Chemed Corporation (CHE) Earnings Call Transcript & Summary

But I'll give him a brief chance to introduce each of themselves and give a brief overview of what they do before we dive into questions.

Nick Westfall, President and CEO of VITAS Healthcare.

Kevin McNamara, CEO of Chemed.

David Williams, CFO of Chemed.

And if you want to just give a brief overview of what Chemed does at a high level, just for anyone who's is unfamiliar.

Chemed has been around for a while, formed in 1971, spin-off of W.R. Grace and Company, have a number of businesses, especially chemical field. It also had a healthcare group that was spun off with the Grace division to formed Omnicare back in 1981. Chemed then went through a -- 1980 bought Roto-Rooter for $17 million with -- that business was nation's original franchisor and the business itself was buying back the franchisees. Since 1980 Chemed's not sold Roto-Rooter, has not sold any franchises -- franchise selling to them. It's an operating franchises we buy back in. But we had -- that was bought in 1980, number of specialty chemicals were sold in the early '90s. And in fact, at one point, the early management changed the name to Roto-Rooter. And then we have a lot of cash, we made an investment in VITAS as a preferred stock investor. And then in 2003, we had the opportunity to -- it was announced to us that they found a buyer. We said, well, we want to be the buyer. And really, at that point, shortly after that, we actually borrowed more money than our market cap. We bought VITAS. And I said, look, we want to be a healthcare company. Roto-Rooter is a great company, great cash flow, very well managed. Let's grow the VITAS business and that Roto-Rooter would not be a distraction, but still be an anchor to windward. And it's also in an industry that -- it's not like we were pushing away sooner. We just said, look, we're stick to our knitting and grow the business. And it's been a success. Both companies have grown their net income at about 12% per annum during that entire period. And again, we think both companies are very well managed. We get a lot of questions about, "Oh, are you going to split them up and so the value be created like that." We get -- we have discussions like that at every single meeting like this. And we say, well, if you look at the history of Chemed, and actually I have been there 40 years. We bought and sold many companies, but always when it was advantageous to Chemed's shareholders. And we just haven't been presented with something we think it was a value creating issue. So in any event, that's why we were here with this strange grouping of Roto-Rooter, VITAS. But Roto-Rooter obviously the leader in their industry. VITAS, certainly as far as revenue, right at the top of the industry in hospice, but that's how we got here.

Okay. Great. So jumping right into kind of more topical questions. It seems like first quarter came in a little better than internal expectations on margin. I'm just curious what drove that upside? And is that sustainable going forward?

Yes. And I'll flip this over to Nick who definitely steered the ship in terms of managing the expenses. But the reality is when we gave our guidance, of course, we didn't give quarterly guidance. We also talked about how we were conservative in terms of approaching, how inflation is going to impact our cost escalation. Excluding, obviously, there's a lag between revenue going up, reimbursement changes in inflation that's in our P&L. So we anticipated high single-digit inflation throughout 2022 compared to 2021. And we actually even benchmarked us in the fourth quarter. That's just a long-winded way of saying this, we expect increasing pressure on inflation throughout the 4 quarters of 2022. So Q1 had more inflation pressure than Q4 of 2021. Q2 of 2022 is going to have a little more inflation than the first quarter of '22. So everything I think you guys have to focus on is, some of us have to relearn it, some of these folks who didn't live through the 80s on ungodly inflation, there's an art to manage this, and there is kind of a compounding even on a sequential basis. So the reality when we gave full year guidance for 2022, you certainly have to anticipate increasing inflationary pressures. On the other hand, Nick is doing a phenomenal job of managing our patients, managing the cost of patients, length of stay is going up, which makes it easier to spread out admission costs. So we're definitely doing a dance, but 2022 is going to be challenging with inflation.

All the metrics of VITAS are changing. In other words, to the extent that probably everyone in this room does have a focus on margin. For a number of reasons, good and bad, margin has been not an issue with VITAS and VITAS what we really want to do as manage and salvage the top line.

