LEASES

9 Months Ended

Sep. 30, 2022

Leases [Abstract]

LEASES

LEASES

The Company leases from CareTrust REIT, Inc. (CareTrust) real property associated with 97 affiliated skilled nursing and senior living facilities used in the Company’s operations, 96 of which are under nine “triple-net” master lease agreements (collectively, the Master Leases), which range in terms from 13 to 20 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. The extension of the term of any of the Master Leases is 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 is 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. If the Company elects to renew the term of a Master Lease, the renewal will be effective to all, but not less than all, of the leased property then subject to the Master Lease. Additionally, four of the 97 facilities leased from CareTrust include an option to purchase that the Company can exercise starting on December 1, 2024.

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 as well as maintenance and repair costs for the leased property.

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%. 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. The terms and conditions of the one stand-alone lease are substantially the same as those for the master leases described above. Total rent expense under the Master Leases was approximately $16,259 and $47,911 for the three and nine months ended September 30, 2022, respectively, and $15,445 and $43,944 for the three and nine months ended September 30, 2021, respectively.

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. The Company is in compliance with requirements of the Master Leases as of September 30, 2022.

In connection with the Spin-Off, the Company guaranteed certain leases of Pennant based on the underlying terms of the leases. The Company does not consider these guarantees to be probable and the likelihood of Pennant defaulting is remote, and therefore no liabilities have been accrued.

The Company has entered into multiple lease agreements with various landlords to operate newly constructed state-of-the-art, full-service healthcare resorts. The term of each lease is 15 years with two five-year renewal options and is subject to annual escalation equal to the percentage change in the Consumer Price Index with a stated cap percentage. The Company also leases certain affiliated operations and certain 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 for continuing operations inclusive of straight-line rent adjustments and rent associated with the Master Leases noted above, was $38,940 and $111,976 for the three and nine months ended September 30, 2022, respectively, and $35,646 and $103,598 for the three and nine months ended September 30, 2021, respectively.

Forty-eight of the Company’s affiliated facilities, excluding the facilities that are operated under the Master Leases with CareTrust, are operated under eight separate master lease arrangements. In the first quarter of 2022, the Company added an operation and extended the term for one of the separate master leases to 14 remaining years. As a result, the lease liabilities and right-of-use assets increased by $120,349 to reflect the new lease obligations. In the third quarter of 2022, the Company added four new operations to one of the separate master leases. As a result, the lease liabilities and right-of-use assets increased by $32,853 to reflect the new lease obligations. 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.

During the three months ended September 30, 2022, Standard Bearer acquired the real estate of three skilled nursing operations, which were previously under separate long-term lease arrangements. The aggregate reduction in the carrying value of the Company's lease liabilities and right-of-use assets related to this acquisition is $10,080.

The components of operating lease expense are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Rent - cost of services(1)	$	38,907	$	35,623	$	111,897	$	103,534
General and administrative expense	33		23		79		64
Depreciation and amortization(2)	289		289		866		869
Variable lease costs(3)	4,121		3,582		13,256		10,719
	$	43,350	$	39,517	$	126,098	$	115,186

(1)Rent- cost of services includes deferred rent expense adjustments of $111 and $351 for the three and nine months ended September 30, 2022, respectively and $125 and $346 for the three and nine months ended September 30, 2021, respectively. Additionally, rent- cost of services includes other variable lease costs such as CPI increases and short-term leases of $1,758 and $3,997 for the three and nine months ended September 30, 2022, respectively, and $1,127 and $2,543 for the three and nine months ended September 30, 2021, respectively.

(2)Depreciation and amortization is related to the amortization of favorable and direct lease costs.

(3)Variable lease costs, including property taxes and insurance, are classified in cost of services in the Company's condensed consolidated statements of income.

Future minimum lease payments for all leases as of September 30, 2022 are as follows:

Year	Amount
2022 (remainder)	$	37,045
2023	147,092
2024	146,501
2025	146,393
2026	146,288
2027	145,770
Thereafter	1,330,030
TOTAL LEASE PAYMENTS	2,099,119
Less: present value adjustment	(778,451)
PRESENT VALUE OF TOTAL LEASE LIABILITIES	1,320,668
Less: current lease liabilities	(60,951)
LONG-TERM OPERATING LEASE LIABILITIES	$	1,259,717

Operating lease liabilities are based on the net present value of the remaining lease payments over the remaining lease term. In determining the present value of lease payments, the Company used its incremental borrowing rate based on the information available at the lease commencement date. As of September 30, 2022, the weighted average remaining lease term is 15.1 years and the weighted average discount rate used to determine the operating lease liabilities is 6.8%.

