Chemed Corporation (CHE) Earnings Call Transcript & Summary

This is Joanna Gajuk. I'm the healthcare equity analyst at Bank of America. I cover home health and other home care companies, and it's my pleasure now to host this session with Chemed, the largest hospice provider that also owns a plumbing company, Roto-Rooter, and today with us, I guess, only joining us with audio is Kevin McNamara, President and CEO; and also Dave Williams, the CFO; as well as Nick Westfall, CEO of Vitas. And I'll just comment to the audience before we start, because the gentlemen-- we go right into Q&A.

So welcome, everyone, again. I guess I'll just start with questions here. So first, I guess on margins. So the Vitas margins have been coming in better than expected actually this year, and the company raised guidance for margins with the third quarter results. So maybe first, can you kind of walk us through what's been driving the upside of the margins, and is that sustainable going forward?

Yes, so this is Dave Williams, the CFO. I'll give you macro comments on the margin, and then I'll flip it to Nick and Kevin then for a more granular discussion. But, the biggest reason we've outperformed margin from our initial guidance we issued in February of 2022, frankly, bluntly, was our inability to grow labor. And so we-- our guidance that we first gave anticipated us actually maintaining existing labor and expanding our labor workforce. And that didn't happen, but census still was better than we would have thought given our inability to grow labor. So frankly, that allowed for us to beat expectation on margin, which we also don't consider sustainable because, ultimately, to grow sustainable capacity, to grow census sustainably, we have to expand our workforce first. That's actually what triggered our hiring and retention program. But then, I'll turn it over to Nick to say the other things he was doing that also exceeded our expectation on margin in terms of his community focus. Nick?

So over 18 months+ back as we navigated through all dynamic aspects of the pandemic, we also initiated the things we spoke about around community access focus, which was-- as our clinical teams and as we were trying to think through how we respond to continuing growing demand out in every market in which we operate, we really focused in on prioritizing not only our hospital accounts, but more importantly, our non-hospital segments, which could be specialty physician offices in the long-term care market. We really have executed on that strategy, which also helps to manage clinical burnout and have some positive benefits related to that as well. So that, I would say, was since the fourth quarter of '21 through the first half of this year and just switching gears to what we discussed in the third quarter and what we'll discuss when we release fourth quarter results in 2023 guidance is some real positive progression by our teams executing not only improved retention, but also our continued ability to attract clinical staff to join the workforce. So in the third quarter, we released a net addition of the 5 clinical disciplines eligible inside of our recruiting and retention program of adding 172 clinicians to our total workforce, which is a real positive change in trend as we grew clinical capacity and saw some early indications of the corresponding growth from a base of care standpoint that having growing clinical capacity allows us to respond to more referrals every single day and continue to bring on more patients on a day-over-day basis. So we're optimistic about that and the combination of growing clinical capacity that has a time lag to it but will result in growth in terms of the total number of lives we're able to care for in the communities in which we serve, that's what we're 5, 6 months in the scene, and excited to talk about when we release fourth quarter results and begin talking about 2023.

And I guess, on the last comment in terms of the traction you've seen in the latter part of third quarter in terms of seeing high admissions and in census growth there, I guess, sequentially. So can you talk about any update you have since then and also the implications into next year. So I understand you're not giving the guidance just yet. But in terms of the color, if these trends would pre-set, would you expect census to grow next year?

Yes. So the trends that we alluded to have-- we're comfortable and we're seeing those continue. The net result of that would be an expectation that we'll have-- we'll provide more granular detail in once we discuss forecasting for 2023, and all of our shareholders will be able to see that as it relates to fourth quarter results as well. So we're very encouraged by that as, frankly, our #1 priority is ensuring we can meet the growing demand in all the communities in which we service. There has been no slowdown in the number of patients that need hospice services, and we want to be the preferred provider of choice in the markets in which we operate. The last item, Joanna, that one of reference as relates to margins is the inflection Dave's alluded to it. I've spoken about it, Kevin has as well on previous calls, that the reality is we grow clinical capacity that will support growth, it will have short-term marginal compression if we're doing a successful job at continuing to build clinical capacity that as we bring that workforce up, get them up to speed, not only caring for existing patients, but building the capacity to bring on more patients tomorrow than we did today. That always has-- we'll have short-term marginal compression that will be factored into some of the forecasting we'll provide for 2023.

