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 (State or Other Jurisdiction of Incorporation or Organization)		33-0861263 (I.R.S. Employer 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 April 30, 2010, 20,734,533 shares of the registrant’s common stock were outstanding.

 

 

THE ENSIGN GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2010

TABLE OF CONTENTS

Part I. Financial Information
Item 1. Financial Statements (unaudited):			2
Condensed Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009			2
Condensed Consolidated Statements of Income for the three months ended March 31, 2010 and 2009			3
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and 2009			4
Notes to Condensed Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3. Quantitative and Qualitative Disclosures About Market Risk			36
Item 4. Controls and Procedures			36
Part II. Other Information
Item 1. Legal Proceedings			37
Item 1A. Risk Factors			37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			61
Item 3. Defaults Upon Senior Securities			61
Item 4. (Removed and Reserved)			61
Item 5. Other Information			61
Item 6. Exhibits			62
Signatures			63
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Part I. Financial Information

Item 1. Financial Statements

THE ENSIGN GROUP, INC.

		March 31,				December 31,
		2010				2009
Assets
Current assets:
Cash and cash equivalents		$	41,452			$	38,855
Accounts receivable—less allowance for doubtful accounts of $8,218 and $7,575 at March 31, 2010 and December 31, 2009, respectively			69,372				62,606
Prepaid income taxes			—				1,242
Prepaid expenses and other current assets			5,866				6,498
Deferred tax asset—current			7,615				8,126
Total current assets			124,305				117,327
Property and equipment, net			241,034				230,774
Insurance subsidiary deposits and investments			13,985				13,810
Escrow deposits			500				7,595
Deferred tax asset			5,488				4,262
Restricted and other assets			5,895				5,650
Intangible assets, net			4,269				4,498
Goodwill			7,432				7,432
Total assets		$	402,908			$	391,348
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	15,079			$	15,498
Accrued wages and related liabilities			27,368				28,756
Accrued self-insurance liabilities—current			10,079				10,074
Other accrued liabilities			11,850				15,375
Income taxes payable			5,350				—
Current maturities of long-term debt			2,087				2,065
Total current liabilities			71,813				71,768
Long-term debt—less current maturities			106,868				107,401
Accrued self-insurance liabilities—less current portion			23,572				22,096
Deferred rent and other long-term liabilities			3,415				2,524
Commitments and contingencies (Note 14)
Stockholders’ equity:
Common stock; $0.001 par value; 75,000 shares authorized; 21,348 and 20,732 shares issued and outstanding at March 31, 2010, respectively, and 21,280 and 20,642 shares issued and outstanding at December 31, 2009, respectively			21				21
Additional paid-in capital			68,002				66,765
Retained earnings			133,222				124,910
Common stock in treasury, at cost, 616 and 638 shares at March 31, 2010 and December 31, 2009, respectively			(4,005	)			(4,137	)
Total stockholders’ equity			197,240				187,559
Total liabilities and stockholders’ equity		$	402,908			$	391,348

See accompanying notes to condensed consolidated financial statements.

THE ENSIGN GROUP, INC.

		Three Months Ended
		March 31,
		2010				2009
Revenue		$	154,174			$	130,285
Expense:
Cost of services (exclusive of facility rent and depreciation and amortization shown separately below)			123,183				104,199
Facility rent—cost of services			3,575				3,701
General and administrative expense			5,774				4,961
Depreciation and amortization			3,955				2,965
Total expenses			136,487				115,826
Income from operations			17,687				14,459
Other income (expense):
Interest expense			(2,280	)			(1,328	)
Interest income			67				70
Other expense, net			(2,213	)			(1,258	)
Income before provision for income taxes			15,474				13,201
Provision for income taxes			6,126				5,278
Net income		$	9,348			$	7,923
Net income per share:
Basic		$	0.45			$	0.39
Diluted		$	0.44			$	0.38
Weighted average common shares outstanding:
Basic			20,686				20,572
Diluted			21,074				20,892

See accompanying notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

		Three months ended
		March 31,
		2010				2009
Cash flows from operating activities:
Net income		$	9,348			$	7,923
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			3,955				2,965
Amortization of deferred financing fees and debt discount			191				53
Deferred income taxes			(715	)			1,026
Provision for doubtful accounts			1,550				1,213
Stock-based compensation			649				517
Excess tax benefit from share based compensation			(333	)			(56	)
Loss on disposition of property and equipment			21				61
Change in operating assets and liabilities
Accounts receivable			(8,316	)			(7,037	)
Prepaid income taxes			1,242				—
Prepaid expenses and other current assets			632				(382	)
Insurance subsidiary deposits			(175	)			50
Accounts payable			(419	)			2,490
Accrued wages and related liabilities			(1,388	)			(26	)
Other accrued liabilities			2,149				1,333
Accrued self-insurance			1,481				326
Deferred rent liability			453				(50	)
Net cash provided by operating activities			10,325				10,406
Cash flows from investing activities:
Purchase of property and equipment			(6,415	)			(4,924	)
Cash payment for business acquisitions			(7,617	)			(22,133	)
Escrow deposits			(500	)			(445	)
Escrow deposits used to fund business acquisitions			7,595				10,090
Cash proceeds from the sale of fixed assets			58				—
Restricted and other assets			1				(181	)
Net cash used in investing activities			(6,878	)			(17,593	)
Cash flows from financing activities:
Payments on long term debt			(542	)			(275	)
Issuance of treasury stock upon exercise of options			132				23
Issuance of common stock upon exercise of options			264				74
Dividends paid			(1,032	)			(925	)
Principal payments on capital lease obligations			—				(7	)
Excess tax benefit from share based compensation			333				56
Payments of deferred financing costs			(5	)			(25	)
Net cash used in financing activities			(850	)			(1,079	)
Net increase (decrease) in cash and cash equivalents			2,597				(8,266	)
Cash and cash equivalents beginning of period			38,855				41,326
Cash and cash equivalents end of period		$	41,452				33,060
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest		$	2,222				1,344
Income taxes		$	6,065				8,100

