ENSG 6.30.14 10Q
Table of Contents

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2014
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from                      to                     .
Commission file number: 001-33757
__________________________
THE ENSIGN GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)
Delaware
33-0861263
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
27101 Puerta Real, Suite 450
Mission Viejo, CA 92691
(Address of Principal Executive Offices and Zip Code)
(949) 487-9500
(Registrant’s Telephone Number, Including Area Code)
N/A
(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)
_____________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
As of August 4, 2014, 22,411,766 shares of the registrant’s common stock were outstanding.
 
 
 
 
 


THE ENSIGN GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2014
TABLE OF CONTENTS
 
 
 
 
Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013
 
 
Condensed Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 Exhibit 101

2
Table of Contents

Part I. Financial Information

Item 1.        Financial Statements
THE ENSIGN GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par values)
(Unaudited)
 
June 30,
2014
 
December 31,
2013
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
22,393

 
$
65,755

Restricted cash—current
6,400

 
—

Accounts receivable—less allowance for doubtful accounts of $17,909 and $16,540 at June 30, 2014 and December 31, 2013, respectively
124,441

 
111,370

Investments—current
4,451

 
5,511

Prepaid income taxes
10,217

 
9,915

Prepaid expenses and other current assets
7,657

 
9,213

Deferred tax asset—current
8,633

 
9,232

Total current assets
184,192

 
210,996

Property and equipment, net
116,784

 
479,770

Insurance subsidiary deposits and investments
17,681

 
16,888

Escrow deposits
1,880

 
1,000

Deferred tax asset
10,930

 
4,464

Restricted cash—less current portion
1,819

 
—

Restricted and other assets
8,169

 
9,804

Intangible assets, net
6,711

 
5,718

Goodwill
24,326

 
23,935

Other indefinite-lived intangibles
8,340

 
7,740

Total assets
$
380,832

 
$
760,315

Liabilities and equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
26,508

 
$
23,793

Accrued wages and related liabilities
44,590

 
40,093

Accrued self-insurance liabilities—current
14,771

 
15,461

Other accrued liabilities
23,697

 
25,698

Current maturities of long-term debt
—

 
7,411

Total current liabilities
109,566

 
112,456

Long-term debt—less current maturities
—

 
251,895

Accrued self-insurance liabilities—less current portion
32,792

 
33,642

Fair value of interest rate swap
—

 
1,828

Deferred rent and other long-term liabilities
3,162

 
3,237

Total liabilities
145,520

 
403,058

 
 
 
 
Commitments and contingencies (Note 17)

 

Equity:
 
 
 
Ensign Group, Inc. stockholders' equity:
 
 
 
Common stock; $0.001 par value; 75,000 shares authorized; 22,777 and 22,382 shares issued and outstanding at June 30, 2014, respectively, and 22,580 and 22,113 shares issued and outstanding at December 31, 2013, respectively
23

 
22

Additional paid-in capital
107,876

 
101,364

Retained earnings (Note 2)
128,721

 
257,502

Common stock in treasury, at cost, 203 and 237 shares at June 30, 2014 and December 31, 2013, respectively
(1,509
)
 
(1,680
)
Accumulated other comprehensive loss
—

 
(1,112
)
Total Ensign Group, Inc. stockholders' equity
235,111

 
356,096

Non-controlling interest
201

 
1,161

Total equity
235,312

 
357,257

Total liabilities and equity
$
380,832

 
$
760,315

See accompanying notes to condensed consolidated financial statements.

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Table of Contents

THE ENSIGN GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
 
Three Months Ended
June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
250,043

 
$
220,086

 
$
489,696

 
$
438,287

Expense:
 
 
 
 
 
 
 
Cost of services (exclusive of facility rent, general and administrative and depreciation and amortization expenses shown separately below)
202,057

 
175,913

 
391,795

 
351,974

U.S. Government inquiry settlement (Note 17)
—

 
—

 
—

 
33,000

Facility rent—cost of services
8,283

 
3,338

 
11,832

 
6,652

General and administrative expense
18,257

 
8,872

 
31,414

 
17,720

Depreciation and amortization
7,804

 
8,671

 
16,666

 
16,403

Total expenses
236,401

 
196,794

 
451,707

 
425,749

Income from operations
13,642

 
23,292

 
37,989

 
12,538

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(8,720
)
 
(3,145
)
 
(12,083
)
 
(6,260
)
Interest income
134

 
129

 
293

 
222

Other expense, net
(8,586
)
 
(3,016
)
 
(11,790
)
 
(6,038
)
Income before provision for income taxes
5,056

 
20,276

 
26,199

 
6,500

Provision for income taxes
3,523

 
7,846

 
11,625

 
4,833

Income from continuing operations
1,533

 
12,430

 
14,574

 
1,667

Loss from discontinued operations, net of income tax benefit of $0 for both the three and six months ended June 30, 2014 and $7 and $1,119 for the three and six months ended June 30, 2013, respectively (Note 4)
—

 
(26
)
 
—

 
(1,774
)
Net income (loss)
1,533

 
12,404

 
14,574


(107
)
Less: net (loss) income attributable to noncontrolling interests
(474
)

37


(959
)

(327
)
Net income attributable to The Ensign Group, Inc.
$
2,007

 
$
12,367

 
$
15,533

 
$
220

Amounts attributable to The Ensign Group, Inc.:
 
 
 
 
 
 
 
Income from continuing operations attributable to The Ensign Group, Inc.
$
2,007

 
$
12,393

 
$
15,533

 
$
1,994

Loss from discontinued operations, net of income tax
—

 
(26
)
 
—

 
(1,774
)
Net income attributable to The Ensign Group, Inc.
$
2,007

 
$
12,367

 
$
15,533

 
$
220

Net income per share:
 
 
 
 
 
 
 
Basic:


 


 
 
 
 
Income from continuing operations attributable to The Ensign Group, Inc.
$
0.09

 
$
0.57

 
$
0.70

 
$
0.09

Loss from discontinued operations
$
—

 
$
—

 
$
—

 
$
(0.08
)
Net income attributable to The Ensign Group, Inc.
$
0.09

 
$
0.57

 
$
0.70

 
$
0.01

Diluted:


 


 
 
 
 
Income from continuing operations attributable to The Ensign Group, Inc.
$
0.09

 
$
0.55

 
$
0.68

 
$
0.09

Loss from discontinued operations
$
—

 
$
—

 
$
—

 
$
(0.08
)
Net income attributable to The Ensign Group, Inc.
$
0.09

 
$
0.55

 
$
0.68

 
$
0.01

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
22,259

 
21,859

 
22,214

 
21,814

Diluted
22,960

 
22,321

 
22,915

 
22,267

 
 
 
 
 
 
 
 
Dividends per share
$
0.070

 
$
0.065

 
$
0.140

 
$
0.130


See accompanying notes to condensed consolidated financial statements.

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

 
Three Months Ended
June 30,
 
Six Months Ended
June 30 ,
 
2014
 
2013
 
2014
 
2013
Net income (loss)
$
1,533

 
$
12,404

 
$
14,574

 
$
(107
)
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Unrealized (loss) gain on interest rate swap, net of income tax
expense (benefit) of $0 and ($78) for the three and six months ended
June 30, 2014, respectively, and ($255) and ($359) for the three and
six months ended June 30, 2013, respectively.
(30
)
 
394

 
89

 
559

Reclassification adjustment on termination of interest rate swap, net of income tax benefit of $638 for the three and six months ended June 30, 2014.
1,023

 
—

 
1,023

 
—

Comprehensive income
2,526

 
12,798

 
15,686

 
452

Less: net (loss) income attributable to noncontrolling interests
(474
)
 
37

 
(959
)
 
(327
)
Comprehensive income attributable to The Ensign Group, Inc.
$
3,000

 
$
12,761

 
$
16,645

 
$
779


See accompanying notes to condensed consolidated financial statements.


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THE ENSIGN GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended
June 30 ,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income (loss)
$
14,574

 
$
(107
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

Loss from sale of discontinued operations (Note 4)
—

 
2,837

U.S. Government inquiry accrual (Note 17)
—

 
33,000

Depreciation and amortization
16,666

 
16,432

Amortization of deferred financing fees and debt discount
391

 
411

Deferred income taxes
(543
)
 
(95
)
Provision for doubtful accounts
6,634

 
5,527

Share-based compensation
2,383

 
1,945

Excess tax benefit from share-based compensation
(1,932
)
 
(908
)
Loss on extinguishment of debt
4,067

 
—

Loss on termination of interest rate swap
1,661

 
—

Gain on sale of equity method investment
—

 
(380
)
Loss on disposition of property and equipment
4

 
1,129

Change in operating assets and liabilities
 
 
 
Accounts receivable
(19,712
)
 
(18,776
)
Prepaid income taxes
(329
)
 
(6,942
)
Prepaid expenses and other current assets
1,605

 
1,577

Insurance subsidiary deposits and investments
267

 
(153
)
Accounts payable
3,733

 
(5,331
)
Accrued wages and related liabilities
4,521

 
(1,336
)
Other accrued liabilities
3,233

 
(1,658
)
Accrued self-insurance
(72
)
 
(291
)
Deferred rent liability
(75
)
 
(274
)
Net cash provided by operating activities
37,076

 
26,607

Cash flows from investing activities:
 
 
 
Purchase of property and equipment
(32,577
)
 
(13,405
)
Cash payment for business acquisitions
(38,442
)
 
(39,310
)
Cash payment for asset acquisitions
(7,513
)
 
—

Escrow deposits
(1,880
)
 
(4,506
)
Escrow deposits used to fund business acquisitions
1,000

 
4,635

Increase in restricted cash
(8,219
)
 
—

Cash proceeds on sale of urgent care franchising business, net of note receivable
—

 
3,610

Cash proceeds on sale of equity method investment
—

 
1,600

Cash proceeds from the sale of property and equipment
1

 
641

Restricted and other assets
226

 
(156
)
Net cash used in investing activities
(87,404
)
 
(46,891
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of debt (Note 15)
340,677

 
10,000

Payments on long-term debt
(241,171
)
 
(3,581
)
Issuance of treasury stock upon exercise of options
171

 
36

Cash retained by CareTrust at separation (Note 2)
(78,731
)
 
—

Issuance of common stock upon exercise of options
2,197

 
1,901

Dividends paid
(3,166
)
 
(1,436
)
Excess tax benefit from share-based compensation
1,941

 
908

Prepayment penalty on early retirement of debt
(2,069
)
 
—

Payments of deferred financing costs
(12,883
)
 
(730
)
Net cash provided by financing activities
6,966

 
7,098

Net decrease in cash and cash equivalents
(43,362
)
 
(13,186
)
Cash and cash equivalents beginning of period
65,755

 
40,685

Cash and cash equivalents end of period
$
22,393

 
$
27,499


See accompanying notes to condensed consolidated financial statements.

