Chemed Corporation (CHE) Earnings Call Transcript & Summary

All right. Thanks, everyone. This is going to be Chemed Corp. We're very happy to have them participating in our conference again this year. We've got Kevin McNamara, Chief Executive Officer of the company; Mike Witzeman, Vice President and Chief Financial Officer; and Joel Wherley, CEO of VITAS.

Well, we're 10 months into the year, and it's a year that have a lot of ups and downs in it. What would -- maybe just give us a little bit of a thought about how the year has progressed for Chemed? What have been some of the positives? What have been some of the challenges?

Sure. I think at the moment, I think we're very positive and optimistic about the future. The second quarter, particularly this year was a rough quarter for both VITAS and for Roto-Rooter, from a VITAS perspective, and we can get into it, but we're extremely confident that we're not going to repeat the Florida Medicare Cap issues that we had in 2025. Roto-Rooter is a little more difficult story. They've had some intense competition over the last few years, but we think we're getting to a point where we can see the light at the end of the tunnel. And the competitive environment seems to be getting a little better, and we're going to take advantage of that over the next 12 to 18 months.

Okay. Just -- I mean, we always get a lot of people trying to just get up to speed on Chemed unique and diverse business model. You've already referenced it VITAS on the hospice provider, Roto-Rooter. Give us just your high-level overview of the company and the overall growth strategy and maybe the earnings algorithm as we think about that.

Yes. I would say that I'd characterize Chemed is from the point we purchased VITAS, which was 2001, just going forward to the pandemic. We had 2 businesses, 2 service businesses that are very disparate, obviously, in the service they provided, but they were similar in that they both were grinded up businesses, grew by largely organic growth rather than acquisition. The -- both were excellent cash flow businesses. They would -- they grew their net income within a percentage point of each other for a 20-year period, which was a very consistent between 11% and 12% per annum. The growth algorithm was to take that consistent growth. The free cash flow is about equal to the reported net income, and Chemed used that to purchase well over $2 billion of Chemed stock, reducing the share count of Chemed from about 27 million to just under 15 million shares outstanding. And through the magic of that leverage over the 20-year period, Chemed's stock price grew about 18% per annum. And again, that was -- when you risk adjust that, seeing better because it wasn't dependent on flashy acquisitions or a lot of putting a lot of goodwill on the books. It was just, as I say, 2 grinded out predictable businesses. The pandemic hit, which was kind of interesting and in that it really decimated VITAS in the 20% of its workforce quit, good percentage of potential patients were not available either in nursing homes where there was no access allowed or failure to go to doctors and hospitals so you get a terminal diagnosis. So no question, VITAS was wildly disrupted. On the opposite standpoint, with everyone confined to their home, Roto-Rooter like most home services companies boomed and had EBITDA margin of in excess of 29%, growing the top line in excess of 10%, balanced out the 2 companies maybe a little bit. But one thing it lost was our consistent growth at both. Following the pandemic, we saw the reverse. VITAS was able in time to replace its workforce to grow back from a -- trying to think of the number from Joel, your low end in census was...

17,000.

Just over 17,000 -- just over 17,000, back to its pre-pandemic levels. Roto-Rooter on the other hand, faced some issues. The boom times in the home services attracted a lot of private equity investment. And that disrupted the Roto-Rooter business, no question about it. It initial stage was they hired a lot of our Roto-Rooter managers. We were able to stem that outflow. But one thing that was a consistent issue following that was the -- on Google. Google advertising, Roto-Rooter went from pretty much the only game in town to bidding with multiple private equity-backed companies across the Google platform in every city in which we operate. So we've been dealing with that for a couple -- for about 2 years. And again, I think we're getting on top of it. But I guess one way to say is we -- our algorithm for growth is 2 consistent grinded up businesses, good cash flow, reduced shares outstanding. And we're getting back to that now. We're hitting an equipoise with both companies now. I'd be remiss if I didn't say that VITAS' biggest problem this past year was a Medicare cap limitation in Florida, which is complicated. All I can say is if I reduced it to 2 sentences, I'd say, -- we saw it coming. We gave a warning. It was about $19 million of -- ended up being $18.9 million of money we had to give back to the government just not because of billings that were not correct, but just due to this above our limitation. And it probably took 100 points out of the Chemed stock price and well over $1 billion. So again, we're returning to normalcy. We've already given the adequate information to suggest that we're not looking at a limitation this year that it was a onetime event. So again, that's -- when we talk about our strategy, it's just to get back to the pre-pandemic level and get back to that earnings profile that we had previously.