Subsequent to September 30, 2022, the Company expanded its operations through long-term lease arrangements with the addition of eight stand-alone skilled nursing operations, adding a total of 1,051 operational skilled nursing beds operated by the Company's affiliated operating subsidiaries. Of the eight, six are part of two new separate master lease agreements and the remaining are part of a separate existing amended master lease agreement. The aggregate impact to the fair value of lease liabilities and right-of-use assets related to both the new long-term lease arrangement and the separate amended master lease agreement is estimated to be approximately $78,505.

Lessor Activities

In connection with the Spin-Off, Ensign affiliates retained ownership of the real estate at 29 senior living operations that were contributed to Pennant. Between October 2019 and September 30, 2022, the Company transferred three additional senior living operations to Pennant. In the second quarter of 2022, the Company completed the sale of real estate associated with two of the senior living operations operated by Pennant and also transferred one senior living operation operated by Pennant back to Ensign affiliates. As of September 30, 2022, Ensign affiliates retained ownership of the real estate for these 29 senior living communities. All of these properties are leased to Pennant on a triple-net basis, whereas the respective Pennant affiliates are responsible for all costs at the properties including: (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. The initial terms range between 14 to 16 years.

Total rental income from all third-party sources for the three and nine months ended September 30, 2022 and 2021 is as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Pennant(1)	$	3,664	$	3,468	$	11,169	$	10,396
Other third-party	458		465		1,381		1,441
	$	4,122	$	3,933	$	12,550	$	11,837

(1) Pennant rental income includes variable rent such as property taxes of $331 and $988 during the three and nine months ended September 30, 2022 and $301 and $881 for the three and nine months ended September 30, 2021.

Future annual rental income for all leases as of September 30, 2022 were as follows:

Year	Amount(1)
2022 (remainder)	$	4,146
2023	16,234
2024	15,737
2025	15,391
2026	15,166
2027	15,166
Thereafter	79,171
TOTAL	$	161,011

(1) Annual rental income includes base rents and variable rental income pursuant to existing leases as of September 30, 2022.

LEASES

LEASES

The Company leases from CareTrust REIT, Inc. (CareTrust) real property associated with 97 affiliated skilled nursing and senior living facilities used in the Company’s operations, 96 of which are under nine “triple-net” master lease agreements (collectively, the Master Leases), which range in terms from 13 to 20 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. The extension of the term of any of the Master Leases is 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 is 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. If the Company elects to renew the term of a Master Lease, the renewal will be effective to all, but not less than all, of the leased property then subject to the Master Lease. Additionally, four of the 97 facilities leased from CareTrust include an option to purchase that the Company can exercise starting on December 1, 2024.

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 as well as maintenance and repair costs for the leased property.

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%. 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. The terms and conditions of the one stand-alone lease are substantially the same as those for the master leases described above. Total rent expense under the Master Leases was approximately $16,259 and $47,911 for the three and nine months ended September 30, 2022, respectively, and $15,445 and $43,944 for the three and nine months ended September 30, 2021, respectively.

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. The Company is in compliance with requirements of the Master Leases as of September 30, 2022.

In connection with the Spin-Off, the Company guaranteed certain leases of Pennant based on the underlying terms of the leases. The Company does not consider these guarantees to be probable and the likelihood of Pennant defaulting is remote, and therefore no liabilities have been accrued.

The Company has entered into multiple lease agreements with various landlords to operate newly constructed state-of-the-art, full-service healthcare resorts. The term of each lease is 15 years with two five-year renewal options and is subject to annual escalation equal to the percentage change in the Consumer Price Index with a stated cap percentage. The Company also leases certain affiliated operations and certain 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 for continuing operations inclusive of straight-line rent adjustments and rent associated with the Master Leases noted above, was $38,940 and $111,976 for the three and nine months ended September 30, 2022, respectively, and $35,646 and $103,598 for the three and nine months ended September 30, 2021, respectively.

Forty-eight of the Company’s affiliated facilities, excluding the facilities that are operated under the Master Leases with CareTrust, are operated under eight separate master lease arrangements. In the first quarter of 2022, the Company added an operation and extended the term for one of the separate master leases to 14 remaining years. As a result, the lease liabilities and right-of-use assets increased by $120,349 to reflect the new lease obligations. In the third quarter of 2022, the Company added four new operations to one of the separate master leases. As a result, the lease liabilities and right-of-use assets increased by $32,853 to reflect the new lease obligations. 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.

