Pennant Group, Inc.: Form 10-Q for the period ended Sep 30, 2023

You should read the following discussion and analysis in conjunction with the Interim Financial Statements and the related notes thereto contained in Part I, Item 1 of this Quarterly Report on Form 10-Q (this “Quarterly Report”). The information contained in this Quarterly Report 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 Quarterly Report and in our other reports filed with the Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 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 Form 10-K, Form 10-Q and Form 8-K, for additional information. The section entitled “Risk Factors” filed within our 2022 Annual Report describes 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 Quarterly Report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.

Special Note About Forward-Looking Statements

This Quarterly Report contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995, that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words “outlook,” “believes,” “expects,” “potential,” “continues,” “may,” “might,” “will,” “should,” “could,” “seeks,” “approximately,” “goals,” “future,” “projects,” “predicts,” “guidance,” “target,” “intends,” “plans,” “estimates,” “anticipates”, the negative version of these words or other comparable words. Forward-looking statements include, but are not limited to, statements related to our expectations regarding the performance of our business, our financial results, our liquidity and capital resources, the effects of competition and the effects of future legislation or regulations and other non-historical statements.

The risk factors discussed in this Quarterly Report and the 2022 Annual Report under the heading “Risk Factors,” could cause our results to differ materially from those expressed in forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to:

• federal and state changes to, or delays receiving, reimbursement and other aspects of Medicaid and Medicare;
• changes in, and compliance with, the laws and regulations affecting the U.S. healthcare industry;
• proposed changes to payment models and reimbursement amounts within the Medicare and Medicaid fee schedules for future calendar years;
• future cost containment measures undertaken by payors;
• government reviews, audits and investigations of our business;
• potential additional regulation affecting the transparency, ownership, operating standards, and staffing of businesses in our industry;
• increased competition and increased cost of acquisition or retention for, or a shortage of, skilled personnel;
• achievement and maintenance of competitive quality of care ratings and referrals from referral sources;
• changes in, and compliance with, state and federal employment, fair housing, safety, licensing and other laws;
• competition from other healthcare providers, state efforts to regulate or deregulate the healthcare services industry, or the construction or expansion of the number of home health, hospice or senior living operations;
• actions of labor unions, including strikes, work stoppages, unfair labor practices claims, or related labor activity;
• costs associated with litigation or any future litigation settlements;
• the leases of our affiliated senior living communities;
• inability to complete future acquisitions at attractive prices or at all, and failure to successfully or efficiently new acquisitions into our existing operations and operating subsidiaries;
• general economic conditions, including a housing downturn, which could affect seniors’ ability to afford resident fees, or inflation and increasing interest rates, which raise the costs of goods and borrowing capital, which may affect the delivery and affordability of our services;
• security breaches and other cyber security incidents;
• the performance of the financial and credit markets and uncertainties related to our ability to obtain financing or the terms of such financing; and
• uncertainties related to the lingering effect of the COVID-19 pandemic, including new regulatory risks impacting our operations, potential litigation, and vaccination mandates

Forward-looking statements involve risks, uncertainties and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. You should not place undue reliance on any forward-looking statements in this Quarterly Report. Although we may from time to time voluntarily update our prior forward-looking statements, we disclaim any commitment to do so except as required by applicable securities laws.

Overview

We are a leading provider of high-quality healthcare services to patients of all ages, including the growing senior population, in the United States. We strive to be the provider of choice in the communities we serve through our innovative operating model. We operate in multiple lines of businesses including home health, hospice and senior living services across Arizona, California, Colorado, Idaho, Iowa, Montana, Nevada, Oklahoma, Oregon, Texas, Utah, Washington, Wisconsin and Wyoming. As of September 30, 2023, our home health and hospice business provided home health, hospice and home care services from 103 agencies operating across these 14 states, and our senior living business operated 51 senior living communities throughout six states.

The following table summarizes our affiliated home health and hospice agencies and senior living communities as of:

(a) See Footnote 3 Transactions with Ensign for discussion of the 2022 Transaction.

Recent Activities

Acquisitions. During the nine months ended September 30, 2023, we expanded our operations with the addition of three home health agencies, three hospice agencies, two home care agencies, as well as two senior living communities. A subsidiary of the Company entered into a separate operations transfer agreement with the prior operator of each acquired operation as part of each transaction.

Trends

We have experienced modest senior living occupancy improvement through the nine months ended September 30, 2023, partly as a result of improving COVID-19 case trends and renewed consideration of senior living communities as a home-based care setting. Though we have seen steady improvements in occupancy throughout 2022 and 2023, we cannot be sure when the occupancy levels in our senior living communities will return to pre-pandemic levels.

When we acquire turnaround or start-up operations, we expect that our combined metrics may be impacted. We expect these metrics to vary from period to period based upon the maturity of the operations within our portfolio. We have generally experienced lower occupancy rates and higher costs at our senior living communities and lower census and higher costs at our home health and hospice agencies for recently acquired operations; as a result, we generally anticipate lower and/or fluctuating consolidated and segment margins during years of acquisition growth.