So maybe, again, for people that are trying to get up to speed, maybe just spend a little -- a minute on the cap issue, why it was sort of a unique thing that you don't think is going to repeat itself.

Joel?

So there's several fronts that came together in the first quarter of the '25 Medicare cap year, which actually is the fourth quarter of the '24 calendar year. So starting October 1, we had an outsized revenue increase, which is the annual increase that each of the providers received. In the state of Florida, it was significantly higher than the average across the United States. So that was one component to it. The other component was during the pandemic, and as Kevin mentioned, given the staffing headwinds that we had faced, we had to prioritize where we were able to deploy our resources, where to focus and more importantly, from a clinical standpoint, how are we going to care for those patients. We did that shifting to what we call the community access initiative, which moved us away from hospitals as a pre-admit location, which typically generate a shorter length of stay patient that also is at a higher acuity and requires more touches. So prioritizing the staff we had available, we focused on the community access or non-hospitals as a pre-admit environment. As we moved through '24, we continue to see a census improvement at record levels. While at the same time, going into October of '24, we were faced with a couple of components, one of which big rate increase. So we had census increase, days of care increase, rate increase. We also were coming off 2 hurricanes in the state of Florida. We had a lot of disruption in our business, and we saw our admissions not track at the same level as our census. And not to get too deep in the weeds on how Medicare billing for hospice is calculated, that put us in a position in that first month of the cap year that we had to then try to dig out from -- essentially in a very simplistic way, we grew too much, and we exceeded the billing limitations. So we had to try to get out from underneath that all year in '25, which we were in a positive trajectory. We just couldn't do it enough to overcome the hole we put ourselves in that fourth quarter. We have been focused strategically on our mitigation efforts to ensure that we were not going to be in that situation with a headwind going into Medicare Cap year '26. And we have moved in a positive direction and feel we're in a very good position to ensure that for the Florida provider number in '26, we do not anticipate any liability whatsoever.

What is -- as you're describing it, what is the mitigation factors that you can employ to -- I mean a lot of that doesn't sound like it's necessarily in your control, but...

There's multiple strategies actually. and refocusing and shifting our selling priorities back towards hospitals as a admit environment, shifting away or not focusing as much on nursing homes and ALFs that typically yield a longer length of stay patient. So those variable is you got to balance the length of stay, you length of -- your referral sources led to length of stay being.

Another important issue is that anyone that follows us closely, but our length of stay metrics came down significantly in the third quarter. So those bubble of long-stay patients that we created during the community access program, they're all still hospice-eligible completely appropriate patients. And so we knew that would moderate over time, and it did moderate in the third quarter. So we enter the first quarter of this year in a much better position...

And what I'm going to add is you, I guess, intimated the one issue. It's pretty predictable. If we look at hospital versus nonhospital, we can -- it's very predictable to say what their length of stay is going with longer length of stay, are will be longer, there's more reimbursement during a plan year. Well, we saw, as Joel mentioned, just basically out of necessity, our percentage of our admits from hospitals falling from our traditional rate of, let's say, 42% to 45%, 46% to as low as just under 39%, okay, of our admits were coming from hospitals. So one of the accommodations you make is you make sure you do some of the things that Joel just said, but you make sure that on a run rate, your hospital admissions are in that 42% to 45% rate. And we've already seen that. I guess I say what gives us so much confidence going into this year? Two things. Number one, we are at that rate and have been for the whole calendar year of 2025, okay? So that's -- we have 20 years' experience saying makes it pretty easy to predict what type of patient we're going to get from that referral metric. And again, going back that to say that's fairly significant, the reimbursement that we got -- the Medicare Cap total goes up by the national average. In the previous year, we got reimbursement in Florida that was 200 basis points higher than that. So our reimbursement went up 200 basis points more than the Medicare Cap limitation. That did not repeat. In other words, we ran all of 2025 to date with running a positive surplus for Medicare cap. We awaited the reimbursement increase, and it was in kind of what we thought, a sweet spot. In other words, the national average went up only 40 basis points less than what we're getting in Florida. So we're getting more than national average in Florida, but 40 basis points, not 200, coupled with our current run rate and the current run rate of billing and run rate in referral network that is 42% plus rather than 39%. It's allowed us to say and maybe hopefully reassure the investing public that Medicare cap limitation was Florida was $18.9 million on its way to 0, not $18.9 million on the way to $100 million.

Yes. Okay. And I'm going to come back to hospice. But in the meantime, you also highlighted on Roto-Rooter, the issues around increased competition, some challenges there. That's in the Google dynamic. That's something that's been a couple of years, I think, no question about it.