During the three months ended September 30, 2022, Standard Bearer acquired the real estate of three skilled nursing operations, which were previously under separate long-term lease arrangements. The aggregate reduction in the carrying value of the Company's lease liabilities and right-of-use assets related to this acquisition is $10,080.

The components of operating lease expense are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Rent - cost of services(1)	$	38,907	$	35,623	$	111,897	$	103,534
General and administrative expense	33		23		79		64
Depreciation and amortization(2)	289		289		866		869
Variable lease costs(3)	4,121		3,582		13,256		10,719
	$	43,350	$	39,517	$	126,098	$	115,186

(1)Rent- cost of services includes deferred rent expense adjustments of $111 and $351 for the three and nine months ended September 30, 2022, respectively and $125 and $346 for the three and nine months ended September 30, 2021, respectively. Additionally, rent- cost of services includes other variable lease costs such as CPI increases and short-term leases of $1,758 and $3,997 for the three and nine months ended September 30, 2022, respectively, and $1,127 and $2,543 for the three and nine months ended September 30, 2021, respectively.

(2)Depreciation and amortization is related to the amortization of favorable and direct lease costs.

(3)Variable lease costs, including property taxes and insurance, are classified in cost of services in the Company's condensed consolidated statements of income.

Future minimum lease payments for all leases as of September 30, 2022 are as follows:

Year	Amount
2022 (remainder)	$	37,045
2023	147,092
2024	146,501
2025	146,393
2026	146,288
2027	145,770
Thereafter	1,330,030
TOTAL LEASE PAYMENTS	2,099,119
Less: present value adjustment	(778,451)
PRESENT VALUE OF TOTAL LEASE LIABILITIES	1,320,668
Less: current lease liabilities	(60,951)
LONG-TERM OPERATING LEASE LIABILITIES	$	1,259,717

Operating lease liabilities are based on the net present value of the remaining lease payments over the remaining lease term. In determining the present value of lease payments, the Company used its incremental borrowing rate based on the information available at the lease commencement date. As of September 30, 2022, the weighted average remaining lease term is 15.1 years and the weighted average discount rate used to determine the operating lease liabilities is 6.8%.

Subsequent to September 30, 2022, the Company expanded its operations through long-term lease arrangements with the addition of eight stand-alone skilled nursing operations, adding a total of 1,051 operational skilled nursing beds operated by the Company's affiliated operating subsidiaries. Of the eight, six are part of two new separate master lease agreements and the remaining are part of a separate existing amended master lease agreement. The aggregate impact to the fair value of lease liabilities and right-of-use assets related to both the new long-term lease arrangement and the separate amended master lease agreement is estimated to be approximately $78,505.

Lessor Activities

In connection with the Spin-Off, Ensign affiliates retained ownership of the real estate at 29 senior living operations that were contributed to Pennant. Between October 2019 and September 30, 2022, the Company transferred three additional senior living operations to Pennant. In the second quarter of 2022, the Company completed the sale of real estate associated with two of the senior living operations operated by Pennant and also transferred one senior living operation operated by Pennant back to Ensign affiliates. As of September 30, 2022, Ensign affiliates retained ownership of the real estate for these 29 senior living communities. All of these properties are leased to Pennant on a triple-net basis, whereas the respective Pennant affiliates are responsible for all costs at the properties including: (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. The initial terms range between 14 to 16 years.

Total rental income from all third-party sources for the three and nine months ended September 30, 2022 and 2021 is as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Pennant(1)	$	3,664	$	3,468	$	11,169	$	10,396
Other third-party	458		465		1,381		1,441
	$	4,122	$	3,933	$	12,550	$	11,837

(1) Pennant rental income includes variable rent such as property taxes of $331 and $988 during the three and nine months ended September 30, 2022 and $301 and $881 for the three and nine months ended September 30, 2021.

Future annual rental income for all leases as of September 30, 2022 were as follows:

Year	Amount(1)
2022 (remainder)	$	4,146
2023	16,234
2024	15,737
2025	15,391
2026	15,166
2027	15,166
Thereafter	79,171
TOTAL	$	161,011

(1) Annual rental income includes base rents and variable rental income pursuant to existing leases as of September 30, 2022.