Chemed Corporation (CHE) Earnings Call Transcript & Summary

Okay. Good morning, everyone, and thank you for joining us. My name is Taji Phillips. I'm a member of the health care services team here at Jefferies, and welcome to the 2023 Jefferies Global Healthcare Conference. Today, we have representatives from Chemed Corporation; David Williams, Chief Financial Officer; and Mike Witzeman, Chief Accounting Officer. Chemed owns 2 distinct business segments: VITAS Healthcare, one of the nation's largest provider of end-of-life hospice care and Roto-Rooter, the leading provider of plumbing, drain cleaning and water cleanup services.

So to go ahead and get started, we'll kick off for the purposes of this conference, we'll focus on VITAS today. Maybe we can start with the state of the union. Can you both give a brief overview of your business model, your history and how you think you're differentiated from other players before we go a little bit deeper?

Yes. And as Taji gives us some great questions to kick off, we also want to encourage the audience. If you have any questions, please raise your hand because we certainly want to take the 25 minutes and be relevant for any concerns or questions you have. But without a doubt, the pandemic and the disruption, the pandemic has created in health care has been something -- nothing short of -- I haven't seen anything that severe in my 40 years of working in health care and consulting with health care companies. But there's also -- at this point, I haven't seen a greater opportunity for our Healthcare segment, VITAS, really since the federal government said hospice is just as appropriate for noncancer patients as cancer patients. Unfortunately, our opportunity for VITAS is growing, I think, is going to come at the expense of some very well-qualified small players who I think are going to have a difficult time competing. And what I mean by that is VITAS, like everyone else saw a significant exodus of licensed health care workers at the start of the pandemic. It was really pretty severe starting in April and May of 2020, and then there was just buzz of episodic event where we had significant attrition, and it really pulled our workforce down by more than 15% by the end of what, Mike, the first quarter of '22, I'd say as we kind of saw a low point in terms of our capacity. At the same time, we saw an opportunity for stability, and that is really when we implemented a higher and new retention program for our bedside licensed health care workers plus the admission nurses. And we put in at what we called -- when we made the announcement in July of 2022, we talked about a retention and hiring program with a cost at that point of $38 million. Where the $38 million came from is if we failed to hire any incremental increase in people. So we hire and people leave. So if we kept the workforce flat in terms of licensed bedside health care workers, it would cost $38 million, giving a bonus of anywhere from about $300,000 to $15,000 depending on your license and that would be payable 12 months of continuous employment. So we made this announcement on July 1, 2022, and all the people are with us through June 30 of '23, so the end of this month, would qualify for this bonus for a total of $38 million. These are also people who were long-tenured employees. These are the people who've been with us for longer for several years, but they've gone through 2-plus years of hell in terms of the workload was too great. They were strained by capacity. They couldn't get scheduled and unscheduled time off. So these were the people that we really wanted to protect and wanted to retain. So for $38 million, we created stability in our tenured workforce. Mike and I actually think the cost of the program will be now closer to $43 million. The difference between the $38 million and the $43 million, that extra $5 million is actually for capacity expansion. That $5 million has resulted, I think we hired 175 net increase in licensed bedside health care workers in Q3 of '22. We did 100 in Q4. We did 200 in Q1 of '23, and we think the second quarter of 2023 will exceed the high watermark of 200 from last quarter. The cost of this capacity expansion isn't $43 million. The cost of this capacity expansion is $5 million. And our opportunity to get increased admissions that is resulting in increased census and then that census us we lose money and half of the patients we admit because they're not in program long enough to recover our cost to set up a plan of care. 14% of our patients live past 6 months, phenomenally profitable and they subsidize those negative margin patients. But my point on all this is for $5 million, we are significantly increasing our capacity. It's couch change. And frankly, it's the federal government that's giving this opportunity that we're taking advantage of that I wish we didn't have to. And the reason I say that is if the government sticks with the 2.8% reimbursement increase that they announced a couple of months ago on the proposed rule, I think cumulatively for the last 3 years have announced increases, the government has increased reimbursement, about 500 basis points less than inflation in the health care model of hospice in a number of other health care plays. And it's not insidious on the government's part. It's just a matter of how they're structured, how they measure increases. And the government looks at 7 quarters of forward-looking inflation in the hospital wage index basket. And that index basket is a little over 50% is labor and other costs. Now hospice is the fleet on the tail of the dog, but we are very small. We're about a $24 billion reimbursement, but hospice utilizes that hospital wage index. Now the 7 quarters of forward-looking inflation, there's no requirement and the federal government traditionally has not actually adjusted the forecasted inflation to the actual measured inflation. And it really didn't matter much from years ago because there wasn't much volatility between the forecast and actual and there was a 15-ish 20-ish basis point differential. And it could have been positive to the reimbursement or negative. But what's happened, obviously, with the jump in inflation over the last 3 years of scheduled reimbursement increases is now there is a material difference between the forecast and inflation. And in our opinion, one of the reasons why there is such a big gap is the executive branch was very optimistic, very hopeful that inflation would be transitory. And then we kind of left the transitory, but they thought it would be coming down fairly quickly. And that was just give it the belief, the narrative that the executive branch believe, but that narrative certainly couldn't be disrupted by various departments with the executive branch, having aggressive forecasts and future inflation. So all this attributed to a negative spread between inflation and reimbursement. Hospices that have scaled, and we're one of the largest hospices in the United States, even with these issues, we have an adjusted EBITDA margin in excess of 15%. Pre-pandemic, it was a little over 17% because of scale. It's actually leveraging our backroom costs, not bedside care, small hospice providers, those under 100 census, but even those under 200 census, and that's the majority of provider numbers out there, they lack scale. This negative spread between inflation on wages and benefits on wages, has squeezed these providers to the point where they're going to have a very, very, very difficult time paying prevailing wages. They don't have the capacity to provide these hiring and retention programs for stability, and they're going to be in a very, very difficult spot. And frankly, hospices that provide great care, but have scale that result in a higher margin. We're going to take advantage, and we're going to be able to pay prevailing wages and increase our capacity by hiring more licensed health care workers. And that's the dynamic we see us facing today.

