UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

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. þ 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). o 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 þ		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 þ No

As of October 30, 2009, 20,630,582 shares of the registrant’s common stock were outstanding.

 

 

THE ENSIGN GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009

TABLE OF CONTENTS

Part I. Financial Information
Item 1. Financial Statements (unaudited):			3
Condensed Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008			3
Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2009 and 2008			4
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and 2008			5
Notes to Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 3. Quantitative and Qualitative Disclosures About Market Risk			43
Item 4. Controls and Procedures			43
Part II. Other Information
Item 1. Legal Proceedings			43
Item 1A. Risk Factors			44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			71
Item 3. Defaults Upon Senior Securities			71
Item 4. Submission of Matters to a Vote of Security Holders			71
Item 5. Other Information			71
Item 6. Exhibits			72
Signatures			73
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Part I. Financial Information

Item 1. Financial Statements

THE ENSIGN GROUP, INC.

		September 30,				December 31,
		2009				2008
Assets
Current assets:
Cash and cash equivalents		$	21,365			$	41,326
Accounts receivable—less allowance for doubtful accounts of $7,045 and $7,266 at September 30, 2009 and December 31, 2008, respectively			51,920				49,188
Prepaid expenses and other current assets			8,076				4,692
Deferred tax asset—current			8,401				9,242
Total current assets			89,762				104,448
Property and equipment, net			181,643				157,029
Insurance subsidiary deposits and investments			13,580				11,745
Escrow deposits			17,014				10,090
Deferred tax asset			4,546				2,565
Restricted and other assets			5,151				5,131
Intangible assets, net			4,385				3,011
Goodwill			5,769				2,882
Total assets		$	321,850			$	296,901
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	12,874			$	12,682
Accrued wages and related liabilities			23,834				25,389
Accrued self-insurance liabilities—current			8,543				7,454
Other accrued liabilities			10,931				11,050
Current maturities of long-term debt			1,122				1,062
Total current liabilities			57,304				57,637
Long-term debt—less current maturities			58,632				59,489
Accrued self-insurance liabilities—less current portion			21,762				18,864
Deferred rent and other long-term liabilities			4,913				4,890
Commitments and contingencies (Note 14)
Stockholders’ equity:
Common stock; $0.001 par value; 75,000 shares authorized; 21,276 and 20,628 shares issued and outstanding at September 30, 2009, respectively, and 21,236 and 20,564 shares issued and outstanding at December 31, 2008, respectively			21				21
Additional paid-in capital			66,171				64,110
Retained earnings			117,249				96,237
Common stock in treasury, at cost, 648 and 672 shares at September 30, 2009 and December 31, 2008, respectively			(4,202	)			(4,347	)
Total stockholders’ equity			179,239				156,021
Total liabilities and stockholders’ equity		$	321,850			$	296,901

See accompanying notes to condensed consolidated financial statements.

THE ENSIGN GROUP, INC.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Revenue		$	132,924			$	116,328			$	395,387			$	345,425
Expense:
Cost of services (exclusive of facility rent and depreciation and amortization shown separately below)			107,264				94,297				316,753				278,364
Facility rent—cost of services			3,707				3,282				11,132				11,229
General and administrative expense			4,883				4,565				15,261				14,628
Depreciation and amortization			3,239				2,350				9,413				6,513
Total expenses			119,093				104,494				352,559				310,734
Income from operations			13,831				11,834				42,828				34,691
Other income (expense):
Interest expense			(1,249	)			(1,183	)			(3,718	)			(3,553	)
Interest income			81				239				220				1,094
Other expense, net			(1,168	)			(944	)			(3,498	)			(2,459	)
Income before provision for income taxes			12,663				10,890				39,330				32,232
Provision for income taxes			4,977				4,093				15,537				12,582
Net income		$	7,686			$	6,797			$	23,793			$	19,650
Net income per share:
Basic		$	0.37			$	0.33			$	1.16			$	0.96
Diluted		$	0.37			$	0.33			$	1.14			$	0.95
Weighted average common shares outstanding:
Basic			20,616				20,525				20,591				20,512
Diluted			20,928				20,777				20,910				20,667

See accompanying notes to condensed consolidated financial statements.

THE ENSIGN GROUP, INC.

		Nine Months Ended
		September 30,
		2009				2008
Cash flows from operating activities:
Net income		$	23,793			$	19,650
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			9,413				6,524
Amortization of deferred financing fees			166				51
Deferred income taxes			(1,271	)			945
Provision for doubtful accounts			2,950				3,050
Stock-based compensation			1,775				1,329
Excess tax benefit from share based compensation			(109	)			(128	)
Loss on disposition of property and equipment			71				212
Change in operating assets and liabilities
Accounts receivable			(5,682	)			2,968
Prepaid expenses and other current assets			(3,384	)			4,316
Insurance subsidiary deposits			(1,835	)			(2,225	)
Accounts payable			192				(2,432	)
Accrued wages and related liabilities			(1,555	)			756
Other accrued liabilities			(40	)			(340	)
Accrued self-insurance			3,987				1,551
Deferred rent liability			212				(628	)
Net cash provided by operating activities			28,683				35,599
Cash flows from investing activities:
Purchase of property and equipment			(16,411	)			(23,511	)
Cash payment for business acquisitions			(22,133	)			(2,005	)
Escrow deposits			(17,014	)			—
Escrow deposits used to fund business acquisitions			10,090				—
Cash proceeds from the sale of fixed assets			111				—
Restricted and other assets			(84	)			(313	)
Net cash used in investing activities			(45,441	)			(25,829	)
Cash flows from financing activities:
Payments on long term debt			(797	)			(2,746	)
Issuance of treasury stock upon exercise of options			145				255
Issuance of common stock upon exercise of options			241				121
Dividends paid			(2,778	)			(2,468	)
Principal payments on capital lease obligations			(21	)			—
Excess tax benefit from share based compensation			109				128
Payments of deferred financing costs			(102	)			(385	)
Net cash used in financing activities			(3,203	)			(5,095	)
Net increase (decrease) in cash and cash equivalents			(19,961	)			4,675
Cash and cash equivalents beginning of period			41,326				51,732
Cash and cash equivalents end of period		$	21,365			$	56,407
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest		$	3,808			$	3,526
Income taxes		$	20,266			$	8,224

See accompanying notes to condensed consolidated financial statements.

