in a subsidiary is initially recognized at estimated fair value on the acquisition date and is presented within total equity in the Company's condensed consolidated balance sheets. The Company presents the noncontrolling interest and the amount of consolidated net income attributable to The Ensign Group, Inc. in its condensed consolidated statements of income and net income per share is calculated based on net income attributable to The Ensign Group, Inc.'s stockholders. The carrying amount of the noncontrolling interest is adjusted based on an allocation of subsidiary earnings based on ownership interest. Noncontrolling interest that has redemption features outside the Company's control is accounted for as redeemable noncontrolling interest and is recorded as temporary equity. Owners of noncontrolling interest in certain of the Company's subsidiaries have the right in certain circumstances to require it to purchase additional ownership interests at an amount as defined in the applicable agreement. The intent of the parties is to approximate fair value at the time of redemption by using a multiple of earnings that is consistent with generally accepted valuation practices. These contingent redemption rights are embedded in the equity security at issuance, are not free-standing instruments, do not represent a de facto financing and are not under the Company's control.

Stock-Based Compensation — The Company measures and recognizes compensation expense for all share-based payment awards made to employees and directors including employee stock options based on estimated fair values, ratably over the requisite service period of the award. Net income has been reduced as a result of the recognition of the fair value of all stock options and restricted stock awards issued, the amount of which is contingent upon the number of future grants and other variables.

Derivatives and Hedging Activities — The Company evaluates variable and fixed interest rate risk exposure on a routine basis and to the extent the Company believes that it is appropriate, it will offset its variable risk exposure by entering into interest rate swap agreements. It is the Company's policy to only utilize derivative instruments for hedging purposes (i.e. not for speculation). The Company formally designates its interest rate swap agreements as hedges and documents all relationships between hedging instruments and hedged items. The Company formally assesses effectiveness of its hedging relationships, both at the hedge inception and on an ongoing basis, then measures and records ineffectiveness. The Company would discontinue hedge accounting prospectively (i) if it is determined that the derivative is no longer effective in offsetting change in the cash flows of a hedged item, (ii) when the derivative expires or is sold, terminated or exercised, (iii) if it is no longer probable that the forecasted transaction will occur, or (iv) if management determines that designation of the derivative as a hedge instrument is no longer appropriate. The Company’s derivative is recorded on the balance sheet at its fair value.

Accumulated Other Comprehensive Loss and Total Comprehensive Income — Accumulated other comprehensive loss refers to revenue, expenses, gains, and losses that are recorded as an element of stockholders’ equity but are excluded from net income. The Company’s other comprehensive loss consists of net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges. As of March 31, 2012, accumulated other comprehensive losses were $2,150, recorded net of tax of $837, or $1,313, in stockholders' equity. As of December 31, 2011, accumulated other comprehensive losses were $2,143, net of tax of $835, or $1,308.


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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Adoption of New Accounting Pronouncements — In December 2011, the FASB indefinitely deferred the provisions that required entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which Other Comprehensive Income is presented (for both interim and annual financial statements). During the deferral period, entities will still need to comply with the existing U.S. GAAP requirements for the presentation of reclassification adjustments. The adoption of this amendment did not have a material effect on the Company's financial statements.
In July 2011, the FASB amended its standards on how health care entities present revenue and bad debt expense. Under the new guidance, health care entities are required to present bad debt expense related to patient service revenue as a reduction of patient service revenue (net of contractual allowances and discounts) on the statement of income for entities that do not assess a patient's ability to pay prior to rendering services. Further, it was determined, net presentation of bad debt expense in revenue would only apply to bad debts that are related to patient service revenue, to entities that provide services prior to assessing a patient's ability to pay, or to entities that recognize revenue prior to deciding that collection is reasonably assured. In addition, the final consensus requires health care entities to disclose information about the activity in the allowance for doubtful accounts, such as recoveries and write-offs, by using a mixture of qualitative and quantitative data. It will also require disclosure of the Company's policies for (i) assessing the timing and amount of uncollectible revenue recognized as bad debt expense; and (ii) assessing collectability in the timing and amount of revenue (net of contractual allowances and discounts). The Company adopted the disclosure requirements of this amendment during the first quarter of the current year. The Company determined the requirements for presentation of bad debt expense related to patient service revenue as a reduction of patient service revenue outlined in the amendment is not applicable as the Company assesses each patient's ability to pay prior to rendering services.


3. COMPUTATION OF NET INCOME PER COMMON SHARE

Basic net income per share is computed by dividing net income attributable to Ensign Group, Inc. stockholders by the weighted average number of outstanding common shares for the period. The computation of diluted net income per share is similar to the computation of basic net income per share except that the denominator is increased to include contingently returnable shares and the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued.

A reconciliation of the numerator and denominator used in the calculation of basic net income per common share follows:
 
Three Months Ended
March 31,
 
2012
 
2011
Numerator:
 
 
 
Net Income
$
12,828

 
$
12,746

Net loss attributable to the noncontrolling interest
(76
)
 

Net income attributable to The Ensign Group, Inc.
12,904

 
12,746

Denominator:
 
 
 
Weighted average shares outstanding for basic net income per share
21,251

 
20,854

Basic net income per common share
$
0.61

 
$
0.61



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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


A reconciliation of the numerator and denominator used in the calculation of diluted net income per common share follows:
 
Three Months Ended
March 31,
 
2012
 
2011
Numerator:
 
 
 
Net Income
$
12,828

 
$
12,746

Net loss attributable to the noncontrolling interest
(76
)
 

Net income attributable to The Ensign Group, Inc.
12,904

 
12,746

Denominator:
 
 
 
Weighted average common shares outstanding
21,251

 
20,854

Plus: incremental shares from assumed conversion (1)
545

 
662

Adjusted weighted average common shares outstanding
21,796

 
21,516

Diluted net income per common share
$
0.59

 
$
0.59

(1)
Options outstanding which are anti-dilutive and therefore not factored into the weighted average common shares amount above were 138 and 9 for the three months ended March 31, 2012 and 2011, respectively.


4. FAIR VALUE MEASUREMENTS

Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair value. These tiers include: Level 1, defined as observable inputs such as quoted market prices in active markets; Level 2, defined as inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and Level 3, defined as observable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011:
 
 
March 31, 2012
 
December 31, 2011
 
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Cash and cash equivalents
 
$
32,618

 
$

 
$

 
$
29,584

 
$

 
$

Interest rate swap
 
$

 
$
2,150

 
$

 
$

 
$
2,143

 
$


Our non-financial assets, which include, long-lived assets, including goodwill, intangible assets and property and equipment are reported at carrying value and are not required to be measured at fair value on a recurring basis. However, on a periodic basis, or whenever events or changes in circumstances indicate that their carrying value may not be recoverable, we assess our long-lived assets for impairment. When impairment has occurred, such long-lived assets are written down to fair value. See Note 2 for further discussion of our significant accounting policies.

Debt Security Investments - Held to Maturity

At March 31, 2012 and December 31, 2011, the Company had approximately $16,366 and $16,466 in debt security investments which were held to maturity and carried at amortized cost. The carrying value of the debt securities approximates fair value. The Company has the intent and ability to hold these debt securities to maturity. Further, at March 31, 2012, approximately $10,095 is held in AAA rated debt securities backed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program and $6,271 is held in AA rated debt securities. At December 31, 2011, approximately $10,140 was held in AAA rated debt securities backed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program and $6,326 was held in AA rated debt securities These debt securities mature from June 2012 to October 2013.


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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Interest Rate Swap Agreement

In connection with the Senior Credit Facility with a five-bank lending consortium arranged by SunTrust and Wells Fargo (the Facility), in July 2011, the Company entered into an interest rate swap agreement in accordance with Company policy to reduce risk from volatility in the income statement due to changes in the LIBOR interest rate. The swap agreement, with a notional amount of $75,000, amortizing concurrently with the related term loan portion of the Facility, was five years in length and set to mature on July 15, 2016. The interest rate swap has been designated as a cash flow hedge and, as such, changes in fair value are reported in other comprehensive income in accordance with hedge accounting. Under the terms of this swap agreement, the net effect of the hedges was to record swap interest expense at a fixed rate of approximately 4.3%, exclusive of fees. Net interest paid under the swap was $226 for the three months ended March 31, 2012. In addition, based on the March 31, 2012 interest rate swap valuation, the Company expects to record swap interest expense of $950 during the year ended December 31, 2012.

The Company assesses hedge effectiveness at inception and on an ongoing basis by performing a regression analysis. The regression analysis compares to the historical monthly changes in fair value of the interest rate swap to the historical monthly changes in the fair value of a hypothetically perfect interest rate swap over the trailing 30 months. The change in fair value of the hypothetical derivative is regarded as a proxy for the present value of the cumulative change in the expected future cash flows on the hedged transaction. The regression analysis serves as the Company's prospective and retrospective assessment of hedge effectiveness. Assuming the hedging relationship qualifies as highly effective, the actual swap will be recorded at fair value on the balance sheet and accumulated other comprehensive income (loss) will be adjusted to reflect the lesser of either the cumulative change in the fair value of the actual swap or the cumulative change in the fair value of the hypothetical derivative.

The interest rate swap agreement is recorded at fair value based upon valuation models which utilize relevant factors such as the contractual terms of the interest rate swap agreements, credit spreads for the contracting parties and interest rate curves. Based on this valuation method, the Company categorized the interest rate swap as Level 2 and recorded accumulated other comprehensive losses as of March 31, 2012 of $2,150, net of tax of $837, or $1,313, in stockholders' equity. As the swap was entered into in the third quarter of 2011, no comparable amount was recorded in the first quarter of the prior year. There are no amounts attributable to hedge ineffectiveness that were required to be recognized in earnings.