That's exactly right. In the 15.5% to 16% margin forecast we had for the entire year, we're still reaffirming that for the duration of the whole year. And the primary driver to it is, we think we'll continue to see days of care, median length of stay, continue to expand. But really, our number 1 focus, number 1, or number 2, 1 is top line growth and ongoing diversification. But the other primary focus is continuing to grow our net clinical capacity. So that's nurses, both RNs, LPNs, home health aide, social workers, and our clinical case managers. And if we're able to continue to be successful doing so, we'll see short-term marginal compression that gets us down to that 15.5% to 16%, but it really sets us up for a launch ramp that we continue to see coming out of the pandemic '23 and '24 and onward.

And when we do give guidance, we try to slightly over -- under promise and over deliver in a rational sense or said definitely, guidance usually can take a couple [indiscernible] before we missed guidance. So we still feel very, very good about the forecast we put out in February, and we think it's manageable even in this inflationary environment but keep going. Inflation will strain later quarters more than the first quarter.

Correct. Yes. So certainly, a big part of that inflation piece is like labor cost pressure. And so just curious like when you look at it, how much of it do you see as temporary 2022 type impacts and how much is longer term? And is there any way to manage that?

The majority of it is probably short to and midterm. I think some of the extreme examples that some of our competitors have referenced in other service lines, right, where you're competing against travel nurses, contracted labor, some of those components. We definitely feel those as much. But from a contract agency perspective, the hospice industry, it only really impacts our continuous care service line. For LPNs, unlike home health that has had a bigger pressure and implication with it. But the reality is for skilled clinical labor, the wage inflation is significantly going to continue to outpace our pricing reimbursement, at least the most recent proposal from the federal government that will be finalized. And so as a business, we just need to continue to prudently balance that, remain competitive in the market, but not swing for extremes, as we grow our clinical workforce to ensure it's sustainable, but not only this year, but for '23 and '24. We feel confident in that.

The conversation that Nick is often having, and this is unfortunate, is clinical personnel might come to their boss and say, I have the opportunity to move to a much more lucrative position. I'd like to stay, what do you suggest? And I'd say, well, take less money or we get a little party for you. Hopefully, you'll come back if you don't like it. We can't. We're a government program. Our job is to take reimbursement as is and make a reasonable margin on whatever that reimbursement is. Now to the extent that overall for the whole industry has like click down to the level of service. That's up to the federal government to determine there are employer asset work.

But if you think about it at a market challenge. So in 2020, we weren't sure what to do in terms of we saw our employees were getting distressed at VITAS. So we gave them an extra 2 weeks of paid time off or PTO and that cost a little under -- a little over $20 million. And as we -- and then we allowed them to carry forward if it was unutilized and they certainly could use it if they find themselves at a quarantine for COVID concerns. And then 2021, we turned around and put another extra week of PTO. So a total of 3 weeks for another $10 million for a total of $30 million. And quite frankly, all that was doing is now trying to create stability within the workforce. Now we're in this inflationary environment. There's about a 20% decline in licensed healthcare workers to accords to some industry statistics. And we're dealing with a high single-digit inflation. That's a long way of saying is, what is the appropriate post-pandemic base wage for a qualified RN in San Francisco, Cincinnati, Miami, Florida. That's an unknown right now. So we're trying to create, and we're exploring other ways of, when you're unknown what the appropriate wage is, but you want to make sure your people are compensated and they can pay -- they can put food on their table, pay for housing, all the costs that are getting strained on inflation, we want to make sure they stay with them. And that's what we're exploring now is what's the appropriate wage. Do we do retention bonuses? Do we do multiyear retention bonuses until we figure out what stability is, what's the new norm of wages? The only thing that Kevin, Nick and I, can say is we have an exceptionally strong balance sheet. And you've heard us talk about this. And the reason you have a strong balance sheet, the reason you want to be under levered in healthcare is when these crises hit, whether it's a major change in reimbursement, major recession, whatever it is. You want to weather it. We are in a position of having the capital due to whatever it takes, a, to maintain our stability and quite frankly, be a little opportunistic about undercapitalized hospice programs out there that we can either maybe get some qualified employees or maybe even acquire them. But for the first time in a long time, I think we're going to be able to put our balance sheet to work on the VITAS [indiscernible]