Thank you for all that commentary. And there's clearly a lot to unpack there. So first, to kind of go back to this conversation around labor, obviously, you've been making a lot of improvements, right? You're expecting that step up from Q1 to Q2 in terms of just incremental hires. Can you maybe talk about if you're looking at that across a continuum of, I think, where you need to be in terms of hires to fulfill your capacity? How many more licensed professionals do you need, I'm just curious?

For -- so the goal is to pick a line in the sand is we want to return to an average daily census of 19,250. There's no magic to that number, except that was the average census we had in the fourth quarter of 2019 before the pandemic hit. We think we'll -- we're going to do more hiring in the first half of 2023 than the second half because we do expect a bit of a pull forward in terms of if people want to work for us, they're going to probably jump in June, and they're not going to be asking if we can hire them in the middle of July just because they'd rather pick up that 12-month hiring bonus that they'll get paid out in 2024. But with that said, we still anticipate at least hitting our initial guidance of 75 increase of bedside licensed health care workers in Q3 and Q4, and I'm optimistic we could exceed that, which is my kind of long-winded estimate guesstimate of I think in late '23 or early '24, we're going to hit that 19,250. And again, remember, our increase in census, our increase in admissions, over half of our admissions have negative margin. Half of our patients that we admit pass away in 2 weeks or less. And we really need almost 30 days at routine home care reimbursement rates to break even on the cost of evaluating patients, meeting with their family, admitting the patient, setting up a plan of care. And frankly, and that takes a good 7 days, a very intensive labor, durable medical equipment delivered on a stat basis, pharmaceuticals on a stat basis and then the dine process traditionally typically takes 3 to 7 days. That's also extremely labor-intensive. We switch out pharmaceuticals. We lose money on over half of our patients. But as we ramp up our census and the 14% of our patients who live past 6 months are phenomenally profitable necessary to subsidize all of the patients we have negative margins on, but we think normality is scheduled comfortably in the first half of '24 at this pace.

And thinking through, I think, hospice admissions generally have been seen across the industry that -- it's been slow to recover, but it's improving, right? And we're hearing that that's driven by, obviously, disruption from the pandemic also kind of referral mix shift, right, less referrals coming from SNFs and assisted living, more so from hospitals. Just curious, what are you seeing in the market today? And what do you think is going to continue to drive that improvement in admissions and volume essentially?

