Chemed Corporation (CHE) Earnings Call Transcript & Summary

Good morning and welcome to the 2020 Jefferies Global Healthcare Conference. I am Brian Tanquilut. I'm the Health Care Services Analyst here at Jefferies. So our next presenter is Chemed. They are the -- one of the largest operators of hospice services, or providers of hospice services in the U.S. today, and they also operate Roto-Rooter. Joining us this morning are the company's CEO, Kevin McNamara; the company's Chief Financial Officer, David Williams; and also the CEO of the company's VITAS Healthcare division, Nick Westfall. So first, thank you guys for doing the conference. I know it's a little different with the virtual format. It was always nice to see you guys in New York, but I guess this works for now. I guess I'll pass it on to you, Kevin, first, to kind of like give us a 1 to 2-minute overview of how things are going, what's the latest and greatest on Chemed and what investors should be thinking about.

Okay. Let me start by saying both our businesses are -- have been deemed essential businesses so that is as much as possible, neither business faced governmental restriction. I would say that in the capsule commentary, VITAS health care workers, they were certainly exposed on the front lines to a lot of patients with COVID-19. The -- they've done -- and Nick can go more into this. They've done a great job. We basically have been able to operate every facility without having insufficient staff, let's put it that way. And things have gone into a certain equipoise and very proud and very confident that, that will continue. I will also say that to the extent that, that being a health care company, they face, obviously, hurdles, things like more expensive protective equipment, some problems on the revenue side and admit side. Just to give you an example, in Florida, the majority of VITAS' admits are from the hospital discharge planners and people directly from the hospital, obviously, particularly in Florida for us, the hospitals did not have their normal groupings of patients so that we have seen that affect their operations a little bit. However, as part of the CARES Act, VITAS received $80.2 million a month or so ago to compensate VITAS for just those type of struggles. So an overview is combination of the nature of their business and the government help, which is something that just came into us, we did not make any type of application for it. They just all -- basically all hospice companies got it based on what their Medicare billings were as a part of the larger group. Roto-Rooter, less of COVID-19 issue, more of an issue of all the businesses in the country were closed. And so the commercial side of their business obviously suffered. Overall, I would say, again, they haven't had much of a problem with their own workforce with COVID-19, a handful of cases. No real issues with the clients of Roto-Rooter in that regard, I would say that we haven't furloughed anybody, kept people reasonably busy. Calls are ticking up. They won't get exactly until we want until all the businesses are open, and we get the return of the commercial business. But again, an essential business that has performed probably from our perspective, above expectation. But at first, Nick, anything you'd like to further color on the VITAS side?

No, I think Kevin pretty much captured everything. Since March, I've been really proud of the team. We've been able to achieve the goals we set out as we entered into the pandemic, which was prioritizing the safety of our employees, patients we continue to serve and all of their families, and we've been able to do that through tireless efforts of sourcing PPE and our current inventory levels are more than sufficient because of the success we've had there. We've also been able to continue to make sure we were educated, committed and ready to continue to respond in the community, recognizing the significant disruption to the health care systems, which is very much community specific. And we were able to leverage some of the CMS 1135 Waivers through telehealth and other vehicles, which we very much appreciated them lifting up for hospice as well as the rest of health care, which allowed us to continue to service existing patients as well as respond to the continuation of referrals even in a disrupted health care system. So I'm sure we'll get into it here in a little bit, but we're continuing to focus on how we are prepared to walk hand-in-hand with our partners in each of the community, our health care partners, and help support them and their patients' needs for the hospice-appropriate patients that will be referred to us as they lift up and modify visit protocols, referral protocols, et cetera, as we all prepare to continue to navigate in this new normal.

No, I appreciate those comments. So I guess, Nick, to follow up on that. As I think about hospice, just the service itself, right, at its core, it's for people who are at end of life. So I mean, the question we get asked is, why was hospice or why were hospice volumes impacted when there's still terminally ill folks out there, right? And how -- if you don't mind just giving us some metrics that you tracked and what you see in terms of the recovery over the last, put it, 6 weeks?

