Chemed Corporation (CHE) Earnings Call Transcript & Summary

Good morning. Welcome to Oppenheimer's 31st Annual Healthcare Conference. I'm Michael Wiederhorn. I cover the payers and provider space. Presenting today is Chemed. We have President and CEO, Kevin McNamara; and Chief Financial Officer, David Williams. We'll do -- we'll be doing this fireside, so I'll just kind of shoot right into the questions here. Welcome, guys. Hopefully, next year -- like I said, hopefully, next year, we'll be back in person and be breaking bread together.

So first question, can you discuss the factors affecting your hospice census and the time line for that to be fixed in your view?

Well, let me start, Mike. Clearly, when we look at what we've been saying for some time externally and internally is COVID-19 had a significant impact on our hospice business, obviously, being a health care business, being a people business, that it's a service to the super elderly who are the most vulnerable. But what we really had were 2 things. On the positive side, we had CARES Act money. We said at the time, there are negative effects of the pandemic and hospice. We needed them, in some respects, that is for the protective equipment and lost revenue and some other things. It was very helpful. But we knew that the effect of the pandemic on nursing homes was going to have a longer-ranging effect. And obviously, the -- at the very basic level, occupancy in senior housing was down. Senior housing is an important referral source for us. But more importantly, it gives us the -- our longer-stay patients are much more likely to come from a senior housing situation than from a hospital discharge plan. So to the extent that we saw occupancy falling, we knew the effect that was going to have long term -- or midterm, I should say, not long term. And it's not surprising that occupancy fell, not only was it -- were these locations seen as kind of hot beds of infection. You have to realize that even our employees were not allowed in the Florida nursing homes to provide service and/or work with people explaining hospice, getting new admits. So we could see it was like a -- it was a gathering storm that really, the first thing that has to happen, I think, is -- and it did, it has happened, is opening up the nursing homes, allowing us to provide good service that makes hospice seem attractive and also be available to talk to the families and the potential patients about the benefits of hospice. So we saw that, clearly, getting the CARES Act money, having a year where our margin was going up for reasons outside of our control -- yes, there were regulatory changes made a little bit easier to conduct hospice and which Dave can -- which we won't spend too much time on. But it also meant that there were some services we weren't able to provide even though we were willing. And since there's a per diem reimbursement, yes, our margins were high. Our reported net income for last year was off the chart. But we knew, as you -- as your question really goes to now was it was going to have a negative impact on census because it's the patients we didn't get 6 months ago, 5 months ago, 4 months ago, 3 months ago who were -- who would be the longer-stayed patients, and we'd still have those patients. Those patients never entered hospice. We may get them yet, some of those particular patients, but it's at a later stage. But it's -- in some respects, and the way we look at it is you can't get patients that have been with you 90 days until you've filled up the bucket of patients that have been with you 60 days. And so from our perspective, we're looking to have the occupancy of senior housing improve. We're looking for -- again, fewer deaths associated with COVID and filling up those shorter-stay buckets that we'd expect with our traditional graduation rates from 1 30-day grouping to the next, we'll see our census going up. Now I think -- whether we said it directly or indirectly, our guidance was based on improvement after the midyear period. And so a gradual improvement, and we have no reason to think at this point that, that guidance is something we have to change at this point. I mean, it seems like -- it seemed to us at the time, the usual guidance of what we're seeing with regard to proliferation of vaccination and opening up, particularly of the Florida senior housing situation. We think that's -- that makes a lot of sense to us. Now I'll say that there's just from a planning standpoint, one of our expectations is we see a decline in the number of long-stay patients. Almost by definition, it makes Medicare Cap a little bit less than an issue, certainly, in Florida, where to the extent that you're running close to the edge, under this scenario. You have abundant surplus to cover your operations. But I think even overall, that will be the silver lining to something that has been a cloud. But again, long-winded way of saying there was an effect on the pandemic on VITAS. We're seeing that now with census. And I think we'll be on track of -- for improved conditions, but there's no sense talking about it too much until it's actually at our feet. Dave, anything to add on that?