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THE ENSIGN GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(In thousands)
(Unaudited)

 
Six Months Ended
June 30 ,
 
2014
 
2013
Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
6,976

 
$
6,267

Income taxes
$
13,683

 
$
9,890

Non-cash financing and investing activity:
 
 
 

Accrued capital expenditures
$
676

 
$
577

Note receivable on sale of urgent care franchising business
$
—

 
$
4,000


See accompanying notes to condensed consolidated financial statements.


7
Table of Contents

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

1. DESCRIPTION OF BUSINESS

The Company - The Ensign Group, Inc., through its subsidiaries (collectively, Ensign or the Company), provides skilled nursing and rehabilitative care services through the operation of 125 facilities, ten home health and eight hospice operations, twelve urgent care centers and a mobile x-ray and diagnostic company as of June 30, 2014, located in Arizona, California, Colorado, Idaho, Iowa, Nebraska, Nevada, Oregon, Texas, Utah, Washington, and Wisconsin. The Company's operations, each of which strives to be the operation of choice in the community it serves, provide a broad spectrum of skilled nursing, assisted living, home health and hospice, mobile x-ray and diagnostic, and urgent care services. The Company's facilities have a collective capacity of approximately 13,800 operational skilled nursing, assisted living and independent living beds. As of June 30, 2014, the Company owned 8 of its 125 facilities and operated an additional 117 facilities through long-term lease arrangements, and had options to purchase two of those 117 facilities. As of December 31, 2013, the Company owned 96 of its 119 facilities and operated an additional 23 facilities through long-term lease arrangements, and had options to purchase two of those 23 facilities. See Note 2, Spin-Off of Real Estate Assets Through a Real Estate Investment Trust, for the change in ownership profile.
The Ensign Group, Inc. is a holding company with no direct operating assets, employees or revenue. All of the Company’s operations are operated by separate, 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 June 30, 2014 and for the three and six months ended June 30, 2014 and 2013 (collectively, the Interim Financial Statements), are unaudited. Certain information and note 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 financial statements and notes thereto for the year ended December 31, 2013 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. SPIN-OFF OF REAL ESTATE ASSETS THROUGH A REAL ESTATE INVESTMENT TRUST
On June 1, 2014, the Company completed the separation of its healthcare business and its real estate business into two publicly traded companies through a tax-free distribution of all of the outstanding shares of common stock of CareTrust REIT, Inc. (CareTrust) to Ensign stockholders on a pro rata basis (the Spin-Off). Ensign stockholders received one share of CareTrust common stock for each share of Ensign common stock held at the close of business on May 22, 2014, the record date for the Spin-Off. The Spin-Off was effective from and after June 1, 2014, with shares of CareTrust common stock distributed on June 2, 2014. CareTrust is listed on the NASDAQ Global Select Market (NASDAQ) and trades under the ticker symbol “CTRE.”
The Company received a private letter ruling from the Internal Revenue Service (the IRS) substantially to the effect that the Spin-Off will qualify as a tax-free transaction for U.S. federal income tax purposes. The private letter ruling relies on certain facts, representations, assumptions and undertakings. The Company also received opinions from its advisors as to the satisfaction of certain requirements for the tax-free treatment of the Spin-Off, and an opinion of counsel that, commencing with CareTrust's taxable year ending on December 31, 2014, CareTrust has been organized in conformity with the requirements for qualification as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended, and its proposed method of operation will enable it to meet the requirements for qualification and taxation as a REIT.

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



Prior to the Spin-Off, the Company entered into a Separation and Distribution Agreement with CareTrust, setting forth the mechanics of the Spin-Off, certain organizational matters and other ongoing obligations of the Company and CareTrust. The Company and CareTrust or their respective subsidiaries, as applicable, also entered into a number of other agreements to govern the relationship between CareTrust and the Company after the Spin-Off.
Immediately before the Spin-Off, on May 30, 2014, while CareTrust was a wholly-owned subsidiary of the Company, CareTrust raised $260,000 of debt financing (The Bond). CareTrust also entered into the Fifth Amended and Restated Loan Agreement, with General Electric Capital Corporation (GECC), which consisted of an additional loan of $50,676 to an aggregate principal amount of $99,000 (the Ten Project Note). The Ten Project Note and The Bond were assumed by CareTrust in connection with the Separation and Distribution Agreement. CareTrust transferred $220,752 to the Company, a portion of which the Company used to retire $208,635 of long-term debt prior to maturity. The remaining portion was used to pay prepayment penalty and other third party fees relating to the early retirement of outstanding debt. The amount retained by the Company of $8,219 was recorded as restricted cash, of which $6,400 is classified as current assets and $1,819 is classified as non-current assets. The amount represents a portion of the proceeds received from CareTrust in connection with the Separation and Distribution Agreement that the Company intends to use to pay up to eight regular quarterly dividend payments. There was no restricted cash as of December 31, 2013. The remaining cash of $78,731 that CareTrust retained on the Spin-Off date was transferred to CareTrust as part of the assets and liabilities contributed to CareTrust in connection with the Spin-Off.
As of March 31, 2014, the Company operated 120 facilities. Prior to the Spin-Off, the Company separated the healthcare operations from the independent living operations at two locations, resulting in a total of 122 facilities. The Company contributed to CareTrust the assets and liabilities associated with all of the 94 real property and three independent living facilities that CareTrust now operates that were previously owned by the Company. The results of the three independent living facilities that were transferred to CareTrust in connection with the Spin-Off were not material to the Company's three and six months ended June 30, 2014 or 2013. The assets and liabilities were contributed to CareTrust based on their historical carrying values, which were as follows (in thousands):
Cash and cash equivalents
 
$
78,731

Other current assets
 
34

Property and equipment, net
 
421,846

Deferred financing costs
 
11,088

Accounts payable and accrued expenses
 
(4,971
)
Current deferred tax liability
 
(125
)
Deferred tax liability
 
(5,925
)
Current maturities of long-term debt
 
(2,342
)
Long-term debt—less current maturities
 
(357,171
)
Net contribution
 
$
141,165

As a result of the Spin-Off, CareTrust owns all of the 94 real property and three independent living facilities that were transferred in connection with the Spin-Off. The Company leases the 94 real property from CareTrust under eight “triple-net” master lease agreements (collectively, the Master Leases). The Company continues to operate the skilled nursing, assisted living and independent living facilities that are leased from CareTrust pursuant to the Master Leases. The Master Leases consist of multiple leases, each with its own pool of properties that has varying maturities and diversity in property geography. Under each Master Lease, the Company’s individual subsidiaries that operate those properties subject to such Master Lease are the tenants and CareTrust’s individual subsidiaries that own the properties are the landlords. The Company guarantees the obligations of the tenants under the Master Leases. If a tenant defaults under a Master Lease with respect to any property, CareTrust is entitled to exercise remedies under such Master Lease as to all properties covered by such Master Lease as though all such properties were in default. In addition, each Master Lease with the tenant contains cross-default provisions that results in a default under all of the Master Leases if a default occurs under any Master Lease.
Commencing in the third year, the rent structure under the Master Leases includes a fixed component, subject to annual escalation equal to the lesser of (1) the percentage change in the Consumer Price Index (but not less than zero) or (2) 2.5%. Annual rent expense under the Master Lease will be approximately $56,000 during each of the first two years of the Master Leases. In addition to rent, the Company is required to pay the following: (1) all impositions and taxes levied on or with respect to the leased properties (other than taxes on the income of the lessor); (2) all utilities and other services necessary or appropriate for the

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



leased properties and the business conducted on the leased properties; (3) all insurance required in connection with the leased properties and the business conducted on the leased properties; (4) all facility maintenance and repair costs; and (5) all fees in connection with any licenses or authorizations necessary or appropriate for the leased properties and the business conducted on the leased properties.
Each Master Lease has a term ranging from 12 to 19 years. At the Company’s option, the Master Leases may be extended for two or three five-year renewal terms beyond the initial term, on the same terms and conditions. If the Company elects to renew the term of a Master Lease, the renewal will be effective as to all, but not less than all, of the leased property then subject to the Master Lease. The extension of the term of any of the Master Leases will be subject to the following conditions: (1) no event of default under any of the Master Leases having occurred and being continuing; and (2) the tenants providing timely notice of their intent to renew. The term of the Master Leases will be subject to termination prior to the expiration of the then current term upon default by the tenants in their obligations, if not cured within any applicable cure periods set forth in the Master Leases.
The Company does not have the ability to terminate the obligations under a Master Lease prior to its expiration without CareTrust’s consent. If a Master Lease is terminated prior to its expiration other than with CareTrust’s consent, the Company may be liable for damages and incur charges such as continued payment of rent through the end of the lease term and maintenance and repair costs for the leased property.
Among other things, under the Master Leases, the Company must maintain compliance with specified financial covenants measured on a quarterly basis, including a portfolio coverage ratio and a minimum rent coverage ratio. The Master Leases also include certain reporting, legal and authorization requirements. As of June 30, 2014, we were in compliance with the Master Leases covenants.
The Company and CareTrust also entered into an Opportunities Agreement, which grants CareTrust the right to match any offer from a third party to finance the acquisition or development of any healthcare or senior-living facility by the Company or any of its affiliates for a period of one year following the Spin-Off. In addition, this agreement requires CareTrust to provide the Company, subject to certain exceptions, a right to either purchase and operate, or lease and operate, the facilities included in any portfolio of five or fewer healthcare or senior living facilities presented to the Company during the first year following the Spin-Off; provided that the portfolio is not subject to an existing lease with an operator or manager that has a remaining term of more than one year, and is not presented to the Company by or on behalf of another operator seeking lease or other financing. If the Company elects to lease and operate such a property or portfolio, the lease would be on substantially the same terms as the Master Leases.
The Company incurred transaction costs of $7,281 and $8,871 for the three and six months ended June 30, 2014, respectively, associated with the Spin-Off, which are included in general and administrative expenses within the condensed consolidated statements of income. There were no transaction costs incurred for the three and six months ended June 30, 2013.

3. 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, home health and hospice operations, urgent care centers and related ancillary services. All intercompany transactions and balances have been eliminated in consolidation. The Company presents noncontrolling interest within the equity section of its consolidated balance sheets. The Company presents the amount of consolidated net income that is attributable to The Ensign Group, Inc. and the noncontrolling interest in its consolidated statements of income.
The consolidated financial statements include the accounts of all entities controlled by the Company through its ownership of a majority voting interest and the accounts of any variable interest entities (VIEs) where the Company is subject to a majority of the risk of loss from the VIE's activities, or entitled to receive a majority of the entity's residual returns, or both. The Company assesses the requirements related to the consolidation of VIEs, including a qualitative assessment of power and economics that considers which entity has the power to direct the activities that "most significantly impact" the VIE's economic performance and has the obligation to absorb losses of, or the right to receive benefits that could be potentially significant to, the VIE. The Company's relationship with variable interest entities was not material at June 30, 2014.