Government Regulation

We have disclosed under the heading “Government Regulation” in the 2022 Annual Report a summary of regulations that we believe materially affect our business, financial condition or results of operations. Since the time of the filing of the 2022 Annual Report, the following regulations have been updated.

On July 28, 2023, CMS issued the Hospice Payment Rate Update final rule (the “Hospice Payment Final Rule”) for fiscal year 2024. The Hospice Payment Final Rule’s hospice payment update percentage is 3.1%, which is an estimated increase of $780 million in payments from fiscal year 2023. The payment update percentage of 3.1% is based on a 3.3% market basket percentage increase, which is reduced by a 0.2% productivity adjustment. The Hospice Payment Final Rule makes permanent the Hospice Quality Reporting program (“HQRP”) data submission threshold policy adopted in the 2016 Hospice Payment Rule Update final rule, which is that hospices must submit at least 90 percent of required data within 30 days of the relevant reporting event. Hospices that fail to meet quality reporting requirements will receive a 4% reduction to the annual hospice payment update percentage increase for that year, which would more than negate the payment update percentage for fiscal year 2024 contained in the Hospice Payment Final Rule for hospices that fail to submit required quality reporting data to CMS.

On November 1, 2023, CMS finalized rules regarding the administration of a Hospice Special Focus Program (HSFP) beginning in CY 2024. Under this final rule, CMS established the data sources for identifying hospices for inclusion in the HSFP, defined the scoring system, and set the criteria for selection into the HSFP. Based on public comments, CMS is finalizing the HSFP without any modifications of the proposed rule with respect to the hospice care index (HCI) score, standardization of HCI scores, and addressing how missing scores will be handled in the HSFP algorithm. Specifically, for missing scores, CMS will replace a hospice’s missing score with a zero after standardization, which is equivalent to replacing a non-reporting hospice’s missing data with the average value for that score or measure. This final rule mandates hospices in the HSFP to be surveyed at least semiannually over 18 months. This final rule also outlines conditions for successful completion and exit from the HSFP, as well as termination from the Medicaid program for those hospices that cannot meet substantial compliance for surveys conducted during the HSFP. Additionally, the final rule implements an informal resolution process for disputes between CMS and hospices related to condition-level deficiencies, similar to the process for home health agencies.

On November 1, 2023, CMS issued the CY 2024 Home Health Prospective Payment System Final Rule (“Home Health Payment Final Rule”). The Home Health Payment Final Rule finalizes an estimated 0.8% aggregate increase to all home health agencies in CY 2024. This increase reflects the effects of the 3.0 percent home health payment update percentage ($525 million increase), an estimated 2.6 percent decrease that reflects the net effects of CMS’s finalized prospective permanent behavior assumption adjustment across all payments (half of the full proposed adjustment), ($455 million decrease), and an estimated 0.4 percent increase that reflects the effects of an update to the fixed-dollar loss ratio (FDL) used in determining outlier payments ($70 million increase). CMS also finalized recalibrated case-mix weights and low utilization payment adjustment thresholds using 2022 data. Overall, the Home Health Payment Final Rule estimates that Medicare payments to all home health agencies will increase in the aggregate by $140.0 million based on its contents.

On October 7, 2023, California enacted SB 253 and SB 261, which require new climate disclosures from companies doing business in California. SB 253 requires companies with annual revenues of $1 billion or more to disclose their greenhouse gas emissions. SB 261 requires companies with annual revenues of $500 million or more to disclose their climate-related risks and the measures they use to reduce and adapt to those risks. These reports are first due from companies in 2026. Additional details regarding the application and requirements of these laws will be included in future regulations.

Segments

We have two reportable segments: (1) home health and hospice services, which includes our home health, home care and hospice businesses; and (2) senior living services, which includes the operation of assisted living, independent living and memory care communities. Our Chief Executive Officer, who is our Chief Operating Decision Maker (“CODM”), reviews financial information at the operating segment level. We also report an “all other” category that includes general and administrative expense from our Service Center.

Common Stock Repurchase Program

On December 12, 2022, the Board of Directors of the Company approved a share repurchase program under which the Company may repurchase up to $1.0 million of its common stock. Under the share repurchase program, the Company may repurchase shares from time to time through open market purchases, including through the use of trading plans intended to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. The timing and total amount of stock repurchases will depend upon business, economic and market conditions, corporate and regulatory requirements, prevailing stock prices, and other considerations. The authorization expires on December 12, 2023, and may be suspended or discontinued at any time and does not obligate the Company to acquire any amount of common stock. No shares were repurchased during the three and nine months ended September 30, 2023.

Key Performance Indicators

We manage the fiscal aspects of our business by monitoring key performance indicators that affect our financial performance. These indicators and their definitions include the following:

Home Health and Hospice Services

• Total home health admissions. Total admissions of home health patients, including new acquisitions, new admissions and readmissions.
• Total Medicare home health admissions. Total admissions of home health patients, who are receiving care under Medicare reimbursement programs, including new acquisitions, new admissions and readmissions.
• Average Medicare revenue per completed 60-day home health episode. The average amount of revenue for each completed 60-day home health episode generated from patients who are receiving care under Medicare reimbursement programs.
• Total hospice admissions. Total admissions of hospice patients, including new acquisitions, new admissions and recertifications.
• Average hospice daily census. The average number of patients who are receiving hospice care during any measurement period divided by the number of days during such measurement period.
• Hospice Medicare revenue per day. The average daily Medicare revenue recorded during any measurement period for services provided to hospice patients.

