Business context and reporting period
The Ensign Group, Inc. filed this unaudited Form 10-Q for the three and nine months ended September 30, 2014. Ensign provides skilled nursing and rehabilitative care, assisted living, home health, hospice, urgent care and related services. At quarter-end, it operated 127 facilities and had 11 home health and 10 hospice operations, 14 urgent care centers and a mobile diagnostics business.
On June 1, 2014, Ensign completed the tax-free spin-off of CareTrust REIT. Ensign transferred 94 owned real estate properties to CareTrust and now leases them under long-term triple-net master leases. Ensign owned 9 of its 127 facilities and leased 118 at September 30, compared with 96 owned and 23 leased at December 31, 2013; this major change affects period-to-period balance-sheet and expense comparisons.
Financial results and key metrics
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $260.8 | $229.3 | $750.5 | $667.5 |
| Operating income | $15.3 | $20.3 | $53.3 | $32.8 |
| Income from continuing operations | $8.4 | $10.6 | $22.9 | $12.3 |
| Net income attributable to Ensign | $8.9 | $10.5 | $24.4 | $10.7 |
| Diluted earnings per share | $0.38 | $0.47 | $1.06 | $0.48 |
| Operating margin | 5.9% | 8.8% | 7.2% | 4.9% |
- Revenue rose 13.8% in Q3 and 12.4% for the nine-month period. Growth included recently acquired operations; same-facility revenue increased 5.8% in Q3 and 5.2% year to date.
- Q3 operating income fell 24.6% and Ensign-attributable net income fell 14.9% year over year. For the nine months, operating income rose 62.3% and attributable net income more than doubled, largely against a prior-year period that included the DOJ settlement charge.
- Q3 cost of services was 80.3% of revenue versus 81.2% a year earlier. Facility rent rose to $18.2 million from $3.4 million, primarily reflecting the CareTrust master leases. General and administrative expense was $13.0 million, including growth-related costs.
- For the nine months, G&A was $44.4 million, including $8.9 million of spin-off costs. Interest expense was $12.5 million and included $5.7 million of debt-retirement and swap-termination charges related to the spin-off.
- Cash from operations was $66.7 million versus $57.1 million. Investing used $99.4 million, including $42.1 million of property and equipment purchases, $43.0 million for business acquisitions and $7.9 million for asset acquisitions. Cash and cash equivalents declined by $26.5 million to $39.2 million.
- At September 30, cash was $39.2 million, current restricted cash was $6.7 million, and current assets and current liabilities were $193.9 million and $118.4 million, respectively. Total assets were $402.9 million versus $760.3 million at December 31, chiefly reflecting the real-estate spin-off.
- Debt was $3.4 million, consisting of an assumed HUD-insured mortgage; there were no borrowings under the $150 million 2014 Credit Facility. The company reported compliance with its credit-facility and master-lease covenants.
- Future minimum lease payments for all leases totaled approximately $1.05 billion. Annual rent under the CareTrust master leases is expected to be about $56 million during each of their first two years.
Material changes, outlook, risks and unusual items
- The spin-off materially changed Ensign’s asset and financing profile: it transferred real estate and related debt to CareTrust, replaced ownership costs with substantial rent obligations, and reduced Ensign’s debt. Ensign used proceeds received from CareTrust to repay debt and retained restricted cash intended for up to eight quarterly dividend payments; $6.7 million remained restricted at quarter-end.
- Management stated that cash balances, operating cash flow and the undrawn credit facility should cover operating needs for at least the next 12 months. No specific company earnings or revenue guidance was provided.
- Occupancy was 77.7% in Q3 versus 77.4% a year earlier; skilled mix by nursing days improved to 27.1% from 26.0%. Management cautioned that acquisitions tend to have lower occupancy and skilled mix, making consolidated occupancy variable as the portfolio grows.
- Medicare and Medicaid generated 70.6% of nine-month revenue. Reimbursement-rate changes, government cost containment, audits and recoupments, therapy payment limits, and compliance requirements are material business risks. CMS’s FY2015 skilled-nursing rule estimated a 2.0% aggregate payment increase; the filing also described a projected 0.3% reduction for home health payments in 2015.
- The DOJ matter was settled and paid in 2013 for $48 million, without an admission of wrongdoing. A five-year Corporate Integrity Agreement is in effect; an uncured material breach could lead to exclusion from federal healthcare programs. The company reported one facility under probe review and none on prepayment or targeted review.
- Other exposures include professional-liability and staffing litigation, self-insurance estimates, regulatory deficiencies, lease cross-defaults, and the risk that the spin-off may not retain tax-free treatment. The IRS notified Ensign that its 2012 tax return would be examined.
Important facts for investors to verify
- How the CareTrust leases’ rent, escalation terms, coverage covenants and cross-default provisions affect ongoing margins, cash flow and financial flexibility.
- Whether same-facility operating trends and acquisition integration can offset the Q3 decline in operating income and the lower occupancy at newer operations.
- The company’s exposure to Medicare and Medicaid reimbursement changes, audits, recoupments, and compliance obligations under the DOJ Corporate Integrity Agreement.
- The adequacy of self-insurance reserves and the status and potential cost of litigation, regulatory reviews and tax examinations.
- Management’s stated 12-month liquidity outlook, including cash availability, restricted dividend funds, capital spending and acquisition needs.