THE ENSIGN GROUP, INC.

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 70 facilities as of September 30, 2009, located in California, Arizona, Texas, Washington, Utah, Colorado and Idaho. All of these facilities are skilled nursing facilities, other than four stand-alone assisted living facilities in Arizona, Texas and Colorado and five campuses that offer both skilled nursing and assisted living services located in California, Arizona and Utah. 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 and assisted living services, physical, occupational and speech therapies, and other rehabilitative and healthcare services, for both long-term residents and short-stay rehabilitation patients. The Company’s facilities have a collective capacity of approximately 8,000 operational skilled nursing, assisted living and independent living beds. As of September 30, 2009, the Company owned 38 of its 70 facilities and operated an additional 32 facilities through long-term lease arrangements, and had options to purchase 9 of those 32 facilities.

The Ensign Group, Inc. is a holding company with no direct operating assets, employees or revenue. All of the Company’s facilities 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 September 30, 2009 and for the three and nine month periods ended September 30, 2009 and 2008 (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, 2008 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 condensed consolidated 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 and assisted living facilities. All intercompany transactions and balances have been eliminated in consolidation. Debt issuance costs, net of $1,363 have been reclassified from intangible assets, net to restricted and other assets on the condensed consolidated balance sheets as of December 31, 2008 to conform to current period presentation.

Estimates and Assumptions — The preparation of condensed consolidated 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 condensed consolidated financial statements relate to revenue, allowance for doubtful accounts, intangible assets and goodwill, impairment of long-lived assets, patient liability, general and professional liability, worker’s compensation, and healthcare claims included in accrued self-insurance liabilities, stock-based compensation 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, and related ancillary services at the facilities. 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 reporting segment.

Fair Value of Financial Instruments — The Company’s financial instruments consist principally of cash and cash equivalents, debt security investments, 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 and respective short durations. 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 at Note 4.

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 approximately 75% of the Company’s revenue for both periods during the three and nine months ended September 30, 2009 and 74% and 75% for the three and nine months ended September 30, 2008, 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 settlements. The Company recorded retroactive adjustments that increased revenue by $(42) and $423 for the three and nine months ended September 30, 2009, respectively, and $60 and $460 for the three and nine months ended September 30, 2008, respectively. The Company records revenue from private pay patients as services are performed.

Accounts Receivable — 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. 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 and Medicaid. The Company periodically refines its procedures for estimating the allowance for doubtful accounts based on experience with the estimation process and changes in circumstances.

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 nine months ended September 30, 2009 or 2008.

Intangible Assets and Goodwill — Intangible assets consist primarily of favorable lease, lease acquisition costs, patient base and trade names. 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 are amortized over 30 years.

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 nine months ended September 30, 2009 or 2008.

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, 2009, the combined self-insured retention and corridor, was $500 per claim with a $1,500 deductible. As of April 1, 2009, 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 66 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 financial statements. 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 $20,329 and $17,938 as of September 30, 2009 and December 31, 2008, 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. 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 $7,896 and $6,511 as of September 30, 2009 and December 31, 2008, 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, which resets every plan year or a lifetime maximum of $5,000 per each covered person’s lifetime on the PPO and EPO plans. The aforementioned coverage only applies to claims paid during the plan year. The Company’s accrued liability under these plans recorded on an undiscounted basis in the accompanying condensed consolidated balance sheets was $2,080 and $1,869 at September 30, 2009 and December 31, 2008, respectively.

The Company believes that adequate provision has been made in the condensed consolidated 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. It is possible, however, that the actual liabilities may exceed the Company’s estimate of loss.

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 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 temporary differences are primarily attributable to compensation accruals, straight line rent adjustments and reserves for doubtful accounts and insurance liabilities. 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. In considering the need for a valuation allowance against some portion or all of its deferred tax assets, the Company must make certain estimates and assumptions regarding future taxable income, the feasibility of tax planning strategies and other factors.

Estimates and judgments regarding deferred tax assets and the associated valuation allowance, if any, 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. However, due to the nature of certain assets and liabilities, there are risks and uncertainties associated with some of the Company’s estimates and judgments. Actual results could differ from these estimates under different assumptions or conditions. The net deferred tax assets as of September 30, 2009 and December 31, 2008 were $12,947 and $11,807, respectively. The Company expects to fully utilize these deferred tax assets; however, their ultimate realization is dependent upon the amount of future taxable income during the periods in which the temporary differences become deductible.

As of January 1, 2007, the Company maintains a liability for underpayment of income taxes and related interest and penalties, if any, for uncertain income tax positions. In considering the need for and magnitude of a liability for uncertain income tax positions, the Company must make certain estimates and assumptions regarding the amount of income tax benefit that will ultimately be realized. The ultimate resolution of an uncertain tax position may not be known for a number of years, during which time the Company may be required to adjust these reserves, in light of changing facts and circumstances.

The Company used an estimate of its annual income tax rate to recognize a provision for income taxes in financial statements for interim periods. However, changes in facts and circumstances could result in adjustments to the Company’s effective tax rate in future quarterly or annual periods.

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 issued on and subsequent to January 1, 2006, the amount of which is contingent upon the number of future options granted and other variables.

Adoption of New Accounting Pronouncements — In June 2009, the Financial Accounting Standards Board (FASB) issued The FASB Accounting Standard Codification and the Hierarchy of Generally Accepted Accounting Principles (the Codification) as a single source of authoritative nongovernmental GAAP to be launched July 1, 2009. The Codification does not change current GAAP, but is intended to simplify user access to all authoritative GAAP by providing all the authoritative literature related to a particular topic in one place. The Codification became effective for the Company in the interim period ending September 30, 2009, and as a result all references made to GAAP use the new Codification numbering system prescribed by the FASB. However, as the Codification is not intended to change existing GAAP, it did not have an impact on the Company’s financial position, operating results or cash flows.