The following table summarizes our overall home health and hospice statistics for the periods indicated:

(a) The year-to-date average Medicare revenue per 60-day completed episode includes post period claim adjustments for prior quarters.

Senior Living Services

• Occupancy. The ratio of actual number of days our units are occupied during any measurement period to the number of days units are available for occupancy during such measurement period.
• Average monthly revenue per occupied unit. The room and board revenue for senior living services during any measurement period divided by actual occupied senior living units for such measurement period divided by the number of months for such measurement period.

The following table summarizes our senior living statistics for the periods indicated:

Revenue Sources

Home Health and Hospice Services

Home Health. We derive the majority of our home health revenue from Medicare and managed care. The Medicare payment is adjusted for 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. Net service revenue is recognized in accordance with PDGM methodology. Under PDGM, Medicare provides agencies with payments for each 30-day period of care provided to beneficiaries. If a beneficiary is still eligible for care after the end of the first 30-day payment period, a second 30-day payment period can begin. There are no limits to the number of periods of care a beneficiary who remains eligible for the home health benefit can receive. While payment for each 30-day period of care is adjusted to reflect the beneficiary’s health condition and needs, a special outlier provision exists to ensure appropriate payment for those beneficiaries that have the most expensive care needs. The PDGM payment under the Medicare program is also adjusted for certain variables including, but not limited to: (a) a low utilization payment adjustment if the number of visits is below an established threshold that varies based on the diagnosis of a beneficiary; (b) a partial payment if the patient transferred to another provider or the Company received a patient from another provider before completing the period of care; (c) adjustment to the admission source of claim if it is determined that the patient had a qualifying stay in a post-acute care setting within 14 days prior to the start of a 30-day payment period; (d) the timing of the 30-day payment period provided to a patient in relation to the admission date, regardless of whether the same home health provider provided care for the entire series of episodes; (e) changes to the acuity of the patient during the previous 30-day period of care; (f) changes in the base payments established by the Medicare program; (g) adjustments to the base payments for case mix and geographic wages; and (h) recoveries of overpayments. For further detail regarding PDGM see the Government Regulation section of our 2022 Annual Report.

Hospice. We derive the majority of our hospice business revenue from Medicare reimbursement. The estimated payment rates are calculated as daily rates for each of the levels of care we deliver. Rates are set based on specific levels of care, are adjusted by a wage index to reflect healthcare labor costs across the country and are established annually through federal legislation. The following are the four levels of care provided under the hospice benefit:

• Routine Home Care (“RHC”). Care that is not classified under any of the other levels of care, such as the work of nurses, social workers or home health aides.
• General Inpatient Care. Pain control or acute or chronic symptom management that cannot be managed in a setting other than an inpatient Medicare-certified facility, such as a hospital, skilled nursing facility or hospice inpatient facility.
• Continuous Home Care. Care for patients experiencing a medical crisis that requires nursing services to achieve palliation and symptom control, if the agency provides a minimum of eight hours of care within a 24-hour period.
• Inpatient Respite Care. Short-term, inpatient care to give temporary relief to the caregiver who regularly provides care to the patient.

CMS has established a two-tiered payment system for RHC. Hospices are reimbursed at a higher rate for RHC services provided from days of service one through 60 and a lower rate for all subsequent days of service. CMS also provides for a Service Intensity Add-On, which increases payments for certain RHC services provided by registered nurses and social workers to hospice patients during the final seven days of life.

Medicare reimbursement is adjusted 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, we monitor our provider numbers and estimate amounts due back to Medicare to the extent that the cap has been exceeded.

Senior Living Services. As of September 30, 2023, we provided assisted living, independent living and memory care services in 51 communities. Within our senior living operations, we generate revenue primarily from private pay sources, with a portion earned from Medicaid or other state-specific programs.

Primary Components of Expense

Cost of Services (excluding rent, general and administrative expense and depreciation and amortization). Our cost of services represents the costs of operating our independent operating subsidiaries, which primarily consists of payroll and related benefits, supplies, purchased services, and ancillary expenses such as the cost of pharmacy and therapy services provided to patients. Cost of services also includes the cost of general and professional liability insurance and other general cost of services specifically attributable to our operations.

Rent—Cost of Services. Rent—cost of services consists solely of base minimum rent amounts payable under lease agreements to our landlords. Our subsidiaries lease and operate but do not own the underlying real estate at our operations, and these amounts do 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 information systems, stock-based compensation and rent for our Service Center offices.