Real quick before we hop off the topic. I don't want it to get lost in this context. I realize we're talking about financial forecasting and everything else. But as an industry for hospice, there's a uniqueness to us that has always existed and will continue coming out of this, which is, we will never be as an industry, the top paying provider given the business dynamics and everything else. So we've never looked at ourselves as competing against hospital systems for the most part. And if you're a registered nurse and you're looking to maximize income, and that's your entire focus. You're going to go be part of a travel nursing company currently or maybe you go back into a health system. People join the hospice industry, because you are aligned with the mission and the calling. You want to feel appropriately compensated, but there's a lot of other things that go towards job satisfaction in addition to compensation, right? It's the ability to fully practice at the top end of your license, having a team, making a difference in the community. And so what we've really continued to hone in on, we're identifying and continuing to filter out candidates as they come in, whether they have the hospice mindset and finding opportunities for people, who had left us over the last 20 months, 22 months that were having a conflict of the crisis and saying, hey, I was offered a $30,000 signing bonus and a 50% raise to go work in a health system that's familiar with me, because that pricing is more advantageous to the health system, than it is to pay a travel nursing company, who's jacked up the rates 300% on that. Well, that nurse as we've now found in many of our markets is saying, I don't really like working in an ICU. I really want to come back and be part of a hospice organization, and we're making sure they understand at VITAS, there's a place to come back, assuming good performance and everything else. And that's another recruiting tool we utilize.

Maybe one last point about this labor issue is do you have any leading indicators that you look at? Like, for example, you mentioned travel nurses potentially getting assignments for like 6 months or something? Is there any way that you've seen a huge wave of people maybe leaving 6 months ago that were 6 months assignments and that you would expect to return or any other leading indicators that -- to give some visibility?

So there's anecdotal examples that we've been referencing from time to time, it's very market specific, but we have absolutely had success in the last few months of -- in specific markets, a unique site, 6, 7 individuals coming back that had left the organization, and they've left for a variety of different reasons. I don't want to put it all on traveling -- the traveling nurse or a health system perspective. But it really was that human interaction and touch and that leader reaching out and saying, how are things going, and then not so well. Is there an opportunity to come back, and so we're able -- we've been able to take advantage of that? And most importantly, from a forecasting and modeling, it's not someone coming back and saying, hey, I'd like to come back, but that 50% price increase in which I got, that's my new expectation on a go-forward basis, because that's really unsustainable for us long term. So we're balancing all those things out.

Yes. So maybe moving off with the labor thing. Hospice census declined like 4% or something in the first quarter. So just curious how it progressed now through second quarter and what the exit rate was in Q1, how things are going?

So the best way to frame it up is, once we got into the pandemic, and this was all baked into our guidance and all the narrative in which we provided, we had sort of anticipated from the time at which the pandemic hit, there was going to be about a 6- to 7-month lag before any provider began to see some of the healthcare system referral disruptions into the macro census and days of care. And that's really borne upon the cohort of patients that are on service in a given day for a hospice provider. And so coming out of the pandemic, whenever it's really in our rearview mirror and let's use January as an illustration, right with the most recent surge. As healthcare systems and referral source disruptions begin to subside, I think we'd be foolhardy to sit and say, it won't take the equivalent 6 to 7 months where you can get back to more traditional days of care and ADC growth, perspective and we built that into our model. So we, of course, when we prepared our guidance near the end of last year, we didn't realize that another variant and surge was going to come, and I don't think anybody did in December and January. So that relevel set a little bit. But we're beginning to see some encouraging trends that we've referenced in our most recent earnings call. And really, we're trying to highlight that through median length of stay expansion and normalcy that comes with it. And how that ends up contributing to total days of care over time.