And Joanna, your point is a very good one, where we took some pains when we talked about Q3 in our conference call to talk about the second half of the third quarter. So intra-quarter Q3, we saw some very good strengthening-- and there's nothing to discourage us from -- that we've seen over the last couple of months -- to dissuade us from that continued strengthening. Obviously, we updated our guidance for the full year, which is really just the fourth quarter, and through our guidance, you can see we anticipated a really bullish growth from Q3 to Q4 for our adjusted EBITDA margin Ex-Cap. And basically, that's all of our price increase with the exception of what Nick anticipates in increased labor in the fourth quarter over the third quarter, takes a little bit out of that price increase. But obviously, the vast majority of our price increase is dropping down to our EBITDA line ex, excluding or with a little bit of takeaway for Nick's growth in our FTE count. So we're very encouraged on putting in that hiring and retention program on July 1. It appears to be working. And right now, it appears to be-- census is following our growth in capacity. But, it's going to be a long slog in '23, but we will be able to measure things from us monthly, and you guys will start measuring the success quarterly.

But, on this retention bonus program that you started in the middle of the year that you mentioned. So it sounds like you're seeing some traction there, right? The net positive hires and the census is following. Can you talk about the competitive dynamics? Are your competitors following you? Also, can you maybe frame for us how meaningful are these bonus payments or these offers, I guess, if they stay as a percentage of the wages for the workers that are eligible for those bonuses.

So we haven't provided a percentage as it relates to their total pay. We did provide a range, which is between $2,000 and $15,000, depending on the clinical discipline. And then there's obviously, there's a regional specificity that goes along with that. But, it's not insignificant as it relates to their overall pay. And outside of the monetary component, really the ongoing recognition of the importance of those clinical disciplines, not only for our existing team members, but how much we do to continue to celebrate and enhance the culture in which we have at each of the sites, which is leading to improvement in our overall retention. That improvement in retention, the team was executing very well on in advance of launching that program, and the program I believe has assisted with that as well, but we'll see how it continues to progress as the first eligible tranche of employees right? Starts to receive that payment in the-- by definition, June 30 of next year. Then, we'll have another year of new hires that stay with us for that 12-month window that will also be receiving those payments. But it's really just another recognition around their importance, and we've really built that into our local culture.

And we haven't seen much in the way of competition in the hospice arena matching this, have we Nick?

We have not. But there's a variety of different flavors by all health care providers that have been tried throughout the entire pandemic, whether it's sign-on bonuses-- a variety of other things, and so yes, we've been keeping a barometer of that. We spent a lot of time thinking through what we felt would be the most beneficial to our workforce as well as to our ability to continue to attract folks and that's how we structured and designed what we internally and externally brand to our candidates as the difference maker program.

And keep in mind that as we talk about, it isn't that big a change from what we've done-- with the government sent us $80.2 million -- we didn't take it in to income. We just said- yes, that's for the preservation of our business as we know it. The first 2 years, we pass that along in the terms of extra paid time off for our workers. But given the shortage of workers we had, more vacation than seen indicated. So we just repurpose that in the form of a stay bonus as it were. So for us, it wasn't that big a change from what we were offering in many respects. So it's just a rebranding and I think it's not a major shift in what we've been doing all along with the money we've seen received in connection with the CARES Act.

Right, and just to clarify on this bonus program. So obviously, the employees that were on your payroll July 1, 2022, they're eligible, and then it sounds like, whoever started after it. So for how long the new hires will be eligible for this bonus program? Is it up until July 1, 2023, and then kind of you start and...

I'm sorry, 12 months, July 1, 2023.

Yes. So all new hires from July 1 of '22 through June 30 of '23 would be eligible when they have been with us for the completion of 1 calendar year, plus the-- and we then get paid out at the end of the subsequent quarter.

