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Fran Murphy
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Fran Murphy is a Senior Financial Executive in the Long Term Care Industry. He currently serves as CFO at The Boston Home. See his LinkedIn profile - http://www.linkedin.com/in/franmurphy.
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  • Medicare Misses the Mark

    In a gaff as memorable as one committed twelve years earlier, it appears that CMS (Centers for Medicare & Medicaid Services) has again missed the mark when calibrating rates for a new system.  As investors in the nursing home space well remember, the move to the Prospective Payment System (NYSE:PPS) back in 1998 was viewed with guarded optimism by the industry.  In that year, HCR ManorCare publicly stated that “management believes that PPS will ultimately be a net positive for its skilled nursing business.”  By July 2000, nine of the countries top nursing home chains had filed for bankruptcy due to reduced revenues stemming from the implementation of PPS.

    I was at Harborside Healthcare then and our new private equity owner saw the value of its shares dive from $25 to nothing in three years.  Only after several years of increasing Medicare rates and deep cost cutting did the industry fight its way back to profitability and respect.

    So what is it this time?  No one has mentioned a problem - not analysts, corporate honchos or even CMS itself. 

    Things are going swimmingly well for skilled nursing companies.  Sun Healthcare, the largest public player had a successful spin off of its real estate operations in the fall.  Privately owned HCR ManorCare, sold its real estate to HCP, Inc., the largest health care REIT (until today's announced deal between Ventas and NHP), for $6.1 billion in December.   At public skilled nursing companies, share prices have jumped over the past three months: Skilled Nursing (+109%); Sun Healthcare (+46%); and Ensign Group (+47%) – all on the back of rising profitability and earnings expectations. 

    However, if you peel back the numbers something startling appears.  Medicare rates are shooting through the roof at a time when government prudence around funding Medicare and Medicaid is reaching a zenith. 

    Investors in the senior living space are likely aware of the wrangling over adoption of the new MDS (minimum data set) and RUG (resource utilization groups) systems for calculating Medicare payments to skilled nursing facilities.  The planned adoption of these rules was slated for 2010 and in the wake of health reform the timing was modified.  Congress finally acted in December 2010 to retroactively square away adoption of both RUG IV and MDS 3.0 effective October 1, 2010.

    CMS has stated its intention that the economic impact of implementing these changes would be “budget neutral”.  Added to these new systems was an announced market basket adjustment of 1.7% that CMS estimated would increase Medicare Part A payments to skilled nursing facilities by $542 million in 2011.  However, with the adoption of concurrent therapy rules it was reasonable to expect an overall increase in Medicare spending of less than 1.7%.

    Despite the stated neutrality of the new regulations, it was expected that there would be winners and losers in the new system.  But judging from reported earnings coming out of the public long term care space, there are only winners.

     

    Impact of Medicare Part A Rates on SNF Profitability
    Company Mcr Part A
    Rate Hike
    Q on Q
    4th Q
    Part A Revenue
    (in 000's)
    Pretax
    Operating
    Income (POI)
    (in 000's)
    Excess
    Part A
    Revenue
    Over 1.7%
    Excess
    Revenue
    As % of
    POI
    Kindred  14.6%   $183,706   $ 32,925   $20,679    62.8%
    Skilled Healthcare  15.5%   $ 63,932   $ 18,718   $ 7,638    40.8%
    Ensign Group  16.4%   $ 61,194   $ 19,092   $ 7,728    40.5%
    National Healthcare  19.0%   $ 48,717   $ 16,500   $ 7,082    42.9%

    As can be seen above, companies reporting 4th quarter results are showing 15% to 19% increases in their Medicare Part A (room and board) rates.  As compared to the expected overall increase of 1.7% to Part A rates.  The excess revenues earned from these Medicare increases are responsible for a huge (40% to 60%) percentage of reported Pretax Operating Income for these companies in the 4th quarter.

    Certainly, the Medicare system cannot afford to overpay by a factor of 10 times or $5.4 billion.  We can be certain that somebody is going to notice this unanticipated spending and soon.  Investors should be aware that CMS will need to recoup these funds.

    I expect that CMS must drastically reduce the RUG-IV payment schedule in 2012 in order to return to the expected 1.7% rate increase forecasted for 2011 and also recoup the excess payments made during 2011. MEDPAC, the watchdog organization for Medicare makes its first annual report to Congress in March, so this problem could be reported shortly.  The impact of reduced reimbursement and profit expectations should cause skilled nursing companies and related private pay senior living companies, that derive a large portion of their revenue from Medicare, to retrace their gains of the past three months.

    While the longer term demographic fundamentals of the industry remain solid, challenges from MEDPAC on SNF operated ancillary businesses such as hospice and homecare; state budget shortfalls leading to lower Medicaid revenues; implementation of proposed generally accepted accounting principals around leases; and, most importantly, reduced Medicare reimbursement are all reasons nursing home investors should be very wary of the frothy market and may want to begin to make their way toward the exits. 