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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



5. REVENUE AND ACCOUNTS RECEIVABLE

Revenue for the three months ended March 31, 2012 and 2011 is summarized in the following table:
 
Three Months Ended
March 31,
 
2012
 
2011
 
Revenue
 
% of
Revenue
 
Revenue
 
% of
Revenue
Medicaid
$
73,583

 
36.4
%
 
$
66,225

 
36.2
%
Medicare
69,794

 
34.5

 
67,643

 
37.0

Medicaid — skilled
5,861

 
2.9

 
4,411

 
2.4

Total Medicaid and Medicare
149,238

 
73.8

 
138,279

 
75.6

Managed care
25,692

 
12.7

 
24,141

 
13.2

Private and other payors
27,230

 
13.5

 
20,523

 
11.2

Revenue
$
202,160

 
100.0
%
 
$
182,943

 
100.0
%

Accounts receivable as of March 31, 2012 and December 31, 2011 is summarized in the following table:
 
March 31,
2012
 
December 31,
2011

Medicaid
$
30,140

 
$
30,286

Managed care
24,777

 
22,068

Medicare
33,526

 
28,061

Private and other payors
18,401

 
18,678

 
106,844

 
99,093

Less allowance for doubtful accounts
(12,794
)
 
(12,782
)
Accounts receivable
$
94,050

 
$
86,311



6. ACQUISITIONS
The Company’s acquisition policy is generally to purchase or lease facilities to complement the Company’s existing portfolio of long-term care facilities. The results of all the Company’s operations are included in the accompanying Interim Financial Statements subsequent to the date of acquisition. Acquisitions are typically paid for in cash and are accounted for using the acquisition method of accounting. Where the Company enters into facility lease agreements, the Company typically does not pay any material amount to the prior facility operator nor does the Company acquire any assets or assume any liabilities, other than rights and obligations under the lease and operations transfer agreement, as part of the transaction. Some leases include options to purchase the facilities. As a result, from time to time, the Company will acquire facilities that the Company has been operating under third-party leases.
During the three months ended March 31, 2012, the Company acquired one stand alone skilled nursing facility, one stand alone assisted living facility and one home health operation. The aggregate purchase price of the three business acquisitions was approximately $5,421, which was paid in cash. The Company also entered into a separate operations transfer agreement with the prior tenant as part of each transaction. The facilities acquired during the three months ended March 31, 2012 are as follows:
On February 1, 2012, the Company purchased one assisted living facility in Nevada for approximately $2,111 which was paid in cash. This acquisition added 60 operational assisted living beds to the Company's operations.
On February 10, 2012, the Company acquired a home health operation in Oregon for approximately $530 which was paid in cash. The acquisition did not have an impact on the Company's operational bed count. The Company recognized $530 in other indefinite-lived intangible assets as part of this transaction.

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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


On March 1, 2012, the Company acquired a skilled nursing facility in Idaho for approximately $2,780 which was paid in cash. This acquisition added 113 operational skilled nursing beds to the Company's operations.
The table below presents the allocation of the purchase price for the facilities acquired in business combinations during the three months ended March 31, 2012 and 2011:
 
March 31,
 
2012
 
2011
Land
$
547

 
$
4,905

Building and improvements
4,114

 
30,503

Equipment, furniture, and fixtures
114

 
1,016

Assembled Occupancy
116

 
650

Other intangible assets
530

 

 
$
5,421

 
$
37,074


In January 2012, the Company announced the formation of Immediate Clinic (IC), a majority owned subsidiary, to develop and operate urgent care facilities and related businesses. The Company has committed $4,000 in capital contributions to the subsidiary during the three month period ended March 31, 2012. The Company anticipates the first IC operated facilities will open in the second quarter of 2012.
On February 15, 2012, IC purchased an equity investment in an urgent care software service provider for $1,400. See additional details in Note 10 Restricted and Other Assets of Notes to Condensed Consolidated Financial Statements.
On March 1, 2012, DRX Urgent Care LLC (DRX), a newly formed subsidiary of IC, purchased substantially all of the assets and assumed certain liabilities of Doctors Express Franchising LLC, a national urgent care franchise system for $2,000, adjusted for certain items at the time of close and redeemable noncontrolling interest. The noncontrolling interest was fair valued at the acquisition date at $11,600. The Company recognized intangible assets of $7,900 in trade name, $3,000 in franchise relationships and $2,724 in goodwill. See additional details in Note 9 Goodwill and Other Indefinite-Lived Intangible Assets- Net and Note 14 Temporary Equity - Redeemable Noncontrolling Interest of Notes to Condensed Consolidated Financial Statements.

On April 1, 2012, the Company acquired a home health and hospice operation in Utah for approximately $3,000 which was paid in cash. The acquisition did not have an impact on the Company's operational bed count. The Company entered into a separate operations transfer agreement with the prior owner as part of this transaction. As of the date of this filing, the preliminary allocation of the purchase price was not completed as necessary valuation information had not yet been finalized.

The Company’s acquisition strategy has been focused on identifying both opportunistic and strategic acquisitions within its target markets that offer strong opportunities for return on invested capital. The facilities acquired by the Company are frequently underperforming financially and can have regulatory and clinical challenges to overcome. Financial information, especially with underperforming facilities, is often inadequate, inaccurate or unavailable. Consequently, the Company believes that prior operating results are not meaningful, representative of the Company’s current operating results or indicative of the integration potential of its newly acquired facilities. The businesses acquired during the three months ended March 31, 2012 were not material acquisitions to the Company individually or in the aggregate. Accordingly, pro forma financial information is not presented. These acquisitions have been included in the March 31, 2012 condensed consolidated balance sheet of the Company, and the operating results have been included in the condensed consolidated statement of income of the Company since the dates the Company gained effective control.


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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



7. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
 
March 31,
2012
 
December 31,
2011

Land
$
67,726

 
$
67,179

Buildings and improvements
311,519

 
297,016

Equipment
70,384

 
66,483

Furniture and fixtures
8,726

 
8,731

Leasehold improvements
29,842

 
28,686

Construction in progress
1,659

 
8,213

 
489,856

 
476,308

Less accumulated depreciation
(79,083
)
 
(72,446
)
Property and equipment, net
$
410,773

 
$
403,862



8. INTANGIBLE ASSETS — Net
 
 
Weighted
 
March 31, 2012
 
December 31, 2011
 
 
Average
Life
 
Gross
Carrying
 
Accumulated
 
 
 
Gross
Carrying
 
Accumulated
 
 
Intangible Assets
 
(Years)
 
Amount
 
Amortization
 
Net
 
Amount
 
Amortization
 
Net
Lease acquisition costs
 
15.5

 
$
846

 
$
(618
)
 
$
228

 
$
846

 
$
(604
)
 
$
242

Favorable lease
 
15.0

 
1,596

 
(346
)
 
1,250

 
1,596

 
(319
)
 
1,277

Patient base
 
0.5

 
2,081

 
(1,933
)
 
148

 
1,966

 
(1,750
)
 
216

Facility trade name
 
30.0

 
733

 
(152
)
 
581

 
733

 
(147
)
 
586

Franchise relationships
 
25.0

 
3,000

 
(10
)
 
2,990

 

 

 

Total
 
 
 
$
8,256

 
$
(3,059
)
 
$
5,197

 
$
5,141

 
$
(2,820
)
 
$
2,321

Amortization expense was $239 and $293 for the three months ended March 31, 2012 and 2011, respectively. Of the $239 in amortization expense incurred during the three months ended March 31, 2012, approximately $184 related to the amortization of patient base intangible assets at recently acquired facilities, which is typically amortized over a period of four to eight months, depending on the classification of the patients and the level of occupancy in a new acquisition on the acquisition date.

Estimated amortization expense for each of the years ending December 31 is as follows:
Year
Amount
2012 (remainder)
$
377

2013
306

2014
306

2015
286

2016
266

2017
261

Thereafter
3,395

 
$
5,197



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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



9. GOODWILL AND OTHER INDEFINITE-LIVED INTANGIBLE ASSETS

The Company performs its annual goodwill impairment analysis during the fourth quarter of each year for each reporting unit that constitutes a business for which discrete financial information is produced and reviewed by operating segment management and provides services that are distinct from the other components of the operating segment. The Company tests for impairment by comparing the net assets of each reporting unit to their respective fair values. The Company determines the estimated fair value of each reporting unit using a discounted cash flow analysis. In the event a unit's net assets exceed its fair value, an implied fair value of goodwill must be determined by assigning the unit's fair value to each asset and liability of the unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is measured by the difference between the goodwill carrying value and the implied fair value.

The following table represents activity in goodwill as of March 31, 2012 and December 31, 2011:
 
 
 
Goodwill
January 1, 2011
$
10,339

Additions
6,838

Impairments

December 31, 2011
17,177

Additions
2,724

Impairments

March 31, 2012
$
19,901


As of March 31, 2012 and December 31, 2011, the Company anticipates that $17,177 in goodwill recognized will be fully deductible for tax purposes. The remaining goodwill balance of $2,724 may be fully deductible for tax purposes dependent on the noncontrolling interest holders exercising their right to require DRX to purchase additional ownership. Refer to additional details in Note 14 Temporary Equity- Redeemable Noncontrolling Interests.
Other indefinite-lived intangible assets consists of the following:
 
March 31,
 
December 31,
 
2012
 
2011
Trade name
$
7,966

 
$
66

Home health and hospice Medicare license
1,945

 
1,415

 
$
9,911

 
$
1,481

During the three months ended March 31, 2012, the Company recognized $7,900 in trade name intangible assets as part of the DRX acquisition on March 1, 2012. Additionally, the Company recorded $530 in home health and hospice Medicare license intangible assets as part of its acquisition of a home health operation in Portland, Oregon on February 10, 2012.


