ENSIGN GROUP, INC quarterly report, Q1 FY2017

Business context and reporting period

The Ensign Group, Inc. filed this unaudited Form 10-Q for the three months ended March 31, 2017, compared with the first quarter of 2016. Through its operating subsidiaries, Ensign provides skilled nursing, assisted and independent living, home health, hospice and ancillary services. At quarter-end, it operated 212 facilities and 40 home health, hospice and home care agencies across 13 states. The parent company is a holding company without direct operating assets, employees or revenue.

Financial performance and liquidity

Revenue grew 15.3%; management attributed $52.0 million of the increase to operations acquired on or after January 1, 2016. GAAP operating margin declined to 1.7% from 4.3%, and net margin to approximately 0.6% from 2.4%. Reported results included an $11.0 million class-action settlement accrual. Cost of services rose to 80.5% of revenue from 79.9%; total expenses were 98.3% of revenue versus 95.7%.

Adjusted EBITDA, a non-GAAP measure, was $41.1 million versus $37.6 million; adjusted EBITDAR was $68.7 million versus $62.6 million. These measures include adjustments for items such as the class-action accrual, closure costs and share-based compensation; they should not be treated as substitutes for GAAP results or cash flow.

Operating cash flow less cash purchases of property and equipment was approximately $7.6 million, compared with negative $5.5 million in Q1 2016. Cash declined by $26.2 million during the quarter, reflecting investing and financing outflows. Gross debt was $267.1 million, including $253.3 million outstanding under the credit facility and $13.9 million of mortgage loans and a promissory note. The company reported compliance with debt covenants. Its $450 million credit facility comprises a $300 million revolver and $150 million term loan; approximately $2.3 million of borrowing capacity was pledged for letters of credit. Management said cash, operating cash flow and available credit should cover operating needs for at least 12 months.

Material changes versus the prior comparable period

• Transitional and skilled services revenue rose 18.1%, assisted and independent living revenue rose 7.2%, and home health and hospice revenue rose 20.5%. The latter two segments benefited from occupancy, census, rate and acquisition growth.
• Growth was acquisition-led, while same-facility transitional and skilled revenue increased 2.2%. Overall skilled-nursing occupancy declined to 74.9% from 76.9%; skilled mix by nursing days fell to 32.0% from 32.5%.
• Interest expense increased to $3.4 million from $1.4 million, primarily due to additional credit-facility borrowing. General and administrative expense rose 22.3%, and rent expense rose 18.2%.
• Net debt repayments were approximately $17.0 million in Q1 2017, compared with net borrowings of approximately $46.6 million in Q1 2016. Share repurchases were $6.1 million, versus $30.0 million in the prior-year quarter.

Outlook, commentary, risks and unusual items

No full-year financial guidance was provided in the supplied filing text. Ensign budgeted approximately $55 million for 2017 renovation projects. It expected a second-quarter 2017 sale-and-lease transaction involving two skilled nursing properties and one assisted living property to generate approximately $38 million in proceeds; the properties would then be leased under a 20-year triple-net master lease, subject to optional extensions and CPI-based escalators. After quarter-end, the company also reported agreements to add three skilled nursing operations for approximately $11.3 million.

In April 2017, after quarter-end, the company reached an agreement in principle to settle a wage-and-hour class action without admitting liability, subject to documentation and court approval. It recorded an $11.0 million accrual in Q1. Other unusual items included $4.0 million of operational closure and lease-termination losses, including a facility closure and termination of certain leases.

Key risks include dependence on Medicare and Medicaid, which together generated 68.2% of Q1 revenue; reimbursement reductions or audits; regulatory and quality-of-care requirements; labor availability and costs; litigation and self-insurance estimates; and substantial long-term lease commitments. Future minimum lease payments were approximately $1.76 billion. Seven operating subsidiaries had Medicare probes scheduled or underway; none was on extended prepayment review or subject to extrapolation at quarter-end. The company also remained subject to a five-year corporate integrity agreement entered into in 2013. Management disclosed a limited, inadvertent confidential-information disclosure at an Arizona entity, which it said had been investigated and addressed.

Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing discusses pending Medicare payment and regulatory changes, including a proposed FY2018 skilled nursing payment update of 1.0%, subject to quality-reporting requirements; this is a proposal, not company guidance.

Important facts for investors to verify

• Whether the $11.0 million class-action settlement receives court approval and whether the final settlement amount or terms differ from the accrual.
• Whether acquisition growth can improve occupancy, skilled mix and margins, particularly at recently acquired and start-up facilities.
• Credit-facility availability, covenant headroom, interest-rate exposure and the effect of the reported increase in borrowings after quarter-end.
• Completion and proceeds of the planned property sale-and-lease transaction, including its long-term rent and other obligations.
• Medicare and Medicaid reimbursement developments, audit outcomes, regulatory compliance costs and changes in patient mix.
• The adequacy of self-insurance reserves and the company’s ability to manage substantial lease commitments and facility-level operating risks.