Yes. Absolutely. So to address the first question regarding why would volumes be impacted. Like when we enter into the pandemic, as everyone knows, we had well over 19,000 patients for what we reported as our average daily census in the first quarter, and many of those patients are continuing to be on service have not passed. And so we're continuing to care for them. And so that became an important piece to continue to access those patients and care for them in their preferred setting. The majority are at home, but obviously, there are patients residing in nursing homes, assisted living facilities, et cetera. And we were successful in continuing to access those patients. The other disruption related to admission flow is very much definition. So it absolutely was disrupted. It's not by definition, disrupted like a commercial side of the business or a restaurant, right? Where it went from 100% to 0. And so what we're really talking about is, are those patients with chronic conditions or advanced illness that typically would traverse the health care system, whether that's a visit inside of the hospital, whether that is a routine or acute visit to a physician office, et cetera, and with the health care system being disrupted, right? Physician offices converting to telehealth exclusively and starting to reopen up in certain markets, the beginning part of May, or hospital systems that went down to 40% bed capacity, 30% bed capacity, exclusively focused on caring and preparing for active COVID patients. Those other non-COVID patients that typically would seek treatment and traverse the system to ultimately be identified as hospice-appropriate and referred to, just hadn't accessed it at the same frequency. And the one component coming out of the pandemic as it releases is the trajectory of those patients' conditions haven't changed. It's unfortunate that they haven't been able to access the care which they need. And so we're making sure we're prepared going back to be in lockstep with those referral sources as they begin to see those patients that may have not been able to access the health care system in the last 60 or 90 days and may have had an acceleration of that disease projection as a result and, therefore, are now hospice-appropriate.

And I'll make 2 other comments that just amplify what Nick has said. But with regard to -- to talk about what this dislocation is. You have to remember that majority of our admits are from hospitals, hospital discharge planners. And there's a reason for that. And the reason is many times these patients are coming right from ICU. They're the sickest, the patients who really need immediately a high -- high-tech professional hospice. So when -- to the extent that where VITAS has the best reputation is among these -- in the hospital setting. So again, just -- I mean that's where VITAS does best, and that's where the flow of patients has been most knocked out of kilter. The other thing that I would say is, and this is a point that goes more to admits. You have to remember that more than half our patients are with us 15 days or less, very sick patients. Well, the very vulnerable populations, the populations that -- the super elderly that might -- being very fragile, get a virus as sort of cold or flu. They might just proceed in a certain way in the hospital and then maybe in the last 5 or 6 days of life would go into hospice. Well, with COVID-19, these patients, as we saw them, were -- it's the same patients, but instead of getting a flu virus or a cold or pneumonia from another source were staying in the hospital, being treated under COVID-19. Hospital system really -- said it was a novel virus. They were put on a ventilator until they died. They were not going into hospice. And again, it is -- that is a significant element or part of VITAS' patient flow. So I just want to make a -- those are a couple of examples of how this pandemic has affected VITAS. But as I said, they've been doing great. We see the effects around the edges.

Brian, only last comment on the reopening components that I think is important is, as an organization, we've been very much focused on not only supporting our existing relationships with our health care partners and referral systems in the markets in which we serve but also reaching out to those that we may not have been serving for whatever reason, pre-pandemic to help educate them around the agility and comprehensiveness that we believe we can provide as a hospice provider in this new normal because of the fact we're able to cohesively provide all levels of care, leverage a variety of different solutions to help be a partner to whatever their new care needs and discharge needs are going to look like. And so time will tell to see if we're also able to make headway in forming new relationships that didn't exist pre-pandemic because of the need of those health care providers in the community.

No, that makes a lot of sense. So I guess, Nick, just one follow-up. With the change in kind of like the composition of the patients, right? I mean the hospitals are keeping the patients for themselves, I guess, so to speak, instead of sending them to you for a short stay. Has there been any impact on your cap computation.

So the mechanisms on the Medicare Cap side of it, particularly in markets where the average reimbursement is significantly higher than the national average. And the reason that becomes so important is you take certain markets on the West Coast where a routine home care day may be reimbursed at 40% above the national average and the Medicare Cap formula is on par with the national average. Any -- even minor disruption to extreme short-stay acute patients will have an impact for all providers from a Medicare Cap perspective. Obviously, that can be short term in nature. And as the reopening continues to pick back up and those highly acute patients become available, hopefully, we'll make up some head count with it. But yes, by definition, the mechanics of the way in which the cap liability is calculated in has added pressure given the inequity in certain markets, it could be impacted over time. But time will tell. And as we -- I think everyone on this call is aware, the Medicare Cap year will end on September 30. And so we felt good against the progress we are making in the markets where we were reporting in anticipated capital liability going into the pandemic. And we're still doing all that we can on a day-to-day basis to minimize that potential cap liability at the end of September or at the end of the fiscal cap year.