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 (ranging from one to 40 years). Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the remaining lease term.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on Interim Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of the Interim 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 but not limited to those related to self-insurance reserves, revenue, leases, intangible assets, goodwill, and income taxes. 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. While we believe that our estimates, assumptions, and judgments are reasonable, they are based on information available when the estimate was made. Refer to Note 2, Basis of Presentation and Summary of Significant Accounting Policies, within the 2022 Annual Report for further information on our critical accounting estimates and policies, which are as follows:

• Self-insurance reserves - The valuation methods and assumptions used in estimating costs up to retention amounts to settle open claims of insureds and an estimate of the cost of insured claims up to retention amounts that have been incurred but not reported;
• Revenue recognition - The estimate of variable considerations to arrive at the transaction price, including methods and assumptions used to determine settlements with Medicare and Medicaid payors or retroactive adjustments due to audits and reviews;
• Leases - We use our estimated incremental borrowing rate based on the information available at lease commencement date in determining the present value of future lease payments;
• Acquisition accounting - The assumptions used to allocate the purchase price paid for assets acquired and liabilities assumed in connection with our acquisitions; and
• Income taxes - The estimation of valuation allowance or the need for and magnitude of liabilities for uncertain tax position.

Recent Accounting Pronouncements

Information concerning recently issued accounting pronouncements, if applicable, are included in Note 2, Basis of Presentation and Summary of Significant Accounting Policies in the Interim Financial Statements.

Results of Operations

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

The following table presents our consolidated GAAP Financial measures for the three and nine months ended September 30, 2023 and 2022:

(In thousands)

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The following tables present certain financial information regarding our reportable segments. General and administrative expenses are not allocated to the reportable segments and are included in “All Other”:

(In thousands)

(In thousands)

The table below provides a reconciliation of Segment Adjusted EBITDAR from Operations to Condensed Consolidated Income from operations:

(In thousands)

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(a) Segment Adjusted EBITDAR from Operations is net income (loss) attributable to the Company's reportable segments excluding interest expense, provision for income taxes, depreciation and amortization expense, rent, and, in order to view the operations performance on a comparable basis from period to period, certain adjustments including: (1) costs at start-up operations, (2) share-based compensation, (3) acquisition related costs and credit allowances, (4) the costs associated with transitioning operations, (5) unusual, non-recurring or redundant charges, and (6) net income attributable to noncontrolling interest. General and administrative expenses are not allocated to the reportable segments, and are included as “All Other”, accordingly the segment earnings measure reported is before allocation of corporate general and administrative expenses. The Company's segment measures may be different from the calculation methods used by other companies and, therefore, comparability may be limited.

(b) Represents results related to start-up operations. This amount excludes rent and depreciation and amortization expense related to such operations.

(c) Share-based compensation expense and related payroll taxes incurred. Share-based compensation expense and related payroll taxes are included in cost of services and general and administrative expense.

(d) Non-capitalizable costs associated with acquisitions, credit allowances, and write offs for amounts in dispute with the prior owners of certain acquired operations.

(e) During the nine months ended September 30, 2023, an affiliate of the Company placed its memory care units into transition and is actively seeking to sublease the units to an unrelated third party. The amount above represents the net operating impact attributable to the units in transition. The amounts reported exclude rent and depreciation and amortization expense related to such operations and include legal settlement costs associated with one of the entities transitioned to Ensign. During January 2022, affiliates of the Company entered into Transfer Agreements with affiliates of Ensign, providing for the transfer of the operations of certain senior living communities (the “Transaction”) from affiliates of the Company to affiliates of Ensign. The closing of the Transaction was completed in two phases with the transfer of two operations on March 1, 2022 and the remainder transferred on April 1, 2022. The amount above represents the net impact on revenue and cost of service attributable to all of the transferred entities. The amounts reported exclude rent and depreciation and amortization expense related to such operations.

(f) Represents unusual or non-recurring charges for legal services, implementation costs, integration costs, and consulting fees in general and administrative and cost of services expenses. The amounts reported for the nine months ended September 30, 2022 include certain costs identified as redundant or non-recurring incurred by the Company for services provided by Ensign under the Transition Services Agreement, and were included in general and administrative expense.

Performance and Valuation Measures:

(In thousands)

(In thousands)

(a) General and administrative expenses are not allocated to any segment for purposes of determining segment profit or loss.

The tables below reconcile Consolidated Net Income to the consolidated Non-GAAP financial measures, Consolidated EBITDA and Consolidated Adjusted EBITDA, and to the Non-GAAP valuation measure, Consolidated Adjusted EBITDAR, for the periods presented:

(In thousands)

(a) Represents results related to start-up operations. This amount excludes rent and depreciation and amortization expense related to such operations.

(b) Share-based compensation expense and related payroll taxes incurred. Share-based compensation expense and related payroll taxes are included in cost of services and general and administrative expense.

(c) Non-capitalizable costs associated with acquisitions, credit allowances, and write offs for amounts in dispute with the prior owners of certain acquired operations.

(d) During the nine months ended September 30, 2023, an affiliate of the Company placed its memory care units into transition and is actively seeking to sublease the units to an unrelated third party. The amount above represents the net operating impact attributable to the units in transition. The amounts reported exclude rent and depreciation and amortization expense related to such operations and include legal settlement costs associated with one of the entities transitioned to Ensign. During January 2022, affiliates of the Company entered into Transfer Agreements with affiliates of Ensign, providing for the transfer of the operations of certain senior living communities (the “Transaction”) from affiliates of the Company to affiliates of Ensign. The closing of the Transaction was completed in two phases with the transfer of two operations on March 1, 2022 and the remainder transferred on April 1, 2022. The amount above represents the net impact on revenue and cost of service attributable to all of the transferred entities. The amounts reported exclude rent and depreciation and amortization expense related to such operations.

