The Ensign Group, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise.
Business context
Ensign operates skilled nursing and rehabilitative care facilities, home health and hospice operations, urgent care centers, and ancillary services. At quarter-end it operated 125 facilities and had approximately 13,834 operational beds or units. On June 1, 2014, Ensign completed the tax-free spin-off of its real estate business as CareTrust REIT and became primarily a healthcare operator leasing properties from CareTrust.
Financial results and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $250.0 | $220.1 | $489.7 | $438.3 |
| Operating income | $13.6 | $23.3 | $38.0 | $12.5 |
| Income from continuing operations | $1.5 | $12.4 | $14.6 | $1.7 |
| Net income attributable to Ensign | $2.0 | $12.4 | $15.5 | $0.2 |
| Diluted EPS attributable to Ensign | $0.09 | $0.55 | $0.68 | $0.09 |
| Operating cash flow | Not separately reported | Not separately reported | $37.1 | $26.6 |
- Q2 revenue increased 13.6%; operating margin was 5.5%, down from 10.6%. For the first half, revenue rose 11.7% and operating margin was 7.8%, versus 2.9% in the prior-year period.
- Q2 occupancy was 77.8%, up from 76.6%; skilled mix by nursing revenue increased to 51.4% from 49.9%. For the first half, occupancy was 78.0%, versus 77.2%.
- Medicare and Medicaid represented 70.2% of Q2 revenue and 70.7% for the first half. Ensign reported $124.4 million of net accounts receivable at June 30, including a $17.9 million allowance for doubtful accounts.
- Six-month investing cash outflow was $87.4 million, including $32.6 million of property and equipment purchases, $38.4 million for business acquisitions, and $7.5 million for asset acquisitions. Financing cash flow was positive $7.0 million. Cash and cash equivalents ended at $22.4 million, down from $65.8 million at year-end; an additional $8.2 million was restricted cash.
- Ensign reported no debt outstanding at June 30, following debt repayments funded in connection with the spin-off. It had a $150 million credit facility available, with potential incremental commitments of up to $75 million, and reported compliance with its covenants. The filing does not provide a clear value for total unused borrowing availability after any borrowing-base or other conditions.
Material changes and unusual items
- The spin-off transferred 94 real estate properties and related debt to CareTrust. Ensign’s total assets fell to $380.8 million from $760.3 million at December 31, 2013; property and equipment declined to $116.8 million from $479.8 million. Ensign retained eight owned facilities and leased 117 facilities at quarter-end.
- Ensign entered into eight triple-net master leases with CareTrust covering the 94 properties. Annual rent is approximately $56 million for each of the first two years, with Ensign also responsible for property taxes, insurance, maintenance, and other costs. Future minimum lease payments across all leases totaled $1.014 billion. The master leases have portfolio and rent-coverage covenants, and cross-default provisions may link facilities.
- Q2 general and administrative expense included $7.3 million of spin-off costs; first-half costs were $8.9 million. Q2 interest expense included approximately $5.7 million of debt-extinguishment and swap-termination losses. These items, together with increased rent under the new leases, materially affected Q2 earnings.
- The prior-year first half included a $33 million charge related to the DOJ inquiry, which was settled for $48 million and paid in October 2013. This makes the year-over-year first-half profit comparison unusually favorable to 2014. Ensign remains subject to a five-year corporate integrity agreement; an uncured material breach could result in exclusion from federal healthcare programs.
- Acquisitions and same-facility performance supported growth: Q2 same-facility revenue increased 7.1%, while recently acquired facilities contributed $14.6 million of year-over-year revenue growth. Ensign cautioned that newer facilities generally have lower occupancy and skilled mix.
Outlook, risks, and contingencies
- Management stated that cash, operating cash flow, and the credit facility should cover operating needs for at least the next 12 months. The company budgeted $44 million for 2014 renovation projects. No company-specific earnings or revenue guidance is provided.
- Management expects occupancy to vary as the portfolio grows and newer acquisitions mature. The filing describes continued acquisition opportunities but notes integration, staffing, regulatory, and investment-return risks.
- CMS’s subsequent FY2015 skilled-nursing rule estimated a 2.0% aggregate payment increase. The filing also described a proposed 0.3% Medicare home-health payment reduction and an estimated 1.4% hospice payment increase. Actual effects on Ensign are not quantified.
- Key exposures include dependence on government reimbursement, audits and recoupments, healthcare regulation, labor and insurance costs, self-insurance reserve estimates, patient-care and staffing litigation, and lease obligations. The spin-off’s tax-free treatment depends on stated assumptions and undertakings; Ensign could face substantial tax and indemnification liabilities if it fails to qualify.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether post-spin-off operating cash flow can support approximately $56 million of annual master-lease rent, other triple-net costs, acquisitions, capital spending, and dividends.
- Lease coverage, cross-default exposure, and compliance with CareTrust master-lease and credit-facility covenants as operations and occupancy change.
- Whether acquisition-related growth translates into durable occupancy, skilled mix, and margins, particularly at newer facilities.
- Exposure to Medicare and Medicaid reimbursement changes, claims audits, self-insurance reserve revisions, and compliance with the corporate integrity agreement.
- Tax-free spin-off assumptions and any indemnification obligations between Ensign and CareTrust; also confirm the status and potential cost of outstanding litigation and regulatory matters.