Yes. Just, Mike, of course, we're watching this very carefully. Although nursing homes is a small cohort relative to our total census, this is an important cohort that if it's disrupted long enough, we'll feel some discomfort or pain. And I think that we have slight discomfort now. What really is we're looking at is the occupancy decline in senior housing is getting less worse. It actually has started improving from the data I've seen, but I think it was down -- the latest reported month, they were down 1% sequentially or 100 basis points. Really, we need -- talking to nursing home operators and analysts -- 3 gates have to be open to normalize senior housing. The first one, of course, is vaccination for both the residents as well as the senior housing workers. And that is going on, and it has happened to a great extent. The second gate that has to be open is the elimination of the abnormal restrictions on visitation that were put in place during the pandemic, either completely eliminating hours or very narrow hours or only 1 or 2 people can visit either distance, no grandchildren. So visitation has to return to pre-pandemic normalization for -- again, for the second gate open, for nursing home occupancy to improve. The third gate is what you call the enticement for grandma to agree to go into a nursing home. And that means the senior housing facility has to return to normalized socialization activities. You're talking bingo. You're talking about Wednesday going to the bowling alley. You're talking about dance lessons, people coming in and doing entertainment in the senior housing. That's kind of -- those are the things that make senior housing tolerable. And people agree to go into it for a variety of reasons, but that certainly is one of the enticements. So we're going to return to normalization in senior housing. The crude term I use is, the only thing worse than putting your grandmother in a nursing home is not having a nursing home to put your grandmother into. We -- our culture is predicated upon quality senior housing for our elderly, and we'll return to that. We have -- we think it's going to -- the normalcy is going to return in the second half of 2021. The only debate Kevin and I have is, is it going to be a V shape? Is it going to be a tsunami? Is it going to be noticeable but methodical? Or is it going to be a slow grind up? And that's the difficult thing to say. We don't know. And I don't think anyone in senior housing knows definitively.

Yes. And just keep in mind that the proof in the pudding is it's what they talk about, our average daily census. Another way to look at it is our median length of stay. Our median length of stay fell from 16-plus to 12 within a relatively short period of time. You can't grow census under those circumstances. It's very difficult. So purely an issue of getting patients who are with you longer than 12 days on -- as a median.

And our attitude right now, we have a high, high degree of confidence on this. It will return to normal. The only thing we're debating is the pace. And we're watching all of the data on a very careful basis. And once we have enough data on improvement, we can project out return-to-normal mix and census levels. But we're not quite there yet.

Okay. That's really good color. Can you remind us about how should we think about margins and how they're affected by the mix shift? And also from a high level, the profitability differences between the short-term hospital discharge patients versus the long-term stay census driven by the senior housing?

Yes. In very, very crude terms, and that's all we're going to talk about, after -- I'll just say comfortably after someone's been in program 60 days, the profitability from 60 to 90 isn't any different than from 150 days to 180 days in that 30-day billing segment. What you're really talking about is the cost to get patients stabilized and on a quality maintenance plan of care for whatever conditions or comorbidities contributed to the terminal prognosis. But the issue we have is, it costs us -- and we'll give these directionally correct numbers, but nicely rounded. It cost us a little under $1,800 per admit for a patient. So if you think about it, 360-day patients who pass away or 180-day patients, days of care are 180. But one of them, we had 3 cost of admissions of about $1,800, exceptionally expensive to set up a plan of care in terms of the day they're admitted. And now you've already incurred $1,800 in cost, then you have to turn around and go through their meds and order probably replacement meds, new meds on a stat basis, plan of care, durable medical equipment is delivered in, oxygen, supplies. Of course, you have the nurses, the social workers, the counselors, the clergy. An entire team descends on that patient really for 7 to 15 days. Very expensive. And if that patient is in program for 7 days on a routine home care basis, fantastic, we got about $2,000 in revenue, not even, $1,500 in revenue. We incurred $1,800 just in admission costs, plus the cost for those first 10 days, you have a negative margin. So really, what you're talking about is the cost to get a patient set up in a plan of care normalized. The family is comfortable. The care team knows exactly how the family wants things to function, how the patient wants things to function, we're off to the races. We just can't have a greater ratio of our patients passing away in less than 30 days and losing the patients that lived in the past 60 days, that turned out to be nicely profitable, as well as those patients are critical to subsidize the 25% of our patients who were only with us 6 to 7 days.