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 79 facilities as of March 31, 2010, located in California, Arizona, Texas, Washington, Utah, Colorado and Idaho. All of these facilities are skilled nursing facilities, other than three 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 9,100 operational skilled nursing, assisted living and independent living beds. As of March 31, 2010, the Company owned 49 of its 79 facilities and operated an additional 30 facilities through long-term lease arrangements, and had options to purchase 8 of those 30 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 March 31, 2010 and for the three month periods ended March 31, 2010 and 2009 (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, 2009 which are included in the Company’s annual report on Form 10-K, File No. 001-33757 (the Annual Report) filed with the Securities and Exchange Commission (the SEC). Management believes that the Interim Financial Statements reflect all adjustments which are of a normal and recurring nature necessary to present fairly the Company’s financial position and results of operations in all material respects. The results of operations presented in the Interim Financial Statements are not necessarily representative of operations for the entire year.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation — The accompanying Interim Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company is the sole member or shareholder of various consolidated limited liability companies and corporations; each established to operate various acquired skilled nursing and assisted living facilities. All intercompany transactions and balances have been eliminated in consolidation.

Estimates and Assumptions — The preparation of Interim Financial Statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. The most significant estimates in the Company’s Interim 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.

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

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 76% and 75% of the Company’s revenue for the three months ended March 31, 2010 and 2009, 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 $315 and $408 for the three months ended March 31, 2010 and 2009, respectively. The Company records revenue from private pay patients, at the agreed upon rate, 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.

Property and Equipment — Property and equipment are initially recorded at their historical cost. Repairs and maintenance are expensed as incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the depreciable assets (ranging from three to 30 years). Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the remaining lease term.

Impairment of Long-Lived Assets — The Company reviews the carrying value of long-lived assets that are held and used in the Company’s operations for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is determined based upon expected undiscounted future net cash flows from the operations to which the assets relate, utilizing management’s best estimate, appropriate assumptions, and projections at the time. If the carrying value is determined to be unrecoverable from future operating cash flows, the asset is deemed impaired and an impairment loss would be recognized to the extent the carrying value exceeded the estimated fair value of the asset. The Company estimates the fair value of assets based on the estimated future discounted cash flows of the asset. Management has evaluated its long-lived assets and has not identified any impairment during the three months ended March 31, 2010 or the year ended December 31, 2009.

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 three 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.

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

Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations. Goodwill is subject to annual testing for impairment. In addition, goodwill is tested for impairment if events occur or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company defines reporting units as the individual facilities. The Company performs its annual test for impairment during the fourth quarter of each year. The Company did not record any impairment charges during the three months ended March 31, 2010 or the year ended December 31, 2009.

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, 2010, the combined self-insured retention and corridor was $500 per claim with a $1,736 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 75 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 Interim 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 $23,426 and $22,279 as of March 31, 2010 and December 31, 2009, 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 $7,946 and $7,624 as of March 31, 2010 and December 31, 2009, 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 $2,279 and $2,267 at March 31, 2010 and December 31, 2009, respectively.

The Company believes that adequate provision has been made in the Interim 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 ENSIGN GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in thousands, except per share data)
(Unaudited)

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 Company generally expects to fully utilize its deferred tax assets; however, when necessary, the Company records a valuation allowance to reduce its net deferred tax assets to the amount that is more likely than not to be realized.

In determining the annual income tax rate for financial statements for interim periods, the Company must consider expected annual income, permanent differences between financial reporting and tax recognition of income or expense and other factors. The provision for income taxes is determined by applying the estimated annual effective tax rate to pretax income, adjusted for discrete transactions occurring during the period. When the Company takes uncertain income tax positions, it records a liability for underpayment of income taxes and related interest and penalties, if any. In considering the need for and magnitude of a liability for such positions, the Company must consider the potential outcomes from a review of the positions by the taxing authorities.

In determining the need for a valuation allowance, the annual income tax rate for interim periods, or the need for and magnitude of liabilities for uncertain tax positions, the Company makes certain estimates and assumptions. These estimates and assumptions are based on, among other things, knowledge of operations, markets, historical trends and likely future changes and, when appropriate, the opinions of advisors with knowledge and expertise in certain fields. Due to certain risks associated with the Company’s estimates and assumptions, actual results could differ.

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 February 2010, the FASB issued amendments to address certain implementation issues related to an entity’s requirement to perform and disclose subsequent events procedures. The amendment requires (1) SEC filers and (2) conduit debt obligors for conduit debt securities that are traded in a public market to “evaluate subsequent events through the date the financial statements are issued.” All other entities are required to “evaluate subsequent events through the date the financial statements are available to be issued.” It further exempts SEC filers from disclosing the date through which subsequent events have been evaluated. For all entities (except conduit debt obligors), these requirements are effective immediately for financial statements that are (1) issued or available to be issued or (2) revised. For conduit debt obligors, the requirements are effective for interim and annual periods ending after June 15, 2010. The adoption of these requirements did not have an impact on the Company’s Interim Financial Statements.

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

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
		March 31,
		2010				2009
Numerator:
Net income		$	9,348			$	7,923
Denominator:
Weighted average shares outstanding for basic net income per share(1)			20,686				20,572
Basic net income per common share		$	0.45			$	0.39

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

		Three Months Ended
		March 31,
		2010				2009
Numerator:
Net income		$	9,348			$	7,923
Denominator:
Weighted average common shares outstanding			20,686				20,572
Plus: incremental shares from assumed conversions(1)			388				320
Adjusted weighted average common shares outstanding			21,074				20,892
Diluted net income per common share		$	0.44			$	0.38

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 March 31, 2010, the Company had approximately $12,068 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.