On March 25, 2013, the Company agreed to terms to sell Doctors Express (DRX), a national urgent care franchise system. The asset sale was effective on April 15, 2013. The results of operations for DRX have been classified as discontinued operations for all periods presented (see Note 4, Discontinued Operations) in the accompanying Interim Financial Statements. In addition,

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


the results of operations of DRX and the loss or impairment related to this divestiture have been classified as discontinued operations in the accompanying condensed consolidated statements of operations for all periods presented.
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, general and professional liability, worker’s compensation, and healthcare claims included in accrued self-insurance liabilities, 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 providing skilled nursing, assisted living, home health and hospice, urgent care and related ancillary services. The Company’s single reportable segment is made up of several individual operating segments grouped together principally based on their geographical locations within the United States. Based on the similar economic and other characteristics of each of the operating segments, management believes the Company meets the criteria for aggregating its operating segments into a single reportable segment.

Fair Value of Financial Instruments —The Company’s financial instruments consist principally of cash and cash equivalents, debt security investments, accounts receivable, insurance subsidiary deposits, accounts payable and borrowings. The Company believes all of the financial instruments’ recorded values approximate fair values because of their nature or respective short durations.
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 healthcare services to residents and is recognized on the date services are provided at amounts billable to the individual. For 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 70.2% and 70.7% of the Company’s revenue for the three and six months ended June 30, 2014, respectively, and 72.7% and 72.8% for the three and six months ended June 30, 2013, respectively. The Company records revenue from these governmental and managed care programs as services are performed at their expected net realizable amounts under these programs. The Company’s revenue from governmental and managed care programs is subject to audit and retroactive adjustment by governmental and third-party agencies. Consistent with healthcare industry accounting practices, any changes to these governmental revenue estimates are recorded in the period the change or adjustment becomes known based on final settlement. The Company recorded retroactive adjustments to revenue which were not material to the Company's consolidated revenue for the three and six months ended June 30, 2014 and 2013.
The Company’s service specific revenue recognition policies are as follows:
Skilled Nursing Revenue
The Company’s revenue is derived primarily from providing long-term healthcare services to residents and is recognized on the date services are provided at amounts billable to individual residents. For residents under reimbursement arrangements with third-party payors, including Medicaid, Medicare and private insurers, revenue is recorded based on contractually agreed-upon amounts on a per patient, daily basis. The Company records revenue from private pay patients, at the agreed-upon rate, as services are performed.
Home Health Revenue
Medicare Revenue
Net service revenue is recorded under the Medicare prospective payment system based on a 60-day episode payment rate that is subject to adjustment based on certain variables including, but not limited to: (a) an outlier payment if patient care was unusually costly; (b) a low utilization payment adjustment if the number of visits was fewer than five; (c) a partial payment if the patient transferred to another provider or the Company received a patient from another provider before completing the episode; (d) a payment adjustment based upon the level of therapy services required; (e) the number of episodes of care provided to a patient, regardless of whether the same home health provider provided care for the entire series of episodes; (f) changes in the

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


base episode payments established by the Medicare Program; (g) adjustments to the base episode payments for case mix and geographic wages; and (h) recoveries of overpayments.
The Company makes adjustments to Medicare revenue on completed episodes to reflect differences between estimated and actual payment amounts, an inability to obtain appropriate billing documentation or authorizations acceptable to the payor and other reasons unrelated to credit risk. Therefore, the Company believes that its reported net service revenue and patient accounts receivable will be the net amounts to be realized from Medicare for services rendered.
In addition to revenue recognized on completed episodes, the Company also recognizes a portion of revenue associated with episodes in progress. Episodes in progress are 60-day episodes of care that begin during the reporting period, but were not completed as of the end of the period. Thereby, estimating revenue and recognizing it on a daily basis.
Non-Medicare Revenue
Episodic Based Revenue - The Company recognizes revenue in a similar manner as it recognizes Medicare revenue for episodic-based rates that are paid by other insurance carriers, including Medicare Advantage programs; however, these rates can vary based upon the negotiated terms.
Non-episodic Based Revenue - Revenue is recorded on an accrual basis based upon the date of service at amounts equal to its established or estimated per-visit rates, as applicable.
Hospice Revenue
Revenue is recorded on an accrual basis based upon the date of service at amounts equal to the estimated payment rates. The estimated payment rates are daily rates for each of the levels of care the Company delivers. The Company makes adjustments to revenue for an inability to obtain appropriate billing documentation or authorizations acceptable to the payor and other reasons unrelated to credit risk. Additionally, as Medicare hospice revenue is subject to an inpatient cap limit and an overall payment cap, the Company monitors its provider numbers and estimates amounts due back to Medicare if a cap has been exceeded. The Company records these adjustments as a reduction to revenue and increases other accrued liabilities.
Accounts Receivable and Allowance for Doubtful Accounts — Accounts receivable consist primarily of amounts due from Medicare and Medicaid programs, other government programs, managed care health plans and private payor sources. Estimated provisions for doubtful accounts are recorded to the extent it is probable that a portion or all of a particular account will not be collected.
In evaluating the collectability of accounts receivable, the Company considers a number of factors, including the age of the accounts, changes in collection patterns, the composition of patient accounts by payor type and the status of ongoing disputes with third-party payors. On an annual basis, the historical collection percentages are reviewed by payor and by state and are updated to reflect the recent collection experience of the Company. In order to determine the appropriate reserve rate percentages which ultimately establish the allowance, the Company analyzes historical cash collection patterns by payor and by state. The percentages applied to the aged receivable balances are based on the Company’s historical experience and time limits, if any, for managed care, Medicare, Medicaid and other payors. The Company periodically refines its estimates of the allowance for doubtful accounts based on experience with the estimation process and changes in circumstances.
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 57 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 asset impairment during the three and six months ended June 30, 2014 or 2013.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Intangible Assets and Goodwill — Definite-lived intangible assets consist primarily of favorable leases, lease acquisition costs, patient base, facility trade names and customer relationships. Favorable leases and lease acquisition costs are amortized over the life of the lease of the facility, typically ranging from ten to 20 years. Patient base is amortized over a period of four to eight months, depending on the classification of the patients and the level of occupancy in a new acquisition on the acquisition date. Trade names at facilities are amortized over 30 years and customer relationships are amortized over 20 years.
The Company's indefinite-lived intangible assets consist of trade names and home health and hospice Medicare licenses. The Company tests indefinite-lived intangible assets for impairment on an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount of the intangible asset may not be recoverable.
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 operations. The Company performs its annual test for impairment during the fourth quarter of each year. See further discussion at Note 11, Goodwill and Other Indefinite-Lived Intangible Assets.
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 January 1, 2013, the combined self-insured retention was $500 per claim, subject to an additional one-time deductible of $1,000 for California facilities and a separate, one-time, deductible of $750 for non-California facilities. 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 $5,000 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 aforementioned blanket aggregate applicable to its other 118 facilities.
The self-insured retention and deductible limits for general and professional liability and California workers' compensation are self-insured through the Captive, the related assets and liabilities of which are included in the accompanying condensed consolidated balance sheets. The Captive is subject to certain statutory requirements as an insurance provider. These requirements include, but are not limited to, maintaining statutory capital. The Company’s policy is to accrue amounts equal to the actuarially estimated costs to settle open claims of insureds, as well as an estimate of the cost of insured claims that have been incurred but not reported. The Company develops information about the size of the ultimate claims based on historical experience, current industry information and actuarial analysis, and evaluates the estimates for claim loss exposure on a quarterly basis. Accrued general liability and professional malpractice liabilities on an undiscounted basis, net of anticipated insurance recoveries, were $28,574 and $29,204 as of June 30, 2014 and December 31, 2013, respectively.
 The Company’s operating subsidiaries are self-insured for workers’ compensation liability in California. To protect itself against loss exposure in California with this policy, the Company has purchased individual stop-loss insurance coverage that insures individual claims that exceed $500 for each claim. In Texas, the operating subsidiaries have elected non-subscriber status for workers’ compensation claims and, effective February 1, 2011, the Company has purchased individual stop-loss coverage that insures individual claims that exceed $750 for each claim. The Company’s operating subsidiaries in other states have third party guaranteed cost coverage. In California and Texas, the Company accrues amounts equal to the estimated costs to settle open claims, as well as an estimate of the cost of claims that have been incurred but not reported. The Company uses actuarial valuations to estimate the liability based on historical experience and industry information. Accrued workers’ compensation liabilities are recorded on an undiscounted basis in the accompanying condensed consolidated balance sheets and were $14,297 and $13,883 as of June 30, 2014 and December 31, 2013, respectively.
In addition, the Company has recorded an asset and equal liability of $1,814 and $3,280 at June 30, 2014 and December 31, 2013, respectively, in order to present the ultimate costs of malpractice and workers' compensation claims and the anticipated insurance recoveries on a gross basis.
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 $300 for each covered person with an aggregate individual stop loss deductible of $75. The Company’s accrued liability under these plans recorded on an undiscounted basis in the accompanying condensed consolidated balance sheets was $2,878 and $2,736 at June 30, 2014 and December 31, 2013, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


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. The self-insured liabilities are based upon estimates, and while management believes that the estimates of loss are reasonable, the ultimate liability may be in excess of or less than the recorded amounts. Due to the inherent volatility of actuarially determined loss estimates, it is reasonably possible that the Company could experience changes in estimated losses that could be material to net income. If the Company’s actual liability exceeds its estimates of loss, its future earnings, cash flows and financial condition would be adversely affected.

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

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

Noncontrolling Interest — The noncontrolling interest in a subsidiary is initially recognized at estimated fair value on the acquisition date and is presented within total equity in the Company's condensed consolidated balance sheets. The Company presents the noncontrolling interest and the amount of consolidated net income attributable to The Ensign Group, Inc. in its condensed consolidated statements of income and net income per share is calculated based on net income attributable to The Ensign Group, Inc.'s stockholders. The carrying amount of the noncontrolling interest is adjusted based on an allocation of subsidiary earnings based on ownership interest.

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

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

Effective May 30, 2014, the Company de-designated its interest rate swap contract that historically qualified for cash flow hedge accounting. This was due to the termination of the interest rate swap agreement related to the early retirement of the Senior

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


Credit Facility. As a result, the loss previously recorded in accumulated other comprehensive loss related to the interest rate swap was recognized in interest expense in the Condensed Consolidated Statements of Income. There was no outstanding interest rate swap contract as of June 30, 2014.

Accumulated Other Comprehensive Loss and Total Comprehensive Income (Loss) — Accumulated other comprehensive loss refers to revenue, expenses, gains, and losses that are recorded as an element of stockholders’ equity but are excluded from net income. The Company’s other comprehensive loss consists of net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges. The Company recognized a loss of $1,023, net of taxes of $638, to interest expense from accumulated other comprehensive loss during the three and six months ended June 30, 2014 related to the termination of the interest rate swap agreement. As of June 30, 2014, accumulated other comprehensive losses were $0, in stockholders' equity. As of December 31, 2013, accumulated other comprehensive losses were $1,828, net of tax of $716, or $1,112.