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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



10. RESTRICTED AND OTHER ASSETS
Restricted and other assets consist primarily of capital reserves and capitalized debt issuance costs. Capital reserves are maintained as part of the mortgage agreements of the Company and certain of its landlords with the U.S. Department of Housing and Urban Development. These capital reserves are restricted for capital improvements and repairs to the related facilities.
Restricted and other assets consist of the following:
 
March 31,
2012
 
December 31,
2011

Deposits with landlords
$
799

 
$
789

Capital improvement reserves with landlords and lenders
3,691

 
3,585

Debt issuance costs, net
3,277

 
3,230

Long-term insurance losses recoverable asset
2,808

 
2,814

Equity method investment
1,400

 

Restricted and other assets
$
11,975

 
$
10,418

Included in other assets, as of March 31, 2012, are anticipated insurance recoveries related to the Company's general and professional liability claims that are recorded on a gross rather than net basis in accordance with an Accounting Standards Update issued by the FASB and a non-marketable equity investment accounted for under the equity method. The investment is recorded at cost and is evaluated periodically for impairment.


11. OTHER ACCRUED LIABILITIES

Other accrued liabilities consist of the following:
 
March 31,
2012
 
December 31,
2011

Quality assurance fee
$
2,077

 
$
3,912

Resident refunds payable
3,362

 
3,346

Deferred revenue
1,982

 
1,856

Cash held in trust for residents
1,692

 
1,648

Resident deposits
1,384

 
1,397

Dividends payable
1,292

 
1,283

Property taxes
2,146

 
2,224

Other
2,977

 
2,911

Other accrued liabilities
$
16,912

 
$
18,577

Quality assurance fee represents amounts payable to California, Utah, Idaho, Washington, Colorado, Iowa, and Nebraska in respect of a mandated fee based on resident days. Resident refunds payable includes amounts due to residents for overpayments and duplicate payments. Deferred revenue occurs when the Company receives payments in advance of services provided. Cash held in trust for residents reflects monies received from, or on behalf of, residents. Maintaining a trust account for residents is a regulatory requirement and, while the trust assets offset the liability, the Company assumes a fiduciary responsibility for these funds. The cash balance related to this liability is included in other current assets in the accompanying condensed consolidated balance sheets.


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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



12. INCOME TAXES

The provision for income taxes for the three months ended March 31, 2012 and 2011 is summarized as follows:

 
Three Months Ended
March 31,
 
2012
 
2011
Current:
 
 
 
Federal
$
4,960

 
$
6,622

State
1,074

 
1,378

 
6,034

 
8,000

Deferred:
 
 
 
Federal
1,788

 
319

State
(135
)
 
(25
)
 
1,653

 
294

Total
$
7,687

 
$
8,294


The Company’s deferred tax assets and liabilities as of March 31, 2012 and December 31, 2011 are summarized as follows:
 
March 31,
2012
 
December 31,
2011

Deferred tax assets (liabilities):
 
 
 
Accrued expenses
$
17,491

 
$
18,690

Allowance for doubtful accounts
5,252

 
5,254

State taxes

 
145

Tax credits
2,070

 
1,775

Total deferred tax assets
24,813

 
25,864

State taxes
(1,162
)


Depreciation and amortization
(8,780
)
 
(9,122
)
Prepaid expenses
(1,815
)
 
(2,033
)
Total deferred tax liabilities
(11,757
)
 
(11,155
)
Net deferred tax assets
$
13,056

 
$
14,709

During the first quarter of 2012, the State of California initiated an examination of the Company's income tax returns for the 2008 and 2009 income tax years. California has not proposed any adjustments. The Company is not currently under examination by any other major income tax jurisdiction. In 2012, the statute of limitations will lapse on the Company's 2007 and 2008 income tax years for state and Federal purposes, respectively; however, the Company does not believe this lapse will significantly impact unrecognized tax benefits for any uncertain tax positions. The Company does not believe the California examination or any other event will significantly impact the balance of unrecognized tax benefits in the next twelve months. The net balance of unrecognized tax benefits was not material to the Interim Financial Statements for the three months ended March 31, 2012 or 2011.


20

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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



13. DEBT

Long-term debt consists of the following:
 
March 31,
2012
 
December 31,
2011

Promissory note with RBS, principal and interest payable monthly and continuing through March 2019, interest at a fixed rate of 4.75%, collateralized by real property, assignment of rents and Company guaranty.
$
21,525

 
$

Senior Credit Facility with SunTrust and Wells Fargo, principal and interest payable quarterly, balance due at July 15, 2016, secured by substantially all of the Company’s personal property.
82,188

 
88,125

Ten Project Note with GECC, principal and interest payable monthly; interest is fixed (rates in effect range from 6.95% to 7.50%), balance due June 2016, collateralized by deeds of trust on real property, assignments of rents, security agreements and fixture financing statements.
50,910

 
51,185

Promissory note with RBS, principal and interest payable monthly and continuing through January 2018, interest at a fixed rate of 6.04%, collateralized by real property, assignment of rents and Company guaranty.
33,909

 
34,149

Promissory notes, principal, and interest payable monthly and continuing through October 2019, interest at fixed rate of 6.0%, collateralized by deed of trust on real property, assignment of rents and security agreement.
9,406

 
9,471

Mortgage note, principal, and interest of $54 payable monthly and continuing through February 2027, interest at fixed rate of 7.5%, collateralized by deed of trust on real property, assignment of rents and security agreement.
5,830

 
5,884

 
203,768

 
188,814

Less current maturities
(7,028
)
 
(6,314
)
Less debt discount
(914
)
 
(944
)
 
$
195,826

 
$
181,556


Promissory Note with RBS Asset Finance, Inc.

On February 17, 2012, two of the Company's real estate holding subsidiaries as Borrowers executed a promissory note in favor of RBS Asset Finance, Inc. (RBS) as Lender for an aggregate of $21,525 (the 2012 RBS Loan). The 2012 RBS Loan was secured by Commercial Deed of Trust, Security Agreement, Assignment of Leases and Rents and Fixture Filings on the two properties owned by the two Borrowers, and other related instruments and agreements, including without limitation a promissory note and a Company guaranty. The 2012 RBS Loan bears interest at a fixed rate of 4.75%. Amounts borrowed under the 2012 RBS Loan may be prepaid starting after the second anniversary of the note subject to certain prepayment fees. The term of the RBS Loan is for seven years, with monthly principal and interest payments commencing on April 1, 2012 and the balance due on March 1, 2019.

Among other things, under the RBS Loan, the Company must maintain compliance with specified financial covenants measured on a quarterly basis, including a minimum debt service coverage ratio, an average occupancy rate and a minimum project yield. The Loan Documents also include certain additional affirmative and negative covenants, including limitations on the disposition of the Borrowers and the collateral. As of March 31, 2012, the Company was in compliance with all loan covenants.



21

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THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



14. TEMPORARY EQUITY- REDEEMABLE NONCONTROLLING INTEREST
Owners of noncontrolling interests in certain of the Company's subsidiaries have the right in certain circumstances to require it to purchase additional ownership interests in DRX at an amount defined in the applicable agreements. The 25% noncontrolling interest is accounted for as redeemable noncontrolling interest as redemption is outside the Company's control. As such, the redeemable noncontrolling interest is reported in the mezzanine section in the Company's condensed consolidated balance sheets as temporary equity. The aggregate estimated maximum amount the Company could be required to pay in future periods is $13,500. As of March 31, 2012, the carrying amount of the redeemable noncontrolling interests is $11,581. The ultimate amount paid could be different as the redemption amount is primarily dependent on the future results of operations of the subject businesses, and the timing of the exercise of these rights.

15. OPTIONS AND AWARDS
Stock-based compensation expense consists of share-based payment awards made to employees and directors, including employee stock options and restricted stock awards, based on estimated fair values. As stock-based compensation expense recognized in the Company’s condensed consolidated statements of income for the three months ended March 31, 2012 and 2011 was based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. The Company estimates forfeitures at the time of grant and, if necessary, revises the estimate in subsequent periods if actual forfeitures differ.
The Company has three option plans, the 2001 Stock Option, Deferred Stock and Restricted Stock Plan (2001 Plan), the 2005 Stock Incentive Plan (2005 Plan) and the 2007 Omnibus Incentive Plan (2007 Plan), all of which have been approved by the stockholders. The total number of shares available under all of the Company’s stock incentive plans was 1,821 as of March 31, 2012.

The Company uses the Black-Scholes option-pricing model to recognize the value of stock-based compensation expense for all share-based payment awards. Determining the appropriate fair-value model and calculating the fair value of stock-based awards at the grant date requires considerable judgment, including estimating stock price volatility, expected option life and forfeiture rates. The Company develops estimates based on historical data and market information, which can change significantly over time. The Company granted 43 options and 63 restricted stock awards from the 2007 Plan during the three months ended March 31, 2012.

The Company used the following assumptions for stock options granted during the three months ended March 31, 2012 and 2011:
 
 
 
 
Weighted
 
 
 
 
Weighted
 
 
Weighted
 
 
 
Options
 
Average Risk-
 
 
Expected
 
Average
 
 
Average
 
Grant Year
 
Granted
 
Free Rate
 
 
 Life
 
Volatility
 
 
Dividend Yield
 
2012
 
43

 
1.18

%
 
6.5 years
 
55

%
 
0.93

%
2011
 
9

 
2.53

%
 
6.5 years
 
55

%
 
0.93

%

For the three months ended March 31, 2012 and 2011, the following represents the exercise price and fair value displayed at grant date for stock option grants:
 
 
 
 
Weighted Average
 
Weighted Average
Grant Year
 
Granted
 
Exercise Price
 
Fair Value of Options
2012
 
43

 
$
27.05

 
$
13.26

2011
 
9

 
$
24.36

 
$
12.42

The weighted average exercise price equaled the weighted average fair value of common stock on the grant date for all options granted during the three-month periods ended March 31, 2012 and 2011 and therefore, the intrinsic value was $0 at date of grant.