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

5. REVENUE AND ACCOUNTS RECEIVABLE

Revenue for the three months ended March 31, 2010 and 2009 is summarized in the following table:

		Three Months Ended March 31,
		2010								2009
						% of								% of
		Revenue				Revenue				Revenue				Revenue
Medicaid		$	61,653				40.0	%		$	52,236				40.1	%
Medicare			51,122				33.2				43,207				33.2
Medicaid — skilled			4,418				2.8				2,282				1.7
Total Medicaid and Medicare			117,193				76.0				97,725				75.0
Managed care			20,569				13.4				17,497				13.4
Private and other payors			16,412				10.6				15,063				11.6
Revenue		$	154,174				100	%		$	130,285				100	%

Accounts receivable as of March 31, 2010 and December 31, 2009 is summarized in the following table:

		March 31,				December 31,
		2010				2009
Medicaid		$	25,376			$	23,902
Managed care			20,164				17,919
Medicare			19,865				17,481
Private and other payors			12,185				10,879
			77,590				70,181
Less allowance for doubtful accounts			(8,218	)			(7,575	)
Accounts receivable		$	69,372			$	62,606

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 Interim Financial Statements subsequent to the date of acquisition. Acquisitions are typically paid for in cash and are accounted for using the acquisition method of accounting. Where the Company enters into facility lease agreements, the Company typically does not pay any material amount to the prior facility operator nor does the Company acquire any assets or assume any liabilities, other than rights and obligations under the lease and operations transfer agreement, as part of the transaction. Some leases include options to purchase the facilities. As a result, from time to time, the Company will acquire facilities that the Company has been operating under third-party leases.

During the three months ended March 31, 2010, the Company acquired two facilities. The aggregate purchase price of the two acquisitions was approximately $7,617, which was paid in cash. The facilities acquired during the three months ended March 31, 2010 are as follows:

•

On January 1, 2010, the Company purchased two skilled nursing facilities in Idaho for $7,617, which was paid in cash. These acquisitions added 158 operational skilled nursing beds to the Company’s operations. The Company also entered into a separate operations transfer agreement with the prior owner as a part of this transaction.

The Company expensed $52 in acquisition related costs during the three months ended March 31, 2010. No Goodwill was recognized in this transaction.

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

The table below presents the allocation of the purchase price for the facilities acquired in business combinations during the three months ended March 31, 2010 and 2009:

		March 31,				March 31,
		2010				2009
Land		$	841			$	3,485
Building and improvements			6,387				13,101
Equipment, furniture, and fixtures			289				675
Goodwill			—				2,887
Other intangible assets			100				1,985
		$	7,617			$	22,133

On May 1, 2010, the Company purchased two skilled nursing facilities in Texas for approximately $8,310, which was paid in cash. This acquisition added approximately 284 operational skilled nursing beds to the Company’s operations. The Company also entered into a separate operations transfer agreement with the prior owner as part of this transaction. As of the date of this filing, the preliminary allocation of the purchase price for the two skilled nursing facilities in Texas was not completed as necessary valuation information has not yet been finalized.

On May 1, 2010, the Company purchased a home health and hospice operation in Idaho for approximately $2,650, which was paid in cash. The acquisition did not have an impact on the Company’s operational bed count. The Company also entered into a separate operations transfer agreement with the prior owner as part of this transaction. As of the date of this filing, the preliminary allocation of the purchase price for the home health and hospice operation in Idaho was not completed as necessary valuation information has not yet been finalized.

The Company’s acquisition strategy has been focused on identifying both opportunistic and strategic acquisitions within its target markets that offer strong opportunities for return on invested capital. The facilities acquired by the Company are frequently underperforming financially and can have regulatory and clinical challenges to overcome. Financial information, especially with underperforming facilities, is often inadequate, inaccurate or unavailable. Consequently, the Company believes that prior operating results are not meaningful 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. The two businesses acquired during the period from January 1, 2010 through May 1, 2010 were not material acquisitions to the Company individually or in the aggregate. Accordingly, pro forma financial information is not presented. The first quarter 2010 acquisitions have been included in the March 31, 2010 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 consist of the following:

		March 31,				December 31,
		2010				2009
Land		$	44,462			$	43,621
Buildings and improvements			167,089				158,803
Equipment			38,143				35,136
Furniture and fixtures			8,363				8,301
Leasehold improvements			19,267				17,978
Construction in progress			3,424				3,036
			280,748				266,875
Less accumulated depreciation			(39,714	)			(36,101	)
Property and equipment, net		$	241,034			$	230,774

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

8. INTANGIBLE ASSETS — Net

		Weighted				March 31, 2010												December 31, 2009
		Average				Gross												Gross
		Life				Carrying				Accumulated								Carrying				Accumulated
Intangible Assets		(Years)				Amount				Amortization				Net				Amount				Amortization				Net
Lease acquisition costs			15.5			$	910			$	(548	)		$	362			$	1,071			$	(694	)		$	377
Favorable lease			20.0				3,573				(326	)			3,247				3,573				(274	)			3,299
Patient base			0.3				534				(503	)			31				1,202				(1,015	)			187
Trade name			30.0				733				(104	)			629				733				(98	)			635
Total						$	5,750			$	(1,481	)		$	4,269			$	6,579			$	(2,081	)		$	4,498

Amortization expense was $328 and $297 for the three months ended March 31, 2010 and 2009, respectively. Of the $328 in amortization expense incurred during the three months ended March 31, 2010, approximately $255 related to the amortization of patient base intangible assets at recently acquired facilities, which is typically amortized over a period of three 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
2010 (remainder)		$	249
2011			291
2012			291
2013			291
2014			290
2015			268
Thereafter			2,589
		$	4,269

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:

		March 31,				December 31,
		2010				2009
Deposits with landlords		$	731			$	725
Capital improvement reserves with landlords and lenders			2,834				2,840
Debt issuance costs, net			2,330				2,085
Restricted and other assets		$	5,895			$	5,650

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

10. OTHER ACCRUED LIABILITIES

Other accrued liabilities consist of the following:

		March 31,				December 31,
		2010				2009
Quality assurance fee		$	1,218			$	5,071
Resident refunds payable			2,891				2,347
Deferred resident revenue			1,230				1,073
Cash held in trust for residents			1,420				1,748
Dividends payable			1,037				1,032
Property taxes			516				1,194
Other			3,538				2,910
Other accrued liabilities		$	11,850			$	15,375

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 months ended March 31, 2010 and 2009 is summarized as follows:

		Three Months Ended
		March 31,
		2010				2009
Current:
Federal		$	5,771			$	3,432
State			1,070				869
			6,841				4,301
Deferred:
Federal			(567	)			991
State			(148	)			(17	)
			(715	)			974
Expense for uncertain tax positions			—				3
Total		$	6,126			$	5,278

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

The Company’s deferred tax assets and liabilities as of March 31, 2010 and December 31, 2009 are summarized as follows:

		March 31,				December 31,
		2010				2009
Deferred tax assets (liabilities):
Accrued expenses		$	13,632			$	12,498
Allowance for doubtful accounts			3,434				3,166
State taxes			—				324
Tax credits			1,174				1,180
Total deferred tax assets			18,240				17,168
State taxes			(629	)			—
Depreciation and amortization			(3,087	)			(3,293	)
Prepaid expenses			(1,421	)			(1,487	)
Total deferred tax liabilities			(5,137	)			(4,780	)
Net deferred tax assets		$	13,103			$	12,388

The Company is not currently under examination by any major income tax jurisdiction; however, its Federal tax returns for years beginning with 2006 and many of its state tax returns for years beginning with 2005 remain subject to potential examination. The statutes of limitations will lapse on the Company’s 2005 and 2006 income tax years for state and Federal purposes in 2010, respectively. The Company does not believe these lapses will significantly impact unrecognized tax benefits for any uncertain tax positions. The Company is not aware of any other event that might significantly impact the balance of unrecognized tax benefits in the next twelve months. The net balance of unrecognized tax benefits was not material to the Interim Financial Statements for the three months ended March 31, 2010.

12. Debt

On November 6, 2009, the Company finalized the Fourth Amended and Restated Loan Agreement (Amended Term Loan) with General Electric Capital Corporation (the Lender) which increased the borrowing capacity of the Amended Term Loan by $40,000, further referred to as the Six Project Loan. The Six Project Loan will mature on September 30, 2014 and is secured by, among other things, a perfected first priority mortgage/deed of trust on the fee simple interest in six of the Company’s skilled nursing facilities (the Property). The Amended Term Loan, which includes both the Ten Project Note (as described below) and the Six Project Loan, is cross collateralized and cross defaulted with the existing Second Amended and Restated Loan and Security Agreement (the Revolver). The interest rate on the loan is calculated at the current five year swap rate on the date of closing plus 585 basis points for half of the loan balance and the three year swap rate on the date of closing plus 585 basis points and therefore floating at 90-day LIBOR plus 575 basis points, reset monthly and subject to a LIBOR floor of 2.0% for the remaining half of the loan balance. The Amended Term Loan did not modify any of the existing terms of the Ten Project Note.

On October 1, 2009, four subsidiaries of The Ensign Group, Inc. entered into four separate promissory notes with Johnson Land Enterprises, LLC (the Seller), for an aggregate of $10,000, as a part of the Company’s acquisition of three skilled nursing facilities in Utah. The unpaid balance of principal and accrued interest from these notes is due on September 30, 2019. The notes bear interest at a rate of 6.0% per annum. As a part of this transaction, the Company recorded a discount to the debt balance in the form of imputed interest of $1,218. This amount will be amortized over the term of the promissory notes, or ten years.

In addition, on October 1, 2009, a subsidiary of The Ensign Group, Inc. in West Jordan, Utah assumed the obligation to pay the remaining principal and interest on bonds which were originally sold to finance the construction of the facility. These bonds were assumed as a part of the Company’s acquisition of three skilled nursing facilities in Utah. The unpaid balance of principal and accrued interest from these bonds is due on July 1, 2015. The bonds bear interest at an annual rate equal to sixty percent of the rate announced from time to time by Bank of America as its prime rate (Prime Rate), which was 2.1% on March 31, 2010.

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. At March 31, 2010 and December 31, 2009, there were no outstanding borrowings under the Revolver. As of March 31, 2010, the amount of borrowing capacity pledged to secure outstanding letters of credit and reserves against collateral for actual and contingent liabilities was $2,133 and $6,000, respectively. In addition, in the event of the Company’s default under the Amended 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.

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

Long-term debt consists of the following:

		March 31,				December 31,
		2010				2009
Ten Project Note 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 March 31, 2010 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.		$	53,069			$	53,200
Six Project Loan with the Lender, principal and interest payable monthly, interest defined above, balance due September 30, 2014, collateralized by deeds of trust on real property, assignments of rents, security agreements and fixture financing statements.			39,726				39,970
Promissory notes, principal, and interest of $69 payable monthly and continuing through September 2019, interest at fixed rate of 6.0%, collateralized by deed of trust on real property, assignment of rents and security agreement.			9,904				9,962
Bond, principal and interest of $20 payable monthly and continuing through July 2015, interest at a fixed rate of 60% of the Prime Rate (as defined by the agreement).			1,184				1,232
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.			6,229				6,290
			110,112				110,654
Less current maturities			(2,087	)			(2,065	)
Less debt discount			(1,157	)			(1,188	)
		$	106,868			$	107,401

The Company is subject to standard reporting requirements and other typical covenants for loans of these types. As of March 31, 2010 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

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 months ended March 31, 2010 and 2009 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 months ended March 31, 2010 and 2009 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 1,350 as of March 31, 2010.