In May 2009, the FASB established general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued (subsequent events). These standards are effective prospectively for interim or annual financial periods ending after June 15, 2009. The Company’s adoption of these standards during the second quarter of fiscal year 2009 had no impact on its consolidated financial statements. The Company has evaluated subsequent events through November 2, 2009, the date of its issuance of the condensed consolidated financial statements.

In April 2009, the FASB expanded fair value disclosures required for all financial instruments to interim periods for publicly traded entities. Entities are required to disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments in financial statements on an interim basis and to highlight any changes of the methods and significant assumptions from prior periods. It does not require interim disclosures of credit or market risks. The revised disclosure requirements had no impact on the Company’s consolidated financial statements.

In September 2006, the FASB issued new standards that defined fair value, established a framework for measuring fair value in accordance with GAAP, and required enhanced disclosures about fair value measurements. This framework became effective for financial statements issued for fiscal years beginning after November 15, 2007. In February 2008, the FASB delayed the effective date of the fair value framework for non-financial assets and liabilities, other than those that are recognized or disclosed at fair value on a recurring basis, to fiscal years beginning after November 15, 2008. In addition, in October 2008, the FASB clarified the application of the fair value framework in an inactive market and to illustrate how an entity would determine fair value in an inactive market. The Company’s adoption of the fair value framework for non-financial assets and liabilities had no impact on its consolidated financial statements.

In December 2007, the FASB revised the requirements for accounting for business combinations which require companies to record most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination at “full fair value.” The revised guidelines require companies to record fair value estimates of contingent consideration and certain other potential liabilities during the original purchase price allocation and to expense acquisition costs as incurred. These requirements apply to all business combinations, including combinations by contract alone. Further, all business combinations are to be accounted for by applying the acquisition method. The revised business combination accounting standards are effective for fiscal years beginning on or after December 15, 2008. The Company adopted the revised business combination accounting standards at the beginning of fiscal year 2009. See Note 6 for a description of the impact of this adoption on the Company’s consolidated financial position and results of operations.

In December 2007, the FASB issued new standards that required noncontrolling interests (previously referred to as minority interests) to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. These guidelines apply to the accounting for noncontrolling interests and transactions with non-controlling interest holders in consolidated financial statements and are to be applied prospectively to all noncontrolling interests, including any that arose before the effective date except that comparative period information must be recast to classify noncontrolling interests in equity, attribute net income and other comprehensive income to noncontrolling interests, and provide other required disclosures. The Company’s adoption of accounting for noncontrolling interests at the beginning of fiscal year 2009 had no impact on its consolidated financial statements.

In September 2008, the Emerging Issues Task Force (EITF) of the FASB concluded that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders and therefore the issuing entity is required to apply the two-class method of computing basic and diluted earnings per share. This determination affects entities that accrue cash dividends on share-based payment awards during the awards’ service period when the dividends do not need to be returned if the employees forfeit the awards. This ruling is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company’s adoption of this conclusion at the beginning of fiscal year 2009 did not have a significant impact on its consolidated financial statements.

3. COMPUTATION OF NET INCOME PER COMMON SHARE

Basic net income per share is computed by dividing net income attributable to common shares 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. In addition, in computing the dilutive effect of convertible securities, the numerator is adjusted to add back (a) any convertible preferred dividends and (b) the after-tax amount of interest, if any, recognized in the period associated with any convertible debt.

A reconciliation of the numerator and denominator used in the calculation of basic net income per common share follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Numerator:
Net income		$	7,686			$	6,797			$	23,793			$	19,650
Denominator:
Weighted average shares outstanding for basic net income per share(1)			20,616				20,525				20,591				20,512
Basic net income per common share		$	0.37			$	0.33			$	1.16			$	0.96

A reconciliation of the numerator and denominator used in the calculation of diluted net income per common share follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Numerator:
Net income		$	7,686			$	6,797			$	23,793			$	19,650
Denominator:
Weighted average common shares outstanding			20,616				20,525				20,591				20,512
Plus: incremental shares from assumed conversions(1)			312				252				319				155
Adjusted weighted average common shares outstanding			20,928				20,777				20,910				20,667
Diluted net income per common share		$	0.37			$	0.33			$	1.14			$	0.95

4. INSURANCE SUBSIDIARY DEPOSITS AND INVESTMENTS

On February 10, 2009, the Company purchased three separate AAA rated debt security investments for an aggregate purchase price of $12,183 with insurance subsidiary deposits and cash from the Captive. The debt securities mature in December 2010, July 2011 and December 2011 and are guaranteed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program upon maturity. The Company has the intent and believes it has the ability to hold these debt securities to maturity.

At September 30, 2009, the Company had approximately $12,104 in debt security investments, which are held to maturity and carried at amortized cost. The fair value of the investments is determined based on “Level 1” inputs, which consist of unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets. The carrying value of the debt securities approximates fair value.