     




    Disclosure: I am short ENSG, SKH, SUNH.
    Feb 28 10:52 AM | Link | 7 Comments
  • HQ Sustainable Marine’s Unsustainable Cash Flow

    HQ Sustainable Marine Industries (HQS) recently appeared on my value screen for good reason.  Currently trading at $6.13, HQS holds $2.76 of cash per diluted common share and trades at 83% of book value consisting, principally, of cash and accounts receivable.  Furthermore, HQS has no debt, sports an enterprise value of 2.2 times EBITDA (NYSE:TTM) and appears to have excellent growth prospects.  I’m not the only one who has noticed this Company, as the Motley Fools CAPS fantasy stock pickers have assigned a rating of ***** to HQS with 108 All Star investors ranking this aquatic food producer operating in the People’s Republic of China as an Outperform versus just two naysayers.  So what’s not to like?

    Well, just about everything else I’ve learned about them.

    First of all the Chairman and the COO are brother and sister and CEO and the Chairman are husband and wife.  Talk about conflicted.

    Also, the Company recently replaced a director, Joseph Emas, whom it reported had left for personal reasons.  The actual reason for his departure, however, is very clear. In January 2010 he entered into a settlement with the SEC which bars him from practice before the Commission because of misrepresentation and omissions in connection with a company’s registration statement.  According to The Vancouver Sun, Mr. Emas has “facilitated share registrations for several Vancouver companies that have evolved into horrendous stock scandals, including one involving a Vancouver Hells Angel.”

    However, Mr. Emas isn’t the only one at the company who has failed in his SEC responsibilities according to HQS’s latest 10K:

    • Jean-Pierre Dallaire timely filed a Form 5 to report one late transaction and his status as an insider.
    • Andrew Intrater timely filed two Forms 5 to report two late transactions and his status as an insider. Mr. Intrater also filed one late filing to report one late transaction.
    • Trond Ringstad filed one late filing to report his status as an insider.
    • Daniel Too timely filed a Form 5 to report one late transaction. Mr. Too also filed two late filings to report six late transactions and his status as an insider.
    • Fred Bild timely filed a Form 5 to report one late transaction. Mr. Bild also filed two late filings to report thirteen late transactions and his status as an insider.
    • Lillian Wang timely filed a Form 5 to report three late transactions.
    • Norbert Sporns timely filed a Form 5 to report three late transactions.
    • Harry Wang timely filed a Form 5 to report four late transactions.
    • Red Coral Group Ltd. timely filed a Form 5 to report four late transactions.

    Now Mr. Intrater might be forgiven for these filings slipping his mind were he not the “audit committee financial expert” as the term is defined by the applicable SEC rules.  However, since Mr. Intrater is not a trained accountant or CPA, this might not come as a complete surprise.

    In fact, the outside auditors themselves, Schwartz Levitsky Feldman LLP (clearly not a Big 4 or even Big 40 CPA firm) have had their share of troubles with the PCAOB which is tasked with oversight over public accounting firms.

    Furthermore, my concerns about HQS’s lack of transparency, self dealings, suspect recapitalizations and refinancings, my inability to find its primary brands on the internet, its branding as a biotech and using terms such as “fry genetics”, all leave me cold.

    But what concerns me most right now about HQS is the giant leap in its accounts receivables during the past quarter which saw receivables jump 44% to $58.2M or a total of 256 days sales in accounts receivables.  During the 4th quarter of 2009, the Company reported sales of $23M and collected just $3.7M of cash.  This is the equivalent of not collecting any of the $40M in receivables outstanding at 9/30/09 and converting just 16% of 4th quarter sales to cash during the final quarter…think about it. During HQS’s conference call, the CEO explained this away as seeding sales to new customers in the Health and Bio segment (which accounted for only $8M of sales during the quarter).  In fact, the deepest the question and answering got on this subject was that collections slowed around the Chinese New Year, reserving of bad debt would mitigate over time and that there is a good chance that past reserves will be recovered. Hardly serious grilling for such a major problem.

    I was happy to have sold my 7,500 shares this morning and would consider becoming a future investor if this Company would grow up from being a small fry to a real Company managed for its shareholders interests.  If not, I’m just as happy seeing it get flushed down the toilet like any pale dead guppy before it infects anyone.



    Disclosure: None
    Mar 22 10:41 AM | Link | 4 Comments
  • nanopool and SiO2- ultra thin layering
    Reading the recent press materials from German, privately held, nanopool GbmH (www.nanopool.eu), I have become fascinated with its potentially disruptive technology, "liquid spray-on glass" or "SiO2- ultra thin layering".  If their claims are true and nanopool - which is currently testing its product in the UK - eventually sells in the US, their product lines could become a major competitor to many established brands and disrupt the sales of others.

    "SiO2- ultra thin layering" is a nano-like product which, apparently, contains no nano particles.  Using raw materials of quartz sand and water or ethanol, the product creates a long term, impermeable, glass layer on most materials including wood, cork, glass, limestone and fabrics.  This results in the creation of a stain resistant supersurface on these materials which is easily cleaned by water and highly bacterial resistant. It is estimated that after application of this product in a hotel or restaurant environment, cleaning costs can be reduced by 40%.  McDonald's is testing the product in Austria.

    A means of investing in this product at this time is not available as nanopool is a private enterprise; its production raw materials are ubiquitous; and its marketing partner, Technology Marketing Management also appears to be private.

    On the other hand, the companies and products that may be disrupted by this technology are clear.  Harsh chemicals like Comet or Chlorox bleach and stain resistant treatments such as Scotch Guard might all be in for tough skating as a result of the newly treated surfaces laid down by nanopool.

    Disclosure: No Positions
    Tags: CLX, ZEP, DD, Technology
    Feb 15 1:12 PM | Link | Comment!
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