That makes a lot of sense. I guess, shifting gears, Kevin, you've obviously been in the business for a long time. As we look out to 2021 and stare down a recession, how are you thinking about on both sides of the business, right? I mean, what can you share with us in terms of your experience? Or how are you thinking about the defensibility of the business in a recessionary environment?

Well, one thing that's very clear is both plumbing, the Roto-Rooter business and VITAS are recession resistant. I mean that's kind of as it has been proven in the past. And it's unusual because normally, we say, again, VITAS clearly is -- I mean it's a government program really not tied to the recession whatsoever. To the extent that we talk about Roto-Rooter, you go back to 2008 to 2010, still a very strong Roto-Rooter business. The thing that's unusual is normally we'd say, well, it's recession resistant, but we expect the commercial to suffer. Well, in this situation, we expect even with the recession, our commercial to improve. Because it's going from a base of 0 and, let's say, with commercial establishments. So we -- what we characterize as commercial is broader than that. But I'm just saying, so yes, it will -- if the economy goes into recession, some of the Roto-Rooter business won't be as robust as we previously were enjoying, but it will be a profound improvement from the current situation, which is still overall for Roto-Rooter, pretty good.

Yes. I'd say if you look at the 2009 time frame, and the worst recession we've ever seen, 2009 basically tied for the second best year ever for that period and earlier. And since then, we've added water restoration, which when you have standing water in any structure, regardless of the recession, the water has to be removed. So I would make the argument, Roto-Rooter is more resistant today than it was in 2009, and we held up fantastic. What we aren't resistant to is a complete shutdown of commercial business on the pandemic or a disruption in our referral stream on the VITAS side, but the fact of the matter is, we're well positioned to ride out anything. And as of today, we actually have no net debt. We have a net cash situation. So we're in a very, very good shape regardless of whether this is a V-shaped or a U-shaped curve recovery post pandemic. Brian, you still there? Hello?

Yes. Can you guys hear me?

Yes, we can. Yes.

Can you hear me okay?

We're having a glitch, you're no longer clear in terms of it's like a smeary sound.

Test, test, can we be heard?

You guys are still on, Brian seemed to have cut out.

Okay. Why don't we just continue -- Dave, why don't you go on some of the questions that you've been getting?

Yes, so, I'd say, the question we really have is most people are not focused on 2020. We're clearly looking at disruption. But obviously, our debt structure is such that we can ride out anything. Then the focus has been more on 2021. And at this point, we're all guessing when we return to a normal economy and a normal occupancy in the hospital and health care infrastructure. But at this point, we would expect actually 2021 to be something above our 2020 guidance that we initially provided before the pandemic. We think we're in great shape. We're right now accumulating cash on our balance sheet, but we're prepared to deploy that cash for the best returns possible for shareholders once we have clarity on direction. But right now, it's business as usual, just recognizing where it's harder to search for our patients. And Roto-Rooter on the West Coast, the commercial business is taking a bigger hit. But that only works out to be about a 10% to 13% impact on our overall Roto-Rooter revenue. And keep in mind on Roto-Rooter, variable cost model, our technicians are paid on commission. So if the jobs don't happen, if the revenue doesn't happen, a big chunk of our cost doesn't occur in the way of compensation for the tax.

Got it. Dave, thanks for that. It's Brian, I'm back. Sorry, I just dropped off a little bit there. I guess I have a follow-up to that point that you just made. I mean 2 things. Number one, capital deployment. I know over the last few years, we've talked about that, how you're building up a lot of cash on the balance sheet. And in the past, you've said, we want to keep the powder dry for when the opportunities and the valuations become compelling. So are we at that point yet? And should we think of you guys as an acquirer going forward?