(e) Represents unusual or non-recurring charges for legal services, implementation costs, integration costs, and consulting fees in general and administrative and cost of services expenses. The amounts reported for the nine months ended September 30, 2022 include certain costs identified as redundant or non-recurring incurred by the Company for services provided by Ensign under the Transition Services Agreement, and were included in general and administrative expense.

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The tables below reconciles Segment Adjusted EBITDAR from Operations to Segment Adjusted EBITDA from Operations for the periods presented:

(In thousands)

(In thousands)

The following discussion includes references to certain performance and valuation measures, which are non-GAAP financial measures, including Consolidated EBITDA, Consolidated Adjusted EBITDA, Segment Adjusted EBITDA from Operations, and Consolidated Adjusted EBITDAR (collectively, “Non-GAAP Financial Measures”). Non-GAAP Financial Measures are used in addition to, and in conjunction with, results presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures. Non-GAAP Financial Measures reflect an additional way of viewing aspects of our operations and company that, when viewed with our GAAP results and the accompanying reconciliations to corresponding GAAP financial measures, we believe can provide a more comprehensive understanding of factors and trends affecting our business.

We believe these Non-GAAP Financial Measures are useful to investors and other external users of our financial statements regarding our results of operations because:

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

We use Non-GAAP Financial Measures:

• as measurements of our operating performance to assist us in comparing our operating performance on a consistent basis from period to period;
• to allocate resources to enhance the financial performance of our business;
• to assess the value of a potential acquisition;
• to assess the value of a transformed operation’s performance;
• to evaluate the effectiveness of our operational strategies; and
• to compare our operating performance to that of our competitors.

We typically use Non-GAAP Financial Measures to compare the operating performance of each operation from period to period. We find that Non-GAAP Financial Measures are useful for this purpose because they do not include such costs as interest expense, income taxes, depreciation and amortization expense, which may vary from period-to-period depending upon various factors, including the method used to finance operations, the date of acquisition of a community or business, and the tax law of the state in which a business unit operates.

We also establish compensation programs and bonuses for our leaders that are partially based upon the achievement of Consolidated Adjusted EBITDAR targets.

Non-GAAP Financial Measures have no standardized meaning defined by GAAP. Therefore, our Non-GAAP Financial Measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for analysis of our results as reported in accordance with GAAP. Some of these limitations are:

• they do not reflect our current or future cash requirements for capital expenditures or contractual commitments;
• they do not reflect changes in, or cash requirements for, our working capital needs;
• they do not reflect the net interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;
• in the case of Consolidated Adjusted EBITDAR, it does not reflect rent expenses, which are normal and recurring operating expenses that are necessary to operate our leased operations;
• they do not reflect any income tax payments we may be required to make;
• although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and do not reflect any cash requirements for such replacements; and
• other companies in our industry may calculate the same Non-GAAP Financial Measures differently than we do, which may limit their usefulness as comparative measures.

We compensate for these limitations by using Non-GAAP Financial Measures only to supplement net income on a basis prepared in accordance with GAAP in order to provide a more complete understanding of the factors and trends affecting our business. Our use of Non-GAAP Financial Measures should not be construed as an inference that our future results will be unaffected by unusual or unexpected items.

We strongly encourage investors to review the Interim Financial Statements, included in this Quarterly Report in their entirety and to not rely on any single financial measure. Because these Non-GAAP Financial Measures are not standardized, it may not be possible to compare these financial measures with other companies’ non-GAAP financial measures having the same or similar names. These Non-GAAP Financial Measures should not be considered a substitute for, nor superior to, financial results and measures determined or calculated in accordance with GAAP. We strongly urge you to review the reconciliation of Consolidated Net Income to the Non-GAAP Financial Measures in the table presented above, along with the Interim Financial Statements and related notes included elsewhere in this Quarterly Report.

We believe the following Non-GAAP Financial Measures are useful to investors as key operating performance measures and valuation measures:

Performance Measures:

Consolidated EBITDA

We believe Consolidated EBITDA is useful to investors in evaluating our operating performance because it helps investors evaluate and compare the results of our operations from period to period by removing the impact of our asset base (depreciation and amortization expense) from our operating results.

We calculate Consolidated EBITDA as net income, before (a) interest expense (b) provision for income taxes and (c) depreciation and amortization.

Consolidated Adjusted EBITDA

We adjust Consolidated EBITDA when evaluating our performance because we believe that the exclusion of the additional items described below provides useful supplemental information to investors regarding our ongoing operating performance. We believe that the presentation of Consolidated Adjusted EBITDA, when considered with Consolidated EBITDA and GAAP Consolidated Net Income is beneficial to an investor’s complete understanding of our operating performance.