22

Table of Contents
THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


The following table represents the employee stock option activity during the three months ended March 31, 2012:
 
Number of
Options
Outstanding
 
Weighted
Average
Exercise Price
 
Number of
Options Vested
 
Weighted
Average
Exercise Price
of Options
Vested
January 1, 2012
1,633

 
$
12.97

 
936

 
$
10.65

Granted
43

 
27.05

 
 
 
 
Forfeited
(7
)
 
15.62

 
 
 
 
Exercised
(84
)
 
9.89

 
 
 
 
March 31, 2012
1,585

 
$
13.50

 
950

 
$
11.08


The following summary information reflects stock options outstanding, vested and related details as of March 31, 2012:
 
 
 
 
 
 
 
 
 
 
Stock Options Vested
 
 
Stock Options Outstanding
 
 
 
 
 
Number Outstanding
 
Black-Scholes Fair Value
 
Remaining Contractual Life (Years)
 
Vested and Exercisable
Year of Grant
 
Exercise Price
 
 
 
 
2003
 
0.67 – 0.81

 
4

 
*

 
1

 
4

2004
 
1.96 – 2.46

 
13

 
*

 
2

 
13

2005
 
4.99 – 5.75

 
94

 
*

 
3

 
94

2006
 
7.05 – 7.50

 
239

 
2,284

 
4

 
239

2008
 
9.38 – 14.87

 
553

 
3,006

 
6

 
370

2009
 
14.88 – 16.70

 
423

 
3,342

 
7

 
188

2010
 
17.47 – 18.16

 
121

 
1,070

 
8

 
40

2011
 
21.61 - 29.30

 
95

 
1,171

 
9

 
2

2012
 
27.05

 
43

 
565

 
10

 

Total
 
 
 
1,585

 
$
11,438

 
 
 
950

* The Company will not recognize the Black-Scholes fair value for awards granted prior to January 1, 2006 unless such awards are modified.
In addition to the above, during the three months ended March 31, 2012 and 2011, the Company granted 63 and 47 restricted stock awards, respectively. All awards were granted at an exercise price of $0 and vest over five years.

A summary of the status of the Company's nonvested restricted stock awards as of March 31, 2012, and changes during the three month period ended March 31, 2012 is presented below:
 
Nonvested Restricted Awards
 
Weighted Average Grant Date Fair Value
Nonvested at January 1, 2011
102

 
$
18.05

Granted
143

 
25.52

Vested
(31
)
 
24.18

Forfeited
(4
)
 
19.16

Nonvested at December 31, 2011
210

 
22.32

Granted
63

 
26.11

Vested
(62
)
 
25.68

Forfeited
(1
)
 
18.96

Nonvested at March 31, 2012
210

 
$
22.48



23

Table of Contents
THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



Total share-based compensation expense recognized for the three months ended March 31, 2012 and 2011 was as follows:
 
Three Months Ended
March 31,
 
2012
 
2011
Share-based compensation expense related to stock options
$
499

 
$
644

Share-based compensation expense related to restricted stock awards
332

 
187

Total
$
831

 
$
831

In future periods, the Company expects to recognize approximately $4,717 and $4,288 in stock-based compensation expense for unvested options and unvested restricted stock awards, respectively, that were outstanding as of March 31, 2012. Future stock based compensation expense will be recognized over 3.0 and 4.0 weighted average years for unvested options and restricted stock awards, respectively. There were 635 unvested and outstanding options at March 31, 2012, of which 603 are expected to vest. The weighted average contractual life for options vested at March 31, 2012 was 6.3 years.

The aggregate intrinsic value of options outstanding, vested, expected to vest and exercised as of March 31, 2012 and December 31, 2011 is as follows:
Options
 
March 31,
2012
 
December 31,
2011
Outstanding
 
$
21,705

 
$
18,942

Vested
 
15,274

 
12,960

Expected to vest
 
5,757

 
5,374

Exercised
 
1,464

 
5,651

The intrinsic value is calculated as the difference between the market value of the underlying common stock and the exercise price of the options.


16. COMMITMENTS AND CONTINGENCIES
Leases — The Company leases certain facilities and its administrative offices under non-cancelable operating leases, most of which have initial lease terms ranging from five to 20 years. The Company also leases certain of its 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. Total rent expense, inclusive of straight-line rent adjustments, was $3,436 and $3,731 for the three months ended March 31, 2012 and 2011, respectively.
Six of the Company’s facilities are operated under two separate three-facility master lease arrangements. Under these master leases, a breach at a single facility could subject one or more of the other 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 the Company’s 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 the Company’s 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.
In addition, a number of the Company’s individual facility leases are held by the same or related landlords, and some of these leases include cross-default provisions that could cause a default at one facility to trigger a technical default with respect to others, potentially subjecting certain leases and facilities to the various remedies available to the landlords under separate but cross-defaulted leases. The Company is not aware of any defaults as of March 31, 2012.
Regulatory Matters — Laws and regulations governing Medicare and Medicaid programs are complex and subject to interpretation. Compliance with such laws and regulations can be subject to future governmental review and interpretation, as well as significant regulatory action including fines, penalties, and exclusion from certain governmental programs. The Company believes that it is in compliance in all material respects with all applicable laws and regulations.

24

Table of Contents
THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


A significant portion of the Company’s revenue is derived from Medicaid and Medicare, for which reimbursement rates are subject to regulatory changes and government funding restrictions. Any significant future change to reimbursement rates could have a material effect on the Company’s operations.
Cost-Containment Measures — Both government and private pay sources have instituted cost-containment measures designed to limit payments made to providers of healthcare services, and there can be no assurance that future measures designed to limit payments made to providers will not adversely affect the Company.
Indemnities — From time to time, the Company enters into certain types of contracts that contingently require the Company to indemnify parties against third-party claims. These contracts primarily include (i) certain real estate leases, under which the Company may be required to indemnify property owners or prior facility operators for post-transfer environmental or other liabilities and other claims arising from the Company’s use of the applicable premises, (ii) operations transfer agreements, in which the Company agrees to indemnify past operators of facilities the Company acquires against certain liabilities arising from the transfer of the operation and/or the operation thereof after the transfer, (iii) certain lending agreements, under which the Company may be required to indemnify the lender against various claims and liabilities, (iv) agreements with certain lenders under which the Company may be required to indemnify such lenders against various claims and liabilities, and (v) certain agreements with the Company’s officers, directors and employees, under which the Company may be required to indemnify such persons for liabilities arising out of their employment relationships. The terms of such obligations vary by contract and, in most instances, a specific or maximum dollar amount is not explicitly stated therein. Generally, amounts under these contracts cannot be reasonably estimated until a specific claim is asserted. Consequently, because no claims have been asserted, no liabilities have been recorded for these obligations on the Company’s balance sheets for any of the periods presented.
Litigation — The skilled nursing business involves a significant risk of liability given the age and health of the Company’s patients and residents and the services the Company provides. The Company and others in the industry are subject to an increasing number of claims and lawsuits, including professional liability claims, alleging that services have resulted in personal injury, elder abuse, wrongful death or other related claims. The defense of these lawsuits may result in significant legal costs, regardless of the outcome, and can result in large settlement amounts or damage awards.
In addition to the potential lawsuits and claims described above, the Company is also subject to potential lawsuits under the Federal False Claims Act and comparable state laws alleging submission of fraudulent claims for services to any healthcare program (such as Medicare) or payor. A violation may provide the basis for exclusion from federally-funded healthcare programs. Such exclusions could have a correlative negative impact on the Company’s financial performance. Some states, including California, Arizona and Texas, have enacted similar whistleblower and false claims laws and regulations. In addition, the Deficit Reduction Act of 2005 created incentives for states to enact anti-fraud legislation modeled on the Federal False Claims Act. As such, the Company could face increased scrutiny, potential liability and legal expenses and costs based on claims under state false claims acts in markets in which it does business.
In May 2009, Congress passed the Fraud Enforcement and Recovery Act (FERA) of 2009 which made significant changes to the Federal False Claims Act (FCA), expanding the types of activities subject to prosecution and whistleblower liability. Following changes by FERA, health care providers face significant penalties for the knowing retention of government overpayments, even if no false claim was involved. Health care providers can now be liable for knowingly and improperly avoiding or decreasing an obligation to pay money or property to the government. This includes the retention of any government overpayment. The government can argue, therefore, that a FCA violation can occur without any affirmative fraudulent action or statement, as long as it is knowingly improper. In addition, FERA extended protections against retaliation for whistleblowers, including protections not only for employees, but also contractors and agents. Thus, there is generally no need for an employment relationship in order to qualify for protection against retaliation for whistleblowing.
In July 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Dodd-Frank Act establishes rigorous standards and supervision to protect the economy and American consumers, investors and businesses. Included under Section 922 of the Dodd-Frank Act, the Securities and Exchange Commission (SEC) will be required to pay a reward to individuals who provide original information to the SEC resulting in monetary sanctions exceeding $1,000 in civil or criminal proceedings. The award will range from 10 to 30 percent of the amount recouped and the amount of the award shall be at the discretion of the SEC. The purpose of this reward program is to “motivate those with inside knowledge to come forward and assist the Government to identify and prosecute persons who have violated securities laws and recover money for victims of financial fraud.”