Recent Accounting Pronouncements — Except for rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws and a limited number of grandfathered standards, the Financial Accounting Standards Board (FASB) ASC is the sole source of authoritative GAAP literature recognized by the FASB and applicable to the Company. The Company has reviewed the FASB issued Accounting Standards Update (ASU) accounting pronouncements and interpretations thereof that have effectiveness dates during the periods reported and in future periods. The Company has carefully considered the new pronouncements below that alter previous generally accepted accounting principles and does not believe that any new or modified principles will have a material impact on the Company's reported financial position or operations in the near term. The applicability of any standard is subject to the formal review of the Company's financial management and certain standards are under consideration.

In April 2014, the FASB issued an accounting standards update that raises the threshold for disposals to qualify as discontinued operations and allows companies to have significant continuing involvement with and continuing cash flows from or to the discontinued operation. It also requires additional disclosures for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. This guidance will be effective for fiscal years beginning after December 15, 2014, which will be the Company's fiscal year 2015, with early adoption permitted. The Company does not expect the adoption of the guidance will have a material impact on the Company's consolidated financial statements.

In May 2014, the FASB and IASB issued their final standard on revenue from contracts with customers that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The new standard supersedes most current revenue recognition guidance, including industry-specific guidance. This guidance will be effective for fiscal years beginning after December 15, 2016, which will be the Company's fiscal year 2017. Early adoption is not permitted. The Company is currently assessing whether the adoption of the guidance will have a material impact on the Company's consolidated financial statements.

4. DISCONTINUED OPERATIONS

On March 25, 2013, the Company agreed to terms to sell DRX, a national urgent care franchise system for approximately $8,000, adjusted for certain assets and liabilities. The asset sale was effective on April 15, 2013. The sale resulted in a pre-tax loss of $2,837 for the six months ended June 30, 2013. The assets acquired at the initial purchase of DRX, including noncontrolling interest, were recorded at fair value. The initial fair value was greater than total cash paid to acquire all interests in DRX and the subsequent sale price. The sale of DRX has been accounted for as discontinued operations. Accordingly, the results of operations of this business for all periods presented and the loss related to this divesture have been classified as discontinued operations in the accompanying condensed consolidated statements of operations.













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




A summary of discontinued operations follows (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Revenue
 
$
—

 
$
104

 
$
—

 
$
728

Cost of services (exclusive of facility rent, general and administrative and depreciation and amortization expenses shown separately below)
 
—

 
(118
)
 
—

 
(739
)
Charges to discontinued operations for the excess carrying amount of goodwill and other indefinite-lived intangible assets
 
—

 
(13
)
 
—

 
(2,837
)
Facility rent—cost of services
 
—

 
(5
)
 
—

 
(12
)
Depreciation and amortization
 
—

 
(1
)
 
—

 
(33
)
Loss from discontinued operations
 
—

 
(33
)
 
—

 
(2,893
)
Benefit from income taxes
 
—

 
(7
)
 
—

 
(1,119
)
Loss from discontinued operations, net of income tax
 
$
—

 
$
(26
)
 
$
—

 
$
(1,774
)

5. COMPUTATION OF NET INCOME PER COMMON SHARE

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

A reconciliation of the numerator and denominator used in the calculation of basic net income per common share follows:
 
Three Months Ended
June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Income from continuing operations
$
1,533

 
$
12,430

 
$
14,574

 
$
1,667

Less: net (loss) income attributable to noncontrolling interests
(474
)
 
37

 
(959
)
 
(327
)
Income from continuing operations attributable to The Ensign Group, Inc.
2,007

 
12,393

 
15,533

 
1,994

Loss from discontinued operations, net of income tax
—

 
(26
)
 
—

 
(1,774
)
Net income attributable to The Ensign Group, Inc.
$
2,007

 
$
12,367

 
$
15,533

 
$
220

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average shares outstanding for basic net income per share
22,259

 
21,859

 
22,214

 
21,814

 
 
 
 
 
 
 
 
Basic net income (loss) per common share:
 
 
 
 
 
 
 
Income from continuing operations attributable to The Ensign Group, Inc.
$
0.09

 
$
0.57

 
$
0.70

 
$
0.09

Loss from discontinued operations
$
—

 
$
—

 
$
—

 
$
(0.08
)
Net income attributable to The Ensign Group, Inc.
$
0.09

 
$
0.57

 
$
0.70

 
$
0.01










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



A reconciliation of the numerator and denominator used in the calculation of diluted net income per common share follows:
 
Three Months Ended
June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Income from continuing operations
$
1,533

 
$
12,430

 
$
14,574

 
$
1,667

Less: net (loss) income attributable to noncontrolling interests
(474
)
 
37

 
(959
)
 
(327
)
Income from continuing operations attributable to The Ensign Group, Inc.
2,007

 
12,393

 
15,533

 
1,994

Loss from discontinued operations, net of income tax
—

 
(26
)
 
—

 
(1,774
)
Net income attributable to The Ensign Group, Inc.
$
2,007

 
$
12,367

 
$
15,533

 
$
220

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding
22,259

 
21,859

 
22,214

 
21,814

Plus: incremental shares from assumed conversion (1)
701

 
462

 
701

 
453

Adjusted weighted average common shares outstanding
22,960

 
22,321

 
22,915

 
22,267

Diluted net income (loss) per common share:
 
 
 
 
 
 
 
Income from continuing operations attributable to The Ensign Group, Inc.
$
0.09

 
$
0.55

 
$
0.68

 
$
0.09

Loss from discontinued operations
$
—

 
$
—

 
$
—

 
$
(0.08
)
Net income attributable to The Ensign Group, Inc.
$
0.09

 
$
0.55

 
$
0.68

 
$
0.01

(1)    Options outstanding which are anti-dilutive and therefore not factored into the weighted average common shares amount above were 608 and 447 for the three and six months ended June 30, 2014 and 341 and 377 for the three and six months ended June 30, 2013, respectively. As discussed in Note 2, Spin-Off Real Estate Assets through a Real Estate Investment Trust and Note 16, Options and Awards effective with the Spin-Off transaction, the holders of the Company's stock options on the date of record received stock options consistent with a conversion ratio that was necessary to maintain the pre spin-off intrinsic value of the options. The stock options terms and conditions are based on the existing terms in the 2001 Plan, 2005 Plan and 2007 Plan. In order to preserve the aggregate intrinsic value of the Company's stock options held by such persons, the exercise prices of such awards were adjusted by using the proportion of the CareTrust when issued closing stock price to the total Company closing stock prices on the distribution date. The number of options outstanding were increased by a conversion rate of 1.83 as a result of the Spin-Off.

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

The following table summarizes the financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
 
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Cash and cash equivalents
 
$
22,393

 
$
—

 
$
—

 
$
65,755

 
$
—

 
$
—

Fair value of interest rate swap
 
$
—

 
$
—

 
$
—

 
$
—

 
$
1,828

 
$
—


Our non-financial assets, which include long-lived assets, including goodwill, intangible assets and property and equipment, are not required to be measured at fair value on a recurring basis. However, on a periodic basis, or whenever events or changes in circumstances indicate that their carrying value may not be recoverable, we assess our long-lived assets for impairment. When impairment has occurred, such long-lived assets are written down to fair value. See Note 3, Summary of Significant Accounting Policies for further discussion of our significant accounting policies.

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



Debt Security Investments - Held to Maturity

At June 30, 2014 and December 31, 2013, the Company had approximately $22,132 and $22,399, respectively, in debt security investments which were classified as held to maturity and carried at amortized cost. The carrying value of the debt securities approximates fair value. The Company has the intent and ability to hold these debt securities to maturity. Further, at June 30, 2014, $1,996 is held in AA-rated debt securities backed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program, and $20,136 is held in A-rated debt securities.

Interest Rate Swap Agreement

In connection with the Senior Credit Facility with a six-bank lending consortium arranged by SunTrust and Wells Fargo (the Senior Credit Facility), in July 2011, the Company entered into an interest rate swap agreement in accordance with Company policy to reduce risk from volatility in the income statement due to changes in the LIBOR interest rate. The swap agreement, with a notional amount of $75,000, amortized concurrently with the related term loan portion of the Senior Credit Facility, was five years in length and set to mature on July 15, 2016. The interest rate swap has been designated as a cash flow hedge and, as such, changes in fair value are reported in other comprehensive income in accordance with hedge accounting. Under the terms of this swap agreement, the net effect of the hedge was to record swap interest expense at a fixed rate of approximately 4.3%, exclusive of fees. Net interest paid under the swap was $168 and $423 for the three and six months ended June 30, 2014 and $262 and $514 for the three and six months ended June 30, 2013, respectively.

Effective May 30, 2014, the Company de-designated its interest rate swap contract that historically qualified for cash flow hedge accounting. This was due to the termination of the interest rate swap agreement related to the early retirement of the Senior Credit Facility. As a result, the Company recognized a loss of $1,023, net of income tax benefit of $638, to interest expense from accumulated other comprehensive loss. See Note 15, Debt for additional information.

There was no outstanding interest rate swap contract as of June 30, 2014. There were no gains or losses due to the discontinuance of cash flow hedge treatment during the three and six months ended June 30, 2013.


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


7. REVENUE AND ACCOUNTS RECEIVABLE

Revenue for the three and six months ended June 30, 2014 and 2013 is summarized in the following tables:
 
Three Months Ended
June 30,
 
2014
 
2013
 
Revenue
 
% of
Revenue
 
Revenue
 
% of
Revenue
Medicaid
$
85,937

 
34.4
%
 
$
78,989

 
35.9
%
Medicare
77,333

 
30.9

 
72,148

 
32.8

Medicaid — skilled
12,353

 
4.9

 
8,939

 
4.0

Total Medicaid and Medicare
175,623

 
70.2

 
160,076

 
72.7

Managed care
35,776

 
14.3

 
27,375

 
12.5

Private and other payors(1)
38,644

 
15.5

 
32,635

 
14.8

Revenue
$
250,043

 
100.0
%
 
$
220,086

 
100.0
%

 
Six Months Ended
June 30,
 
2014
 
2013
 
Revenue
 
% of
Revenue
 
Revenue
 
% of
Revenue
Medicaid
$
169,279

 
34.6
%
 
$
155,499

 
35.5
%
Medicare
153,803

 
31.4

 
146,075

 
33.3

Medicaid — skilled
22,961

 
4.7

 
17,412

 
4.0

Total Medicaid and Medicare
346,043

 
70.7

 
318,986

 
72.8

Managed care
68,754

 
14.0

 
56,560

 
12.9

Private and other payors(1)
74,899

 
15.3

 
62,741

 
14.3

Revenue
$
489,696

 
100.0
%
 
$
438,287

 
100.0
%
(1) Private and other payors includes revenue from urgent care centers and other ancillary services.