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

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 106 options were granted during the three month period ended March 31, 2010. The Company used the following assumptions for stock options granted during the three months ended March 31, 2010 and 2009:

										Weighted												Weighted
										Average								Weighted				Average
						Options				Risk-Free				Expected				Average				Dividend
Grant Year		Plan				Granted				Rate				Life				Volatility				Yield
2010			2007				106				2.82	%		6.5 years					55	%			1.08	%
2009			2007				169				2.17	%		6.5 years					55	%			1.08	%

For the three months ended March 31, 2010 and 2009, the following represents the Company’s weighted average exercise price, grant date intrinsic value and fair value displayed at grant date:

						Weighted Average				Weighted Average
						Exercise Price of				Fair Value of
Grant Year		Granted				Common Stock				Options
2010			106			$	17.47			$	8.86
2009			169			$	16.70			$	8.31

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 March 31, 2010 and 2009 and therefore, the intrinsic value was $0.

The following table represents the employee stock option activity during the three months ended March 31, 2010:

						Weighted								Weighted
		Number of				Average				Number of				Average Exercise
		Options				Exercise				Options				Price of Options
		Outstanding				Price				Vested				Vested
January 1, 2010			2,025			$	10.68				709			$	7.29
Granted			106				17.47
Forfeited			(29	)			11.65
Exercised			(86	)			4.58
March 31, 2010			2,016			$	11.28				723			$	8.36

The following summary information reflects stock options outstanding, vested and related details as of March 31, 2010:

																		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				9			$	*				3				9
2004		$	1.96 – 2.46				40				*				4				40
2005		$	4.99 – 5.75				213				*				5				162
2006		$	7.05 – 7.50				459				4,411				6				269
2008		$	9.38 – 14.87				703				3,774				8				212
2009		$	14.92 – 16.70				486				3,845				9				31
2010		$	17.47				106				939				10				—
Total							2,016			$	12,969								723

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

The Company recognized $649 and $517 in compensation expense during the three months ended March 31, 2010 and 2009, respectively. In future periods, the Company expects to recognize approximately $8,052 in stock-based compensation expense over the next 2.6 weighted average years for unvested options that were outstanding as of March 31, 2010. There were 1,293 unvested and outstanding options at March 31, 2010, of which 1,171 are expected to vest. The weighted average contractual life for options vested at March 31, 2010 was 7.6 years.

The aggregate intrinsic value of options outstanding, vested, expected to vest and exercised as of March 31, 2010 and December 31, 2009 is as follows:

		March 31,				December 31,
Options		2010				2009
Outstanding		$	12,093			$	9,779
Vested			6,440				5,732
Expected to vest			5,154				3,806
Exercised			1,095				625

The intrinsic value is calculated as the difference between the market value of the underlying common stock 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, 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 $3,670 and $3,817 for the three months ended March 31, 2010 and 2009, respectively.

Six of the Company’s facilities are operated under two separate three-facility master lease arrangements. Under these master leases, a breach at a single facility could subject one or more of the other facilities covered by the same master lease to the same default risk. Failure to comply with Medicare and Medicaid provider requirements is a default under several of the Company’s leases, master lease agreements and debt financing instruments. In addition, other potential defaults related to an individual facility may cause a default of an entire master lease portfolio and could trigger cross-default provisions in the Company’s outstanding debt arrangements and other leases. With an indivisible lease, it is difficult to restructure the composition of the portfolio or economic terms of the lease without the consent of the landlord.

In addition, a number of the Company’s individual facility leases are held by the same or related landlords, and some of these leases include cross-default provisions that could cause a default at one facility to trigger a technical default with respect to others, potentially subjecting certain leases and facilities to the various remedies available to the landlords under separate but cross-defaulted leases. The Company is not aware of any defaults as of March 31, 2010.

Regulatory Matters — Laws and regulations governing Medicare and Medicaid programs are complex and subject to interpretation. Compliance with such laws and regulations can be subject to future governmental review and interpretation, as well as significant regulatory action including fines, penalties, and exclusion from certain governmental programs. The Company believes that it is in compliance in all material respects with all applicable laws and regulations.

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.

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

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. The Company had two operations subject to probe review during the three months ended March 31, 2010. The Company anticipates that these probe reviews will increase in frequency in the future. Further, the Company currently has no facilities on prepayment review; however, others may be placed on prepayment review in the future. If a facility fails prepayment review, the facility could then be subject to undergo targeted review, which is a review that targets perceived claims deficiencies. The Company has no facilities that are currently undergoing targeted review.

Other Matters — In March 2007, the Company 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 the Company’s 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.

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

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 79 facilities. In February 2008, the U.S. Attorney contacted two additional current employees. 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 and respond to requests for information as they are received relative to the investigation.

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.

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

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 is 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 March 31, 2010 and December 31, 2009, respectively. Revenue from reimbursements under the Medicare and Medicaid programs accounted for approximately 76% and 75% of the Company’s revenue for the three months ended March 31, 2010 and 2009, 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, the Service Center or the Captive are operated by the same entity. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and related notes included in the Annual Report.

Overview

We are a provider of skilled nursing and rehabilitative care services through the operation of 79 facilities located in California, Arizona, Texas, Washington, Utah, Colorado and Idaho as of March 31, 2010. All of these facilities are skilled nursing facilities, other than three 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 March 31, 2010, we owned 49 of our facilities and operated an additional 30 facilities under long-term lease arrangements, and had options to purchase 8 of those 30 facilities. The following table summarizes our facilities and operational skilled nursing, assisted living and independent living beds by ownership status as of March 31, 2010:

						Leased				Leased
						(with a				(without a
						Purchase				Purchase
		Owned				Option)				Option)				Total
Number of facilities			49				8				22				79
Percent of total			62.0	%			10.1	%			27.9	%			100	%
Operational skilled nursing, assisted living and independent living beds			5,412				1,042				2,622				9,076
Percent of total			59.6	%			11.5	%			28.9	%			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

On January 1, 2010, we purchased two skilled nursing facilities in Idaho for approximately $7.6 million, which was paid in cash. This acquisition added 158 operational beds to our operations. We also entered into a separate operations transfer agreement with the prior owner as part of this transaction.