We calculate Consolidated Adjusted EBITDA by adjusting Consolidated EBITDA to exclude the effects of non-core business items, which for the reported periods includes, to the extent applicable:

• costs at start-up operations;
• share-based compensation expense;
• acquisition related costs and credit allowances;
• costs associated with transitioning operations; and
• unusual, non-recurring, or redundant charges.

Segment Adjusted EBITDA from Operations

We calculate Segment Adjusted EBITDA from Operations by adjusting Segment Adjusted EBITDAR from Operations to include rent-cost of services. We believe that the inclusion of rent-cost of services provides useful supplemental information to investors regarding our ongoing operating performance for each segment.

Valuation Measure:

Consolidated Adjusted EBITDAR

We use Consolidated Adjusted EBITDAR as one measure in determining the value of prospective acquisitions. It is also a measure commonly used by us, research analysts and investors to compare the enterprise value of different companies in the healthcare industry, without regard to differences in capital structures. Additionally, we believe the use of Consolidated Adjusted EBITDAR allows us, research analysts and investors to compare operational results of companies with operating and finance leases. A significant portion of finance lease expenditures are recorded in interest, whereas operating lease expenditures are recorded in rent expense.

This measure is not displayed as a performance measure as it excludes rent expense, which is a normal and recurring operating expense and, as such, does not reflect our cash requirements for leasing commitments. Our presentation of Consolidated Adjusted EBITDAR should not be construed as a financial performance measure.

The adjustments made and previously described in the computation of Consolidated Adjusted EBITDA are also made when computing Consolidated Adjusted EBITDAR. We calculate Consolidated Adjusted EBITDAR by excluding rent-cost of services and rent related to start up operations from Consolidated Adjusted EBITDA.

Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022

Revenue

(In thousands)

(a) Home care and other revenue is included with home health revenue in other disclosures in this Quarterly Report.

Our total revenue increased $21.8 million, or 18.5% during the three months ended September 30, 2023. We experienced growth of $15.7 million from increased operational performance in our Home Health and Hospice segment from increased admissions and rates when compared to the three months ended September 30, 2022. The growth in our Senior Living segment resulted in an increase in revenue of $6.1 million driven primarily by the combination of increased occupancy and improved average rate per occupied room.

Home Health and Hospice Services

(In thousands)

Home health and hospice revenue increased $15.7 million, or 18.3%. Revenue grew due to an increase in certain key performance indicators including, an increase of 6.7% in total home health admissions, an increase in total hospice admissions of 1.7%, an increase in average daily hospice census of 17.7%, and an increase of 4.0% in hospice Medicare revenue per day, during the three months ended September 30, 2023 compared to the prior year quarter. Growth was also driven by the addition of nine home health and hospice operations between September 30, 2022 and September 30, 2023, resulting in an increase of $3.8 million or 4.4%.

Senior Living Services

Senior living revenue increased $6.1 million, or 18.9%, for the three months ended September 30, 2023 compared to the prior year quarter. Revenue grew primarily due to a 12.1% increase in average monthly revenue per occupied unit and an increase of 240 basis points in occupancy between September 30, 2022 and September 30, 2023. Growth was also driven by the addition of two senior living communities between September 30, 2022 and September 30, 2023, resulting in an increase of $0.6 million or 1.8% overall.

Cost of Services

The following table sets forth total cost of services by each of our reportable segments for the periods indicated:

(In thousands)

Total consolidated cost of services increased $17.7 million, or 18.7%, for the three months ended September 30, 2023 when compared to the three months ended September 30, 2022. Cost of services as a percentage of revenue increased by 20 basis points from 80.0% to 80.2% for the three months ended September 30, 2023 when compared to the three months ended September 30, 2022.

Home Health and Hospice Services

(In thousands)

Cost of services related to our Home Health and Hospice Services segment increased $13.7 million, or 19.2%, primarily due to increased volume of services provided. Cost of services as a percentage of revenue for the three months ended September 30, 2023 increased 70 basis points for the three months ended September 30, 2023 when compared to the three months ended September 30, 2022, primarily due to increased wages, benefits and other staffing costs.

Senior Living Services

(In thousands)

Cost of services related to our Senior Living Services segment increased $4.0 million, or 17.1%, primarily due to increased wages and benefits. As a percentage of revenue, costs of service decreased by 110 basis points for the three months ended September 30, 2023 when compared to the three months ended September 30, 2022.

Rent—Cost of Services. Rent expense increased 6.5% from $9.4 million to $10.0 million in the three months ended September 30, 2023 when compared to the three months ended September 30, 2022, primarily as a result of the newly acquired senior living communities. Rent as a percentage of total revenue decreased 80 basis points from 7.9% to 7.1% for the three months ended September 30, 2023 compared to the three months ended September 30, 2022.

General and Administrative Expense. Our general and administrative expense increased $3.5 million or 60.2% from $5.9 million to $9.4 million for the three months ended September 30, 2023 when compared to the three months ended September 30, 2022. General and administrative expense as a percentage of revenue increased 170 basis points from 5.0% to 6.7%. The primary driver of the increase in general and administrative expense was the increase in share-based compensation of $3.7 million due primarily to the modification of certain outstanding RSUs during the three months ended September 30, 2022 that resulted in a reduction of expense in that quarter. For further detail see Note 12, Options and Awards to the Interim Financial Statements included elsewhere in this Quarterly Report.