Accounts receivable as of June 30, 2014 and December 31, 2013 is summarized in the following table:
 
June 30,
2014
 
December 31, 2013
Medicaid
$
47,736

 
$
38,068

Managed care
34,437

 
30,911

Medicare
32,766

 
34,562

Private and other payors
27,411

 
24,369

 
142,350

 
127,910

Less: allowance for doubtful accounts
(17,909
)
 
(16,540
)
Accounts receivable
$
124,441

 
$
111,370



8. ACQUISITIONS
The Company’s acquisition policy is generally to purchase or lease operations to complement the Company’s existing portfolio. The results of all the Company’s operations are included in the accompanying Interim Financial Statements subsequent to the date of acquisition. Acquisitions are typically paid for in cash and are accounted for using the acquisition method of accounting. Where the Company enters into facility lease agreements, the Company typically does not pay any material amount to the prior facility operator nor does the Company acquire any assets or assume any liabilities, other than rights and obligations under the

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



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 six months ended June 30, 2014, the Company acquired four stand-alone skilled nursing facilities, one assisted living facility, one home health agency, one hospice agency, one primary care group and one transitional care management company. The aggregate purchase price of the nine business acquisitions was approximately $38,442, which was paid in cash. The Company also entered into a separate operations transfer agreement with the prior operator as part of each transaction. The details of the operations acquired during the three and six months ended June 30, 2014 are as follows:
•
On March 1, 2014, the Company acquired a skilled nursing facility in Arizona for approximately $9,108, which was paid in cash. The acquisition added 196 operational skilled nursing beds to the Company's operations.
•
On March 3, 2014, the Company acquired a transitional care management company in Idaho for $40, which was paid in cash. The Company recorded $31 of goodwill as a part of this transaction. This acquisition did not have an impact on the Company's operational bed count.
•
On April 1, 2014 the Company acquired a home health and hospice agency in Idaho and a primary care group in Washington in two separate transactions, for an aggregate purchase price of approximately $1,350, which was paid in cash. The Company recorded $360 of goodwill as a part of the primary care group acquisition. These acquisitions did not impact the Company's operational bed count.
•
On May 1, 2014, the Company acquired a skilled nursing facility in Arizona for approximately $10,127, which was paid in cash. This acquisition added 230 operational skilled nursing beds to the Company's operations.
•
On May 3, 2014, the Company acquired an assisted living facility in California and the underlying assets of a skilled nursing facility which the Company previously operated under a long-term lease agreement for an aggregate purchase price of approximately $16,012, which was paid in cash. The assisted living facility acquisition added 144 operational assisted living units to the Company's operations. The skilled nursing facility acquisition did not have an impact on our bed count.
•
On June 1, 2014, the Company entered into long-term lease agreements and assumed the operations of one skilled nursing facility in Washington and one skilled nursing facility in Colorado. These acquisitions added 199 operational skilled nursing beds to the Company's operations. The Company did not acquire any material assets or assume any liabilities other than the tenant's post-assumption rights and obligations under the leases.
•
In a separate transaction, on June 1, 2014, the Company acquired two skilled nursing facilities in Wisconsin for an aggregate purchase price of approximately $4,507, which was paid in cash. The acquisition added 138 operational skilled nursing beds to the Company's operations.

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



The table below presents the allocation of the purchase price for the operations acquired in business combinations during the six months ended June 30, 2014 and 2013:
 
June 30,
 
2014
 
2013
Land
$
8,094

 
$
7,591

Building and improvements
27,228

 
23,702

Equipment, furniture, and fixtures
1,344

 
1,204

Assembled occupancy
425

 
695

Definite-lived intangible assets
360

 
—

Goodwill
391

 
1,966

Other indefinite-lived intangible assets
600

 
4,152

 
$
38,442

 
$
39,310


In addition, on May 7, 2014, the Company purchased the underlying assets of one skilled nursing facility in Utah which it previously operated under a long-term lease agreement for approximately $4,812, which was paid in cash.    

On July 1, 2014, the Company entered into a long-term lease agreement and assumed the operations of one skilled nursing facility in Washington. The acquisition added 67 operational skilled nursing beds to the Company's operations. The Company did not acquire any material assets or assume any liabilities other than the tenant's post-assumption rights and obligations under the lease.
On July 1, 2014, the Company acquired a hospice agency in Colorado for approximately $1,760, which was paid in cash. This acquisition did not impact the Company's operational bed count. As of the date of this filing, the preliminary allocation of the purchase price for this acquisition was not completed as necessary valuation information was not yet available.
On August 1, 2014, the Company acquired a home health agency in California for approximately $1,100 which was paid in cash. This acquisition did not impact the Company's operational bed count. As of the date of this filing, the preliminary allocation of the purchase price for this acquisition was not completed as necessary valuation information was not yet available.

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 operations acquired by the Company are frequently underperforming financially and can have regulatory and clinical challenges to overcome. Financial information, especially with underperforming operations, is often inadequate, inaccurate or unavailable. Consequently, the Company believes that prior operating results are not a meaningful, representation of the Company’s current operating results or indicative of the integration potential of its newly acquired operations. The businesses acquired during the three and six months ended June 30, 2014 were not material acquisitions to the Company individually or in the aggregate. Accordingly, pro forma financial information is not presented. These acquisitions have been included in the June 30, 2014 condensed consolidated balance sheet of the Company, and the operating results have been included in the condensed consolidated statements of operations of the Company since the dates the Company gained effective control.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



9. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
 
June 30,
2014
 
December 31, 2013
Land
$
16,774

 
$
79,679

Buildings and improvements
40,868

 
379,021

Equipment
69,604

 
97,984

Furniture and fixtures
6,178

 
8,851

Leasehold improvements
40,118

 
44,123

Construction in progress
581

 
2,081

 
174,123

 
611,739

Less: accumulated depreciation
(57,339
)
 
(131,969
)
Property and equipment, net
$
116,784

 
$
479,770


See Note 2, Spin-Off Real Estate Assets through a Real Estate Investment Trust for the impact of the Spin-Off on property and equipment and Note 8, Acquisitions for information on acquisitions during the six months ended June 30, 2014.

10. INTANGIBLE ASSETS — Net
 
 
Weighted Average Life (Years)
 
June 30, 2014
 
December 31, 2013
 
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
 
Intangible Assets
 
 
 
 
Net
 
 
 
Net
Lease acquisition costs
 
15.5
 
$
684

 
$
(611
)
 
$
73

 
$
684

 
$
(589
)
 
$
95

Favorable lease
 
15.0
 
2,210

 
(586
)
 
1,624

 
1,596

 
(532
)
 
1,064

Assembled occupancy
 
0.5
 
3,404

 
(3,154
)
 
250

 
2,979

 
(2,948
)
 
31

Facility trade name
 
30.0
 
733

 
(208
)
 
525

 
733

 
(195
)
 
538

Customer relationships
 
20.0
 
4,560

 
(321
)
 
4,239

 
4,200

 
(210
)
 
3,990

Total
 
 
 
$
11,591

 
$
(4,880
)
 
$
6,711

 
$
10,192

 
$
(4,474
)
 
$
5,718

Amortization expense was $258 and $406 for the three and six months ended June 30, 2014 and $325 and $507 for the three and six months ended June 30, 2013, respectively. Of the $406 in amortization expense incurred during the six months ended June 30, 2014, approximately $207 related to the amortization of patient base intangible assets at recently acquired facilities, which is typically amortized over a period of four to eight months, depending on the classification of the patients and the level of occupancy in a new acquisition on the acquisition date.
Estimated amortization expense for each of the years ending December 31 is as follows:
Year
Amount
2014 (remainder)
$
1,095

2015
423

2016
404

2017
386

2018
289

2019
280

Thereafter
3,834

 
$
6,711



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



11. GOODWILL AND OTHER INDEFINITE-LIVED INTANGIBLE ASSETS

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

The following table represents activity in goodwill as of and for the six months ended June 30, 2014:
 
Goodwill
January 1, 2014
$
23,935

Impairments
—

Additions
391

June 30, 2014
$
24,326


As of June 30, 2014, the Company anticipates that total goodwill recognized will be fully deductible for tax purposes. See further discussion of goodwill acquired at Note 8, Acquisitions.

Other indefinite-lived intangible assets consists of the following:
 
June 30,
 
December 31,
 
2014
 
2013
Trade name
$
1,033

 
$
1,033

Home health and hospice Medicare license
7,307

 
6,707

 
$
8,340

 
$
7,740


12. RESTRICTED AND OTHER ASSETS
Restricted and other assets consist of the following:
 
June 30,
2014
 
December 31,
2013
Note receivable
2,104

 
2,000

Debt issuance costs, net
2,908

 
2,801

Long-term insurance losses recoverable asset
1,814

 
3,280

Deposits with landlords
886

 
872

Capital improvement reserves with landlords and lenders
361

 
706

Other long-term assets
96

 
145

Restricted and other assets
$
8,169

 
$
9,804

Included in restricted and other assets as of June 30, 2014, are anticipated insurance recoveries related to the Company's general and professional liability claims that are recorded on a gross rather than net basis in accordance with an Accounting Standards Update issued by the FASB, capitalized debt issuance costs and notes receivable.

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


13. OTHER ACCRUED LIABILITIES

Other accrued liabilities consist of the following:
 
June 30,
2014
 
December 31,
2013
Quality assurance fee
$
2,768

 
$
3,933

Resident refunds payable
5,668

 
5,238

Deferred revenue
4,184

 
4,633

Cash held in trust for residents
1,823

 
1,780

Resident deposits
1,575

 
1,680

Dividends payable
1,580

 
1,564

Property taxes
2,254

 
2,894

Other
3,845

 
3,976

Other accrued liabilities
$
23,697

 
$
25,698

Quality assurance fee represents amounts payable to California, Arizona, Utah, Idaho, Washington, Colorado, Iowa, and Nebraska in respect of a mandated fee based on resident days. Resident refunds payable includes amounts due to residents for overpayments and duplicate payments. Deferred revenue occurs when the Company receives payments in advance of services provided. Cash held in trust for residents reflects monies received from, or on behalf of, residents. Maintaining a trust account for residents is a regulatory requirement and, while the trust assets offset the liabilities, 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.

14. INCOME TAXES
During the first quarter of 2012, the State of California initiated an examination of the Company's income tax returns for the 2008 and 2009 income tax years. The examination was primarily focused on the Captive and the treatment of related insurance matters. The Company is not currently under examination by any other major income tax jurisdiction. During 2014, the statutes of limitations will lapse on the Company's 2010 Federal tax year and certain 2009 and 2010 state tax years. The Company does not believe the Federal or state statute lapses, the California examination, or any other event will significantly impact the balance of unrecognized tax benefits in the next twelve months. The net balance of unrecognized tax benefits was not material to the Interim Financial Statements for the three and six months ended June 30, 2014 or 2013.
For the six months ended June 30, 2014, and the year ended December 31, 2013, the Company incurred 6,899 and 3,884, respectively, of third-party costs in connection with the Spin-Off. The Company has determined that 8,820 of the third-party costs directly facilitating the Spin-Off are permanently non-deductible for tax purposes and has reflected this determination in its calculation of the estimated annual effective tax rate. The Company's net tax benefit for the deductible portion of these costs will be approximately $768.
See Note 2, Spin-Off of Real Estate Assets Through a Real Estate Investment Trust, for the changes to the Company's balance sheet as a result of the Spin-Off on the portions of the Company's consolidated deferred tax assets and liabilities that no longer pertain to the Company.