Yes. And keep mind, when you talk about mix shift, we have relatively the same number of total patients, just -- but just fewer long-stay patients. So it's not like that -- what's missing -- it's not an internal way of doing business. It's just that there's a cohort of longer-stay patients that are not there. I mean, we basically have about the same number of short-stay patients. It's not an industry that's shifting in the short-stay patients other than one group was just not participating in it.

Yes. We just went a long-enough period of time through the pandemic, basically a year now, where we were leaking the patients had a greater probability to being long stay, and we were increasing our intake of patients that have a greater probability of being short stay. Again, we -- the good news in all of this is we're providing quality care to all patients, even the short-stay patients that are phenomenally unprofitable. We're just -- we are a mini microcosm of what went on in the hospitals where whenever you have cross subsidization between patients and you have disruption than normal referral and mix patterns, things get dislocated, like they did in hospitals where they lost a very profitable procedures and surgeries and kept the negative margin procedures. We were slightly like that where we've lost a certain ratio of our very profitable patients and we actually increased temporarily during this pandemic, our intake of very short-stay expensive patients. But Mike, our attitude is, it will work its way through in 2021. We have a long runway. We -- this is health care. You have to be able to be prepared to manage the disruption, have the balance sheet that can absorb it. In this case, it's just a little less profitable than we would have thought, and we will recover. And it's probably going to take -- it took us a full 12 months to notice this impact. It will probably -- unless it's a real tsunami, it will roughly take us 12 months to be completely out of it on a financial basis. I think once things start improving, it won't even be noticed 6 months later.

One thing, Mike, kind of inside baseball, we do not publicly report, call it, it's -- and I'm speaking in gross medical terms, the buckets of patients. But as I said, when we see our 60-day and up patient total going up, we'll be very confident that we can say, given we'll apply our graduation rate and it will be just -- then it will be a mathematical exercise for us to see the nature of improvement and how it will happen. It's a phenomenon that, long term -- again, not that there's any big rationale for doing this, but we could -- we can very accurately predict next year's sales of -- next quarter's sales of VITAS and looking in the future. And so we will, I think, have a pretty good handle on when this is turning around, and it won't be really guess work. It will just be -- it will be abundantly clear for the numbers.

That's really good color. To move over, just the competitive environment continues to be pretty dynamic. There's been recent deals, I guess by HCA, Brookdale Assets, Seasons Hospice as well was just acquired recently. Can you kind of give us your take on kind of what the -- what's your thoughts on the competitive environment? And do you think it's the -- there's -- the managed care players, private equity hospitals? Or do you think they're getting more aggressive in this arena?

Well, I'll just start by saying, if you want to give a -- if we want to give our thinking on it, we first have to eliminate the part that doesn't make too much sense in -- with regard to valuation by some of the financial buyers because that's prefaced in small part by the hot potato theory. That is as long as they can move it along at 100% profit, they'll pay anything. And some -- we're seeing some of that. I think the jury is still out with regard to kind of the grouping of services within 1 organization, whether they want it, whether the managed care is going to take over interest at hospice. We haven't seen it. We haven't seen any real progress on carve out disappearing. But it's something we watch very carefully. We don't know fully what to make of it other than that people are paying a lot of money for hospices. Dave, anything you'd add?

The only thing I'd add, with the rare exception of the seasons, the fact is most of the deals, most of the transactions that we're seeing going through at multiples that make my head spin, it's predominantly home health with a smattering of hospice. But there seems to be the chase is really on the home health. Hospice is like icing on the cake.

And keep in mind also that from our perspective, when we're looking at these, we don't do VITAS [ light ] at this point. And to the extent that the hospice operations that are involved are programs with a census under 100, they're not of much interest to them. They wouldn't be profitable to us. And if they don't have the prospect of getting to a size of about averages in the sense of 300, there's that much point for us to getting involved as we're presently constituted.