25

Table of Contents
THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


The State of California has established minimum staffing requirements for facilities operating in the state. Failure to meet these requirements can, among other things, jeopardize a facility’s compliance with the conditions of participation as established under relevant state and federal healthcare programs; it may also subject the facility to a notice of deficiency, a citation, civil money penalty, or the possibility of litigation.
For example, a class action suit was previously filed against the Company in the State of California, alleging, among other things, violations of certain Health and Safety Code provisions and a violation of the Consumer Legal Remedies Act at certain of the Company’s California facilities. In 2007, the Company settled this class action suit and the settlement was approved by the affected class and the Court. The Company continues to be subject to similar claims and legal actions, and is currently defending against one such claim venued in Los Angeles Superior Court. In the wake of the substantial judgment awarded to a group of plaintiffs in a recent case against one of the Company’s competitors, the Company expects that plaintiff’s attorneys will become increasingly more aggressive in their pursuit of claims alleging non-compliance with such minimum staffing requirements. The Company does not believe that the ultimate resolution of any known such action will have a material adverse effect on the Company’s business, financial condition or results of operations. However, if there were a significant increase in the number of these claims or an increase in amounts owing should plaintiffs be successful in their prosecution of these claims, this could materially adversely affect the Company’s business, financial condition, results of operations and cash flows.
The Company has been, and continues to be, subject to claims and legal actions that arise in the ordinary course of business, including potential claims related to care and treatment provided at its facilities as well as employment related claims. The Company does not believe that the ultimate resolution of these actions will have a material adverse effect on the Company’s business, cash flows, financial condition or results of operations. A significant increase in the number of these claims or an increase in amounts owing should plaintiffs be successful in their prosecution of these claims, could materially adversely affect the Company’s business, financial condition, results of operations and cash flows.
Medicare Revenue Recoupments — The Company is subject to reviews relating to Medicare services, billings and potential overpayments. The Company had one operation subject to probe review during the three months ended March 31, 2012. The Company anticipates that these probe reviews will increase in frequency in the future. Further, the Company currently has no facilities on prepayment review; however, others may be placed on prepayment review in the future. If a facility fails prepayment review, the facility could then be subject to undergo targeted review, which is a review that targets perceived claims deficiencies. The Company has no facilities that are currently undergoing targeted review.
Other Matters — In March 2007, the Company learned that the United States Attorney for the Central District of California (DOJ) had commenced an investigation of certain of its facilities and had issued an authorized investigative demand to the Company's bank seeking information pertaining to a total of 18 of its facilities. The DOJ also subsequently served a subpoena on the Company's independent external auditors in 2007, and in 2008 served search warrants and subpoenas on its Service Center and six of its Southern California skilled nursing facilities, seeking specific patient files and other information. Subsequent subpoenas issued to the Company covered additional documentation from the six facilities as well as eight of the other facilities. Based upon the issuance of the subpoenas and execution of the search warrants, the Company concluded that the government had undertaken parallel criminal and civil investigations. The Company pledged full cooperation to, and has been cooperating fully with, the government.

In September 2010 the Company's board of directors appointed a special committee consisting solely of independent directors to advance discussions with the DOJ regarding its investigation. The special committee retained independent counsel, and counsel has retained third party consultants, to facilitate its work. The Company and the special committee have continued cooperating with the DOJ, working to provide information necessary to aid the DOJ's investigation and move the matter toward resolution.

In December 2011, independent counsel for the Company's special committee received confirmation that the DOJ has closed its criminal investigation, although as a matter of course the DOJ reserves the right to reopen such inquiries if new facts come to light. In January 2012, the DOJ also indicated that the government would be seeking certain additional information in furtherance of the remaining investigation, and that it would formalize its request for that information in a new subpoena. In January 2012, the Office of the Inspector General of the United States Department of Health & Human Services (HHS) served the new subpoena, seeking specific patient records and documents from 2007 to 2011 from the six Southern California skilled nursing facilities that have been the subject of previous requests. HHS also issued a subpoena to the Company's independent external auditors requesting an update to the information requested in the 2007 subpoena to them, and a subpoena to the Company's independent internal auditors requesting similar information. The Company has produced records called for in the January 2012 subpoena, and discussions between government representatives and counsel for the special committee are ongoing.


26

Table of Contents
THE ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


The Company intends to continue cooperating with the government's representatives to move the matter toward resolution. In addition, the Company continues to make improvements to its compliance programs and systems. The Company cannot predict or provide any assurance as to the possible outcome of the investigations or any possible related proceedings, or as to the possible outcome of any litigation, nor can it estimate the possible loss or range of loss that may result from any such proceedings and, therefore, the Company has not recorded any related accruals. If any litigation were to proceed, and the Company is subjected to, alleged to be liable for, or agree to a settlement of, claims or obligations under federal Medicare statutes, the federal False Claims Act, or similar state and federal statutes and related regulations, its business, financial condition and results of operations could be materially and adversely affected and its stock price could decline.
Concentrations
Credit Risk — The Company has significant accounts receivable balances, the collectability of which is dependent on the availability of funds from certain governmental programs, primarily Medicare and Medicaid. These receivables represent the only significant concentration of credit risk for the Company. The Company does not believe there are significant credit risks associated with these governmental programs. The Company believes that an appropriate allowance has been recorded for the possibility of these receivables proving uncollectible, and continually monitors and adjusts these allowances as necessary. The Company’s receivables from Medicare and Medicaid payor programs accounted for approximately 60.0% and 58.9% of its total accounts receivable as of March 31, 2012 and December 31, 2011, respectively. Revenue from reimbursements under the Medicare and Medicaid programs accounted for approximately 73.8% and 75.6% of the Company’s revenue during the three months ended March 31, 2012 and 2011, respectively.
Cash in Excess of FDIC Limits — The Company currently has bank deposits with financial institutions in the U.S. that exceed FDIC insurance limits. FDIC insurance provides protection for bank deposits up to $250. In addition, the Company has uninsured bank deposits with a financial institution outside the U.S. As of May 1, 2012, the Company had approximately $1,000 in uninsured cash deposits. All uninsured bank deposits are held at high quality credit institutions.


27

Table of Contents


Item 2.        Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this Report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with the Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K (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 Forms 10-Q and 8-K, for additional information. The section entitled “Risk Factors” contained in Part II, Item 1A of this Report, and similar discussions in our other SEC filings, also describe some of the important risk factors that may affect our business, financial condition, results of operations and/or liquidity. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.
This Report contains "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, which include, but are not limited to the Company’s expected future financial position, results of operations, cash flows, financing plans, business strategy, budgets, capital expenditures, competitive positions, growth opportunities 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. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section “Risk Factors” contained in Part II, Item 1A of this Report. These forward-looking statements speak only as of the date of this Report, and are based on our current expectations, estimates and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, except as otherwise required by law. As used in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the words, “we,” “our” and “us” refer to The Ensign Group, Inc. and its consolidated subsidiaries. All of our skilled nursing, assisted living and home health and hospice operations, the Service Center and the Captive are operated by separate, wholly-owned, independent subsidiaries that have their own management, employees and assets. The use of “we,” “us,” “our” and similar verbiage in this quarterly report is not meant to imply that any of our facilities, the Service Center or the Captive are operated by the same entity. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and related notes included in the Annual Report.
Overview
We are a provider of skilled nursing and rehabilitative care services through the operation of 104 facilities, five home health and three hospice operations as of March 31, 2012, located in Arizona, California, Colorado, Idaho, Iowa, Nebraska, Nevada, Oregon, Texas, Utah and Washington. Our operations, each of which strives to be the service of choice in the community it serves, provide a broad spectrum of skilled nursing, assisted living, home health and hospice services, including physical, occupational and speech therapies, and other rehabilitative and healthcare services, for both long-term residents and short-stay rehabilitation patients. We recently entered into a joint venture to develop and operate urgent care facilities and related businesses. These walk-in clinics will offer daily access to healthcare for minor injuries and illnesses, including x-ray and lab services, all from convenient neighborhood locations with no appointments. As of March 31, 2012, we owned 79 of our 104 facilities and operated an additional 25 facilities under long-term lease arrangements, and had options to purchase five of those 25 facilities. The following table summarizes our facilities and operational skilled nursing, assisted living and independent living beds by ownership status as of March 31, 2012:
 
Owned
 
Leased (with a Purchase Option)
 
Leased (without a Purchase Option)
 
Total
Number of facilities
79

 
5

 
20

 
104

Percent of total
76.0
%
 
4.8
%
 
19.2
%
 
100
%
Operational skilled nursing, assisted living and independent living beds
8,861

 
657

 
2,305

 
11,823

Percent of total
74.9
%
 
5.6
%
 
19.5
%
 
100
%

28

Table of Contents

The Ensign Group, Inc. is a holding company with no direct operating assets, employees or revenues. All of our skilled nursing, assisted living and home health and hospice operations are operated by separate, wholly-owned, independent subsidiaries, which have their own management, employees and assets. In addition, one of our wholly-owned independent subsidiaries, which we call our Service Center, provides centralized accounting, payroll, human resources, information technology, legal, risk management and other services to each operating subsidiary through contractual relationships between such subsidiaries. In addition, we have the Captive that provides some claims-made coverage to our operating subsidiaries for general and professional liability, as well as for certain workers’ compensation insurance liabilities. References herein to the consolidated “Company” and “its” assets and activities, as well as the use of the terms “we,” “us,” “our” and similar verbiage in this quarterly report is not meant to imply that The Ensign Group, Inc. has direct operating assets, employees or revenue, or that any of the facilities, the Service Center or the Captive are operated by the same entity.