The Company recorded total pre-tax charges related to the pending settlement with the U.S. Department of Justice (DOJ) and related expenses of $33,000 during the six months ended June 30, 2013. The Company recorded estimated tax benefits of $10,373 during the six months ended June 30, 2013. See Note 17, Commitments and Contingencies.



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



15. DEBT
Long-term debt consists of the following:
 
June 30,
2014
 
December 31,
2013
Promissory note with RBS, principal and interest payable monthly and continuing through March 2019, interest at a fixed rate, collateralized by real property, assignment of rents and Company guaranty.
—

 
20,347

Senior Credit Facility with SunTrust and Wells Fargo, principal and interest payable quarterly, balance due at February 1, 2018, secured by substantially all of the Company’s personal property.
—

 
144,325

Ten Project Note with GECC, principal and interest payable monthly; interest is fixed, balance due June 2016, collateralized by deeds of trust on real property, assignment of rents, security agreements and fixture financing statements.
—

 
48,864

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

 
32,122

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

 
8,919

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

 
5,429

 
—

 
260,006

Less current maturities
—

 
(7,411
)
Less debt discount
—

 
(700
)
 
$
—

 
$
251,895


2014 Credit Facility with a Lending Consortium Arranged by SunTrust (the 2014 Credit Facility)
On May 30, 2014, the Company entered into the 2014 Credit Facility in an aggregate principal amount of $150,000 from a syndicate of banks and other financial institutions. Under the 2014 Credit Facility, the Company may seek to obtain incremental revolving or term loans in an aggregate amount not to exceed $75,000. The interest rates applicable to loans under the 2014 Credit Facility are, at the Company’s option, equal to either a base rate plus a margin ranging from 1.25% to 2.25% per annum or LIBOR plus a margin ranging from 2.25% to 3.25% per annum, based on the debt to Consolidated EBITDA ratio of the Company and its subsidiaries as defined in the agreement. In addition, the Company will pay a commitment fee on the unused portion of the commitments under the 2014 Credit Facility that will range from 0.30% to 0.50% per annum, depending on the debt to Consolidated EBITDA ratio of the Company and its subsidiaries. Loans made under the 2014 Credit Facility are not subject to interim amortization. The Company is not required to repay any loans under the 2014 Credit Facility prior to maturity, other than to the extent the outstanding borrowings exceed the aggregate commitments under the 2014 Credit Facility. The Company is permitted to prepay all or any portion of the loans under the 2014 Credit Facility prior to maturity without premium or penalty, subject to reimbursement of any LIBOR breakage costs of the lenders. In connection with the 2014 Credit Facility, the Company incurred financing costs of approximately $2,013, which were deferred and are being amortized over the term of the 2014 Credit Facility. As of June 30, 2014, there were no borrowings outstanding under the 2014 Credit Facility.

The 2014 Credit Facility is guaranteed, jointly and severally, by certain of the Company’s wholly owned subsidiaries. The 2014 Credit Facility contains customary covenants that, among other things, restrict, subject to certain exceptions, the ability of the Company and its subsidiaries to grant liens on their assets, incur indebtedness, sell assets, make investments, engage in acquisitions, mergers or consolidations, amend certain material agreements and pay certain dividends and other restricted payments. Under the 2014 Credit Facility, the Company must comply with financial maintenance covenants to be tested quarterly, consisting of a maximum debt to consolidated EBITDA ratio, and a minimum interest/rent coverage ratio. The majority of lenders can require that the Company and its subsidiaries mortgage certain of their real property assets to secure the 2014 Credit Facility if an event of default occurs, the debt to consolidated EBITDA ratio is above 2.50:1.00 for two consecutive fiscal quarters, or the Company’s
liquidity is equal or less than 10% of the Aggregate Revolving Commitment Amount as defined in the agreement for ten consecutive business days, provided that such mortgages will no longer be required if the event of default is cured, the debt to consolidated EBITDA ratio is below 2.50:1.00 for two consecutive fiscal quarters, or the Company’s liquidity is above 10% of the Aggregate

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



Revolving Commitment Amount as defined in the agreement for ninety consecutive days, as applicable. As of June 30, 2014, the Company is in compliance with all loan covenants.

CareTrust Indebtedness

Immediately before the Spin-Off on May 30, 2014, while CareTrust was a wholly-owned subsidiary of the Company, CareTrust raised $260,000 of debt financing, which was part of the net assets contributed to CareTrust as part of the Spin-Off. See Note 2, Spin-Off of Real Estate Assets Through a Real Estate Investment Trust.

Senior Credit Facility with a Lending Consortium Arranged by SunTrust and Wells Fargo (the Senior Credit Facility)
On July 15, 2011, the Company entered into the Senior Credit Facility in an aggregate principal amount of up to $150,000 comprised of a $75,000 revolving credit facility and a $75,000 term loan advanced in one drawing on July 15, 2011. Borrowings under the term loan portion of the Senior Credit Facility amortize in equal quarterly installments commencing on September 30, 2011, in an aggregate annual amount equal to 5.0% per annum of the original principal amount. Amounts borrowed pursuant to the Senior Credit Facility were guaranteed by certain of the Company’s wholly-owned subsidiaries and secured by substantially all of their personal property. To reduce the risk related to interest rate fluctuations, the Company, on behalf of the subsidiaries, entered into an interest rate swap agreement to effectively fix the interest rate on the term loan portion of the Senior Credit Facility. See further details of the interest rate swap at Note 6, Fair Value Measurements.

On May 30, 2014, the Senior Credit Facility outstanding was paid in full with a portion of the proceeds received from CareTrust in connection with the Spin-Off.
Promissory Note with RBS Asset Finance, Inc.

On February 17, 2012, two of the Company's real estate holding subsidiaries as Borrowers executed a promissory note in favor of RBS Asset Finance, Inc. (RBS) as Lender for an aggregate of $21,525 (the 2012 RBS Loan). The 2012 RBS Loan was secured by Commercial Deed of Trust, Security Agreement, Assignment of Leases and Rents and Fixture Filings on the properties
owned by the Borrowers, and other related instruments and agreements, including without limitation a promissory note and a Company guaranty. The 2012 RBS Loan had a fixed interest rate of 4.75%.

On May 30, 2014, the RBS Loan was paid in full with a portion of the proceeds received from CareTrust in connection with the Spin-Off.

Promissory Note with RBS Asset Finance, Inc.

On December 31, 2010, four of the Company's real estate holding subsidiaries executed a promissory note with RBS as Lender for an aggregate of $35,000 (RBS Loan). The RBS Loan was secured by Commercial Deeds of Trust, Security Agreements, Assignment of Leases and Rents and Fixture Fillings on the four properties and other related instruments and agreements, including without limitation a promissory note and a Company guaranty. The RBS Loan had a fixed interest rate of 6.04%.

On May 30, 2014, the RBS Loan was paid in full with a portion of the proceeds received from CareTrust in connection with the Spin-Off.

Term Loan with General Electric Capital Corporation

On December 29, 2006, a number of the Company's independent real estate holding subsidiaries jointly entered into The Ten Project Note with GECC, which consisted of an approximately $55,700 multiple-advance term loan. The Ten Project Note was secured by the real and personal property comprising the ten facilities owned by these subsidiaries.

On May 30, 2014, the Company entered into the Fifth Amended and Restated Loan Agreement, with GECC, which consisted of an additional loan of $50,676 to an aggregate principal amount of $99,000. The Ten Project Note matures in May 2017 and are currently secured by the real and personal property comprising the ten facilities owned by these subsidiaries. The initial term loan of $55,700 was funded in advances, with each advance bearing interest at a separate rate. The interest rates range from 6.95% to
7.50% per annum. The additional loan of $50,676 bears interest at a floating rate equal to the three month LIBOR plus 3.35%, reset monthly and subject to a LIBOR floor of 0.50%, with monthly principal and interest payments based on a 25 years amortization.

On May 30, 2014, the Ten Project Note was assumed by CareTrust in connection with the Spin-Off.

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



Promissory Notes with Johnson Land Enterprises, Inc.

On October 1, 2009, four subsidiaries of The Ensign Group, Inc. entered into four separate promissory notes with Johnson Land Enterprises, LLC, for an aggregate of $10,000, as a part of the Company’s acquisition of three skilled nursing facilities in Utah.

On May 30, 2014, the Company repaid the majority of the four promissory notes with a portion of the proceeds received from CareTrust in connection with the Separation and Distribution Agreement. The remaining $615 was assumed by CareTrust in connection with the Spin-Off.

Mortgage Loan with Continental Wingate Associates, Inc.

Ensign Southland LLC, a subsidiary of The Ensign Group, Inc., entered into a mortgage loan on January 30, 2001 with Continental Wingate Associates, Inc. The mortgage loan is insured with the U.S. Department of Housing and Urban Development, or HUD, which subjects the Company's Southland facility to HUD oversight and periodic inspections. The mortgage loan was secured by the real property comprising the Southland Care Center facility and the rents, issues and profits thereof, as well as all personal property used in the operation of the facility.

On May 30, 2014, the mortgage loan was paid in full with a portion of the proceeds received from CareTrust in connection with the Spin-Off.

In connection with the debt retirements, the Company incurred losses of $5,728 consisting of $4,067 in repayment penalty and write off of unamortized debt discount and deferred financing costs and $1,661 of recognized loss due to the discontinuance of cash flow hedge accounting for the related interest-rate swap, which are included in interest expense within the condensed consolidated statements of income. The charges and loss were recognized in the second quarter of 2014.

16. OPTIONS AND AWARDS
Stock-based compensation expense consists of share-based payment awards made to employees and directors, including employee stock options and restricted stock awards, based on estimated fair values. As stock-based compensation expense recognized in the Company’s condensed consolidated statements of income for the three and six months ended June 30, 2014 and 2013 was based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. The Company estimates forfeitures at the time of grant and, if necessary, revises the estimate in subsequent periods if actual forfeitures differ.
The Company has three option plans, the 2001 Stock Option, Deferred Stock and Restricted Stock Plan (2001 Plan), the 2005 Stock Incentive Plan (2005 Plan) and the 2007 Omnibus Incentive Plan (2007 Plan), all of which have been approved by the stockholders. The total number of shares available under all of the Company’s stock incentive plans was 1,327 as of June 30, 2014.

