Addus HomeCare Corporation (ADUS) Earnings Call Transcript & Summary

Thanks, everyone, for joining us. My name is Joanna Gajuk. I'm a health care equity analyst at Bank of America Equity Research. I cover some of the small and medium cap health care providers for the team. And it's now my pleasure to host this session with Addus HomeCare. They are one of the largest personal care providers, but they also have presence in some other verticals in home care. And today with us, we have Dirk Allison, CEO; Brad Bickham, who's the President and COO; and Brian Poff, the CFO. So we agreed we're going to go right into Q&A. So thank you for doing that.

So first, I want to talk about the most, I guess, topical rule ever for this industry, it seems like, because it's nonstop. Medicaid Access Rule, right, was finalized and the key provision there, the 80/20 rule, essentially finalized that percentages. But there were a lot of clarifications to definitions in the rule. So maybe give us your kind of high-level view of the regulation and, in particular, that 80/20 rule and what does it mean for the company.

Okay. Thank you. We appreciate that. Well, certainly, we all saw that the 80/20 came out recently, the Medicaid Access Rule. And so at the year being out there for comments, most of which were positive comments, honestly, about a lot of the rule, but not about the 80/20. A lot of concern that 80/20 doesn't work for every state that we all bring in or that the industry operates in and that there ought to be more ability for states to -- if they wanted to have a percentage to make it their own. CMS didn't listen. CMS came out and basically said 80/20. But what they did do, they did this to the industry as we talked about certain aspects around what is in the 80%. Not just direct labor, but also things up to supervisory visits. They have a special carve-out for clinical wages, payroll taxes, unemployment taxes. There's a number of things that were included in the 80% that actually lowers the 80% a bit. And so from an industry standpoint, the biggest disappointment for a company like Addus is what it's -- what we believe it will do to the industry if, in fact, it gets into effect. Now one of the aspects I didn't mention before I talk about that is that it went from 4 years to 6 years. And so realistically, those of us in the industry that look at it and say, CMS is actually putting in a rule and they give us 6 years to implement it causes us to believe that there should -- there possibly will be a lot of changes between today and when this is implemented in 6 years. There's 2 presidential elections that will happen between those times. There's already been a bill in Congress in the House to take the 80% out of the CMS's ability to make the change. While we do not believe that will get through with the Biden administration and that he would veto it even if it got through the House and the Senate, it does show you that people are starting to think about it. So for us, our biggest disappointment is not that it really hurts Addus. We don't believe long term, it will have a negative effect on us because of our strategy. We're very large in most of the states in which we operate. It allows us to spread cost over a higher revenue base than a lot of the people in the industry. This is basically an industry of mom-and-pops. Probably the top 5, 6 providers represent 45% of the market across the nation. So really, the people that provide a lot of care, small mom-and-pops, that are going to be dramatically affected by this rule. If in fact, it's in. Their margins, EBITDA margins, probably run around 6% at best, and this is cutting that dramatically. So for us, while we think we'll be able to do fine, it does concern us for the industry in that it will drive a lot of folks out of business. On the other hand, Addus will be a survivor so we could pick up a lot of market share. And this is similar to what we see -- we have seen in Illinois. Illinois already has a 77% number. Illinois is our biggest market for personal care. And what we saw over time is as that rule came into effect, the mom-and-pops either sold their business or just allowed their business to go away. And so today, probably anywhere from 60% to 70% of the market is held by 2 providers, one of which obviously is Addus. So we believe that if you look at -- even if you said, some percentage of our margin wouldn't go away, the fact that each percentage of market share gain is a nice number for us as far as additional revenue dollars and, quite frankly, additional gross profit margin dollars, we feel very comfortable that over a 6-year time, a number of things will happen. One, we'll get bigger in the states. Two, we think a lot of states will address this through raising rates. And over a period of time, allowing us to get to an 80% figure, if that does in fact become law, in a very controlled manner. Similar to what we did with minimum wage, which we just came through in a number of states over the last 5 to 6 years. So all being said, to move it around, when we first saw the proposed rule a year ago, it was very concerning to us. We spent a year looking at ways to become more efficient, more effective. We looked at ways to deal with this rule. We changed our strategy, really focused on or reemphasized our strategy to be very large in the states in which we operate to give us not only the revenue base to spread costs but also the voice with the state leaders that make the decision on rates. So we're okay with the rule. We'll continue to operate as we are, and we believe our strategy will be very effective.