Facility Acquisition History
 
December 31,
 
March 31,
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
Cumulative number of facilities
46

 
57

 
61

 
63

 
77

 
82

 
102

 
104

Cumulative number of operational skilled nursing, assisted living and independent living beds
5,585

 
6,667

 
7,105

 
7,324

 
8,948

 
9,539

 
11,702

 
11,823


The following table sets forth the location of our facilities and the number of operational beds located at our facilities as of March 31, 2012:
 
CA
 
AZ
 
TX
 
UT
 
CO
 
WA
 
ID
 
NV
 
NE
 
IA
 
Total
Number of facilities
35

 
13

 
21

 
11

 
5

 
3

 
4

 
3

 
4

 
5

 
104

Operational skilled nursing, assisted living and independent living beds
3,864

 
1,903

 
2,662

 
1,342

 
463

 
274

 
359

 
304

 
296

 
356

 
11,823


On February 1, 2012, we acquired an assisted living facility in Nevada for approximately $2.1 million, which was paid in cash. This acquisition added 60 operational assisted living beds to our operation. We also entered into a separate operations transfer agreement with the prior tenant as part of such transaction.

On February 10, 2012, we acquired a home health operation in Oregon for approximately $0.5 million which was paid in cash. The acquisition did not have an impact on the Company's operational bed count. We also entered into a separate operations transfer agreement with the prior tenant as part of such transaction.
On March 1, 2012, we acquired a skilled nursing facility in Idaho for approximately $2.8 million which was paid in cash. This acquisition added 113 operational skilled nursing beds to our operations. We also entered into a separate operations transfer agreement with the prior tenant as part of such transaction.
On April 1, 2012, we acquired a home health and hospice operation in Utah for approximately $3.0 million which was paid in cash. The acquisition did not have an impact on our operational bed count. We also entered into a separate operations transfer agreement with the prior owner as part of this transaction.
See further discussion of facility acquisitions in Note 6 in Notes to Condensed Consolidated Financial Statements.

Recent Developments

Immediate Clinic

On January 10, 2012, we announced a joint venture to develop and operate urgent care facilities and related businesses. The joint venture, Immediate Clinic LLC (IC), will be led by Dr. John Shufeldt, a founder and former Chief Executive Officer of a large privately-owned provider of urgent care and occupational medical services. IC will offer daily access to healthcare for minor injuries and illnesses, including x-ray and lab services, all from convenient neighborhood locations with no appointments. Design and construction planning for several new locations is currently underway, and IC is also seeking opportunities to acquire existing urgent care operations across the United States. To date, we have committed $4.0 million to the joint venture and IC expects to open its first facilities within the second quarter of fiscal 2012.

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On February 15, 2012, IC purchased an equity investment in an urgent care software service provider for $1.4 million. In addition, on March 1, 2012, DRX Urgent Care LLC (DRX), a newly formed subsidiary of IC, purchased substantially all of the assets and assumed certain liabilities of Doctors Express Franchising LLC, a national urgent care franchise system for $2.0 million, adjusted for certain items at the time of close and redeemable noncontrolling interest of $11.6 million. We recognized intangible assets of $7.9 million in trade name, $3.0 million in franchise relationships and $2.7 million in goodwill as part of this transaction.

Appointment of New Member to Board of Directors

On February 8, 2012 our board of directors increased the number of directors from six directors to seven and, at the recommendation of the board of directors, appointed Daren J. Shaw to fill the newly created vacancy effective March 1, 2012. Mr. Shaw will serve as a Class II Director with a term that is set to expire at the 2012 annual meeting of shareholders, will be eligible to participate in all compensation plans in which non-management directors participate and will enter into our standard indemnification agreement for directors. Mr. Shaw has not yet been appointed to serve on any board committee by the board of directors.

Promissory Note with RBS

On February 22, 2012, two of our real estate holding subsidiaries as Borrowers executed a promissory note in favor of RBS Asset Finance, Inc. (RBS) as Lender for an aggregate of $21.5 million (the 2012 RBS Loan). The 2012 RBS Loan was secured by Commercial Deed of Trust, Security Agreement, Assignment of Leases and Rents and Fixture Filings on the two properties owned by the two Borrowers, and other related instruments and agreements, including without limitation a promissory note and a Company guaranty. The 2012 RBS Loan bears interest at a fixed rate of 4.75%. The term of the RBS Loan is for seven years, with monthly principal and interest payments commencing on March 1, 2012 and the balance due on March 1, 2019.
Key Performance Indicators
We manage our skilled nursing business by monitoring key performance indicators that affect our financial performance. These indicators and their definitions include the following:
Routine revenue: Routine revenue is generated by the contracted daily rate charged for all contractually inclusive skilled nursing services. The inclusion of therapy and other ancillary treatments varies by payor source and by contract. Services provided outside of the routine contractual agreement are recorded separately as ancillary revenue, including Medicare Part B therapy services, and are not included in the routine revenue definition.
Skilled revenue: The amount of routine revenue generated from patients in our skilled nursing facilities who are receiving higher levels of care under Medicare, managed care, Medicaid, or other skilled reimbursement programs. The other skilled residents that are included in this population represent very high acuity residents 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 assisted living services.
Skilled mix: The amount of our skilled revenue as a percentage of our total routine revenue. Skilled mix (in days) represents the number of days our Medicare, managed care, or other skilled patients are receiving services at our skilled nursing facilities divided by the total number of days patients (less days from assisted living services) from all payor sources are receiving services at our skilled nursing facilities for any given period (less days from assisted living services).
Quality mix: The amount of routine non-Medicaid revenue as a percentage of our total routine revenue. Quality mix (in days) represents the number of days our non-Medicaid patients are receiving services at our skilled nursing facilities divided by the total number of days patients from all payor sources are receiving services at our skilled nursing facilities for any given period (less days from assisted living services).
Average daily rates: The routine revenue by payor source for a period at our skilled nursing facilities divided by actual patient days for that revenue source for that given period.
Occupancy percentage (operational beds): The total number of residents occupying a bed in a skilled nursing, assisted living or independent living 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, assisted living and independent living facilities that we own or operate and the total number of operational beds associated with these facilities.

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Skilled and Quality 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 and quality mix for the periods indicated as a percentage of our total routine revenue (less revenue from assisted living services) and as a percentage of total patient days (less days from assisted living services):
 
Three Months Ended
March 31,
 
2012
 
2011
Skilled Mix:
 
 
 
Days
26.3
%
 
26.2
%
Revenue
50.5
%
 
52.8
%
Quality Mix:
 
 
 
Days
39.3
%
 
38.2
%
Revenue
60.0
%
 
61.1
%
Occupancy. We define occupancy as the ratio of actual patient days (one patient day equals one resident occupying one bed for one day) during any measurement period to the number of beds in facilities which are available for occupancy during the measurement period. The number of licensed and independent living beds in a skilled nursing, assisted living or independent living 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 define occupancy in operational beds as the ratio of actual patient days during any measurement period to the number of available patient days for that period. 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 the periods indicated:
 
Three Months Ended
March 31,
 
2012
 
2011
Occupancy:
 
 
 
Operational beds at end of period
11,823

 
10,314

Available patient days
1,067,162

 
907,546

Actual patient days
851,511

 
731,485

Occupancy percentage (based on operational beds)
79.8
%
 
80.6
%

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Revenue Sources
Our total revenue represents revenue derived primarily from providing services to patients and residents of skilled nursing facilities, and to a lesser extent from assisted living facilities and ancillary services. We receive service revenue from Medicaid, Medicare, private payors and other third-party payors, and managed care sources. The sources and amounts of our revenue are determined by a number of factors, including bed capacity and occupancy rates of our healthcare facilities, the mix of patients at our facilities and the rates of reimbursement among payors. Payment for ancillary services varies based upon the service provided and the type of payor. The following table sets forth our total revenue by payor source and as a percentage of total revenue for the periods indicated:
 
 
Three Months Ended March 31,
 
 
2012
 
2011
 
 
$
 
%
 
$
 
%
 
 
(Dollars in thousands)
Revenue:
 
 
 
 
 
 
 
 
Medicaid
 
$
73,583

 
36.4
%
 
$
66,225

 
36.2
%
Medicare
 
69,794

 
34.5

 
67,643

 
37.0

Medicaid-skilled
 
5,861

 
2.9

 
4,411

 
2.4

Total
 
149,238

 
73.8

 
138,279

 
75.6

Managed Care
 
25,692

 
12.7

 
24,141

 
13.2

Private and Other(1)
 
27,230

 
13.5

 
20,523

 
11.2

Total revenue
 
$
202,160

 
100.0
%
 
$
182,943

 
100.0
%
______________________
(1)
Includes revenue from assisted living facilities and home health and hospice operations.
Critical Accounting Policies Update
There have been no significant changes during the three month period ended March 31, 2012 to the items that we disclosed as our critical accounting policies and estimates in our discussion and analysis of financial condition and results of operations in our Annual Report on Form 10-K filed with the SEC, except for the following:

Noncontrolling Interest

The noncontrolling interest in a subsidiary is initially recognized at estimated fair value on the acquisition date and is presented within total equity in our condensed consolidated balance sheets. We present the noncontrolling interest and the amount of consolidated net income attributable to The Ensign Group, Inc. in our condensed consolidated statements of income and net income per share is calculated based on net income attributable to The Ensign Group, Inc.'s stockholders. The carrying amount of the noncontrolling interest is adjusted based on an allocation of subsidiary earnings based on ownership interest. Noncontrolling interest that has redemption features outside our control is accounted for as redeemable noncontrolling interest and is recorded as temporary equity. Owners of noncontrolling interest in certain of our subsidiaries have the right in certain circumstances to require it to purchase additional ownership interests at an amount as defined in the applicable agreement. The intent of the parties is to approximate fair value at the time of redemption by using a multiple of earnings that is consistent with generally accepted valuation practices. These contingent redemption rights are embedded in the equity security at issuance, are not free-standing instruments, do not represent a de facto financing and are not under our control.
Industry Trends
The skilled nursing 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 of patient care to lower cost settings. The skilled nursing 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 United States 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, inpatient rehabilitation facilities and other post-acute care settings.