If you think about it, Joanna, when we announced the cost of the program was fully loaded, including fringes would have been $38 million. That's if we maintain flat FTE headcount. We did-- some people quit, we replace them, but we stay flat. I'm actually hoping this program cost us $42 million, $43 million-- that extra $5 million is retention, hiring and retention for the increase in our capacity, and that's really the exciting part about this. If we are successful in expanding our capacity, hiring more licensed health care workers, we're frankly taking share-- market share from our contiguous competitors, either in a market or a market next to us. We're getting the RNs, the LPNs, the home health aides. So my-- our goal is to expand our workforce as fast as possible because, frankly, the shortage of licensed health care workers is going to continue for the next several years throughout this country. And we do know from experience, if we can hold on to a licensed health care worker for 12 months, the probability their with us for several years is exceptionally high. So you're right, we have-- the program is running 12 months, but the final pay-out will actually won't-- the final $4 million or $5 million of this program won't be fully paid out until June 30, 2024. But all costs-- we're talking about all the costs, it's a 12-month program. The majority of it gets paid out on June 30 of '23. Any hires from July 1 of '22 through June 30 of '23 get paid out the following year. But our goal-- the #1 goal was to stop the churning of our employees to increase retention. But the close #2 goal is expand capacity because if we have the health care workers, we're going to get the referrals given the dynamics of the labor shortage in the health care community in this country.

So I guess when it comes to thinking about [indiscernible] this retention bonus program, would this create a situation where you need to kind of compensate with the people-- they're going to start, say, July 1 of 2023 by kind of accelerating the wage increases? Or are you not thinking about it this way, that this is going to be-- about incremental new hires will be harder to get. So instead of offering these bonuses then the wage is going to be forced to compensate for that.

No, this is not a substitute for paying prevailing wage. We continue to pay market for these. So the higher...

And the increased cycle and bonus cycles remain the same.

Yes. Yes. So this is not a substitute for deferred compensation. We're paying prevailing wages now when we expect to-- if the market says their wages have to go up 6.5% next year, that's what we pay.

It is a onetime program, but we also measure a variety of other pieces. It's not all compensation driven, particularly for resources that desire to come to hospice and work in the hospice industry. There's a lot of things professionally, clinicians get out of it, but making sure you're competitive from a prevailing wage standpoint is our #1 priority and is mutually exclusive from this program.

And when it comes to wages. So like I said, you don't have a guidance yet and it may be hard to predict specifically, but can you give us a sense of what was the-- what were the wage increases that you did last year? And then how do you think about wage increases going forward in terms of magnitude of ranges of what would be reasonable to expect?

Yes. So we haven't-- we won't be providing macro salary wage transition, because it is very much market-specific, discipline-specific, and performance-related inside of our organization. On a go-forward basis, our philosophy for managing and ensuring we are competitive from a market rate standpoint is exactly that. From an operational standpoint, we have really tried to marry the federal government's pricing increase as closely as we can to the overall company merit increase that gets implemented in a given year, recognizing overall company is a host of clinical and nonclinical workforce within. So we've been effective towards managing at that rate or being good, responsible stewards of governmental funding as well as balancing mission and margin for our organization as well as our shareholders.

And Joanna, for additional color, Nick actually had 2 increases for his health care workers in calendar '22, at the start of the year, as well as in June of this year. So he's actually passed through 2 wage increases for its licensed health care workers.

But when you-- if you would combine those 2 increases, what was the overall average wage increase you did last year?

We don't want to release that.

Okay, I see. And I guess, talking about...

But I can-- suffice it to say, the 2 increases cumulatively were very effective and noticeable to our employees, but not enough to turn down the churn that was going on in the first half of 2022.

Right, and to that end...

Our improvement from a turnover standpoint is not just-- obviously, being competitive from a wage standpoint is table stakes for any health care provider. But the complementary component that goes into improving the overall experience, not only for our existing clinicians as well as attracting others in the market to want to join us, has a lot to do with other factors that our local leaders, managers and fellow team members is front of mind, top of mind, and they're doing a fantastic job executing on, particularly in the second half of this calendar year.

