CareTrust REIT, Inc. — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. The filing includes fourth-quarter results and was filed February 11, 2015.
Business context
CareTrust became an independent, publicly traded healthcare-property REIT following its June 1, 2014 spin-off from The Ensign Group, Inc. (Ensign). The 2014 statements combine pre-spin-off carve-out results with post-spin-off consolidated results; management cautions that pre-spin-off allocations and historical results may not reflect CareTrust’s standalone cost structure or future performance.
At year-end, the portfolio comprised 102 properties: 94 leased to Ensign, five leased to three other tenants, and three independent living facilities (ILFs) operated by CareTrust. The company also held a $7.5 million preferred equity investment. Ensign generated about 95% of fourth-quarter 2014 revenue.
Financial and operating results
| Metric | 2014 | 2013 |
|---|---|---|
| Total revenue | $58.9 million | $48.8 million |
| Net income (loss) | $(8.1) million | $(0.4) million |
| FFO | $14.9 million | $23.0 million |
| FAD | $16.6 million | $23.7 million |
| Cash from operating activities | $21.9 million | $26.6 million |
| Cash and cash equivalents at year-end | $25.3 million | $0.9 million |
Revenue increased 20.7%, with rental income up $10.1 million, mainly from post-spin-off rent arrangements and acquired properties. Net loss widened as interest expense rose to $21.6 million from $12.6 million and general and administrative expense increased to $11.1 million from $5.4 million. A $4.1 million debt-extinguishment loss also weighed on earnings. The reported net loss margin was approximately 13.8%.
Fourth-quarter 2014 revenue was $16.1 million and net income was $0.6 million, compared with fourth-quarter 2013 revenue of $12.9 million and a net loss of $1.2 million. Quarterly data are unaudited; earlier periods are carve-out results.
Investing cash outflow was $53.6 million, including real estate acquisitions and a $7.5 million preferred equity investment. Financing cash inflow was $56.1 million. CareTrust reported $482.6 million of assets and $113.5 million of equity at year-end.
Debt, liquidity and distributions
Year-end debt totaled approximately $358.2 million: $260.0 million of 5.875% senior notes due 2021 and approximately $98.2 million of mortgage debt. The $150 million secured revolving facility had no balance outstanding; $84.2 million was available subject to borrowing-base limits. Management reported compliance with applicable debt covenants and believed cash, operating cash flow and facility availability would cover operations, scheduled debt service and dividend requirements for at least 12 months.
Annual interest costs were estimated at approximately $24.0 million, with a weighted-average interest rate of about 5.8%. Approximately $50.1 million of the GECC mortgage debt was floating-rate; management estimated a 100-basis-point rate increase would add $0.5 million to annual interest expense on that portion. Debt maturities include approximately $92.4 million in 2017 and $260.0 million thereafter.
To address accumulated earnings and profits associated with the spin-off and its intended 2014 REIT qualification, CareTrust paid a $132.0 million special dividend: $33.0 million in cash and $99.0 million in stock, issuing 8,974,249 shares. A quarterly cash dividend of $0.125 per share was declared in the fourth quarter and paid January 15, 2015. The company stated it expected quarterly cash dividends of approximately 80% of FAD, subject to board discretion and REIT distribution requirements.
Material changes, outlook and notable items
- CareTrust issued $260.0 million of senior notes, transferred approximately $220.8 million of net proceeds to Ensign, and used remaining proceeds toward the special dividend. It also repaid or refinanced prior credit-facility and term-loan balances in connection with the spin-off.
- 2014 acquisitions included three assisted living and memory-care facilities in Idaho for $12.0 million, a Minnesota facility for $7.2 million, and a Virginia facility for $6.6 million. The company also made the $7.5 million preferred equity investment, carrying a 12% preferred return.
- Management estimated 2015 general and administrative expense of $6.2–$6.9 million, depreciation and amortization of approximately $23.0 million, and revenue and operating expenses for its three operated ILFs of approximately $2.6 million and $2.3 million, respectively. These are estimates, not formal earnings guidance.
- After year-end, CareTrust acquired a 170-bed Colorado skilled nursing facility for $18.0 million in January 2015. It also expected a separate 169-unit Virginia transaction to close in mid-2015.
- Ensign master leases provide $56.0 million of annual rent in each of their first two years, with subsequent CPI-linked annual increases capped at 2.5% and a zero floor. The filing reports approximately 1.91x lease coverage based on specified 12-month property ANOI.
Risks and contingencies
- Tenant concentration: Dependence on Ensign exposes rent, debt-service capacity and dividends to Ensign’s financial condition, operating performance and willingness to renew leases. A default under one Ensign master lease can trigger defaults under the others.
- Healthcare and regulatory exposure: Tenants rely on Medicare, Medicaid and other payors and face reimbursement changes, extensive licensing and compliance requirements, and enforcement risk. The filing also notes Ensign’s 2013 settlement with the U.S. Department of Justice and continuing corporate-integrity-agreement obligations; CareTrust says it has no liability for the investigation itself but has certain compliance obligations.
- Leverage and interest rates: Debt covenants, refinancing needs, secured property collateral and variable-rate borrowing may constrain flexibility or increase costs.
- REIT and spin-off tax risks: REIT qualification depends on ongoing technical tests. CareTrust disclosed uncertainty in its accumulated earnings-and-profits estimate and risk that the IRS could challenge it. The filing also describes potential tax and indemnification exposure if the spin-off fails to qualify as tax-free.
- Property and geographic risks: Texas and California each accounted for about 25% of 2014 rental income; natural disasters, local market conditions, environmental liabilities, tenant failures and difficulty re-leasing specialized properties could affect results.
- The company reported no material legal proceedings involving CareTrust or its subsidiaries. Ensign-related matters are subject to contractual indemnities, whose value depends on Ensign’s ability to perform.
Important facts for investors to verify
- Ensign’s current operating and financial capacity to meet lease, reimbursement and indemnification obligations, and the extent of CareTrust’s continuing revenue concentration.
- Reconciliation of reported GAAP net loss with FFO and FAD, including the effects of debt refinancing, spin-off costs, and recurring standalone-company expenses.
- Actual unrestricted liquidity and borrowing availability under the facility’s borrowing base, together with covenant headroom and the 2017 mortgage maturity/refinancing plan.
- Whether the special dividend satisfied the REIT earnings-and-profits distribution requirement and whether CareTrust continues to meet REIT qualification tests.
- Performance and returns from the new third-party acquisitions and preferred equity investment, including the expected Virginia closing and development milestones.