Effective with the Spin-Off transaction (see Note 2, Spin-Off of Real Estate Assets Through a Real Estate Investment Trust, for further information), all holders of the Company's restricted stock awards on the May 22, 2014 date of record for the spin-off received CareTrust restricted stock awards consistent with the distribution ratio, with terms and conditions substantially similar to the terms and conditions applicable to the Company's restricted stock awards. Also, effective with the Spin-Off transaction, the holders of the Company's stock options on the date of record received stock options consistent with a conversion ratio that was necessary to maintain the pre spin-off intrinsic value of the options. The stock options terms and conditions are based on the preexisting terms in the 2001 Plan, 2005 Plan and 2007 Plan, including nondiscretionary antidilution provisions. In order to preserve the aggregate intrinsic value of the Company's stock options held by such persons, the exercise prices of such awards were adjusted by using the proportion of the CareTrust when issued closing stock price to the total Company closing stock prices on the distribution date. All of these adjustments were designed to equalize the fair value of each award before and after Spin-Off. These adjustments were accounted for as modifications to the original awards. A comparison of the fair value of the modified awards with the fair value of the original awards immediately before the modification did not yield incremental value. Accordingly, the Company did not record any incremental compensation expense as a result of the modifications to the awards on the Spin-Off date.

The Company's future share-based compensation expense will not be significantly impacted by the equity award adjustments that occurred as a result of the Spin-Off. Deferred compensation costs as of the date of Spin-Off reflected the unamortized balance of the original grant date fair value of the equity awards held by the Company's employees (regardless of whether those awards are linked to the Company's stock or CareTrust stock).

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



The Company uses the Black-Scholes option-pricing model to recognize the value of stock-based compensation expense for all share-based payment awards. Determining the appropriate fair-value model and calculating the fair value of stock-based awards at the grant date requires considerable judgment, including estimating stock price volatility, expected option life and forfeiture rates. The Company develops estimates based on historical data and market information, which can change significantly over time. The Company granted 931 options and 4 restricted stock awards from the 2007 Plan during the six months ended June 30, 2014.

The Company used the following assumptions for stock options granted during the three months ended June 30, 2014 and 2013:
Grant Year
 
Options Granted
 
Weighted Average Risk-Free Rate
 
Expected Life
 
Weighted Average Volatility
 
Weighted Average Dividend Yield
2014
 
664

 
1.80
%
 
6.5 years
 
55
%
 
0.64
%
2013
 
47

 
1.48
%
 
6.5 years
 
55
%
 
0.93
%

The Company used the following assumptions for stock options granted during the six months ended June 30, 2014 and 2013:
Grant Year
 
Options Granted
 
Weighted Average Risk-Free Rate
 
Expected Life
 
Weighted Average Volatility
 
Weighted Average Dividend Yield
2014
 
931

 
1.80
%
-
1.84
%
 
6.5 years
 
55
%
 
0.64
%
2013
 
150

 
1.18
%
-
1.48
%
 
6.5 years
 
55
%
 
0.93
%

For the six months ended June 30, 2014 and 2013, the following represents the exercise price and fair value displayed at grant date for stock option grants:
Grant Year
 
Granted
 
Weighted Average Exercise Price
 
Weighted Average Fair Value of Options
2014
 
931

 
$
24.38

 
$
12.51

2013
 
150

 
$
17.39

 
$
8.55


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 June 30, 2014 and 2013 and therefore, the intrinsic value was $0 at date of grant.

As discussed above and in Note 2, Spin-Off Real Estate Assets through a Real Estate Investment Trust, the weighted average exercise prices shown in the table above for the six months ended June 30, 2014 were reduced as a result of the Spin-Off. The number of options outstanding shown in the table below for the six months ended June 30, 2014 were increased as a result of the Spin-Off.


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


The following table represents the employee stock option activity during the six months ended June 30, 2014:
 
Number of
Options
Outstanding
 
Weighted
Average
Exercise Price
 
Number of
Options Vested
 
Weighted
Average
Exercise Price
of Options
Vested
January 1, 2014
2,290

 
$
11.30

 
681

 
$
7.76

Granted
931

 
24.38

 
 
 
 
Forfeited
(35
)
 
14.29

 
 
 
 
Exercised
(315
)
 
7.52

 
 
 
 
June 30, 2014
2,871

 
$
15.92

 
1,122

 
$
8.58


The following summary information reflects stock options outstanding, vested and related details as of June 30, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
Stock Options Vested
 
 
Stock Options Outstanding
 
 
 
 
 
Number Outstanding
 
Black-Scholes Fair Value
 
Remaining Contractual Life (Years)
 
Vested and Exercisable
Year of Grant
 
Exercise Price
 
 
 
 
2005
 
2.72
-
3.14
 
31

 
*

 
1
 
31

2006
 
3.85
-
4.09
 
125

 
654

 
2
 
125

2008
 
5.12
-
8.11
 
336

 
1,027

 
4
 
336

2009
 
8.12
-
9.11
 
427

 
1,835

 
5
 
371

2010
 
9.53
-
9.91
 
109

 
528

 
6
 
72

2011
 
11.79
-
15.98
 
136

 
917

 
7
 
56

2012
 
13.12
-
15.91
 
367

 
2,709

 
8
 
87

2013
 
15.96
-
22.98
 
410

 
4,010
 
9
 
44

2014
 
21.09
-
25.70
 
930

 
11,636
 
10
 
—

Total
 
 
 
 
 
2,871

 
$
23,316

 
 

1,122

* The Company will not recognize the Black-Scholes fair value for awards granted prior to January 1, 2006 unless such awards are modified.
The Company did not grant any restricted stock awards during the three and six months ended June 30, 2014. The Company granted 14 and 60 restricted stock awards during the three and six months ended June 30, 2013, respectively. All awards were granted at an exercise price of $0 and generally vest over five years.
A summary of the status of the Company's nonvested restricted stock awards as of June 30, 2014, and changes during the six-month period ended June 30, 2014 is presented below:
 
Nonvested Restricted Awards
 
Weighted Average Grant Date Fair Value
Nonvested at January 1, 2014
230

 
$
28.68

Granted
4

 
43.87

Vested
(34
)
 
26.95

Forfeited
(8
)
 
30.40

Nonvested at June 30, 2014
192

 
$
29.20


As a result of the Spin-Off, holders of outstanding restricted stock awards received an additional share of restricted stock unit award in CareTrust common stock at the Spin-Off so that the intrinsic value of these awards were equivalent to those that existed immediately prior to the Spin-Off. The weighted average grant date fair value shown in the table above did not change as a result of the Spin-Off. The number of nonvested restricted awards shown in the table below did not change as a result of the Spin-Off.

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



In addition, during the three and six months ended June 30, 2014, the Company granted 2 and 4 automatic quarterly stock awards to non-employee directors for their service on the Company's board of directors. The fair value per share of these stock awards ranged from $44.71 to $42.62 based on the market price on the grant date.

Total share-based compensation expense recognized for the three and six months ended June 30, 2014 and 2013 was as follows:
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Share-based compensation expense related to stock options
$
711

 
$
505

 
$
1,354

 
$
1,079

Share-based compensation expense related to restricted stock awards
387

 
328

 
817

 
643

Share-based compensation expense related to stock awards
106

 
121

 
212

 
607

Total
$
1,204

 
$
954

 
$
2,383

 
$
2,329

In future periods, the Company expects to recognize approximately $17,158 and $4,916 in share-based compensation expense for unvested options and unvested restricted stock awards, respectively, that were outstanding as of June 30, 2014. Future share-based compensation expense will be recognized over 4.4 and 3.1 weighted average years for unvested options and restricted stock awards, respectively. There were 1,750 unvested and outstanding options at June 30, 2014, of which 1,558 are expected to vest. The weighted average contractual life for options outstanding, vested and expected to vest at June 30, 2014 was 7.1 years.

The aggregate intrinsic value of options outstanding, vested, expected to vest and exercised as of June 30, 2014 and December 31, 2013 is as follows:
Options
 
June 30,
2014
 
December 31,
2013
Outstanding
 
$
43,531

 
$
29,431

Vested
 
25,241

 
20,465

Expected to vest
 
15,407

 
7,873

Exercised
 
5,306

 
8,709

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

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


17. COMMITMENTS AND CONTINGENCIES
Leases — As a result of the Spin-Off, the Company leases from CareTrust real property associated with 94 skilled nursing, assisted living and independent living facilities used in the Company’s operations under the Master Leases. The Master Leases consist of multiple leases, each with its own pool of properties, that have varying maturities and diversity in property geography. Under each Master Lease, the Company's individual subsidiaries that operate those properties are the tenants and CareTrust's individual subsidiaries that own the properties subject to the Master Leases are the landlords. Commencing the third year, the rent structure under the Master Leases include a fixed component, subject to annual escalation equal to the lesser of (1) the percentage change in the Consumer Price Index (but not less than zero) or (2) 2.5%. Annual rent expense under the Master Lease will be approximately $56,000 during each of the first two years of the Master Leases.
The Master Leases is commonly known as a triple-net lease. Accordingly, in addition to rent, the Company is required to pay the following: (1) all impositions and taxes levied on or with respect to the leased properties (other than taxes on the income of the lessor), (2) all utilities and other services necessary or appropriate for the leased properties and the business conducted on the leased properties, (3) all insurance required in connection with the leased properties and the business conducted on the leased properties, (4) all facility maintenance and repair costs and (5) all fees in connection with any licenses or authorizations necessary or appropriate for the leased properties and the business conducted on the leased properties. Total rent expense under the Master Leases was $4,667 for the one month period ended June 30, 2014, as a result of the Spin-Off on June 1, 2014. There was no rent expense under the Master Leases in 2013.
At the Company’s option, the Master Leases may be extended for two or three five-year renewal terms beyond the initial term, on the same terms and conditions. If the Company elects to renew the term of a master lease, the renewal will be effective as to all, but not less than all, of the leased property then subject to the master lease.
Among other things, under the Master Leases, the Company must maintain compliance with specified financial covenant measured on a quarterly basis, including a portfolio coverage ratio and a minimum rent coverage ratio. The Master Leases also include certain reporting, legal and authorization requirements. As of June 30, 2014, we were in compliance with the Master Leases covenants.
The Company and CareTrust also entered into an Opportunities Agreement, which grants CareTrust the right to match any offer from a third party to finance the acquisition or development of any healthcare or senior-living facility by the Company or any of its affiliates for a period of one year following the Spin-Off. In addition, this agreement requires CareTrust to provide the Company, subject to certain exceptions, a right to either purchase and operate, or lease and operate, the facilities included in any portfolio of five or fewer healthcare or senior living facilities presented to the Company during the first year following the Spin-Off; provided that the portfolio is not subject to an existing lease with an operator or manager that has a remaining term of more than one year, and is not presented to the Company by or on behalf of another operator seeking lease or other financing. If the Company elects to lease and operate such a property or portfolio, the lease would be on substantially the same terms as the Master Leases.
The Company also 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. In addition, the Company 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 and rent associated with the Master Leases noted above, was $8,333 and $11,938 for the three and six months ended June 30, 2014 and $3,446 and $6,882 for the three and six months ended June 30, 2013, respectively.
Future minimum lease payments for all leases as of June 30, 2014 are as follows:
Year
 
Amount
Remaining 2014
 
28,541

2015
 
69,534

2016
 
69,560

2017
 
69,556

2018
 
69,602

2019
 
68,555

Thereafter
 
638,578

 
 