5. REVENUE AND ACCOUNTS RECEIVABLE

Revenue for the three and nine months ended September 30, 2009 and 2008, respectively, is summarized in the following tables:

		Three Months Ended September 30,
		2009								2008
						% of								% of
		Revenue				Revenue				Revenue				Revenue
Medicaid — custodial		$	53,589				40.3	%		$	46,426				39.9	%
Medicare			42,027				31.6				37,610				32.3
Medicaid — skilled			3,640				2.7				2,364				2.0
Total Medicaid and Medicare			99,256				74.6				86,400				74.2
Managed care			17,996				13.6				16,142				13.9
Private and other payors			15,672				11.8				13,786				11.9
Revenue		$	132,924				100.0	%		$	116,328				100.0	%

		Nine Months Ended September 30,
		2009								2008
						% of								% of
		Revenue				Revenue				Revenue				Revenue
Medicaid — custodial		$	159,428				40.3	%		$	136,748				39.6	%
Medicare			128,389				32.5				114,405				33.1
Medicaid — skilled			8,627				2.2				6,446				1.9
Total Medicaid and Medicare			296,444				75.0				257,599				74.6
Managed care			52,675				13.3				47,320				13.7
Private and other payors			46,268				11.7				40,506				11.7
Revenue		$	395,387				100.0	%		$	345,425				100.0	%

Accounts receivable consisted of the following:

		September 30,				December 31,
		2009				2008
Medicaid		$	20,593			$	20,736
Managed care			16,036				15,321
Medicare			13,797				12,818
Private and other payors			8,539				7,579
			58,965				56,454
Less allowance for doubtful accounts			(7,045	)			(7,266	)
Accounts receivable		$	51,920			$	49,188

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 operations of all the Company’s facilities are included in the accompanying condensed consolidated 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 nine months ended September 30, 2009, the Company acquired seven facilities. The aggregate purchase price of six of the seven acquisitions was approximately $20,507, which was paid in cash. The Company acquired the remaining facility pursuant to a long-term lease arrangement between the Company and the real property owner of the facility. In this transaction, the Company assumed ownership of the skilled nursing operating business at this facility for approximately $1,626, which was paid in cash. The facilities acquired during the nine months ended September 30, 2009 are as follows:

	•		On January 1, 2009, the Company assumed an existing lease for a 149 operational bed skilled nursing facility in San Luis Obispo, California. The Company purchased the tenant’s rights under the lease agreement from the prior tenant and operator for approximately $1,626. The Company did not acquire any material assets or assume any liabilities other than the prior tenant’s post-assumption rights and obligations under the lease. The Company also entered into a separate operations transfer agreement with the prior tenant as a part of this transaction.
	•		On January 1, 2009, the Company purchased a skilled nursing facility in Lufkin, Texas for approximately $7,955, which was paid in cash. This facility added 150 operational beds to the Company’s operations. The Company also entered into a separate operations transfer agreement with the prior tenant as a part of this transaction.
	•		On January 15, 2009, the Company assumed the operations of a skilled nursing facility which also has the capacity to provide assisted living and independent living services in Riverside, California. On March 27, 2009, the Company purchased this facility for approximately $1,752, which was paid in cash. This acquisition added 38 operational skilled nursing, 54 operational assisted living and 24 independent living beds to the Company’s operations. The Company also entered into a separate operations transfer agreement with the prior tenant as a part of this transaction.
	•		On February 1, 2009, the Company purchased three skilled nursing facilities and one assisted living facility in Colorado for approximately $10,800, which was paid in cash. These acquisitions added 217 operational skilled nursing and 38 operational assisted living beds to the Company’s operations. The Company also entered into a separate operations transfer agreement with the prior tenant as a part of this transaction.

Goodwill recognized in these transactions amounted to $2,887, which is expected to be fully deductible for tax purposes. In addition, the Company recognized other intangible assets in the form of favorable lease assets and patient base of $1,597 and $388, respectively. The Company expensed $76 and $177 in acquisition related costs which were previously capitalizable during the three and nine months ended September 30, 2009.

The table below presents the allocation of the purchase price for the facilities acquired in business combinations during the nine months ended September 30, 2009 and the year ended December 31, 2008:

		September 30,				December 31,
		2009				2008
Land		$	3,485			$	—
Building and improvements			13,101				—
Equipment, furniture, and fixtures			675				—
Goodwill			2,887				—
Other intangible assets			1,985				2,005
		$	22,133			$	2,005

In addition, on September 30, 2009, the lease on one of the Company’s assisted living facilities in Arizona expired and the Company decided not to exercise its renewal option on this facility. As the operations of this facility were not material to the Company as a whole, the disposal of this facility was not shown as discontinued operations in the Company’s condensed consolidated statement of income for the three and nine months ended September 30, 2009. Total revenues for the three and nine months ended September 30, 2009 for this facility were $496 and $1,412, respectively and net loss for the three and nine months ended September 30, 2009 for this facility was $156 and $206, respectively.

On October 1, 2009, the Company purchased a skilled nursing facility which also has the capacity to provide independent living and hospice services in Dallas, Texas for approximately $17,000, which was paid in cash. This acquisition added 264 operational skilled nursing beds, 39 independent living units and hospice care services to the Company’s operations. The Company also entered into a separate operations transfer agreement with the prior tenant as part of this transaction. No goodwill will be recognized as a part of this transaction. In addition, the Company will recognize other intangible assets in the form of patient base of $213. Total revenue for this facility recognized by the seller during the twelve months ended December 31, 2008 was approximately $18,000.

The table below presents the preliminary allocation of the purchase price for the above noted facility:

		October 1,
		2009
Land		$	2,447
Building and improvements			13,738
Equipment, furniture, and fixtures			602
Other intangible assets			213
Goodwill			—
		$	17,000

On October 1, 2009, the Company purchased three skilled nursing facilities in Utah for approximately $23,000, of which $13,000 was paid in cash and the remaining $10,000 was financed through a short term loan with the seller. This acquisition added an aggregate of 396 operational skilled nursing beds to our operations. The Company also entered into a separate operations transfer agreement with the prior tenant as part of this transaction. Total revenue for these facilities, recognized by the seller during the twelve months ended December 31, 2008 was approximately $16,000. As of the date of this filing, the preliminary allocation of the purchase price for the three skilled nursing facilities in Utah was not completed as necessary valuation information has not yet been finalized

Taking into account the above transactions, the Company paid an aggregate of $62,133 to purchase seven skilled nursing facilities, one skilled nursing facility which also provides independent living services, one skilled nursing facility which also provides assisted living and independent living services, one assisted living facility and lease one skilled nursing facility.