On May 1, 2010, we purchased two skilled nursing facilities in Texas for approximately $8.3 million, which was paid in cash. This acquisition added approximately 284 operational beds to our operation. We also entered into a separate operations transfer agreement with the prior owner as part of this transaction.

On May 1, 2010, we purchased a home health and hospice operation in Idaho for approximately $2.7 million, which was paid in cash. This acquisition did not impact our total operational bed count. We also entered into a separate operations transfer agreement with the prior owner as part of this transaction.

See further discussion of facility acquisitions in Note 6 above.

Facility Acquisition History

		December 31,																																												March 31,
		1999				2000				2001				2002				2003				2004				2005				2006				2007				2008				2009				2010
Cumulative number of facilities			5				13				19				24				41				43				46				57				61				63				77				79
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				8,948				9,076

The following table sets forth the location of our facilities and the number of operational beds located at our facilities as of March 31, 2010:

		CA				AZ				TX				UT				CO				WA				ID				Total
Number of facilities			33				12				15				9				4				3				3				79
Operational skilled nursing, assisted living and independent living beds			3,708				1,818				1,811				967				248				278				246				9,076

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
		March 31,
		2010				2009
Skilled Mix:
Days			26.0	%			25.2	%
Revenue			49.8	%			48.6	%
Quality Mix:
Days			37.7	%			38.0	%
Revenue			58.4	%			58.2	%

Occupancy. We define occupancy as the ratio of actual patient days (one patient day equals one resident occupying one bed for one day) during any measurement period to the number of beds in facilities which are available for occupancy during the measurement period. The number of licensed and independent living beds in a skilled nursing, assisted living or independent living facility that are actually operational and available for occupancy may be less than the total official licensed bed capacity. This sometimes occurs due to the permanent dedication of bed space to alternative purposes, such as enhanced therapy treatment space or other desirable uses calculated to improve service offerings and/or operational efficiencies in a facility. In some cases, three- and four-bed wards have been reduced to two-bed rooms for resident comfort, and larger wards have been reduced to conform to changes in Medicare requirements. These beds are seldom expected to be placed back into service. We define occupancy in operational beds as the ratio of actual patient days during any measurement period to the number of available patient days for that period. We believe that reporting occupancy based on operational beds is consistent with industry practices and provides a more useful measure of actual occupancy performance from period to period.

The following table summarizes our overall occupancy statistics for the periods indicated:

		Three Months Ended
		March 31,
		2010				2009
Occupancy:
Operational beds at end of period			9,076				7,994
Available patient days			816,840				710,000
Actual patient days			649,084				566,619
Occupancy percentage (based on operational beds)			79.5	%			79.8	%

Revenue Sources

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

		Three Months Ended March 31,
		2010								2009
		$				%				$				%
Revenue:
Medicaid		$	61,653				40.0	%		$	52,236				40.1	%
Medicare			51,122				33.2				43,207				33.2
Medicaid-skilled			4,418				2.8				2,282				1.7
Total			117,193				76.0				97,725				75.0
Managed Care			20,569				13.4				17,497				13.4
Private and Other(1)			16,412				10.6				15,063				11.6
Total revenue		$	154,174				100	%		$	130,285				100	%

Critical Accounting Policies Update

There have been no significant changes during the three month period ended March 31, 2010 to the items that we disclosed as our critical accounting policies and estimates in our discussion and analysis of financial condition and results of operations in our Annual Report on Form 10-K filed with the SEC.

Industry Trends

The skilled nursing industry has evolved to meet the growing demand for post-acute and custodial healthcare services generated by an aging population, increasing life expectancies and the trend toward shifting of patient care to lower cost settings. The skilled nursing industry has evolved in recent years, which we believe has led to a number of favorable improvements in the industry, as described below:

	•		Shift of Patient Care to Lower Cost Alternatives. The growth of the senior population in the United States continues to increase healthcare costs, often faster than the available funding from government-sponsored healthcare programs. In response, federal and state governments have adopted cost-containment measures that encourage the treatment of patients in more cost-effective settings such as skilled nursing facilities, for which the staffing requirements and associated costs are often significantly lower than acute care hospitals, inpatient rehabilitation facilities and other post-acute care settings. As a result, skilled nursing facilities are generally serving a larger population of higher-acuity patients than in the past.
	•		Significant Acquisition and Consolidation Opportunities. The skilled nursing industry is large and highly fragmented, characterized predominantly by numerous local and regional providers. We believe this fragmentation provides significant acquisition and consolidation opportunities for us.

	•		Improving Supply and Demand Balance. The number of skilled nursing facilities has declined modestly over the past several years. We expect that the supply and demand balance in the skilled nursing industry will continue to improve due to the shift of patient care to lower cost settings, an aging population and increasing life expectancies.
	•		Increased Demand Driven by Aging Populations and Increased Life Expectancy. As life expectancy continues to increase in the United States and seniors account for a higher percentage of the total U.S. population, we believe the overall demand for skilled nursing services will increase. At present, the primary market demographic for skilled nursing services is primarily individuals age 75 and older. According to U.S. Census Bureau Interim Projections, there will be 46 million people in the United States in 2010 that are over 65 years old. The U.S. Census Bureau estimates this group is one of the fastest growing segments of the United States population and is expected to more than double between 2000 and 2030.