Not to overstate this, but Kevin brought up a great point in terms of we had-- we still had $50 million of cash on our balance sheet that was kind of trapped there from the CARES Act money. But, the fact of the matter is we have a strong balance sheet. We're putting that balance sheet to work relative to this hiring and retention program, because in my terminology, we're using couch change to get market share from our competitors, and that is just money extremely well spent. If we're right on our prediction of expanding our FTEs hanging on over a year, will result in these being 3, 4, 5-year employees. This is going to be the cheapest acquisition strategy we've ever come up with.

All right. Just want to follow up on those, I guess, other factors you mentioned that are driving the improved retention or at least the net hiring, specifically, I want to ask about that. What were your successes? I mean, obviously, the retention bonus program is probably getting a word out about that. But any other kind of trends you would see, what resonates well because you mentioned there are some other factors, not just the wages or maybe that bonus? And also have you seen nurses returning from travel assignments? Is that maybe helping get the permanent staff in?

No, it's not as much the travel component. The travel nurse impact, I'm not going to say is the hospice industry was absolutely impacted by it, but it's much larger on a percentage impact towards hospital segment, the home health segment, et cetera. People come and want to join the hospice industry for a variety of different reasons. It's obviously very mission-focused. And a lot of those things factor into the importance of culture and without getting into all the specifics that comes up frequently with the industry trade associations, et cetera, that want to, hey, can you provide your game plan for the 15 things you're doing in reinforcing at a local level? The short answer is no, because we believe that is helping to differentiate us locally inside of the market. But, a lot of it is returning to the things that have always been important for our team members that is really that reinforcing the mission-oriented approach that is really impacting patients and families and the latitude and flexibility that all of our team members have to be that cohesive comprehensive care provider in every single one of our markets.

Yes, thanks for that. And also, when it comes to census, so we were talking about before-- some growth there. And I guess for the year, the guidance goes for a decline census for the year. So based on that number, would you expect to grow into next year? And also, can you maybe-- frame for the audience, how do you think about the long-term outlook for hospice volumes going forward? And has anything changed that view, what has been happening the last 2 years?

Yes. So it's okay, maybe we'll start at the end from a long-term outlook standpoint and then come back to some big stuff we'll reference as it relates to 2023 until we get into the guidance. But, the long-term outlook for hospice and the growing demand, we're still very bullish on based upon a variety of factors that are out there that start with the hospice benefit continuing to be, in my opinion, which granted is little-- bit biased, but it is the most cost-effective benefit that has been enacted since the early '80s when it was written in the Medicare rules. And so it's not only improving overall quality but reducing total cost of care to the Medicare trust fund that needs it. We see it in the total number of beneficiaries accessing the hospice benefit, continuing to increase every year, greater than it had the prior year, and not only with the total number of beneficiaries accessing the hospice benefit, whether that's 52% of all Medicare deaths or 48% of all Medicare deaths, there's maybe some short-term noise inside of it. But it is a benefit that is being better understood. Care can be provided out in patients' residence of choice, which is the majority of the time at home or maybe in a facility. But the reality is there's a lot of momentum towards that need, and it's not just from a sheer number of people accessing the benefit, but the earlier people can access the benefit, the more total care can be provided from providers. So 50% of folks-- or 52% of folks are accessing the benefit. Unfortunately, still 25% of them are accessing the benefit for less than 7 days, and that's a real opportunity as we continue to educate that communities across the country, but also the health care partners that identify and refer patients to hospice by doing so earlier in their disease trajectory, which will allow and enable not only more people to access the benefit, but to access the benefit for a more appropriate time horizon than just a few days. That's what makes us so bullish.

So how would you frame kind of the attitude of this growth? Are you talking about mid-single, high-single digits? And also the other part of my question in terms of how should we think about next year whether you can versus the decline in census comp this year, does it mean that you would expect to grow next year?

Yes. Our expectation, Joanna, is the labor will-- the expanded labor program that we started in the third quarter is going to lead to census growth next year. The timing of that, quite frankly, we're still trying to parse that up. We're trying to-- it appears to be a shorter lag than we initially anticipated in terms of census returning. But we need more data points before we can say anything definitive. We need to see what the fourth quarter turns out to be before we think we can give intelligent guidance for next year.