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 and may be misleading as the information is not representative of the Company’s current operating results or indicative of the integration potential of its newly acquired facilities. Also, the eleven businesses acquired during the period from January 1, 2009 through October 1, 2009 were not material acquisitions to the Company individually or in the aggregate. Accordingly, pro forma financial information is not presented. The pre-October acquisitions have been included in the September 30, 2009 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.

7. 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 3 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.

Property and equipment consist of the following:

		September 30,				December 31,
		2009				2008
Land		$	33,925			$	30,440
Buildings and improvements			121,511				103,278
Equipment			31,391				22,790
Furniture and fixtures			8,223				8,198
Leasehold improvements			16,836				13,276
Construction in progress			2,689				3,922
			214,575				181,904
Less accumulated depreciation			(32,932	)			(24,875	)
Property and equipment, net		$	181,643			$	157,029

8. INTANGIBLE ASSETS — Net

		Weighted				September 30, 2009												December 31, 2008
		Average				Gross												Gross
		Life				Carrying				Accumulated								Carrying				Accumulated
Intangible Assets		(Years)				Amount				Amortization				Net				Amount				Amortization				Net
Lease acquisition costs			15.5			$	1,071			$	(678	)		$	393			$	1,071			$	(629	)		$	442
Favorable lease			20.0				3,573				(222	)			3,351				1,976				(67	)			1,909
Customer base			0.3				630				(630	)			—				242				(242	)			—
Trade name			30.0				733				(92	)			641				733				(73	)			660
Total						$	6,007			$	(1,622	)		$	4,385			$	4,022			$	(1,011	)		$	3,011

Amortization expense was $87 and $611 for the three and nine months ended September 30, 2009 and $117 and $297 for the three and nine months ended September 30, 2008, respectively. Of the $611 in amortization expense incurred during the nine months ended September 30, 2009, approximately $388 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
2009 (remainder)		$	73
2010			291
2011			291
2012			291
2013			290
2014			290
Thereafter			2,859
		$	4,385

Goodwill

The Company performed its annual goodwill impairment analysis during the fourth quarter of fiscal year 2008 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 Company recorded no goodwill impairment for the nine months ended September 30, 2009 or the year ended December 31, 2008.

9. RESTRICTED AND OTHER ASSETS

Restricted and other assets consist primarily of capital reserves and deposits. 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:

		September 30,				December 31,
		2009				2008
Deposits with landlords		$	812			$	903
Capital improvement reserves with landlords and lenders			3,041				2,865
Debt issuance costs, net			1,298				1,363
Restricted and other assets		$	5,151			$	5,131

10. OTHER ACCRUED LIABILITIES

Other accrued liabilities consist of the following:

		September 30,				December 31,
		2009				2008
Quality assurance fee		$	1,730			$	1,422
Resident refunds payable			1,905				1,533
Deferred resident revenue			1,157				1,475
Cash held in trust for residents			1,194				1,082
Dividends payable			928				925
Income taxes payable			—				1,096
Property taxes			1,500				962
Other			2,517				2,555
Other accrued liabilities		$	10,931			$	11,050

Quality assurance fee represents amounts payable to the State of California in respect of a mandated fee based on resident days. Resident refunds payable includes amounts due to residents for overpayments and duplicate payments. Deferred resident 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.

11. INCOME TAXES

The provision for income taxes for the three and nine months ended September 30, 2009 and 2008 is summarized as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Current:
Federal		$	4,249			$	2,579			$	13,892			$	9,909
State			793				455				2,823				1,930
			5,042				3,034				16,715				11,839
Deferred:
Federal			(55	)			1,167				(850	)			816
State			26				281				(421	)			192
			(29	)			1,448				(1,271	)			1,008
Expense (benefit) for uncertain tax positions			(23	)			—				47				97
Other expense (benefit), net			(13	)			(389	)			46				(362	)
Total		$	4,977			$	4,093			$	15,537			$	12,582

The Company’s deferred tax assets and liabilities as of September 30, 2009 and December 31, 2008 are summarized as follows:

		September 30,				December 31,
		2009				2008
Deferred tax assets (liabilities):
Accrued expenses		$	12,389			$	10,503
Allowance for doubtful accounts			2,956				3,059
State taxes			43				314
Tax credits			1,165				1,132
Total deferred tax assets			16,553				15,008
Depreciation and amortization			(2,247	)			(2,106	)
Prepaid expenses			(1,359	)			(1,095	)
Total deferred tax liabilities			(3,606	)			(3,201	)
Net deferred tax assets		$	12,947			$	11,807

12. Debt

The Company has a Second Amended and Restated Loan and Security Agreement (the Revolver) with General Electric Capital Corporation (the Lender) under which the Company may borrow up to the lesser of $50,000 or 85% of the eligible accounts receivable. The Revolver will expire on February 21, 2013. The Company was in compliance with all covenants as of September 30, 2009. At September 30, 2009 and December 31, 2008, there were no outstanding borrowings under the Revolver. As of September 30, 2009, the amount of borrowing capacity pledged to secure outstanding letters of credit was $2,133. In addition, the Revolver includes provisions that allow the Lender to establish reserves against collateral for actual and contingent liabilities, a right which the Lender exercised with the Company’s cooperation in December 2008. This reserve restricts $6.0 million of the Company’s borrowing capacity, and may be reduced or eliminated based upon developments with respect to the ongoing U.S. Attorney investigation described in Note 14. In addition, in the event of the Company’s default under the Third Amended and Restated Loan Agreement (the Term Loan), the Lender has the right to take control of the Company’s facilities encumbered by the loan to the extent necessary to make such payments and perform such acts that are required under the loan.