It's definitely normalizing. And you could see that in our sequential numbers on what we report every quarter. And I have an investor presentation here. It's a pretty thick presentation. We update every quarter. I encourage everyone to go through there. There's actually some very, very, very good operational metrics to give you a feel for that improvement. But we're returning to more normal in terms of our nursing home and SNF referrals in our ALFs, and we're beginning to go back to acute hospitals for more referrals as we have the capacity to take those on. We had to -- we were forced to deemphasize hospital admissions primarily because the effort to -- in hospitals, if you're in an acute hospital, the statistical probability you're going to be a short-stay patient is significant. And it takes the same amount of effort and resources to admit a patient and put a plan in care in place, whether it's a hospital or a nonhospital as a preadmit location. But the issue is if we're going to take that effort and scarce resources, we want to treat a patient for 45 days, not for 5 days, given it's the equal amount of resource to get that patient set up and stabilized. So we had to deemphasize high acuity care because it was such a monster of consuming resources, but we have to get back to that. The Medicare Cap billing limitation kind of insists we get back there. We've been able to avoid, even though we have had a drop in admissions from pre-pandemic levels, we were able to avoid the Medicare cap being a major problem. It's actually typically about where it's always been because our higher reimbursement by acuity care also fell that gave us room under the cap cushion to have lower admissions. And what I mean by that is reimbursement for a day of routine home care is, what, Mike, about $150 to $180. But for inpatient care or continuous care is about $1,100 to $1,300 a day. So having less high acuity care, even though we had less admissions was really why we were able to maintain cap cushion. But now as we return to normal, we need those shorter-stay patients and the community needs it for quality and of life care. We need to take those on to make sure: one, we're taking care of all the patients within the community; and two, we can get paid for all care provided by averaging down our length of stay. So we see everything returning to normal, slow but steady, and I expect to be completely in there by 2024 and probably earlier 2024. Any other thoughts we should hit on, Mike.

No. Thank you.

Also, just to remind if there are any questions from the audience, we're happy to feel that. Please just raise your hand if you have one. Go ahead.

[indiscernible]?

So the question is Medicare Advantage and the impact on hospice. Currently, nothing right now, but there has been -- CMMI has put a demonstration project in place, and it's now been running 3 years, and they just extended out for 2 more years through 2025, I believe, it could be fiscal '26. But frankly, the uptake on the demonstration project has not been great. And what I say that is there's no compelling reason for financial savings or better quality of care or working in the continuum for MA to have the ability to provide hospice as one of its options. But -- and the reason it is multiple. But right now, the majority of the people are participating in the demonstration project, and it's not large, is primarily insurance companies that already have a captive hospice. And they're just not seeing much advantage to it, again, from the continuum or from the economics, quality of care or anything else, length of stay. In our opinion, we think there's actually a fair amount of headline risk if MA plans provided hospice. And the reason is if an MA plan is recommending a hospice, are they doing it because that's the best answer for the patient and for the patient to stay at home and receive that care? Or is it more of a cost savings so they can avoid the curative care costs? Right now in hospice, there's some noise and everything else is there's been inappropriate behavior in hospice. We can look at CMS in the proposed rule to talk about their constant of waste, abuse, fraud. Hospice has exceptionally low probability of systemically bad behavior in hospice. And the reason actually is inherent and embedded in the benefit itself. You need 3 significant gates open for a patient to be admitted to hospice. The first one is the patient has to believe they're terminal. And when the patient believes they're terminal, they contractually agree to exit curative care for the disease and conditions that contribute to that terminal prognosis. If they're terminal for renal kidney, they will not receive curative care for renal kidney. They can receive care for dermatology, they can receive care for -- you can get physical therapy for last year's hip replacement, they can get the arthritic medication they need, anything that's unrelated to the disease and condition for the terminal prognosis. So that's the one gate. The second gate is the physician that's been treating that patient for these severe issues that result in the terminal prognosis, who is independent from the hospice agency, and they have no financial relationship with that hospice. They have to sign a physician certification saying they agreed that the patient is terminal. And then finally, our Medical Director at the hospice has to agree. So those 3 gates have to be open, but the biggest one, no patient gives up curative care unless they think they're terminal. And the last thing that protects systemic bad behavior within hospice. I'm going to reiterate something before, you can't systemically trick large groups of people to give up curative care. But then the other fourth thing is the Medicare cap billing limitation. That keeps providers from even legally gaming the system by going after patients if length of stay is the key driver for profitability, well, let's pick on areas that have statistical probability to be length of stay, the billing cap limitation will quickly shut down those hospices. So from that standpoint, there's not bad behavior in hospice. When they talk about fraud, waste and abuse, it primarily relates to if a patient is in a nursing home and they're on hospice, that nursing home really lose the ability to provide DME and get paid for by Medicare. Some nursing homes still bid bill for DME that is probably arguably inappropriate. CMS also takes a hard stance on Part D as well as fee-for-service and that is economically when a patient likes hospice, they stay within Medicare Advantage, but they convert to fee-for-service for care outside of hospice. And CMS takes the position well, really no care is appropriate outside of hospice even though explicitly within the regs, it is, but they take a hard stance on that. They also take a stance on Part D, all Med should be covered under hospice even though Specifically, hospice is only required provide the med related to the disease and conditions that relate to the terminal prognosis. So if they're renal kidney, we pay everything for renal kidney, but they're allowed to get Medicaid if they want to take medication to delay the progression of dementia that is appropriate under reimbursement is probably not appropriate and the hospice is always trying to counsel patients to discontinue any care that doesn't contribute to quality life on the remaining days or months you have left. So that's quite frankly, why there's not systemic bad behavior in hospice traditionally. But CMS is looking at people who are building off of patients who are already in hospice, but that really is a concern outside of the hospice provider.