And like I said, we're -- the CMMI has a long way to go on their demo project on the carve-in. But at the end of the day, even on a universal basis, of the 1.2 million people who'll receive hospice in a 12-month period, only about 18% will be live discharge and go back into the curative care continuum. So that's about 0.25 million patients a year, and that's at 100% of the entire hospice universe. So like I suspect in the end, that carve-in won't [ appear ] there. But we'll let it play out for the next few years and see what they come up with.

That's great. I don't want to ignore Roto-Rooter. So as we have a few more minutes here, why don't we shift over to Roto-Rooter, kind of get your color there, how you see the mix of the business shaking out post-COVID? Do we return to a historical mix margin profile? Or do you think something's changed permanently? Can you give some color there and update on that?

Well, let me start by saying, we can guess at why were Roto-Rooters businesses kind of hitting on all cylinders. Phone is ringing at record levels. Maybe that's because people had more time at home. They're noticing things. They have the wherewithal to have them fixed, and they have kind of an incentive to look at having them fixed because they're looking at them 24 hours a day. I don't know. Putting that aside, I would say that to the extent that what Roto-Rooter has done over the last 12 months is -- well, it's -- they've had an effect on competition. In other words, just the -- Roto-Rooter has taken market share. It's not just the market has gone up. I mean, that is for more services requested. But they've gained a lot of market share. You have a lot of -- most of Roto-Rooter's competitors are mom-and-pop operations that have had great difficulty dealing with the pandemic. And we're talking about an aging blue-collar workforce that we are competing against. So it won't be a faucet that has been turned on and will be turned off, will force any one point in time. I think that Roto-Rooter has -- when you look at their numbers, certainly, one of the areas that they've -- a couple of years ago, we added a new service, the water restoration. That's just a manna from heaven, going from $0 to $140 million in sales in short order. I think what we're seeing at Roto-Rooter that's really helping them is a fine-tuning of an existing service, and that's excavation. And the Roto-Rooter is becoming a lot more scientific with it, in a lot of areas, the preeminent name for excavation. And I think that will drive the results for a period beyond the pandemic. But no, I mean, it's -- when you look at Roto-Rooter's business from -- well, the way we look at it, we see a lot of strength. The core strength is growing core business. That is mainlines. That's where the other services come from. And I think that the strength that they're seeing is not so much pandemic related, but it's been so strong, it's hard to -- it is hard to say that it will continue to go up at the current rate. But again, it's been a great business, and I think it's going to do very well for the near future. Dave, anything you would add?

I'd just say I think very similar to the Great Recession, that we're going to emerge clearly on Roto-Rooter, I think VITAS as well. But clearly, on Roto-Rooter, we're going to emerge from the pandemic in a stronger, better market-penetrated position than we entered it, just like the Great Recession, just like 9/11. So yes, I think Roto-Rooter is well positioned. We did pull down our guidance to the traditional sustainable 6% growth rate in '21 for Roto-Rooter guidance in terms of revenue and EBITDA profitability. But the fact is, we think there's probably more wind at the Roto-Rooter's back. But again, we're all just trying to gauge kind of as we go post-pandemic, the impact. But everything looks exceptionally positive on the Roto-Rooter side.

Yes. And I'd say that it all comes down to the fact that -- I say the phone is ringing off the hook. It doesn't do as much good if we don't have the service people to provide the service. And I would -- I'm comfortable in saying that Roto-Rooter is doing a good job putting more workers in the traces.

And I'd add to that, what we are doing, we've run our own plumbing schools. We're -- technicians are graduating on a monthly basis out of it. At the same time, when we have systemically short of manpower in markets, frankly, that gives us significant pricing power as well, which is a massive silver lining to the extent that we want to hire 15 more men, we can only get our paws on 11. Well, the fact is that is a shortage of supply and demand, and we can pass that through in our next pricing grid. So yes, Roto-Rooter is phenomenally positioned. And we think we've completely validated the strength, the core competency of, one, our brand; and two, the benefit of running three, 24/7, 365 days a year call centers. It has been a major boon during the pandemic having those live call centers.