I think we're more confident in overall profitability there and actual census number growing.

Yes. And on the flip side, I guess, average length of stay improved. And so how is that kind of progressing?

Yes. Average length of stay improved. And keep in mind that's for your discharge cohort. I think the -- what reinforced this group is they pay more attention to a median length of stay and expansion of what that meant. And so on a year-over-year basis for the first quarter, if I recall off the top of my head, the comparative was a 2-day improvement from a median length of stay, as well as we saw improvement inside of the quarter and see and anticipate that continuing to occur. And so that will lead towards good things as it relates to patients coming on the benefit in a more historical traditional norm and that leading to days of care growth and expansion over time.

Yes. It sounds like admissions from senior housing continue to decline, but the admits from nursing homes are increasing.

That's right. It really focuses on where they're coming from to the extent that we don't -- internally, we don't talk about overall admissions as a driver of the business anymore. It's become traditional to -- that's one of the headline issues for the hospice industry. Internal management, it has been pushed to the sideline. It's a question of where you're getting admissions from and because the source will determine the length of care on average, which drives census. So to the extent that I say that one of our major midterm goals is salvaging the top line, which is census ADC length. It will come from getting -- returning to have strong referrals from those sources that give you the longer-stay patients. And then -- and so when we analyzed the month's activities, we analyze how well we're doing from those sources. So I guess this is a long-winded way of saying is, it's like a Pee-wee Herman events when you say you're admits are down, we meant to do that. That's -- there's -- it's true.

But in this case, if 30% of our patient's pre-pandemic passed away in 7 days or less. If you think about the effort to bring in on the admissions process is all the same. Setting up a plan of care, very, very, very labor time intensive in the first 7 days of preadmit to actually getting that stabilization. Those are all negative margin patients. And if the efforts are the same and you have the choice on a scarce resource of licensed healthcare workers that you want a 3-day patient or a 33-day patient, quite frankly, were triage scarce resource. We are treating less negative margin patients today as a percentage than we were pre pandemic. And that, quite frankly, is why Nick has done such a great job of managing expenses is, we're really focused on the patients, who can maximize the benefit of setting up that plan of care and not passing away 3 days into a plan of care. We're focusing on referral sources that are screaming as that they need help. Senior housing is one of those key areas. We don't turn down any appropriate patients. But without a doubt, negative margin patients and cross subsidization is the reality of current hospice reimbursement and scarce resources, we're trying to maximize the days available for palliative care to our entire patient base.

And just one thing I'll say and say how does this happen? One thing that we're down lower than we'd like to be is admitting nurses at hospitals, they're basically gone. You'll get fewer hospital admissions, fewer short-stay patients. But it's a scarce -- admitting nurses are a scarce resource. And so as they get redeployed, you're still responding to the, let's say, a hospital-based patient, but without admitting nurse on site, you're going to be less effective in garnering those patients.

From a directional standpoint, it gives -- it's kudos to the entire team for how we've collectively executed on those things, because that refocus also helps all of our clinical care teams manage burnout, right, when you're dealing with a patient that's now going to be a patient of family on beyond service for 60 days, as opposed to 20 patients and families that are going to be on service for 3 days in that whole intensity. And so as we look at it in the non -- in the community-based admission performance on a sequential basis, and I'll put that into physician offices, SNFs, ALFs, on a sequential basis, Q4 to Q1, it was up about 5.5%. And our total admission number was down 8.9%. So directionally, we're doing a great job of executing on that on a year-over-year basis, it was up about 2.5. And so that's kudos to the team as we think about supporting one another, but also dealing with the situation in which we find ourselves. Nursing home occupancy continue -- everybody here, I'm sure tracks the same numbers, which I do, that are publicly available continues to uptick in a positive direction. And then other partners like Brookdale. They just announced a record quarter, as it relates to net new entrants and occupancy. And so when you think about the entire collective of the long-term care market, I think there's some positive outlook from pent-up demand.