1,013,926


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


Six of the Company’s facilities, excluding the facilities that are operated under the Master Leases from CareTrust, 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.
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. Any significant future change to reimbursement rates or regulation on how services are provided 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.
Income Tax Examinations — During the first quarter of 2012, the State of California initiated an examination of the Company's income tax returns for the 2008 and 2009 income tax years. The examination was primarily focused on the Captive and the treatment of related insurance matters. The Company is not currently under examination by any other major income tax jurisdiction. See Note 14, Income Taxes.
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, and (iv) 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

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


or decreasing an obligation to pay money or property to the government. This includes the retention of any government overpayment. The government can argue, therefore, that a FCA violation can occur without any affirmative fraudulent action or statement, as long as it is knowingly improper. In addition, FERA extended protections against retaliation for whistleblowers, including protections not only for employees, but also contractors and agents. Thus, there is generally no need for an employment relationship in order to qualify for protection against retaliation for whistleblowing.
In July 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Dodd-Frank Act establishes rigorous standards and supervision to protect the economy and American consumers, investors and businesses. Included under Section 922 of the Dodd-Frank Act, the Securities and Exchange Commission (SEC) will be required to pay a reward to individuals who provide original information to the SEC resulting in monetary sanctions exceeding $1,000 in civil or criminal proceedings. The award will range from 10 to 30 percent of the amount recouped and the amount of the award shall be at the discretion of the SEC. The purpose of this reward program is to “motivate those with inside knowledge to come forward and assist the Government to identify and prosecute persons who have violated securities laws and recover money for victims of financial fraud.”
Healthcare litigation (including class action litigation) is common and is filed based upon a wide variety of claims and theories, and we are routinely subjected to varying types of claims. One particular type of suit arises from alleged violations of state-established minimum staffing requirements for skilled nursing facilities. Failure to meet these requirements can, among other things, jeopardize a facility's compliance with conditions of participation under certain state and federal healthcare programs; it may also subject the facility to a notice of deficiency, a citation, civil monetary penalty, or litigation. These class-action “staffing” suits have the potential to result in large jury verdicts and settlements, and have become more prevalent in the wake of a previous substantial jury award against one of the Company's competitors. The Company expects the plaintiff's bar to continue to be aggressive in their pursuit of these staffing and similar claims.
A class action staffing suit was previously filed against the Company in the State of California, alleging, among other things, violations of certain Health and Safety Code provisions and a violation of the Consumer Legal Remedies Act at certain of the Company's California facilities. In 2007, the Company settled this class action suit, and the settlement was approved by the affected class and the Court. The Company has been defending a second such staffing class-action claim filed in Los Angeles Superior Court; however, a settlement was reached with class counsel and has received Court approval. The total costs associated with the settlement, including attorney's fees, estimated class payout, and related costs and expenses, are projected to be approximately $6,500, of which, approximately $1,500 of this amount was recorded during the year ended December 31, 2013, with the balance having been expensed in prior periods. The Company believes that the settlement will not have a material ongoing adverse effect on the Company’s business, financial condition or results of operations.
Other claims and suits, including class actions, continue to be filed against us and other companies in our industry. If there were a significant increase in the number of these claims or an increase in amounts owing should plaintiffs be successful in their prosecution of these claims, this could materially adversely affect the Company’s business, financial condition, results of operations and cash flows.
The Company has been, and continues to be, subject to claims and legal actions that arise in the ordinary course of business, including potential claims related to care and treatment provided at its facilities as well as employment related claims. The Company does not believe that the ultimate resolution of these actions will have a material adverse effect on the Company’s business, cash flows, financial condition or results of operations. A significant increase in the number of these claims or an increase in amounts owing should plaintiffs be successful in their prosecution of these claims, could materially adversely affect the Company’s business, financial condition, results of operations and cash flows.

The Company cannot predict or provide any assurance as to the possible outcome of any litigation. If any litigation were to proceed, and the Company is subjected to, alleged to be liable for, or agrees to a settlement of, claims or obligations under federal Medicare statutes, the federal False Claims Act, or similar state and federal statutes and related regulations, its business, financial condition and results of operations and cash flows could be materially and adversely affected and its stock price could be adversely impacted. Among other things, any settlement or litigation could involve the payment of substantial sums to settle any alleged civil violations, and may also include the Company's assumption of specific procedural and financial obligations going forward under a corporate integrity agreement and/or other arrangement with the government.
Medicare Revenue Recoupments — The Company is subject to reviews relating to Medicare services, billings and potential overpayments. The Company had one operation subject to probe review during the six months ended June 30, 2014. 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

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


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.

U.S. Government Inquiry — In late 2006, the Company learned that it might be the subject of an on-going criminal and civil investigation by the DOJ. This was confirmed in March 2007. The investigation was prompted by a whistleblower complaint, and related primarily to claims submitted to the Medicare program for rehabilitation services provided at skilled nursing facilities in Southern California. The Company, through its outside counsel and a special committee of independent directors established by its board, worked cooperatively with the U.S. Attorney's office to produce information requested by the government as part of an ongoing dialogue designed to resolve the issue.

In December 2011, the DOJ notified the Company that it had closed its criminal investigation without action although, as is typical, it reserved the right to reopen the criminal case if new facts came to light. This left only the civil investigation to resolve, and the Company continued to supply requested information to the DOJ and the Office of the Inspector General of the United States Department of Health and Human Services (HHS), including specific patient records and documents from 2007 to 2011 from six Southern California skilled nursing facilities that had been the subject of previous requests.

In early 2013, discussions between government representatives and the Company's special committee, its outside counsel and their experts had advanced sufficiently that the Company recorded an initial estimated liability in the amount of $15,000 in the fourth quarter of 2012 for the resolution of claims connected to the investigation. In April 2013, the Company and government representatives reached an agreement in principle to resolve the allegations and close the investigation. Based on these discussions, the Company recorded and announced an additional charge in the amount of $33,000 in the first quarter of 2013, increasing the total reserve to resolve the matter to $48,000 (the Reserve Amount).

In October 2013, the Company completed and executed a settlement agreement (the Settlement Agreement) with the Department of Justice and received the final approval of the Office of Inspector General-HHS and the United States District Court for the Central District of California. The settlement agreement fully and finally resolves the previously disclosed DOJ investigation and any ancillary claims which have been pending since 2006. Pursuant to the settlement agreement, the Company made a single lump-sum remittance to the government in the amount of $48,000 in October 2013. The Company has denied engaging in any illegal conduct, and has agreed to the settlement amount without any admission of wrongdoing in order to resolve the allegations and to avoid the uncertainty and expense of protracted litigation.

In connection with the settlement and effective as of October 1, 2013, the Company entered into a five-year corporate integrity agreement with the Office of Inspector General-HHS (the CIA). The CIA acknowledges the existence of the Company’s current compliance program, and requires that the Company continue during the term of the CIA to maintain a compliance program designed to promote compliance with the statutes, regulations, and written directives of Medicare, Medicaid, and all other Federal health care programs. The Company is also required to maintain several elements of its existing program during the term of the CIA, including maintaining a compliance officer, a compliance committee of the board of directors, and a code of conduct. The CIA requires that the Company conduct certain additional compliance-related activities during the term of the CIA, including various training and monitoring procedures, and maintaining a disciplinary process for compliance obligations. Pursuant to the CIA, the Company is required to notify the Office of Inspector General-HHS in writing, of, among other things: (i) any ongoing government investigation or legal proceeding involving an allegation that the Company has committed a crime or has engaged in fraudulent activities; (ii) any other matter that a reasonable person would consider a probable violation of applicable criminal, civil, or administrative laws related to compliance with federal healthcare programs; and (iii) any change in location, sale, closing, purchase, or establishment of a new business unit or location related to items or services that may be reimbursed by Federal health care programs. The Company is also subject to periodic reporting and certification requirements attesting that the provisions of the CIA are being implemented and followed, as well as certain document and record retention mandates.

Participation in federal healthcare programs by the Company is not affected by the Settlement Agreement or the CIA. In the event of an uncured material breach of the CIA, the Company could be excluded from participation in federal healthcare programs and/or subject to prosecution.

Concentrations
Credit Risk — The Company has significant accounts receivable balances, the collectability of which is dependent on the availability of funds from certain governmental programs, primarily Medicare and Medicaid. These receivables represent the only significant concentration of credit risk for the Company. The Company does not believe there are significant credit risks associated with these governmental programs. The Company believes that an appropriate allowance has been recorded for the possibility of these receivables proving uncollectible, and continually monitors and adjusts these allowances as necessary. The Company’s

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


receivables from Medicare and Medicaid payor programs accounted for approximately 56.6% and 56.8% of its total accounts receivable as of June 30, 2014 and December 31, 2013, respectively. Revenue from reimbursement under the Medicare and Medicaid programs accounted for 70.2% and 70.7% of the Company’s revenue for the three and six months ended June 30, 2014 and 72.7% and 72.8% during the three and six months ended June 30, 2013, respectively.
Cash in Excess of FDIC Limits — The Company currently has bank deposits with financial institutions in the U.S. that exceed FDIC insurance limits. FDIC insurance provides protection for bank deposits up to $250. In addition, the Company has uninsured bank deposits with a financial institution outside the U.S. As of August 4, 2014, the Company had approximately $1,000 in uninsured cash deposits. All uninsured bank deposits are held at high quality credit institutions.

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Table of Contents

Item 2.        Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this Report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with the Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K (Annual Report), which discusses our business and related risks in greater detail, as well as subsequent reports we may file from time to time on Forms 10-Q and 8-K, for additional information. The section entitled “Risk Factors” contained in Part II, Item 1A of this Report, and similar discussions in our other SEC filings, also describe some of the important risk factors that may affect our business, financial condition, results of operations and/or liquidity. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.
This Report contains "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, which include, but are not limited to the Company’s expected future financial position, results of operations, cash flows, financing plans, business strategy, budgets, capital expenditures, competitive positions, growth opportunities, 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 operations, the Service Center and the Captive are operated by separate, wholly-owned, independent subsidiaries that have their own management, employees and assets. The use of “we,” “us,” “our” and similar verbiage in this quarterly report is not meant to imply that any of our facilities, the Service Center or the Captive are operated by the same entity. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and related notes included in the Annual Report.
Overview
We are a provider of skilled nursing and rehabilitative care services through the operation of 125 facilities, ten home health and eight hospice operations, twelve urgent care centers and a mobile x-ray and diagnostic company as of June 30, 2014, located in Arizona, California, Colorado, Idaho, Iowa, Nebraska, Nevada, Oregon, Texas, Utah, Washington, and Wisconsin. Our operations, each of which strives to be the service of choice in the community it serves, provide a broad spectrum of skilled nursing, assisted living, home health and hospice, mobile ancillary, and urgent care services. As of June 30, 2014, we owned 8 of our 125 facilities and operated an additional 117 facilities under long-term lease arrangements, and had options to purchase two of those 117 facilities.

The following table summarizes our facilities and operational skilled nursing, assisted living and independent living beds by ownership status as of June 30, 2014:
 
Owned
 
Leased (with a Purchase Option)