Depreciation and Amortization. Depreciation and amortization expense was essentially flat as a percentage of total revenue. The impact of increased capital expenditures on depreciation was offset by the prior year impairment of assets that were transferred to Ensign during the current year.

Provision for Income Taxes. We recorded income tax expense of $1.1 million and $1.1 million or 19.3% and 17.7% of earnings before income taxes for the three months ended September 30, 2023 and 2022, respectively. The increase in the effective tax rate is primarily due to not having the impact of the Ensign Transaction in the current year.

Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

Revenue

(In thousands)

(a) Home care and other revenue is included with home health revenue in other disclosures in this Quarterly Report.

Our total revenue increased $50.4 million, or 14.4%, during the nine months ended September 30, 2023. The increase in revenue was driven by increases in key metrics for home health and hospice and senior living, including hospice admissions, hospice revenue per day, hospice average daily census, senior living occupancy, and senior living revenue per occupied room.

Home Health and Hospice Services

(In thousands)

(a) The year-to-date average for Medicare revenue per 60-day completed episode includes post period claim adjustments for prior periods.

Home health and hospice revenue increased $36.0 million, or 14.3% during the nine months ended September 30, 2023. Segment revenue grew primarily due an increase in hospice average daily census of 12.1%, an increase of 5.9% in home health admissions, inclusive of an increase in total Medicare home health admissions of 3.5%, and an increase of 4.1% in hospice admissions. The addition of nine home health and hospice operations between September 30, 2022 and September 30, 2023, added revenue of $5.7 million or 2.3%.

Senior Living Services

Senior living revenue increased $14.4 million, or 14.8%, for the nine months ended September 30, 2023 compared to the same period in the prior year primarily due to an increase of 13.3% in average monthly revenue per occupied unit and an increase of 330 basis points in the occupancy rate between September 30, 2022 and September 30, 2023. The acquisition of two senior living communities between September 30, 2022 and September 30, 2023, added $1.1 million or 1.2% in revenue.

Cost of Services

(In thousands)

Consolidated cost of services increased $43.5 million, or 15.7%, during the nine months ended September 30, 2023. Cost of services as a percentage of revenue for the nine months ended September 30, 2023 increased by 80 basis points to 80.5% from 79.7% compared to the nine months ended September 30, 2022.

Home Health and Hospice Services

Cost of services related to our Home Health and Hospice services segment increased $33.9 million, or 16.3%, primarily due to the increased volume of services from the growth in admissions and average daily census. Cost of services as a percentage of revenue for the nine months ended September 30, 2023 increased by 140 basis points compared to the nine months ended September 30, 2022 primarily due to increased wages and benefits.

Senior Living Services

Cost of services related to our Senior Living services segment increased $9.6 million, or 13.8%, during the nine months ended September 30, 2023 in response to higher occupancy and wage rate increases. As a percentage of revenue, costs of service decreased by 70 basis points during the nine months ended September 30, 2023 when compared to the nine months ended September 30, 2022.

Rent—Cost of Services. Rent increased 3.2% from $28.5 million to $29.4 million during the nine months ended September 30, 2023 compared to the same period in the prior year, primarily as a result of the newly acquired senior living communities. As a percentage of revenue, rent—cost of services decreased 80 basis points when compared to the nine months ended September 30, 2022 due to improved senior living performance.

General and Administrative Expense. Our general and administrative expense increased $1.3 million, or 4.9%, from $25.7 million to $26.9 million for the nine months ended September 30, 2023 when compared to the nine months ended September 30, 2022. The increase in general and administrative expense was due to an increase of $1.4 million in share-based compensation, for the nine months ended September 30, 2023 when compared to the nine months ended September 30, 2022.

Depreciation and Amortization. Depreciation and amortization expense was essentially flat as a percentage of total revenue.

Loss on asset dispositions and impairment, net. Loss on asset dispositions and impairment, net decreased $6.7 million for the nine months ended September 30, 2023 when compared to the nine months ended September 30, 2022 due to senior living communities transferred to Ensign in 2022.

Provision for Income Taxes. We recorded income tax expense of $3.9 million and $0.2 million, or 29.3% and 6.3% of earnings before income taxes, for the nine months ended September 30, 2023 and 2022, respectively. The increase in the effective tax rate is primarily due to not having the impact of the Ensign Transaction in the current year.

Liquidity and Capital Resources

Our primary sources of liquidity are net cash provided by operating activities and borrowings under our revolving credit facility.

Revolving Credit Facility

On February 23, 2021, Pennant entered into an amendment to its existing credit agreement (as amended, the “Credit Agreement”), which provides for an increased revolving credit facility with a syndicate of banks with a borrowing capacity of $150.0 million (the “Revolving Credit Facility”). The Revolving Credit Facility is not subject to interim amortization and the Company will not be required to repay any loans under the Revolving Credit Facility prior to maturity in 2026. On June 12, 2023, Pennant entered into a second amendment to the Credit Agreement that modified the reference rate from LIBOR to Standard Overnight Financing Rate (“SOFR”). The Company is permitted to prepay all or any portion of the loans under the Revolving Credit Facility prior to maturity without premium or penalty, subject to reimbursement of any SOFR breakage costs of the lenders.