There's some pent-up demand.

There's definitely pent-up demand.

Yes. So for the -- I think for VITAS, you talked about a 1% to 1.5% decline in census growth. And so I'm just curious, looking at 2023, is there any shift in what you would expect as maybe some of the labor pressures ease and COVID eases, has the long-term volume growth outlook changed? I think you're talking about different shape of it.

The short answer is yes. We'll get to it when we provide guidance for '23. But it goes back, and that's why I started with a 6- to 7-month lag, right, where total days of care in those trends in hospice, things build upon one another, and there's a natural tail to all of that. And so if we're building upon that tail, ramping into the end of the year, you'd expect that trajectory to continue in 2023.

Yes. And with all the variability and potentially and maybe the average census, can you talk about what your fixed and variable cost structure is and how you're able to flex up and down potentially to unexpected changes?

So on the fixed side of things, I think it's pretty straightforward, right, when we think about back office, but we also have call centers, care connection centers. And so we're able to have fixed costs affiliated with it that we can ratchet up and down as well as some variability there. And then by definition, the vast majority of our labor cost is purely variable out at a program level and heavily predicated on plans of care and patient needs. And so that determines total amount of clinical capacity that needs to be deployed. And we've been able to leverage telehealth...

There is -- it's iron law of economics. There are economies of scale. And then on a retrenchment, there are diseconomies of scale. And I think Nick has done a great job managing those movements, which, in some respects, are immovable, but he has done a pretty good job.

Yes, yes. And I would say for to put a metric or a number on it. So you're talking about 46%, 47% of our cost of sales on the VITAS segment would actually be what I would call the true raw variable cost. And then you get into this game of step variable or semi fix. But if we get a large enough program, we have our medical director, who will hire another medical director. All of a sudden, the facility isn't quite large enough. So we get -- that would be a wider step variable. But if you actually look at over 18-year operating history, absent of disruptions such as like this, you actually see massive consistency in our gross margin. That really has been running right around the 23-ish, 24% and that really is reflective -- the reality is its vast majority of it is variable, if you look at variability over a 12-month period. And it goes to Kevin's point, when you see a bit of a drop in revenue, you would actually expect a strain on margin, because you lost that contribution to the extent we have less negative margin patients, that's really why we're getting the positive surprise on our guidance. Maximizing the benefit of a scarce resource in a licensed healthcare worker is actually maximizing or limiting those costs. So I expect to continue to get a lift at least through the next couple of quarters, because of what Nick is doing in the field. But eventually, we'll catch up and we'll be running at a true variable cost back probably in '23 or '24.

Yes. But scalability for our business model is absolutely imperative, right, when you think about size of each of our locations and 2 of our largest locations on their own would be a top 10 hospice provider of their own company. And so we look to go into markets and go as deep as we can, caring for as many lives as we can, to be the best partner. And frankly, that's what we're continuing to bet on because by doing that, we think it gives -- puts us in the best position to reduce total cost of care to the payors and the partners and maximize outcomes for patients and families.

Yes. We only have a minute left. So maybe my last question is the 2023 proposal called for like a 2.7-ish percent rate update. And it seems like CPI and wage indexes is trending higher than that. So is there like an expectation of what you think the final rate could look like?

The government is using lag data and they're using incomplete data, and they haven't provided us enough transparency. But we can do the math. The increase we get every year, 65% is based upon the hospital wage index basket, 35% is based upon CPI. If you just took 35% of the 8.5 headline number from March 31, you back up the 40 bps of productivity factor that they put in, we would end up at their proposed rate increase. So that assumes basically the hospital wage in this basket is 0, which I think everyone in this room can say, I think we all can agree there's significant pressure on hospital wages.

[ It is not a discussion ] -- the increase is -- what the increase shall be, not what it may be.

All right. Great. I think that's all we have time for, but thanks for coming and really appreciate.

Thanks.

Thanks.

Thanks.