Well, the fact we're still competing -- acquisitions, we still consider extremely overvalued, and that's largely driven by the fact that real rates are negative. So there's so much cash in the system, and rates are so low, we don't see much economic return to the shareholders for the risk incurred on these acquisitions. That's a long way of saying that we still suspect that it's going to be share repurchase and dividends as the form of a return to our shareholders, not much in the way of acquisitions on the health care side. VITAS -- or on Roto-Rooter, we completed the acquisition of our largest franchisees. There's about $100 million in street sales we'd also like to acquire on the Roto-Rooter side, but it's going to be in much smaller acquisitions. We're prepared to do those when the third or fourth generation family is ready to get rid of that franchise. But it's not going to ring the bell like the last 3 acquisitions we did on Roto-Rooter.

That makes sense. And then I guess the other part of your comment earlier, so 2021 will be positive in terms of growth versus your pre-COVID 2020 expectations. So how are you thinking about kind of like 3 to 5 years, the growth trajectory of the business? Obviously, there are tailwinds. There's demographics and all that stuff. But if you don't mind just walking us through your thinking on the growth outlook.

At 30,000 feet, so we're going to keep an eye, so we're going to talk on that, which is just an averaging of VITAS and Roto-Rooter results. But to have any granular discussion, you have to dive into the individual operating units. However, at the high level, we would fully expect to increase our overall profitability, our bucket of profitability, our EBITDA, our net income in the mid-single-digit ranges. So we're talking 6% to 8%. And then we think we can augment that increase in aggregate profitability by reducing our share count with our free cash flow. So not taking on debt to buying our shares, just utilizing our cash. We think we can get another 200 basis points of growth. So that's a long way of saying that we think on a sustainable basis, we can grow adjusted GAAP EPS high single digits. So let's just call it 7% to 9%. And we think that's very sustainable in both of the segments averaging in. We would expect the VITAS growth to be a little more robust than Roto-Rooter, which is an industry that can only grow at household formation rates. So you're talking low 1%. Roto-Rooter is clearly taking market share. But net-net is adjusted GAAP EPS, call it a 7% to 9% sustainable growth rate with share repurchasing from our free cash flow.

No, that makes sense. And I guess the last area I want to focus on is just the regulatory environment. There's been a lot of discussion about Medicare Advantage eventually or potentially paying for hospice and then the proposed CMS rule. Also, if you don't mind just giving us comments on those things and what your latest thinking is on those topics.

So if we start at the end, though, on the proposed rule, we're -- granted it's, as always, only proposed. But the rate increase of blended 2.6%, we think is good and reflective of the value, the recognition of the value of the industry. And so hopefully, that moves and progresses towards it being finalized in -- to be announced in August. There's only other sort of a minor administrative component that I know the industry is going to continue to be very vocal on around an election addendum that really hones in on related and unrelated costs. And so as an organization, we'll be able and ready to comply with it, October 1, should it go live, but we also think there is an opportunity for collaboration and insight to really help CMS achieve what their stated goal is. And so there's probably some room for improvement there. Related VBID, the VBID demonstration and the potential for evaluation of MA carve-in, obviously, CMMI has come out recently to announce that it still will continue planning moving forward with that demonstration in the start of 2021. But we haven't -- on our end, we're not aware else or we haven't seen a great appetite from the plans with the way in which that demonstration is structured to participate in it. They recognize the value of the hospice benefit, but to date, it's really functioning very, very effectively. And also, by definition, it would only apply to a subset of the MA population, which is roughly, call it, 35% of the total Medicare population. And really, it's the 80-plus members in that range. So it's really a much smaller subset that could potentially participate in the carve-in, recognizing the remaining 60% to 80% of the Medicare population still would run through the fee-for-service mechanism. So I think time will tell.

I even add there's -- Nick as I think you've been very polite, I'd characterize it as exceptionally low to minimal appetite to date on the MA plans. But again, that could change depending on how CMS wants to structure things. But hospice at the tail end of the continuum, only 19% of patients who -- 81% of patients in our hospice never leave hospice and they pass away under that care. So there really isn't much interaction with the continuum which really takes away the large economic advantage of trying to blend in hospice into MA.

Got it. I appreciate that. Guys, thank you so much. We really appreciate your time today and all your insights. So thank you, and stay safe.