So it sounds like you're plan -- your competitive market advantage is definitely -- has grown here and the marketplace is somewhat changed, I guess, from a competitive environment. Do you want to comment on that from the competitive environment on the commercial and residential side? Is there anything worth adding there?

Yes. Our competition is typically well-established, multigenerational, family-run plumbing and drain cleaning businesses, several of them in every market we operate in. And those are the ones we do have the competitive advantage. The fact that we paid commission, and many of our competitors pay an hourly wage to their employees, during the early part of a pandemic, they couldn't take that risk. They furloughed or they shut down for a period of time. We stayed open. We didn't lose a single day. We picked up share there. Our competition got diminished. How you measure that, Mike, is impossible. There's -- actually, there's not even a bureau of labor and statistics on same-day, next-day emergency plumbing, drain cleaning service. But you guys can look at the revenue growth, the industry can only grow at the rate of household formation. So clearly, we've taken share. It's just really hard to say definitively how much. You can even debate how much do we hang on post-pandemic. But again, Roto-Rooter's brand was further exposed. We picked up customers we haven't seen ever or haven't seen in years. We expect that to continue. And just to -- you guys haven't brought up the HSW acquisition, which was predominantly commercial. Without a doubt, that got hurt with the pandemic and the economic lockdowns. Not good news for accelerating performance on HSW, but that also gave us a silver lining of, what the heck, let's do some deconstruction and reset pricing and the workforce since things are struggling anyway in terms of commercial demand. So HSW, we probably are delayed 12 to 18 months on the total performance improvement we're looking for. But we are actually accelerating in some areas that would have taken us several years to implement change. At the end of the day, I guess, I can't say enough good things about the path for Roto-Rooter and the sustainability. VITAS as well, except a few other factors aren't in our control in terms of timing. Otherwise, I'd be just as bullish on VITAS.

And one last question as we run out of time here. Just capital deployment, what's your latest view? You guys have always been great stewards of capital. So it's -- kind of what's your updated view in terms of capital uses?

I'll start by saying, if for the reason I mentioned, that as far as we're unlikely to be very active in acquiring the hospice businesses that cover [ Barker ] for 2 reasons. I think the most important reason is that they just don't fit our profile. I mean, they're a concatenation of small programs that don't work for us. Dave's always quick to add, and at incredible multiples. So I don't see us moving in that regard or in acquisitions for Roto-Rooter. Let me say on the health care. I mean, it's not like we're not looking to turn the pancake over. We're constantly looking on some other services that VITAS could provide. We stick our toe in the water from here to there. I -- We never rule that out. There are people in VITAS who spend all of their time thinking about that they haven't risen to the service at this point. And we're a pretty conservative company. With regard to Roto-Rooter, we will continue to buy whatever comes available. Every year, we are able to buy smaller ones to become part of our independent contractor network. Those have all been very good buys. But we don't anticipate significant dollars for acquisitions for Roto-Rooter. That leaves us with a lot of stock buybacks. The recent price swoon, I think it's given us a real opportunity to look at that, and we have. And then we'll continue to pay our dividend. Dave, anything you'd add as color to any of that?

No, I mean our dividend cost is about $22 million, $23 million a year. We're a hair under $300 million of free cash flow sustainable right now. Keeping in mind, last -- 2020 was spiked by about $120 million of cash flow between CARES Act, not paying the employee or a portion of FICA taxes. I think that's $40 million. But the fact is we'll do just a hair under $300 million of free cash flow, $22.5 million goes to the dividend. We think the remaining portion is share repurchasing. I think multiples are high, but with the correction on our stock price, we're nicely north of a 4% free cash flow yield. So our attitude is buying stock. Buying our shares back is excellent use of capital at this point in time.

Well, that's great. We are out of time here. As always, it's a pleasure to have you guys here and presenting and participating in our conference. I want to thank you, thank both of you. And hopefully, next year, we'll be back in person. Everyone, enjoy the rest of the conference, and thanks.

Thanks, Mike. Thanks, everyone.