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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. We believe this fragmentation provides significant acquisition and consolidation opportunities for us.
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 and Increased Life Expectancy. As life expectancy continues to increase in the United States and seniors account for a higher percentage of the total U.S. population, we believe the overall demand for skilled nursing services will increase. At present, the primary market demographic for skilled nursing services is primarily individuals age 75 and older. According to the 2010 U.S. Census, there were over 40 million people in the United States in 2010 that are over 65 years old. The 2010 U.S. Census estimates this group is one of the fastest growing segments of the United States population and is expected to more than double between 2000 and 2030.

We believe the skilled nursing 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 seniors are looking for alternatives outside the family for their care.
Effects of Changing Prices. Medicare reimbursement rates and procedures are subject to change from time to time, which could materially impact our revenue. Medicare reimburses our skilled nursing facilities under a prospective payment system (PPS) for certain inpatient covered services. Under the PPS, facilities are paid a predetermined amount per patient, per day, based on the anticipated costs of treating patients. The amount to be paid is determined by classifying each patient into a resource utilization group (RUG) category that is based upon each patient’s acuity level. As of October 1, 2010, the RUG categories were expanded from 53 to 66 with the introduction of minimum data set (MDS) 3.0. Should future changes in skilled nursing facility payments reduce rates or increase the standards for reaching certain reimbursement levels, our Medicare revenues could be reduced, with a corresponding adverse impact on our financial condition or results of operations.
On July 29, 2011, the Centers for Medicare and Medicaid Services (CMS) announced a final rule reducing Medicare skilled nursing facility PPS payments in fiscal year 2012 by $3.87 billion, or 11.1% lower than payments for fiscal year 2011. CMS announced it is recalibrating the case-mix indexes (CMIs) for fiscal year 2012 to restore overall payments to their intended levels on a prospective basis. Each RUG group consists of CMIs that reflect a patient's severity of illness and the services that a patient requires in the skilled nursing facility. In transitioning from the previous classification system to the new RUG-IV, CMS adjusted the CMIs for fiscal year 2011 based on forecasted utilization under this new classification system to establish parity in overall payments. The fiscal year 2011 recalibration of the CMIs was calculated to result in a reduction to skilled nursing facility payments of $4.47 billion or 12.6%. However, this reduction would be partially offset by the fiscal year 2012 update to Medicare payments to skilled nursing facilities. The update, a 1.7% or $600 million increase, reflects a 2.7% market basket increase, reduced by a 1.0% multi-factor productivity (MFP) adjustment mandated by the Patient Protection and Affordable Care Act (PPACA). The Combined MFP-adjusted market basket increase and the fiscal year 2012 recalibration will yield a net reduction of $3.87 billion, or 11.1%.
On August 2, 2011, the President signed into law the Budget Control Act of 2011 (Budget Control Act), which raised the debt ceiling and put into effect a series of actions for deficit reduction. The Budget Control Act creates a Congressional Joint Select Committee on Deficit Reduction (the Committee) that was tasked with proposing additional deficit reduction of at least $1.5 trillion over ten years. As the Committee was unable to achieve its targeted savings, this regulation triggered automatic reductions in discretionary and mandatory spending starting in 2013, including reductions of not more than 2% to payments to Medicare providers. The Budget Control Act also requires Congress to vote on an amendment to the Constitution that would require a balanced budget.
Should future changes in PPS include further reduced rates or increased standards for reaching certain reimbursement levels, our Medicare revenues derived from our skilled nursing facilities (including rehabilitation therapy services provided at our skilled nursing facilities) could be reduced, with a corresponding adverse impact on our financial condition or results of operations.
The Deficit Reduction Act of 2005 (DRA) added Sec. 1833(g)(5) of the Social Security Act and directed the Centers for Medicare and Medicaid Services to develop a process that allows exceptions for Medicare beneficiaries to therapy caps when continued therapy is deemed medically necessary. The therapy cap exception was reauthorized in a number of subsequent laws, most recently in legislation which extends the exceptions process through December 31, 2012. The application of annual caps, or the discontinuation of exceptions to the annual caps, could have an adverse effect on our rehabilitation therapy revenue.

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Additionally, the exceptions to these caps may not be extended beyond December 31, 2012, which could also have an adverse effect on our revenue after that date.

On March 24, 2011, the governor of California signed Assembly Bill 97 (AB 97), the budget trailer bill on health, into law.  AB 97 outlines significant cuts to  state  health and human services programs.  Specifically, the law reduces provider payments by 10% for physicians, pharmacy, clinics, medical transportation, certain hospitals, home health, and nursing facilities.  AB X1 19 Long Term Care  was subsequently approved by the governor on June 28, 2011.  AB X1 19 limits  the 10% payment reduction to skilled-nursing providers to 14 months for the services provided on June 1, 2011 through July 31, 2012, with a promise to repay by December 31, 2012.  Federal approval was obtained on October 27, 2011. However, the application as to how the cash deferral will be applied is still being finalized. The effective date is June 1, 2011, or on such other date or dates as may be applicable.  The impact of this new law on us cannot be predicted with certainty as the application of the law has not been finalized.  There can be no assurance that the reduction in provider payments will not lead to material adverse consequences in the future.

Federal Health Care Reform. On March 23, 2010, President Obama signed PPACA into law, which contained several sweeping changes to America’s health insurance system. Among other reforms contained in PPACA, many Medicare providers received reductions in their market basket updates. Unlike for some other Medicare providers, PPACA makes no reduction to the market basket update for skilled nursing facilities in fiscal years 2010 or 2011. However, under PPACA, the skilled nursing facility market basket update will be subject to a full productivity adjustment beginning in fiscal year 2012. In addition, PPACA enacted several reforms with respect to skilled nursing facilities and hospice organizations, including payment measures to realize significant savings of federal and state funds by deterring and prosecuting fraud and abuse in both the Medicare and Medicaid programs. While many of the provisions of PPACA will not take effect for several years or are subject to further refinement through the promulgation of regulations, some key provisions of PPACA are:

Enhanced CMPs and Escrow Provisions — PPACA included expanded civil monetary penalty (CMP) provisions applicable to all Medicare and Medicaid providers. PPACA provided for the imposition of CMPs of up to $50,000 and, in some cases, treble damages, for actions relating to alleged false statements to the federal government.

Nursing Home Transparency Requirements — In addition to expanded CMP provisions, PPACA imposed substantial new transparency requirements for Medicare-participating nursing facilities. Existing law required Medicare providers to disclose to CMS: (1) any person or entity that owns directly or indirectly an ownership interest of five percent or more in a provider; (2) officers and directors (if a corporation) and partners (if a partnership); and (3) holders of a mortgage, deed of trust, note or other obligation secured by the entity or the property of the entity. PPACA expanded the information required to be disclosed to include: (4) the facility’s organizational structure; (5) additional information on officers, directors, trustees, and “managing employees” of the facility (including their names, titles, and start dates of services); and (6) information on any “additional disclosable party” of the facility. CMS has not yet promulgated regulations to implement these provisions.

Face-to-Face Encounter Requirements — PPACA imposes new patient face-to-face encounter requirements on home health agencies and hospices to establish a patient's ongoing eligibility for Medicare home health services or hospice services, as applicable. A certifying physician or other designated health care professional must conduct the face-to-face encounters within a specified timeframe, and failure of the face-to-face encounter to occur and be properly documented during the applicable timeframe could render the patient's care ineligible for reimbursement under Medicare.

Suspension of Payments During Pending Fraud Investigations — PPACA also provided the federal government with expanded authority to suspend payment if a provider is investigated for allegations or issues of fraud. Section 6402 of the PPACA provides that Medicare and Medicaid payments may be suspended pending a “credible investigation of fraud,” unless the Secretary of Health and Human Services determined that good cause exists not to suspend payments. “Credible investigation of fraud” is undefined, although the Secretary must consult with the Office of the Inspector General (OIG) in determining whether a credible investigation of fraud exists. This suspension authority created a new mechanism for the federal government to suspend both Medicare and Medicaid payments for allegations of fraud, independent of whether a state exercised its authority to suspend Medicaid payments pending a fraud investigation. To the extent the Secretary applied this suspension of payments provision to one or more of our facilities for allegations of fraud, such a suspension could adversely affect our revenue, cash flow, financial condition and results of operations. OIG promulgated regulations making these provisions effective as of March 25, 2011.

Overpayment Reporting and Repayment; Expanded False Claims Act Liability — PPACA also enacted several important changes that expand potential liability under the federal False Claims Act. PPACA provided that overpayments related to services provided to both Medicare and Medicaid beneficiaries must be reported and returned to the applicable payor within the later of sixty days of identification of the overpayment, or the date the corresponding cost report (if applicable)

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is due. Any overpayment retained after the deadline is considered an “obligation” for purposes of the federal False Claims Act.

Voluntary Pilot Program — Bundled Payments — To support the policies of making all providers responsible during an episode of care and rewarding value over volume, HHS will establish, test and evaluate alternative payment methodologies for Medicare services through a five-year, national, voluntary pilot program starting in 2013. This program will provide incentives for providers to coordinate patient care across the continuum and to be jointly accountable for an entire episode of care centered around a hospitalization. HHS will develop qualifying provider payment methods that may include bundled payments and bids from entities for episodes of care that begins three days prior to hospitalization and spans 30 days following discharge. The bundled payment will cover the costs of acute care inpatient services; physicians’ services delivered in and outside of an acute care hospital; outpatient hospital services including emergency department services; post-acute care services, including home health services, skilled nursing services, inpatient rehabilitation services; and inpatient hospital services. The payment methodology will include payment for services, such as care coordination, medication reconciliation, discharge planning and transitional care services, and other patient-centered activities. Payments for items and services cannot result in spending more than would otherwise be expended for such entities if the pilot program were not implemented. As with Medicare’s shared savings program discussed above, payment arrangements among providers on the backside of the bundled payment must take into account significant hurdles under the Anti-kickback Law, the Stark Law and the Civil Monetary Penalties Law. This pilot program may expand in 2016 if expansion would reduce Medicare spending without also reducing quality of care.