We believe the skilled nursing industry has been and will continue to be impacted by several other trends. The use of long-term care insurance is increasing among seniors as a means of planning for the costs of skilled nursing services. In addition, as a result of increased mobility in society, reduction of average family size, and the increased number of two-wage earner couples, more seniors are looking for alternatives outside the family for their care.

Effects of Changing Prices. Medicare reimbursement rates and procedures are subject to change from time to time, which could materially impact our revenue. Medicare reimburses our skilled nursing facilities under a prospective payment system (PPS) for certain inpatient covered services. Under the PPS, facilities are paid a predetermined amount per patient, per day, based on the anticipated costs of treating patients. The amount to be paid is determined by classifying each patient into a resource utilization group (RUG) category that is based upon each patient’s acuity level. As of January 1, 2006, the RUG categories were expanded from 44 to 53, with increased reimbursement rates for treating higher acuity patients. Should future changes in skilled nursing facility payments reduce rates or increase the standards for reaching certain reimbursement levels, our Medicare revenues could be reduced, with a corresponding adverse impact on our financial condition or results of operation.

The Deficit Reduction Act of 2005 (DRA) added Sec. 1833(g)(5) of the Social Security Act and directed the Centers for Medicare and Medicaid Services to develop a process that allows exceptions for Medicare beneficiaries to therapy caps when continued therapy is deemed medically necessary. The therapy cap exception was reauthorized in a number of subsequent laws, most recently as part of the Patient Protection and Affordable Care Act, which extended the exception from January 1, 2010, to December 31, 2010.

On July 31, 2009, Centers for Medicare and Medicaid Services (CMS) released its final rule on the fiscal year 2010 PPS reimbursement rates for skilled nursing facilities, which resulted in a 2.2% market basket increase. The fiscal year 2010 recalibration of the case mix index (CMI) is expected to correct a forecast error resulting in a 3.3% rate reduction.

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

•

Enhanced CMPs and Escrow Provisions — Effective March 23, 2010, the Affordable Care Act includes expanded civil monetary penalty (CMP) provisions applicable to all Medicare and Medicaid providers. The Affordable Care Act provides for the imposition of CMPs of up to $50,000 and, in some cases, treble damages, for actions relating to alleged false statements to the federal government.

•

Nursing Home Transparency Requirements — In addition to expanded CMP provisions, the Affordable Care Act imposes substantial new transparency requirements for Medicare-participating nursing facilities. Existing law requires Medicare providers to disclose to CMS: (1) any person or entity that owns directly or indirectly an ownership interest of five percent or more in a provider; (2) officers and directors (if a corporation) and partners (if a partnership); and (3) holders of a mortgage, deed of trust, note or other obligation secured by the entity or the property of the entity. The Affordable Care Act expands the information required to be disclosed to include: (4) the facility’s organizational structure; (5) additional information on officers, directors, trustees, and “managing employees” of the facility (including their names, titles, and start dates of services); and (6) information on any “additional disclosable party” of the facility. Beginning March 23, 2010, facilities must have this information available for submission to the Secretary of Health & Human Services, the OIG, the state in which the facility is located, and the state long-term care ombudsman upon request.

•

Suspension of Payments During Pending Fraud Investigations — The Affordable Care Act also provides the federal government with expanded authority to suspend payment if a provider is investigated for allegations or issues of fraud. The Affordable Care Act provides that Medicare and Medicaid payments may be suspended pending a “credible investigation of fraud,” unless the Secretary of Health and Human Services determines that good cause exists not to suspend payments. This suspension authority creates a new mechanism for the federal government to suspend both Medicare and Medicaid payments for allegations of fraud, independent of whether a state exercises its authority to suspend Medicaid payments pending a fraud investigation.

•

Overpayment Reporting and Repayment; Expanded False Claims Act Liability — The Affordable Care Act also enacted several important changes that expand potential liability under the federal False Claims Act. Effective March 23, 2010, the Affordable Care Act provides that overpayments related to services provided to both Medicare and Medicaid beneficiaries must be reported and returned to the applicable payor within the later of sixty days of identification of the overpayment, or the date the corresponding cost report (if applicable) is due. Any overpayment retained after the deadline is considered an “obligation” for purposes of the federal False Claims Act.

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

Historically, adjustments to reimbursement under Medicare have had a significant effect on our revenue. For a discussion of historic adjustments and recent changes to the Medicare program and related reimbursement rates see Risk Factors — Risks Related to Our Business and Industry — “Our revenue could be impacted by federal and state changes to reimbursement and other aspects of Medicaid and Medicare,” “Our future revenue, financial condition and results of operations could be impacted by continued cost containment pressures on Medicaid spending,” “We may not be fully reimbursed for all services for which each facility bills through consolidated billing, which could adversely affect our revenue, financial condition and results of operations” and “Reforms to the U.S. healthcare system will impose new requirements upon us and may lower our reimbursements.“The federal government and state governments continue to focus on efforts to curb spending on healthcare programs such as Medicare and Medicaid. We are not able to predict the outcome of the legislative process. We also cannot predict the extent to which proposals will be adopted or, if adopted and implemented, what effect, if any, such proposals and existing new legislation will have on us. Efforts to impose reduced allowances, greater discounts and more stringent cost controls by government and other payors are expected to continue and could adversely affect our business, financial condition and results of operations.

