The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes, which appear elsewhere in this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report. See Item 1A. - "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements."
Overview
We are a provider of skilled nursing and rehabilitative care services through the operation of 108 facilities, six home health and four hospice operations as of December 31, 2012, located in Arizona, California, Colorado, Idaho, Iowa, Nebraska, Nevada, Oregon, Texas, Utah and Washington. Our operations, each of which strives to be the service provider of choice in the community it serves, provide a broad spectrum of skilled nursing, assisted living, home health and hospice services, including physical, occupational and speech therapies, and other rehabilitative and healthcare services, for both long-term residents and short-stay rehabilitation patients. We recently entered into a business to develop and operate urgent care centers. These walk-in clinics will offer daily access to healthcare for minor injuries and illnesses, including x-ray and lab services, all from convenient neighborhood locations with no appointments. As of December 31, 2012, we owned 86 of our 108 facilities and operated an additional 22 facilities under long-term lease arrangements, and had options to purchase two of those 22 facilities.

We encourage and empower our facility leaders and staff to make their facility the "facility of choice" in the community it serves. This means that our leaders and staff are generally free to discern and address the unique needs and priorities of healthcare professionals, customers and other stakeholders in the local community or market, and then work to create a superior service offering and reputation for that particular community or market to encourage prospective customers and referral sources to choose or recommend the facility. The following table summarizes our facilities and operational skilled nursing, assisted living and independent living beds by ownership status as of December 31, 2012:

                                                            Leased         Leased
                                                           (with a       (without a
                                                           Purchase       Purchase
                                                Owned      Option)        Option)         Total
Number of facilities                               86           2           20              108
Percent of total                                 79.6 %       1.9 %       18.5 %          100.0 %
Operational skilled nursing, assisted living
and independent living beds                     9,479         414        2,305           12,198
Percent of total                                 77.7 %       3.4 %       18.9 %          100.0 %

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

Recent Developments

U.S. Government Inquiry - We, through the special committee and our outside counsel, continue to work cooperatively with the DOJ. Ensign anticipates that this ongoing dialogue will continue in 2013 as part of our effort to resolve this matter. Based on information gathered by us in connection with the work of the special committee, our outside counsel and their experts, we recorded an estimated liability in the amount of $15.0 million in the fourth quarter of 2012 related to our efforts to achieve a global, company-wide, resolution of any claims connected to the investigation. Active settlement discussions with the DOJ are ongoing and, until concluded, the outcome remains uncertain and the amount related to the resolution of any claims connected to this pending investigation could differ materially from our estimates. At this time, we cannot estimate the possible range of loss that may result from any such proceedings or discussions.

We cannot predict or provide any assurance as to the possible outcome of the investigations or any possible related proceedings, or as to the possible outcome of any litigation. If any litigation were to proceed, and we are subjected to, alleged to be liable for, or agree to a settlement of, claims or obligations under federal Medicare statutes, the federal False Claims Act, or similar state and federal statutes and related regulations, our business, financial condition and results of operations and cash flows could be materially and adversely affected and our 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 our assumption of specific procedural and financial obligations going forward under a corporate integrity agreement and/or other arrangement with the government.

Board of Directors - Effective June 15, 2012, Mr. Daren J. Shaw was appointed by the board of directors, at the recommendation of the nomination and corporate governance committee, to serve on the audit committee with Mr. John Nackel and Mr. Thomas Maloof (Chair). Mr. Shaw has also been appointed by the board of directors to serve on the nomination and corporate governance committee and the compensation committee. On July 26, 2012, the board of directors appointed Mr. Shaw to serve as the chair of the audit committee effective September 1, 2012.

On October 31, 2012, Van R. Johnson informed the board of directors that he intends to retire from the board of directors at the close of the Annual Meeting of the Shareholders for 2013. Mr. Johnson's resignation is due to his acceptance of a full-time volunteer assignment from his church that will require him to step away from all outside business engagements, including the board of directors. Mr. Johnson has served on the board of directors since 2009 and is currently serving as the Chairman of the Nomination and Corporate Governance Committee.