And another, as Nick started to imply, they're going to give guidance in February. There's nothing that Nick has observed that would suggest as just as a starting point, we are at this-- in a matter of time back to 19,300 in census. That's just a matter of time, there's nothing in the industry or our position in it or within our geography that we serve to suggest that, that isn't-- I don't want-- when I say imminent, that it is very, very achievable, in the relatively short term. We're not talking about-- we're talking about a lag-- normalcy is already starting to return. We started to see normalcy in the labor market when we employed the different vehicle program. We used that as-- not as a cure-all, but as an accelerant to something we had already observed. But we're seeing that normalcy in many factors in hospice. Nick is on the ground, he sees the factors that will allow us to achieve that already being in evidence.

And for anyone that follows the hospice industry, particularly now, you strongly encourage people to pay attention as it relates to sequential ADC growth, sometimes year-over-year comparables. And by definition, average daily census is exactly that: it's an average. And so when you start comparing averages of averages or growth rates with the timing becomes a big important factor of that.

Nick brings up a great point. Everything we're going to be looking at, really, it started in Q3 of this year. It's a sequential improvement from third quarter to fourth quarter, fourth quarter to first quarter of '23, where look-- everything is sequential from our standpoint. Compared to the prior year is an interesting data point, but it's methodical adjustable improvement.

Right, exactly. And I guess, to that end, in terms of length of stay, right? So we've seen the average improved in third quarter. And also, can you give us the flavor for how this progressed through the quarter, I guess? And what was the exit? How we should think about this progression going forward?

We don't look at it inside of a quarter. I think the primary number would like to encourage everyone, I think, which is the best, both leading indicator of the business and on average, the majority of patients, as we speak a lot about is focusing on median length of stay. The median length of stay throughout the year as well as it was released in the third quarter, and we'll discuss in the fourth quarter, has really continued to improve. And while it may not sound like a lot, whether it's-- we hit a low of 11 days in January, every day really matters and it becomes an indication around the return, I'll say, to normalcy of patients appearing to access the hospice benefit earlier than they had been in the height of the pandemic, and that's a function of a lot of different things, including people's inability to access the health care system as part of a normal progression of disease management for 2.5 years. So that factors into things as much as anything else. And it's just-- it's encouraging for the industry, and it's encouraging for the country as we put the pandemic and the disruption to the health care system hopefully in the rear-view mirror and learn how to safely navigate within our new normal.

And a different topic on staying on hospice in terms of reimbursement, so relatively stable, we know [indiscernible] for fiscal '23 that started October 1. But I guess the other part of reimbursement for the industry that we start to talk about is the Medicare Advantage, where it's [indiscernible] payer and so far been the benefit has been carved out. But there is the demonstration that's going on, right? And in the second year now, and CMS recently published a report, some of some of these results that I have seen. So can you give us a sense of what's your take on the report? And if CMS really achieving the goals that they stated for this demonstration and what does it mean going forward in terms of the likelihood of this demonstration becoming not just a demonstration, but actually being rolled out nationwide.

Yes. I think it'd be very interesting to see the continued release of information from CMMI, right? It's not CMS, just the innovation arm that's tasked with these things. Upon reviewing the first year's results, there were some very interesting observations inside of it and some silent data points inside of it, didn't speak to patient and family improvement or outcomes. The number of beneficiaries impacted, if I'm going off the top of my head, was roughly 9,000 in total amongst a 600,000-plus number of beneficiaries who had that option. So overall hospice adoption rate was no different as being a participant in the plan as opposed to not being a participant. And the vast majority of non-hospice care, which would be community palliative care services in the demonstration project was not provided by any of the hospice providers, which is a diametrically opposed reality than what happens in the actual market today. It was performed by-- there's no transparency to it, but it seems to be performed by providers owned by those insurance companies. And so it's-- it continues to consume a lot of oxygen, but there's nothing material at least through the first year of the demonstration project. Obviously, the second year is closing out. They just did another presentation, I believe, on Thursday or Friday of last week. So we're keeping an eye on it, but the level of engagement adoption is still rather de minimis and the plans that are participating the vast majority own hospice providers in the markets that they're participating. So we're obviously keeping a very close eye on it but the information in the first year supported the overwhelmingly negative sentiment from the hospice provider community that was participating in year 1 that they saw it as price cutting and they didn't see any additional patients or unfortunately, additional patients earlier in their disease trajectory by being part of an in-network coordination.