Long-term debt consists of the following:

		September 30,				December 31,
		2009				2008
Term Loan with the Lender, multiple-advance term loan, principal and interest payable monthly; interest is fixed at time of draw at 10-year Treasury Note rate plus 2.25% (rates in effect at September 30, 2009 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		$	53,434			$	54,102
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			6,320				6,449
			59,754				60,551
Less current maturities			(1,122	)			(1,062	)
		$	58,632			$	59,489

Under the Term Loan, the Company is subject to standard reporting requirements and other typical covenants for a loan of this type. As of September 30, 2009 the Company was in compliance with such loan covenants.

The carrying value of the Company’s long-term debt is considered to approximate the fair value of such debt for all periods presented based upon the interest rates that the Company believes it can currently obtain for similar debt.

13. OPTIONS AND WARRANTS

Stock-based compensation expense consists of share-based payment awards made to employees and directors including employee stock options based on estimated fair values. Stock-based compensation expense recognized in the Company’s condensed consolidated statements of income for the three and nine months ended September 30, 2009 and 2008 does not include compensation expense for share-based payment awards granted prior to, but not yet vested as of January 1, 2006, but does include compensation expense for the share-based payment awards granted on or subsequent to January 1, 2006 based on the grant date fair value. As stock-based compensation expense recognized in the Company’s condensed consolidated statements of income for the three and nine months ended September 30, 2009 and 2008 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. In the 2001 Plan and the 2005 Plan, options may be exercised for unvested shares of common stock, which have full stockholder rights including voting, dividend and liquidation rights. The Company retains the right to repurchase any or all unvested shares at the exercise price paid per share of any or all unvested shares should the optionee cease to remain in service while holding such unvested shares. The total number of shares available under all of the Company’s stock incentive plans was 1,126 as of September 30, 2009.

On July 23, 2009 the Company’s board of directors adopted an amendment to the Company’s 2007 Omnibus Incentive Plan, amending the equity compensation program for the Company’s non-employee directors to phase out a program of automatic non-qualified stock option grants and phase in a program providing for automatic quarterly stock awards to non-employee directors for their service on the Company’s board of directors.

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. Approximately 386 options were granted during the nine month period ended September 30, 2009. The Company used the following assumptions for stock options granted during the nine months ended September 30, 2009 and the year ended December 31, 2008:

										Weighted												Weighted
										Average								Weighted				Average
						Options				Risk-Free				Expected				Average				Dividend
Grant Year		Plan				Granted				Rate				Life				Volatility				Yield
2009			2007				386				2.17 – 2.94	%		6.5 years					55	%			1.08	%
2008			2007				836				2.88 – 3.47	%		6.5 years					45 – 50	%			1.45	%

For the nine months ended September 30, 2009 and the year ended December 31, 2008, the following represents the Company’s weighted average exercise price, grant date intrinsic value and fair value displayed at grant date:

						Weighted				Weighted
						Average Exercise				Average Fair
						Price of Common				Value of
Grant Year		Granted				Stock				Options
2009			386			$	16.09			$	8.06
2008			836			$	12.00			$	5.33

The weighted average exercise price equaled the weighted average fair value of common stock on the grant date for all options granted during the periods ended September 30, 2009 and December 31, 2008, and therefore, the intrinsic value was $0.

The following table represents the employee stock option activity during the year ended December 31, 2008 and the nine months ended September 30, 2009:

						Weighted								Weighted
		Number of				Average				Number of				Average
		Options				Exercise				Options				Exercise
		Outstanding				Price				Vested				Price
December 31, 2007			1,023			$	6.19				316			$	5.25
Granted			836				12.00
Forfeited			(72	)			8.21
Exercised			(84	)			5.21
December 31, 2008			1,703				9.01				451				5.74
Granted			386				16.09
Forfeitures			(96	)			11.46
Exercised			(64	)			6.79
September 30, 2009			1,929			$	10.38				638			$	7.07

The following summary information reflects stock options outstanding, vesting and related details as of September 30, 2009:

																		Stock Options
		Stock Options Outstanding																Vested
														Remaining				Number
						Number				Black-Scholes				Contractual				Vested and
Year of Grant		Exercise Price				Outstanding				Fair Value				Life (Years)				Exercisable
2003		$	0.67–0.81				39			$	*				5				39
2004		$	1.96–2.46				46				*				6				40
2005		$	4.99–5.75				247				*				7				145
2006		$	7.05–7.50				496				4,757				8				291
2008		$	9.38–14.87				734				3,929				9				120
2009		$	14.92–16.70				367				2,958				10				3
Total							1,929			$	11,644								638

The Company recognized $783 and $1,775 in compensation expense during the three and nine months ended September 30, 2009 and $576 and $1,329 during the three and nine months ended September 30, 2008, respectively. In future periods, the Company expects to recognize approximately $7.6 million in stock-based compensation expense over the next 2.8 weighted average years for unvested options that were outstanding as of September 30, 2009. There were 1,291 unvested and outstanding options at September 30, 2009, of which 1,102 are expected to vest. The weighted average contractual life for options vested at September 30, 2009 was 6.7 years.

The aggregate intrinsic value of options outstanding, vested, expected to vest and exercised as of September 30, 2009 and December 31, 2008 is as follows:

		September 30,				December 31,
Options		2009				2008
Outstanding		$	7,956			$	13,778
Vested			4,446				7,513
Expected to vest			3,510				2,353
Exercised			530				996

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

14. COMMITMENTS AND CONTINGENCIES

Leases — The Company leases certain facilities and its administrative offices under non-cancelable operating leases and one capital lease, 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 $3,835 and $11,491 for the three and nine months ended September 30, 2009, respectively, and $4,252 and $12,733 for the three and nine months ended September 30, 2008, respectively.

On July 15, 2009, the Company entered into the fourth amendment to the lease for its Service Center. The amendment extended the lease for ten years from the end of the existing lease term. In addition, the lease amendment expands the amount of rentable space by 9,110 square feet. Estimated future minimum lease payments related to the fourth amendment to the lease for the Service Center for each of the years ending December 31 are as follows:

Year		Amount
2009 (remainder)		$	—
2010			195
2011			322
2012			574
2013			598
2014			616
Thereafter			3,050
		$	5,355

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 September 30, 2009.