Senior Credit Facility - On February 1, 2013, we entered into the third amendment to the senior credit facility with a six-bank lending consortium arranged by SunTrust and Wells Fargo (the Senior Credit Facility) (the Third Amendment), which amends our existing Senior Credit Facility agreement, dated as of July 15, 2011. The Third Amendment revises the Senior Credit Facility agreement to, among other things, (i) increase the revolving credit portion of the Senior Credit Facility by $75.0 million to an aggregate principal amount of $150.0 million, and (ii) extend the maturity date from July 15, 2016 to February 1, 2018. Except as set forth in the Third Amendment, all other terms and conditions of the Senior Credit Facility remain in full force and effect.

Urgent Care

Immediate Clinic (IC) - On January 10, 2012, we announced a joint venture to develop and operate urgent care facilities and related businesses. Immediate Clinic (IC) will offer daily access to healthcare for minor injuries and illnesses, including x-ray and lab services, all from convenient neighborhood locations with no appointments. Design and construction planning for several new locations is currently underway, and IC is also seeking opportunities to acquire existing urgent care operations across the United States. As of December 31, 2012, IC was operating three urgent care centers, and anticipates opening two additional centers during the first quarter of 2013.

Our joint venture partner and IC's Chief Executive Officer, Dr. John Shufeldt resigned on September 12, 2012. On October 4, 2012, we invested an additional $6.0 million to IC in exchange for senior preferred stock which resulted in our holding approximately 96% of the outstanding interests in the joint venture on a fully-diluted basis. The proceeds of such investment will be used to continue the development of additional clinics in the Northwest. In addition, on December 20, 2012, IC redeemed all remaining minority interests in IC.

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

assets of $7.9 million in trade name, $3.0 million in franchise relationships and $2.7 million in goodwill as part of this transaction. On December 31, 2012, IC purchased the remaining ownership interest in DRX for approximately $5.3 million.

Mobile X-Ray and Diagnostics

On December 31, 2012, the Company purchased 80% of the membership interest of a mobile x-ray and diagnostic company for $5.8 million, plus preliminary net working capital of approximately $1.3 million for total consideration of approximately $7.1 million, which was paid in cash. The mobile diagnostic company is a leader in providing mobile diagnostic services, including digital x-ray, ultrasound, electrocardiograms, ankle-brachial index, and phlebotomy services to people in their homes or at long-term care facilities. The Company believes the acquisition is strategic given the mobile diagnostic company's experienced management team. This acquisition will provide the Company with a broad set of services to its customers in the markets it serves.

The Company recognized intangible assets of approximately $0.9 million in trade name, $4.2 million in customer relationship and $2.1 million in goodwill as part of this transaction. See additional details in Note 9 Goodwill and Other Indefinite-Lived Intangible Assets-Net in Notes to Consolidated Financial Statements. The Company's preliminary determination of the fair value of the tangible and intangible assets acquired and liabilities assumed is based on estimates and assumptions that are subject to change. During the measurement period, when information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustment will be included in the purchase price allocation retrospectively. The measurement period is expected to extend as long as one year from the date of acquisition.

Acquisitions

On January 1, 2013, we acquired one home health operation in Washington and two hospice operations in California and Arizona, respectively, for an aggregate purchase price of approximately $4.5 million, which was paid in cash. These acquisitions did not impact our overall bed count.

During the fourth quarter of 2012, we purchased a skilled nursing facility in Texas for $2.6 million, which was paid in cash. This acquisition added 92 operational skilled nursing beds to our operations.

During the third quarter of 2012, we purchased two skilled nursing facilities in Idaho for $4.5 million in one transaction, which was paid in cash. One of the skilled nursing facilities acquired also offers assisted living services. This acquisition added 94 operational skilled nursing beds and 24 assisted living units to our operations.