So how would you expect this to play out...

Joanna, I apologize... Our next meeting actually starts at 11:30.

All right. So I guess to wrap it up, because I guess there was also a question...

No, I got a bad time of that. I'm sorry, it's only 11:15. I was looking at 11:20.

Our screen has had the wrong time all day.

No, we're in good shape. I apologize.

You're ahead of time. Alright, sounds like a good place to be! Because there was actually a question...

The screen says 11:29.

The screen says [indiscernible], 10 minutes early to everything...

Alright, because there was actually a question outside of the hospice discussion, I want to ask on behalf of one of the clients who posed the question. Because obviously, the company also on the Roto-Rooter business, like I mentioned as an introduction, we didn't get a chance to talk about it yet. But before I ask this question let me ask that-- the question in terms of thoughts around splitting that to different businesses, hospice and Roto-Rooter.

Yes, right, we-- obviously, over the 19 years that we've owned VITAS and Roto-Rooter together, that question comes up quite a bit. And we're prepared to do anything that creates long-term shareholder value, but we have not seen any even slight, let alone compelling reason to separate the businesses. If it creates value, we'll do it. But right now, we see no reason to. But we're always-- this is a constant thing that comes up, and we always studied some of the parts- evaluation. Are we getting a discount because of disparate operations? And we haven't seen any of that. We bend over backwards to show transparency in both segments for the performance, and we'll leave it to you folks to do some of the parts, but there's no compelling reason to separate the business from a valuation standpoint.

Here in the headquarters, I mean, we're not going to sit here and say there's a strategy behind capturing synergies between the 2 businesses. But I am going to say that-- in a very basic way, I say that we're in the business-- committed to the business of providing services that are basic, predictable, and growing largely organically and that both have great cash flow, and then we use the cash flow to reduce the shares outstanding and taking virtually no risk with 2 very basic businesses, just earning the cash and deploying it for share repurchase. The 2 companies combined have resulted in Chemed raising its net income 24% per annum for the last 19 years. And again, part of that last statement was risk- taking virtually no risk. So that's, in many respects, the businesses-- the business that we see from the Chemed perspective. And given the fact that the disarray in much of the health care field caused by the pandemic, Roto-Rooter has been a fantastic company that benefited from many of the effects of the pandemic. That's been a godsend in many respects. So some-- there's no grand strategy behind it. It's just, as Dave says, driven by value creation. And the underlying factor of that is cash flow. And all those elements remain kind of in place for the current time being. So we get a lot of questions about it. We've got an open mind, but doesn't seem to be any value-driven reason to change.

And the last question on the Roto-Rooter in terms of the outlook. So you mentioned basically business benefited during the pandemic, good cash flow. So how do you think about this business going forward that the pandemic created these tough comps? Would you expect-- is it reasonable to assume growth into next year? We see the biggest unknown is recession. But I guess, if it was a meaningful perception, what this could mean for that business?

Well, again, we've owned it since 1980. So we've seen recessions in the fact of the business. And I'll just tell you that, just as briefly as I can, that yes, we expect growth in sales and earnings for Roto-Rooter no matter almost matter how deep the recession is, at this point, I can-- with a reasonable bounds. And the rate of growth is going to be more tied to our historic levels of mid-single digits on the sales side, a little bit better than that on the income side in theory. And when we-- it will be good cash flow, and we use that cash flow for stock repurchase and the overall total return for that business, will continue to be, from our perspective, good despite what could be a coming recession. I didn't say depression, the recession. Great.

And that's all the time we have for this session. I understand you have a meeting. So I want to make sure you're there on time. So thank you, gentlemen, for taking the time and thanks to the audience. And I hope you stay for the upcoming session after a short lunch break and we also have a full day scheduled for tomorrow. So thanks again for the time, and I hope to see you, everyone, maybe in-person next time next year. Thank you.