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 with all applicable laws and regulations.

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. Although the Company is not aware of any significant future rate changes, significant changes to the 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.

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 financial business, financial condition or, results of operations. A significant increase in the number of these claims or an increase in amounts owing under successful 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. Two facilities were subject to probe review during the nine months ended September 30, 2009, which did not result in any Medicare revenue recoupments in 2009. In 2008, one facility was subject to probe review, which was subsequently concluded with a Medicare revenue recoupment, net of appeal recoveries, to the federal government and related resident copayments of approximately $4, which was paid during the second quarter of 2008. The Company anticipates that these probe reviews will increase in frequency in the future. In addition, two of the Company’s facilities are currently on prepayment review, and 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 and certain of its officers received a series of notices from its bank indicating that the United States Attorney for the Central District of California had issued an authorized investigative demand, a request for records similar to a subpoena, to our bank. The U.S. Attorney subsequently rescinded that demand. The rescinded demand requested documents from the Company’s bank related to financial transactions involving the Company, ten of its operating subsidiaries, an outside investor group, and certain of the Company’s current and former officers. Subsequently, in June 2007, the U.S. Attorney sent a letter to one of the Company’s current employees requesting a meeting. The letter indicated that the U.S. Attorney and the U.S. Department of Health and Human Services Office of Inspector General were conducting an investigation of claims submitted to the Medicare program for rehabilitation services provided at unspecified facilities. Although both the Company and the employee offered to cooperate, the U.S. Attorney later withdrew its meeting request.

On December 17, 2007, the Company was informed by Deloitte & Touche LLP, its independent registered public accounting firm, that the U.S. Attorney served a grand jury subpoena on Deloitte & Touche LLP, relating to The Ensign Group, Inc., and several of its operating subsidiaries. The subpoena confirmed the Company’s previously reported belief that the U.S. Attorney was conducting an investigation involving facilities operated by certain of the Company’s operating subsidiaries. All together, the March 2007 authorized investigative demand and the December 2007 subpoena specifically covered information from a total of 18 of the Company’s 70 facilities. In February 2008, the U.S. Attorney contacted two additional current employees. Both the Company and the employees contacted have offered to cooperate and meet with the U.S. Attorney, however, to date, the U.S. Attorney has declined these offers. Based on these events, the Company believes that the U.S. Attorney may be conducting parallel criminal, civil and administrative investigations involving The Ensign Group, Inc. and one or more of its skilled nursing facilities.

Pursuant to these investigations, on December 17, 2008, representatives from the U.S. Department of Justice (DOJ) served search warrants on the Company’s Service Center and six of its Southern California skilled nursing facilities. Following the execution of the warrants on the six facilities, a subpoena was issued covering eight additional facilities. Among other things, the warrants covered specific patient records at the six facilities. On May 4, 2009, the U.S. Attorney served a second subpoena requesting additional patient records on the same patients who were covered by the original warrants. The Company has worked with the U.S. Attorney’s office to produce information responsive to both subpoenas. The Company and its regulatory counsel continue to actively work with the U.S. Attorney’s office to determine what additional information, if any, will be assistive.

The Company is cooperating with the U.S. Attorney’s office and intends to continue working with them to the extent they will allow the Company to help move their inquiry forward. To the Company’s knowledge, however, neither The Ensign Group, Inc. nor any of its operating subsidiaries or employees has been formally charged with any wrongdoing. The Company cannot predict or provide any assurance as to the possible outcome of the investigation or any possible related proceedings, or as to the possible outcome of any qui tam litigation that may follow, nor can the Company 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. To the extent the U.S. Attorney’s office elects to pursue this matter, or if the investigation has been instigated by a qui tam relator who elects to pursue the matter, and the Company is subjected to or alleged to be liable for claims or obligations under federal Medicare statutes, the federal False Claims Act, or similar state and federal statutes and related regulations, the Company’s business, financial condition and results of operations could be materially and adversely affected and its stock price could decline.

The Company initiated an internal investigation in November 2006 when it became aware of an allegation of possible reimbursement irregularities at one or more of the Company’s facilities. This investigation focused on 12 facilities, and included all six of the facilities which were covered by the warrants served in December 2008. The Company retained outside counsel to assist in looking into these matters. The Company and its outside counsel concluded this investigation in February 2008 without identifying any systemic or patterns and practices of fraudulent or intentional misconduct. The Company made observations at certain facilities regarding areas of potential improvement in some of its recordkeeping and billing practices and has implemented measures, some of which were already underway before the investigation began, that the Company believes will strengthen its recordkeeping and billing processes. None of these additional findings or observations appears to be rooted in fraudulent or intentional misconduct. The Company continues to evaluate the measures it has implemented for effectiveness, and is continuing to seek ways to improve these processes.

As a byproduct of its investigation, the Company identified a limited number of selected Medicare claims for which adequate backup documentation could not be located or for which other billing deficiencies existed. The Company, with the assistance of independent consultants experienced in Medicare billing, completed a billing review on these claims. To the extent missing documentation was not located, the Company treated the claims as overpayments. Consistent with healthcare industry accounting practices, the Company records any charge for refunded payments against revenue in the period in which the claim adjustment becomes known. During the year ended December 31, 2007, the Company accrued a liability of approximately $224, plus interest, for selected Medicare claims for which documentation has not been located or for other billing deficiencies identified to date. These claims have been submitted for settlement with the Medicare Fiscal Intermediary. If additional reviews result in identification and quantification of additional amounts to be refunded, the Company would accrue additional liabilities for claim costs and interest, and repay any amounts due in normal course. If future investigations ultimately result in findings of significant billing and reimbursement noncompliance which could require the Company to record significant additional provisions or remit payments, the Company’s 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 58% and 59% of its total accounts receivable as of September 30, 2009 and December 31, 2008, respectively. Revenue from reimbursements under the Medicare and Medicaid programs accounted for approximately 75% of the Company’s revenue for both periods during the three and nine months ended September 30, 2009 and 74% and 75% for the three and nine months ended September 30, 2008, 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.