During the second quarter of 2012, we purchased a home health and hospice business with operations in Utah and Arizona and a skilled nursing facility in Texas in two separate transactions for an aggregate purchase price of $11.0 million. All second quarter acquisitions were paid for in cash. The skilled nursing facility acquisition added 150 operational skilled nursing beds, while the home health operations did not impact our overall bed count.

During the first quarter of 2012, we purchased one assisted living facility in Nevada, one home health operation in Oregon and one skilled nursing facility in Idaho in three separate transactions for an aggregate purchase price of $5.4 million. All first quarter acquisitions were paid for in cash. These acquisitions added an aggregate of 113 operational skilled nursing beds and 60 assisted living units to our operations, while the home health operations acquisition did not impact our overall bed count.

We also entered into separate operations transfer agreements with the prior operator as part of each of the above noted transactions.

In addition, during the year ended December 31, 2012, we purchased the underlying assets of three of our skilled nursing facilities in California which we previously operated under long-term lease agreements, which contained options to purchase, for $11.4 million, which was paid in cash. These acquisitions did not impact our operational bed count.
See further discussion of acquisitions in Note 6 in Notes to Consolidated Financial Statements.

Key Performance Indicators
We manage our skilled nursing business by monitoring key performance indicators that affect our financial performance. These indicators and their definitions include the following:
• Routine revenue: Routine revenue is generated by the contracted daily rate charged for all contractually inclusive skilled nursing services. The inclusion of therapy and other ancillary treatments varies by payor source and by contract. Services provided outside of the routine contractual agreement are recorded separately as ancillary revenue, including Medicare Part B therapy services, and are not included in the routine revenue definition.

• Skilled revenue: The amount of routine revenue generated from patients in our skilled nursing facilities who are receiving higher levels of care under Medicare, managed care, Medicaid, or other skilled reimbursement programs. The other skilled residents that are included in this population represent very high acuity residents who are receiving high levels of nursing and ancillary services which are reimbursed by payors other than Medicare or managed care. Skilled revenue excludes any revenue generated from our assisted living services.

• Skilled mix: The amount of our skilled revenue as a percentage of our total routine revenue. Skilled mix (in days) represents the number of days our Medicare, managed care, or other skilled patients are receiving services at our skilled nursing facilities divided by the total number of days patients (less days from assisted living services) from all payor sources are receiving services at our skilled nursing facilities for any given period (less days from assisted living services).

• Quality mix: The amount of routine non-Medicaid revenue as a percentage of our total routine revenue. Quality mix (in days) represents the number of days our non-Medicaid patients are receiving services at our skilled nursing facilities divided by the total number of days patients from all payor sources are receiving services at our skilled nursing facilities for any given period (less days from assisted living services).

• Average daily rates: The routine revenue by payor source for a period at our skilled nursing facilities divided by actual patient days for that revenue source for that given period.

• Occupancy percentage (operational beds): The total number of residents occupying a bed in a skilled nursing, assisted living or independent living facility as a percentage of the beds in a facility which are available for occupancy during the measurement period.

• Number of facilities and operational beds: The total number of skilled nursing, assisted living and independent living facilities that we own or operate and the total number of operational beds associated with these facilities.

Skilled and Quality Mix. Like most skilled nursing providers, we measure both patient days and revenue by payor. Medicare, managed care and other skilled patients, whom we refer to as high acuity patients, typically require a higher level of skilled nursing and rehabilitative care. Accordingly, Medicare and managed care reimbursement rates are typically higher than from other payors. In most states, Medicaid reimbursement rates are generally the lowest of all payor types. Changes in the payor mix can significantly affect our revenue and profitability.