And you mentioned your experience in Illinois that resulted in higher revenues of market share came to you, essentially. And you also alluded to more consolidation. So should we expect more deals done by you pretty soon? Or is it going to be kind of over the next couple of years, you're expecting like acceleration because of this rule?

I think the consolidation in the personal care industry that was going to happen in the next year to 18 months will happen just organically. It won't be because of the Medicare Access Rule. Because if I'm a small provider and I'm looking at the rule being 6 years away, I've got a lot of time before I have to decide if I'm going to get out of the business. A lot of things can change in that time. So we really feel it will be a couple of years, if the rule is still in place in that point in time and the administration is driving that direction, then we think we'll start to see some of the small mom-and-pops decide to try to get out in the business at that point. But for this year, we believe it will be business as normal.

Okay. And when it comes to the fundamentals here, I guess, the EBITDA margins, you alluded -- you expect them to come in about 11% for the full year, right? In Q1, it was actually even better, right? It was 11.6%. And Q1 tends to be actually the worst quarter when it comes to margins for that business, right? So should we think about the margins improving from here for the rest of the year? And also specifically, any puts and takes when -- I know you don't give guidance. That's why I'm trying to get a sense from you. Where do you think this year is headed? And maybe in Q2, when it comes, to just how to think about sequentially Q1 to Q2 and then puts and takes around margins?

Yes, Joanna. I think we still expect the full year to be over 11%, so a good start in Q1. I think just thinking ahead, sequentially to Q2, I think the thing, what you mentioned, is our merit increases across the organization typically go into effect on March 1. So you've got only 1 month of that cost in Q1. You'll have a full quarter in Q2. Kind of offsetting that, we usually get some relief on the payroll tax, people hitting kind of certain caps going Q1 to Q2. That will kind of offset that. So I think the way we characterize it is to expect Q2, Q3 to be pretty consistent with Q1. Maybe there might be a little bit of an uptick. But really, Q4 is really typically our best quarter of the year. Primary reason for that is we get our hospice rate increase October 1 every year with no corresponding cost. We really give that -- those rate increases in the first quarter.

I'm thinking about fundamentals for personal care. I guess, maybe we can talk about this segment first, given the size. The top line continues to outperform. You've been doing pretty well there. And I guess, it's largely the rates, right, the average revenue per hour has been increasing to a high single digits for the last 3 years, right? So is there a risk that at some point, it's going to slow down? How should we think about the outlook for pricing in personal care?

Yes. I think for '24 with the most recent Illinois rate increase we got on January 1, which was a nice increase, there's a lot of pass-through component to that down to the caregivers. But I think we've said, we expect to be at or above kind of the top end of our normal kind of long-term 3% to 5% range in personal care for '24. But I think getting out of '24 into '25 and beyond, we would expect to see that moderate some as most of our larger states have kind of hit their targets as far as minimum wage that would be funded through reimbursement. I would expect that mix to go back to probably more 2/3 volume, 1/3 rate. So if you think about 3% to 5% as kind of our target range, you're probably thinking about 1% to 2% rate, 2% to 3% on the volume side, long term. But for '24, we would expect it to still be at or above the top end of that 3% to 5%.

And in that business, you've clearly done a pretty good job when it comes to hiring. And I guess, you were making some changes to recruiting, onboarding process. And I guess it seems like things are working pretty well. So can you flesh it out a little bit on how things are tracking so far this year, when it comes to hiring and retention? And if you can throw some numbers around where you are on some of these metrics? And how does it compare versus say COVID? Like as in is there more room to continue improve some of these this year into next year?