Going back to this conversation about the Medicare fee-for-service proposal right for hospice. Clearly, you were very clear that it came in lower than your expectations. So just curious, can you provide some updates on your strategy to mitigate this headwind before the final rate comes out? And if it is finalized as proposed, what operational efficiencies can you leverage to offset the negative impact? And then one quick follow-up case we only have a few minutes left. As a scale provider, you also alluded to this being an opportunity right, you're positioning yourself to make sure you're hiring more labor. I guess as we look at other mom-and-pops, I could struggle if this is finalized, how are you thinking about the market for being acquisitive? Would you be aggressive? What's the outlook on that?

Two great questions. So you're -- the first question was how bad is the reimbursement spread between where reimbursement is go for an inflation pressures. And it is significant. Frankly, our concern and VITAS is one of the first hospices in the United States, we started before Medicare accepted the benefit. We were not for profit initially and was flipped to for profit to access capital to be able to actually provide needed care in all the communities. So frankly, our metrics are like a not-for-profit. But without a doubt, the squeeze on these small not-for-profit primarily, not-for-profit players, I think, creates headline risk within the hospice industry. My concern is as these small hospices and a lot of them in rural markets are trying to do good work, but they can't afford to pay prevailing wages, the quality of their care has to diminish. And they're going to disappoint patients and families as they're scrambling to care for as many people as possible. And it's inevitable there's some very bad anecdotal stories will come out with hospice care that compared to prepandemic seems to be inadequate. And any hospice care is better than no hospice care in some of these communities. But frankly, I think that's a problem. And I don't see -- when we talk about, well, they give relief to hospice. No, you're really talking will they give relief to the -- all the health care plays that utilize the various forms of the hospital wage index basket. And I think there is a reasonable probability, CMS will move a bit off of that, but I don't think they can do a large scale just because of the overall cost that means, but then they have to balance out access to care. And CMS has just an incredibly -- basically, have an impossible job in this inflationary environment, given what we've all seen on debt and budget concerns in Washington. But that is going to be a problem. On a go-forward basis, what we are doing is we are paying prevailing wage for our health care workers. The hiring and retention program we put in place wasn't in lieu of appropriate raises and keeping people below prevailing wage. It was an addition to. So although this program is going to cost $43 million, we think with the labor expansion we put in place, it's really $5 million for a growth in capacity. And going to your question, will we buy hospice programs? That $5 million that we're spending for capacity expansion, if you transfer that for a stabilized census what that means down the road, we are paying -- if things were going for 12x to 14x adjusted EBITDA and acquisitions, we're paying less than 1x by that $5 million compared to what it means in census. It's a long-winded way of saying, you don't pay for something you can get for fair and normal competition. So that's our growth strategy. We are prepared, but this is blue sky. This is a thesis. We're not opposed to buying a platform in a market and a community and a state that we're not in. But then frankly, then we'll utilize our ability to have a better platform, prevailing wage, better work environment, better quality of life if you want to be in hospice, and we will start competing on wages that are under scaled competitors won't. So I can see us doing strategic positioning and acquisitions, but only because we can bring down the multiple through normal growth through competition.

Well, that's about time. Thank you so much for joining us. David and Mike. We really appreciate it and thank the audience for joining and participating. Enjoy the rest of the day.

Thank you.