The following table summarizes our overall skilled mix and quality mix for the periods indicated as a percentage of our total routine revenue (less revenue from assisted living services) and as a percentage of total patient days (less days from assisted living services):

               2012         2011      2010
Skilled Mix:
Days           25.9 %       25.5 %   25.0 %
Revenue        50.0 %       51.3 %   49.1 %
Quality Mix:
Days           39.1 %       38.1 %   36.7 %
Revenue        59.5 %       60.1 %   57.8 %

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

                                                            Year Ended December 31,
                                                       2012          2011          2010
Occupancy:
Operational beds at end of period                      12,198        11,702         9,539
Available patient days                              4,371,034     3,945,511     3,389,313
Actual patient days                                 3,452,598     3,124,724     2,706,543
Occupancy percentage (based on operational beds)         79.0 %        79.2 %        79.9 %

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

                                                           Year Ended December 31,
                                          2012                        2011                      2010
                                      $              %            $            %            $            %
                                                           (Dollars in thousands)
Revenue:
Medicaid- custodial            $     302,046        36.6 %   $ 277,736        36.6 %   $ 259,711        40.0 %
Medicare                             278,578        33.8       272,283        35.9       219,217        33.7
Medicaid-skilled                      25,418         3.1        20,290         2.7        17,573         2.7
Total                                606,042        73.5       570,309        75.2       496,501        76.4
Managed care                         106,268        12.9        94,266        12.4        84,364        13.0
Private and other payors(1)          112,409        13.6        93,702        12.4        68,667        10.6
Total revenue                  $     824,719       100.0 %   $ 758,277       100.0 %   $ 649,532       100.0 %

Primary Components of Expense

Cost of Services (exclusive of facility rent and depreciation and amortization shown separately). Our cost of services represents the costs of operating our facilities and primarily consists of payroll and related benefits, supplies, purchased services, and ancillary expenses such as the cost of pharmacy and therapy services provided to residents. Cost of services also includes the cost of general and professional liability insurance and other general cost of services with respect to our operations.

Facility Rent - Cost of Services. Facility rent - cost of services consists solely of base minimum rent amounts payable under lease agreements to third-party owners of the facilities that we operate but do not own and does not include taxes, insurance, impounds, capital reserves or other charges payable under the applicable lease agreements.

General and Administrative Expense. General and administrative expense consists primarily of payroll and related benefits and travel expenses for our Service Center personnel, including training and other operational support. General and administrative expense also includes professional fees (including accounting and legal fees), costs relating to our information systems, stock-based compensation and rent for our Service Center office.

Depreciation and Amortization. Property and equipment are recorded at their original historical cost. Depreciation is computed using the straight-line method over the estimated useful lives of the depreciable assets. The following is a summary of the depreciable lives of our depreciable assets:

Buildings and improvements        Generally 15 to 30 years
                                  Shorter of the lease term or estimated useful
Leasehold improvements            life, generally 5 to 15 years
Furniture and equipment           3 to 10 years

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements and related disclosures requires us to make judgments, 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 period. On an ongoing basis we review our judgments and estimates, including those related to doubtful accounts, income taxes, stock compensation, intangible assets and loss contingencies. We base our estimates and judgments upon our historical experience, knowledge of current conditions and our belief of what could occur in the future considering available information, including assumptions that we believe to be reasonable under the circumstances. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported. The following summarizes our critical accounting policies, defined as those policies that we believe: (a) are the most important to the portrayal of our financial condition and results of operations; and (b) require management's most subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.
Revenue Recognition
We recognize 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. Our revenue is derived primarily from providing healthcare services to residents and is recognized on the date services are provided at amounts billable to individual residents. For residents under reimbursement arrangements with third-party payors, including Medicaid, Medicare and private insurers, revenue is recorded based on contractually agreed-upon amounts on a per patient, daily basis. Revenue from the Medicare and Medicaid programs accounted for 73.5% and 75.2% of our revenue for the years ended December 31, 2012 and 2011, respectively. We record revenue from these governmental and managed care programs as services are performed at their expected net realizable amounts under these programs. Our 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. We recorded retroactive adjustments that increased (decreased) revenue by $0.1 million, $0.3 million and $(0.1) million for the years ended December 31, 2012, 2011 and 2010, respectively.

Our service specific revenue recognition policies are as follows:
Skilled Nursing Revenue
Our revenue is derived primarily from providing long-term healthcare services to . . .