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, 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 facilities, 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 or the Service Center 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 70 facilities located in California, Arizona, Texas, Washington, Utah, Colorado and Idaho as of September 30, 2009. All of these facilities are skilled nursing facilities, other than four stand-alone assisted living facilities in Arizona, Texas and Colorado and five campuses that offer both skilled nursing and assisted living services in California, Arizona and Utah. Our facilities provide a broad spectrum of skilled nursing and assisted living services, physical, occupational and speech therapies, and other rehabilitative and healthcare services, for both long-term residents and short-stay rehabilitation patients. We encourage and empower our facility leaders and staff to make their facility the “facility of choice” in the community it serves. This means that our facility leaders and staff are generally free to discern and address the unique needs and priorities of healthcare professionals, customers and other stakeholders in the local community or market, and then work to create a superior service offering and reputation for that particular community or market to encourage prospective customers and referral sources to choose or recommend the facility. As of September 30, 2009, we owned 38 of our facilities and operated an additional 32 facilities under long-term lease arrangements, and had options to purchase 9 of those 32 facilities. The following table summarizes our facilities and licensed and independent living beds by ownership status as of September 30, 2009:

						Leased				Leased
						(with a				(without a
						Purchase				Purchase
		Owned				Option)				Option)				Total
Number of facilities			38				9				23				70
Percent of total			54.2	%			12.9	%			32.9	%			100	%
Operational skilled nursing, assisted living and independent living beds			4,174				1,056				2,743				7,973
Percent of total			52.4	%			13.2	%			34.4	%			100	%

The Ensign Group, Inc. is a holding company with no direct operating assets, employees or revenues. All of our facilities 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.

Recent Developments

During the first quarter of 2009, we acquired five skilled nursing facilities, one skilled nursing facility which also has the capacity to provide assisted living and independent living services and one assisted living facility. The aggregate purchase price of six of the seven facilities was $20.5 million. We acquired the remaining facility pursuant to a long-term lease arrangement with the real property owner of the facility. In this transaction, we assumed ownership of the skilled nursing operating business at this facility for approximately $1.6 million. These acquisitions added an aggregate of 554 operational skilled nursing, 92 operational assisted living and 24 independent living beds to our operations.

On September 30, 2009, the lease on one of our assisted living facilities in Arizona expired and we decided not to exercise our renewal option on this facility. As the operations of this facility were not material to us as a whole, the disposal of this facility was not shown as discontinued operations in our condensed consolidated statement of income for the three and nine months ended September 30, 2009. Total revenues for the three and nine months ended September 30, 2009 for this facility were $496 and $1,412, respectively and net loss for the three and nine months ended September 30, 2009 for this facility was $156 and $206, respectively.

On October 1, 2009, we purchased a skilled nursing facility which also has the capacity to provide independent living and hospice services in Dallas, Texas for approximately $17.0 million, which was paid in cash. This acquisition added 264 operational skilled nursing beds, 39 independent living units and hospice care services to our operations. We also entered into a separate operations transfer agreement with the prior tenant as part of this transaction.

On October 1, 2009, we purchased three skilled nursing facilities in Utah for approximately $23.0 million, of which $13.0 million was paid in cash and the remaining $10.0 million was financed through a short term loan with the seller. This acquisition added an aggregate of 396 operational skilled nursing beds to our operations. We also entered into a separate operations transfer agreement with the prior tenant as part of this transaction.

See further discussion of facility acquisitions in Note 6 above.

Facility Acquisition History

																																										As of
		As of December 31,																																								September 30,
		1999				2000				2001				2002				2003				2004				2005				2006				2007				2008				2009
Cumulative number of facilities			5				13				19				24				41				43				46				57				61				63				70
Cumulative number of operational skilled nursing, assisted living and independent living beds			665				1,571				2,155				2,751				4,959				5,213				5,585				6,667				7,105				7,324				7,973

The following table sets forth the location of our facilities and the number of operational beds located at our facilities as of September 30, 2009:

		CA				AZ				TX				UT				CO				WA				ID				Total
Number of facilities			33				12				11				6				4				3				1				70
Operational skilled nursing, assisted living and independent living beds			3,713				1,836				1,226				577				255				278				88				7,973

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 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.

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								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Skilled Mix:
Days			24.5	%			24.7	%			24.7	%			25.2	%
Revenue			48.1	%			48.5	%			48.2	%			49.0	%
Quality Mix:
Days			37.4	%			37.6	%			37.4	%			38.0	%
Revenue			57.7	%			58.3	%			57.8	%			58.6	%

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								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Occupancy:
Operational beds at end of period			7,973				7,588				7,973				7,588
Available patient days			730,920				666,048				2,167,556				1,966,112
Actual patient days			581,041				535,237				1,724,398				1,594,616
Occupancy percentage (based on operational beds)			79.5	%			80.4	%			79.6	%			81.1	%

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 September 30,																Nine Months Ended September 30,
		2009								2008								2009								2008
		$				%				$				%				$				%				$				%
														(in thousands)
Revenue:
Medicaid-custodial		$	53,589				40.3	%		$	46,426				39.9	%		$	159,428				40.3	%		$	136,748				39.6	%
Medicare			42,027				31.6				37,610				32.3				128,389				32.5				114,405				33.1
Medicaid-skilled			3,640				2.7				2,364				2.0				8,627				2.2				6,446				1.9
Total			99,256				74.6				86,400				74.2				296,444				75.0				257,599				74.6
Managed Care			17,996				13.6				16,142				13.9				52,675				13.3				47,320				13.7
Private and Other(1)			15,672				11.8				13,786				11.9				46,268				11.7				40,506				11.7
Total revenue		$	132,924				100.0	%		$	116,328				100.0	%		$	395,387				100.0	%		$	345,425				100.0	%