Yes. I think if you look at our hiring, first quarter was solid for us. It was sequentially a nice improvement over Q4, but Q4 has some seasonality in it kind of comparable to prior year. A little -- and I'd say the only reason why it was kind of comparable to prior years, January was a little soft because of some weather events that kept people out of the office, kept people from coming to their office to kind of finish their paperwork and get through the process. We actually saw really good hiring numbers in February and March, and that trend continued into April as well. And some of the reasons for that is we did implement, I guess, it was probably midyear last year when we finished the full rollout of our new candidate tracking system. Certainly improved the candidate throughput there. It made it easier for candidates to apply. It was mobile optimized. People can take the -- complete the whole application process with their phone. More text-enabled instead of kind of e-mail-based. So we certainly saw some improvements there. And now we're kind of on to our kind of next alliteration of that, and that's really starting to add some chat bot features to engage more actively with potential candidates to kind of pull them through. And so we're starting to pilot that in a few locations. And so far, that's been positive. We've actually seen some improved throughput from candidate to actually employed and actually working that first case, where we're starting to cut out some of the days that it takes to get somebody through the process and get them to that first billable case.

And any numbers you can throw at us, when it comes to like where you are on retention and turnover and how this compares say versus the industry or how things were, I guess, before COVID?

Yes. I think we're kind of back industry-wide more to kind of the pre-COVID numbers. I mean during COVID, I mean, you actually saw kind of industry-wide, I mean, the numbers were pretty shocking. It's like 90% turnover rates. We weren't quite that bad. Now I think it's more kind of in that 50%, 55%. We tend to do a little bit better than the industry. I still think there's room to improve that number. And some of the initiatives that we have there is really geared to address some of the reasons why we lose caregivers. We do a lot of surveys with caregivers, and the interesting thing is kind of the #1 reason we found that people will leave is they don't get enough hours, which is ironic since one of our biggest challenges is we need -- we have open ships that are available. So some of the things that we're doing is really trying to address that disconnect. We recently rolled out a caregiver application that we've been developing. It provides for greater communication with the caregiver, a lot of opportunities for them to self-service to basically tell us, okay, how many hours would you like to work? And then more importantly, what is your availability? Because those are the bits of information that is difficult to get from the caregiver. And then frankly, as soon as you get it from the caregiver, it could be stale in a week. So we really need to enable them and encourage them to be able to kind of self-service that. And if you think about it, if we can get their schedule and availability, we've got the client's schedule and availability, and we can start matching that up better. And so we're starting to see some real buy-in from our caregivers in utilizing that application. And so I think that can help us maximize our existing workforce and reduce that turnover rate.

And I guess when it comes to personal care, the last maybe couple of quarters, maybe 12 months, you definitely guys talking more about value-based care in that business. So can you give us a background there and maybe more details in terms of the types of contracts? Because sometimes, I get questioned. People get confused how can you have like a value-based care because they think capitation. But my understanding is when you say value-based care, it's more quality driven or maybe some bonus payments. So can you give us a sense of what this value-based care in personal care looks like now for this company?

Yes. We've got several value-based arrangements out there. Primarily, we got a handful in New Mexico. We've got one in Illinois. We've got one in Arizona. And there are maybe some -- a little bit of differences between them. But I think fundamentally, we get paid for our services at the rate that we normally would get paid for. There can be a gain share component to it so there is an upside component, depending on how we do with certain metrics. Some of those may be related just to rehospitalization. Some may be a combination of hospitalizations, ED usage and then also looking at value metric or quality metrics as well. But we've invested in our value-based program. We recently rolled out a new software, case management software. Really, that was one of the, I think, the gating items to really be able to scale that program. It was just the technology piece, and I think we've addressed that in the Q1. We've had some good results with that. We're now able to -- we've moved from having a team of individuals that have been getting changes in condition that our caregivers send to us to now, it's going into the system. So the system is now doing risk scoring on clients so that we can be -- scale it to be able to target specific individuals who actually need to have some sort of intervention. So really positive about that development and what that bodes for the future for us.