Accountable Care Organizations — PPACA authorized CMS to enter into contracts with Accountable Care Organizations (ACOs). ACOs are entities of providers and suppliers organized to deliver services to Medicare beneficiaries and eligible to receive a share of any cost savings the entity can achieve by delivering services to those beneficiaries at a cost below a set baseline and with sufficient quality of care. CMS recently finalized regulations to implement the ACO initiative. The widespread adoption of ACO payment methodologies in the Medicare program, and in other programs and payors, could impact our operations and reimbursement for our services.

On March 26, 2012, the United States Supreme Court held a lengthy argument beginning its examination of the constitutionality of the PPACA. The justices took up four separate legal issues raised by the PPACA. The Supreme Court is also expected to examine whether the entire PPACA or just a portion of it would need to be struck down should the Supreme Court decide that the "individual mandate" was unconstitutional.

The Supreme Court's decision could have a wide ranging impact on the healthcare and health insurance systems, particularly if the entire PPACA is judged unconstitutional. At this time, we cannot predict how the Supreme Court will rule, or what impact that ruling will have on our business.

The provisions of PPACA discussed above are examples of recently-enacted federal health reform provisions that we believe may have a material impact on the long-term care industry and on our business. However, the foregoing discussion is not intended to constitute, nor does it constitute, an exhaustive review and discussion of PPACA. It is possible that these and other provisions of PPACA may be interpreted, clarified, or applied to our facilities or operations in a way that could have a material adverse impact on the results of operations.

Historically, adjustments to reimbursement under Medicare have had a significant effect on our revenue. For a discussion of historic adjustments and recent changes to the Medicare program and related reimbursement rates see Risk Factors - Risks Related to Our Business and Industry - “Our revenue could be impacted by federal and state changes to reimbursement and other aspects of Medicaid and Medicare,” “Our future revenue, financial condition and results of operations could be impacted by continued cost containment pressures on Medicaid spending,” “We may not be fully reimbursed for all services for which each facility bills through consolidated billing, which could adversely affect our revenue, financial condition and results of operations” and “Reforms to the U.S. healthcare system will impose new requirements upon us and may lower our reimbursements." 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.


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Results of Operations

The following table sets forth details of our revenue, expenses and earnings as a percentage of total revenue for the periods indicated:
 
Three Months Ended
March 31,
 
2012
 
2011
Revenue
100.0
 %
 
100.0
 %
Expenses:
 
 
 
Cost of services (exclusive of facility rent, general and administrative expense and depreciation and amortization shown separately below)
79.6

 
78.2

Facility rent—cost of services
1.6

 
2.0

General and administrative expense
3.8

 
4.0

Depreciation and amortization
3.4

 
2.8

Total expenses
88.4

 
87.0

Income from operations
11.6

 
13.0

Other income (expense):
 
 
 
Interest expense
(1.4
)
 
(1.5
)
Interest income

 

Other expense, net
(1.4
)
 
(1.5
)
Income before provision for income taxes
10.2

 
11.5

Provision for income taxes
3.8

 
4.5

Net income
6.4

 
7.0

Less: net (loss) attributable to the noncontrolling interests

 

Net income attributable to Ensign
6.4
 %
 
7.0
 %

The table below reconciles net income to EBITDA and EBITDAR for the periods presented:
 
Three Months Ended
March 31,
 
2012
 
2011
 
(Dollars in thousands)
Consolidated Statement of Income Data:
 
 
 
Net income attributable to Ensign Group, Inc.
$
12,904

 
$
12,746

Net (loss) attributable to noncontrolling interests
(76
)
 

Interest expense, net
2,874

 
2,672

Provision for income taxes
7,687

 
8,294

Depreciation and amortization
6,924

 
5,059

EBITDA(1)
$
30,313

 
$
28,771

Facility rent—cost of services
3,321

 
3,616

EBITDAR(1)
$
33,634

 
$
32,387

_______________________
(1)
EBITDA and EBITDAR are supplemental 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, define and prescribe the conditions for use of certain non-GAAP financial information. We calculate EBITDA as net income, before net losses attributable to noncontrolling interest, before (a) interest expense, net, (b) provision for income taxes, and (c) depreciation and amortization. We calculate EBITDAR by adjusting EBITDA to exclude facility rent—cost of services. 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

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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 EBITDA and EBITDAR are useful to investors and other external users of our financial statements in evaluating our operating performance because:
they are widely used by investors and analysts in our industry as a supplemental measure to evaluate the overall operating performance of companies in our industry without regard to items such as interest expense, net and depreciation and amortization, which can vary substantially from company to company depending on the book value of assets, capital structure and the method by which assets were acquired; and
they help investors evaluate and compare the results of our operations from period to period by removing the impact of our capital structure and asset base from our operating results.
We use EBITDA and EBITDAR:
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 evaluate the effectiveness of our operational strategies; and
to compare our operating performance to that of our competitors.
We typically use EBITDA and EBITDAR to compare the operating performance of each skilled nursing and assisted living facility. EBITDA and EBITDAR are useful in this regard because they do not include such costs as net interest expense, income taxes, depreciation and amortization expense, and, with respect to EBITDAR, facility rent — cost of services, which may vary from period-to-period depending upon various factors, including the method used to finance facilities, the amount of debt that we have incurred, whether a facility 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. As a result, we believe that the use of EBITDA and EBITDAR provide a meaningful and consistent comparison of our business between periods by eliminating certain items required by GAAP.
We also establish compensation programs and bonuses for our facility level employees that are partially based upon the achievement of EBITDAR targets.
Despite the importance of these measures in analyzing our underlying business, designing incentive compensation and for our goal setting, EBITDA and EBITDAR are non-GAAP financial measures that have no standardized meaning defined by GAAP. Therefore, our EBITDA and EBITDAR measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for analysis of our results as reported in accordance with GAAP. Some of these limitations are:
they do not reflect our current or future cash requirements for capital expenditures or contractual commitments;
they do not reflect changes in, or cash requirements for, our working capital needs;
they do not reflect the net interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;
they do not reflect 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 EBITDA and EBITDAR do not reflect any cash requirements for such replacements; and
other companies in our industry may calculate these measures differently than we do, which may limit their usefulness as comparative measures.
We compensate for these limitations by using them only to supplement net income on a basis prepared in accordance with GAAP in order to provide a more complete understanding of the factors and trends affecting our business.
Management strongly encourages investors to review our condensed consolidated financial statements in their entirety and to not rely on any single financial measure. Because these non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies’ non-GAAP financial measures having the same or similar names. For information about our financial results as reported in accordance with GAAP, see our condensed consolidated financial statements and related notes included elsewhere in this document.

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Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011
 
Three Months Ended
March 31,
 
 
 
 
 
2012
 
2011
 
 
 
 
 
(Dollars in thousands)
 
Change
 
% Change
Total Facility Results:
 
 
 
 
 
 
 
Revenue
$
202,160

 
$
182,943

 
$
19,217

 
10.5
 %
Number of facilities at period end
104

 
86

 
18

 
20.9
 %
Actual patient days
851,511

 
731,485

 
120,026

 
16.4
 %
Occupancy percentage — Operational beds
79.8
%
 
80.6
%
 
 
 
(0.8
)%
Skilled mix by nursing days
26.3
%
 
26.2
%
 
 
 
0.1
 %
Skilled mix by nursing revenue
50.5
%
 
52.8
%
 
 
 
(2.3
)%
 
Three Months Ended
March 31,
 
 
 
 
 
2012
 
2011
 
 
 
 
 
(Dollars in thousands)
 
Change
 
% Change
Same Facility Results(1):
 
 
 
 
 
 
 
Revenue
$
141,313

 
$
143,333

 
$
(2,020
)
 
(1.4
)%
Number of facilities at period end
62

 
62

 

 
 %
Actual patient days
540,265

 
533,537

 
6,728

 
1.3
 %
Occupancy percentage — Operational beds
83.5
%
 
83.1
%
 
 
 
0.4
 %
Skilled mix by nursing days
29.9
%
 
29.5
%
 
 
 
0.4
 %
Skilled mix by nursing revenue
54.5
%
 
56.6
%
 
 
 
(2.1
)%
 
Three Months Ended
March 31,
 
 
 
 
 
2012
 
2011
 
 
 
 
 
(Dollars in thousands)
 
Change
 
% Change
Transitioning Facility Results(2):
 
 
 
 
 
 
 
Revenue
$
35,843

 
$
34,309

 
$
1,534

 
4.5
 %
Number of facilities at period end
20

 
20

 

 
 %
Actual patient days
161,983

 
161,275

 
708

 
0.4
 %
Occupancy percentage — Operational beds
73.7
%
 
74.2
%
 
 
 
(0.5
)%
Skilled mix by nursing days
17.8
%
 
15.3
%
 
 
 
2.5
 %
Skilled mix by nursing revenue
38.2
%
 
36.2
%
 
 
 
2.0
 %
 
Three Months Ended
March 31,
 
 
 
 
 
2012
 
2011
 
 
 
 
 
(Dollars in thousands)
 
Change
 
% Change
Recently Acquired Facility Results(3):
 
 
 
 
 
 
 
Revenue
$
25,004

 
$
5,301

 
$
19,703

 
NM
Number of facilities at period end
22