The Credit Agreement contains customary covenants that, among other things, restrict, subject to certain exceptions, the ability of the Company and its independent operating 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. Financial covenants require compliance with certain levels of leverage ratios that impact the amount of interest. As of September 30, 2023, the Company was compliant with all such financial covenants.

As of September 30, 2023, we had $3.4 million of cash and $90.8 million of available borrowing capacity on our Revolving Credit Facility.

We believe that our existing cash, cash generated through operations, and access to available borrowing capacity under our existing Credit Agreement, will be sufficient to provide adequate liquidity for the next twelve months for our operating activities and for opportunities of acquisition growth.

The following table presents selected data from our Condensed Consolidated Statement of Cash Flows for the periods presented:

(In thousands)

Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

Our net cash flow from operating activities for the nine months ended September 30, 2023 increased by $14.9 million when compared to the nine months ended September 30, 2022. The primary driver of this difference was a $5.9 million increase in Net income, and a $4.9 million net increase in cash flows from the change in operating assets and liabilities, partially offset by a decrease of $4.2 million in non-cash expenses.

Our net cash used in investing activities for the nine months ended September 30, 2023 decreased by $2.6 million compared to the nine months ended September 30, 2022, primarily driven by a $2.1 million increase in business acquisitions and other assets offset by a $4.7 million decrease in purchases of property and equipment during the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022.

Our net cash used in financing activities increased by approximately $14.0 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. The increase was primarily due to a net reduction in the balance on our line of credit during the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022.

Contractual Obligations, Commitments and Contingencies

We continue to make draws and payments on our Revolving Credit Facility, as described in Note 11, Debt, to the Interim Financial Statements in Part I of this Quarterly Report. Additionally, we have right-of-use assets obtained in exchange for new operating lease obligations, as described in the supplemental disclosures of cash flow information in the Condensed Consolidated Statement of Cash Flows and in Note 13, Leases, to the Interim Financial Statements in Part I of this Quarterly Report.

Besides those transactions there have been no other material changes to our total obligations during the period covered by this Quarterly Report outside of the normal course of our business.

Interest Rate Risk. We are exposed to risks associated with market changes in interest rates. On June 12, 2023, Pennant entered into a second amendment to the Credit Agreement that modified the reference rate from LIBOR to SOFR. A 1.0% interest rate change would cause interest expense to change by approximately $0.6 million annually based upon our outstanding long-term debt as of September 30, 2023. We manage our exposure to this market risk by monitoring available financing alternatives.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no material changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

We have disclosed under the heading “Risk Factors” in the 2022 Annual Report risk factors that materially affect our business, financial condition or results of operations. You should carefully consider the risk factors set forth in the 2022 Annual Report and the other information set forth elsewhere in this Quarterly Report. You should be aware that these risk factors and other information may not describe every risk facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Since the filing of our 2022 Annual Report on February 23, 2023, the following additions have been made to the risk factors previously disclosed.

Any economic downturn, deepening of an economic downturn, continued deficit spending by the Federal Government or state budget pressures may result in a reduction in payments and covered services. Adverse economic developments in the United States could lead to a reduction in Federal Government expenditures, including governmentally funded programs in which we participate, such as Medicare and Medicaid. In addition, if at any time the Federal Government is not able to meet its debt payments due to Congress failing to appropriate funds for the payment of these obligations, the Federal Government may stop or delay making payments on its obligations, including funding for government programs in which we participate, such as Medicare and Medicaid. Failure of the government to make payments under these programs could have a material adverse effect on our business and consolidated financial condition, results of operations and cash flows. Further, any failure by the United States Congress to complete the federal budget process and fund government operations may result in a Federal Government shutdown, potentially causing us to incur substantial costs without reimbursement under the Medicare program, which could have a material adverse effect on our business and consolidated financial condition, results of operations and cash flows. As an example, the failure of the 2011 Joint Select Committee to meet its Deficit Reduction goal resulted in an automatic reduction in Medicare home health and hospice payments of 2% beginning April 1, 2013 ("sequestration" - suspended from May 1, 2020 through March 31, 2022; reinstated at 1% for the period April 1, 2022 through June 30, 2022 and at 2% thereafter). In addition, the Federal Reserve has increased interest rates repeatedly and significantly in recent quarters and may further increase or decrease interest rates in future quarters, impacting our cost of capital, our operating costs, and the economy as a whole.

Union activity is increasing and could impact our operations. Throughout 2023, there has been a trend of increasing union activity, including strikes in the health care industry and in locations, such as California, in which we operate. Labor disputes and unionization efforts, among our own employees or among the employees of our referral partners, payors, vendors, joint venture partners, acquisition targets, or other parties, could lead to work stoppages, slowdown, strikes, lockouts, and increased costs, which could materially impact our operations.