Results of Operations

The following table sets forth details of our revenue, expenses and earnings as a percentage of total revenue for the periods indicated:

		Three Months Ended
		March 31,
		2010				2009
Revenue			100.0	%			100.0	%
Expenses:
Cost of services (exclusive of facility rent and depreciation and amortization shown separately below)			79.9				80.0
Facility rent—cost of services			2.3				2.8
General and administrative expense			3.7				3.8
Depreciation and amortization			2.6				2.3
Total expenses			88.5				88.9
Income from operations			11.5				11.1
Other income (expense):
Interest expense			(1.5	)			(1.0	)
Interest income			0.1				0.1
Other expense, net			(1.4	)			(0.9	)
Income before provision for income taxes			10.1				10.2
Provision for income taxes			4.0				4.1
Net income			6.1	%			6.1	%

The table below reconciles net income to EBITDA and EBITDAR for the periods presented:

		Three Months Ended
		March 31,
		2010				2009
Consolidated Statement of Income Data:
Net income		$	9,348			$	7,923
Interest expense, net			2,213				1,258
Provision for income taxes			6,126				5,278
Depreciation and amortization			3,955				2,965
EBITDA(1)		$	21,642			$	17,424
Facility rent—cost of services			3,575				3,701
EBITDAR(1)		$	25,217			$	21,125

We believe EBITDA and EBITDAR are useful to investors and other external users of our financial statements in evaluating our operating performance because:

	•		they are widely used by investors and analysts in our industry as a supplemental measure to evaluate the overall operating performance of companies in our industry without regard to items such as interest expense, net and depreciation and amortization, which can vary substantially from company to company depending on the book value of assets, capital structure and the method by which assets were acquired; and
	•		they help investors evaluate and compare the results of our operations from period to period by removing the impact of our capital structure and asset base from our operating results.

We use EBITDA and EBITDAR:

	•		as measurements of our operating performance to assist us in comparing our operating performance on a consistent basis;
	•		to allocate resources to enhance the financial performance of our business;
	•		to evaluate the effectiveness of our operational strategies; and
	•		to compare our operating performance to that of our competitors.

We typically use EBITDA and EBITDAR to compare the operating performance of each skilled nursing and assisted living facility. EBITDA and EBITDAR are useful in this regard because they do not include such costs as net interest expense, income taxes, depreciation and amortization expense, and, with respect to EBITDAR, facility rent — cost of services, which may vary from period-to-period depending upon various factors, including the method used to finance facilities, the amount of debt that we have incurred, whether a facility is owned or leased, the date of acquisition of a facility or business, or the tax law of the state in which a business unit operates. As a result, we believe that the use of EBITDA and EBITDAR provide a meaningful and consistent comparison of our business between periods by eliminating certain items required by GAAP.

We also establish compensation programs and bonuses for our facility level employees that are partially based upon the achievement of EBITDAR targets.

Despite the importance of these measures in analyzing our underlying business, designing incentive compensation and for our goal setting, EBITDA and EBITDAR are non-GAAP financial measures that have no standardized meaning defined by GAAP. Therefore, our EBITDA and EBITDAR measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for analysis of our results as reported in accordance with GAAP. Some of these limitations are:

	•		they do not reflect our current or future cash requirements for capital expenditures or contractual commitments;
	•		they do not reflect changes in, or cash requirements for, our working capital needs;
	•		they do not reflect the net interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;
	•		they do not reflect any income tax payments we may be required to make;
	•		although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and EBITDAR do not reflect any cash requirements for such replacements; and
	•		other companies in our industry may calculate these measures differently than we do, which may limit their usefulness as comparative measures.

We compensate for these limitations by using them only to supplement net income on a basis prepared in accordance with GAAP in order to provide a more complete understanding of the factors and trends affecting our business.

Management strongly encourages investors to review our condensed consolidated financial statements in their entirety and to not rely on any single financial measure. Because these non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies’ non-GAAP financial measures having the same or similar names. For information about our financial results as reported in accordance with GAAP, see our condensed consolidated financial statements and related notes included elsewhere in this document.

Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009

		Three Months Ended
		March 31,
		2010				2009				Change				% Change
		(Dollars in thousands)
Total Facility Results:
Revenue		$	154,174			$	130,285			$	23,889				18.3	%
Number of facilities at period end			79				70				9				12.9	%
Actual patient days			649,084				566,619				82,465				14.6	%
Occupancy percentage — Operational beds			79.5	%			79.8	%							(0.3	)%
Skilled mix by nursing days			26.0	%			25.2	%							0.8	%
Skilled mix by nursing revenue			49.8	%			48.6	%							1.2	%

		Three Months Ended
		March 31,
		2010				2009				Change				% Change
		(Dollars in thousands)
Same Facility Results(1):
Revenue		$	121,150			$	116,304			$	4,846				4.2	%
Number of facilities at period end			56				56				—				—	%
Actual patient days			485,501				496,857				(11,356	)			(2.3	)%
Occupancy percentage — Operational beds			82.8	%			82.3	%							0.5	%
Skilled mix by nursing days			29.5	%			26.8	%							2.7	%
Skilled mix by nursing revenue			54.0	%			50.4	%							3.6	%

		Three Months Ended
		March 31,
		2010				2009				Change				% Change
		(Dollars in thousands)
Transitioning Facility Results(2):
Revenue		$	8,164			$	8,239			$	(75	)			(0.9	)%
Number of facilities at period end			6				6				—				—	%
Actual patient days			39,977				38,792				1,185				3.1	%
Occupancy percentage — Operational beds			69.7	%			67.7	%							2.0	%
Skilled mix by nursing days			18.9	%			19.3	%							(0.4	)%
Skilled mix by nursing revenue			40.3	%			44.6	%							(4.3	)%

		Three Months Ended
		March 31,
		2010				2009				Change				% Change
		(Dollars in thousands)
Recently Acquired Facility Results(3):
Revenue		$	24,860			$	5,742			$	19,118				NM	%
Number of facilities at period end			17				7				10				NM	%
Actual patient days			123,606				30,970				92,636				NM	%
Occupancy percentage — Operational beds			71.4	%			63.3	%							8.1	%
Skilled mix by nursing days			15.0	%			8.1	%							6.9	%
Skilled mix by nursing revenue			31.8	%			17.4	%							14.4	%