And so you said this new software that you just launched, case management, is there anything else that you need when it comes to just driving growth there? So from here, it's just essentially signing more contracts? So I guess, are there certain markets that are more prone for this kind of setup versus others and where you are? I mean, are there more opportunities? Or are we talking about just you would have to add additional states in order to expand value-based care?

Yes. No, actually, the payers that we're currently operating or working with are looking for us to expand the existing arrangements. In addition, there is -- we haven't had a lack of interest from other payers. But you do need a payer on the other side that's got risk for those items. So there's no lack of demand for that type of arrangement. It's really getting with a payer that's going to be a good partner with you to be able to make sure that if we've got interventions that need to take place, we get an engaged case manager on the other side that can help us make those changes. But I think the other thing with the software, what it also is allowing us to do is as we get more and more data, we get -- we can look at what interventions we take and what -- how did that impact the care for that, a particular client. We're going to be able to tweak the algorithm and, I think, do a better job of being able to really risk score and then also evaluate the interventions that we take, which ones work, which ones don't.

And also, thinking about this value-based care, and so you mentioned 3 different states where you currently have this in place. Can you help us size them up? How big, I guess, as a percent of revenues, where you're value-based care now? And where do you think this could be in 5 years?

Yes. Well, right now, it's immaterial, excuse me. Right now, it is still immaterial, very small for us. But if you take the revenue we're generating, and as Brad said, there's really 2 components to the revenue. There's not just the success fee, so to speak, and the gain share that we get for hitting certain metrics. But we also get paid the revenue that we normally would be at personal care hours or even home health visits and whatnot. So if you add all that up, while it's still relatively minor, we'd like to see that grow substantially in the next 5-plus years. Does that mean it grows to 3 or 4x the size it is today? As a $1 billion company, it's going to be hard to become material for a while. But it is certainly something we're very excited about. In fact, one of the things that Brad mentioned, we're doing one new contract. It's a small contract, and it's where we're actually -- instead of gaining share, we're taking some risk. Now it's very minimal. We're only taking risk for our part, for ours. But the reason we did it is we wanted to have a -- I won't say experiment, but we wanted to enter into a contract with a payer that we could partner together to determine if adding personal care hours can help reduce the overall medical loss ratio for their patient base. And so we're excited about that. We've only been in it less than a few months. But it is something that we'll be able to see a little different metric that if it works and works well, that will help us then go to Medicare Advantage providers and be able to work with them in a different area, not only with the aspect of a visit -- emergency room visits, the rehospitalization, but quality care metrics and then also potentially, take some risk adding to a patient base that we don't currently do.

I mean, there's a lot I want to follow-up. But -- so on this last contract, so you're saying you kind of guarantee the number of hours? Or they kind of pay you per member fee for personal care, and then it's kind of -- you take the risk of if that patient actually requires more hours than it's getting paid? Or how should we think about -- like where is the risk?

We set the care plan. And then we -- so we control the hours of personal care that, that patient gets. We do not get reimbursed for those hours. The reimbursement of those hours will be on the gain share at the end. And so that's our way of saying, it's like the Medicare Advantage. When they came out a few years ago, CMS came out and said Medicare Advantage can add personal care as a supplemental benefit. Well, Medicare Advantage plans didn't get paid more money to do that. They didn't really understand personal care like we understand personal care and what it can do for that patient and the cost. So for them, it was kind of a marketing opportunity. We want to be able to show them now, even if you don't get additional funds for this, we can help you control your cost by using personal care hours to help do that, to identify the change of control. And the whole reason why personal care makes sense is we're in there earlier and more often than any other home-based service. So that's why this particular contract, when it came up and we were talking together to partner on this, made a lot of sense for us. Now again, because it's new to us, we're still gathering data, we minimized our risk. We know what our risk is, and it's very immaterial overall. But it's a learning experience, and that's really what we wanted out of this contract.