See, the money -- first on the competitive level. First, private equity came into the sector, disrupted the -- our then current operating models. And by that, I mean, we were spending, depending on market, between $40 and $60 per click for getting referrals on Google or sponsored ads from paid search. And paid search at that time probably was about 40% to 45% of our leads were coming from paid search. The rest were coming from the natural or free search on Google, okay? So 2 things happened. I'll really summarize what ends up being a longer discussion when we're in the private meetings. But 2 things happened. Number one, private equity came in and started bidding a lot more for placement in the paid search. We had to pay more. They were paying -- they were paying much more, let's say, $120, $130 per click, okay? Initially, we matched them paying a lot more. That's a margin issue. But we saw that even with matching them, there were just so many of them that we went from a preeminent position to a less than preeminent position and actually had significant decreases over each of the last 2 years in telephone calls, like the rates for the last 2 years have declined double digit. We're talking about double-digit declines in actual phone calls we received. On the positive side, what we said is the disruption caused by private equity, that is the real disruption was in the number of paid search leads we were getting. In other words, last year, we tried -- we paid more for click and got less -- fewer clicks or fewer calls. What we've seen in the last 2 quarters is we've held constant at a reduced level of pay per click. We've paid -- we've gotten more clicks. So our actual spending has been up, but we've gotten more from it. Last year, we paid more and got less. This year, we're paying more and getting more, which I think is a pretty good indication that the competitive levels caused by the largely private equity advertising competitors has -- the competition has abated somewhat. And I think we're on top of that. It's always something. The other thing, if you followed our results, we've said that the other thing we're dealing with is Google is not that excited about giving free advertising to people who otherwise would pay for it. So they've been changing their algorithm gradually, but most recently about halfway through the second quarter of last year to pretty significantly exclude larger competitors from what's known as the map portion of the natural search, okay? I think the most important part of the natural search. And so the net effect is we're getting more jobs from the paid search, paying a little bit more for them, but getting more and getting fewer jobs from the free search. I mean order of magnitude, there's been a switch. We've gone from 55-45 to 45-55, okay? And that's our meeting so far today, people have said what's our body language for Roto-Rooter. And I guess what we tried to say is we're not out of the woods. We've got a lot of good things going for us. We have a lot of negatives that are no longer negatives, but we're still dealing on the marketing side. We're still dealing with some issues with Google. On the executional side, we've been pretty happy with our close rates and what we're doing when we actually do get the phone call, let's put it that way.

So you're getting the more hits, is that -- can you really see that competition has dropped out and...

Well, let's say, Mike, was the last 2 quarters, our paid search were up 9%.

They're up a little lower -- a little below 9% each of the last 2 quarters. We also know -- we do studies, our SEO has done a study. the private equity competitors who are bidding, they're not showing up on the unpaid section either, right, because they're willing to pay. And so we're getting more -- we're still bidding the exact same dollar amount per click, but we're getting a lot more clicks. It can only -- I think the only conclusion can really be that the competitors are bidding less, bidding less often because they're not showing up on the unpaid search just like us.

And what -- when you think about the economics of the business, are they at a point where they're not making money? I just...

I don't think -- the segments of their money, keep mind that a lot of them are treating plumbing as a loss leader, okay? So to answer your question, as they're competing with us, they're not making much money. I just -- I'll give you an example, not an outlier, not a big outlier. They pay for a click. And let's assume that 45% of their clicks are paid, okay? For that paid click, they're paying on average $120, okay, for a job. They are doing that job for $80, okay? Then they're also paying a plumber to go out and do it. I mean that -- and their thinking behind it is -- I mean, I think every business school would say this is a good idea. I don't necessarily agree with it, but they'd say, all they're looking at is the acquisition cost of somebody who could be a lifetime customer of their HVAC business as well. So they're saying it's a small price to pay. That's a pretty theoretical approach to a dollars and cents grinded out industry. We'll see how it works out for them. The only thing we can say is that we noticed that transactions in the sector are much fewer and far between. In other words, fewer mom-and-pop plumbing companies are being purchased by these private equity-backed HVAC companies. And also, we don't see the exits from those put together. And I don't know what their investment horizons are, but some of them started a good 4, 4.5 years ago.

Yes, it started in '21, generally speaking, from some of the folks we've talked to in the industry and things, '26 is going to be the year that they need to probably figure out what to do with these businesses. And so we knew or we kind of theorized all along, at some point, they were going to have to go from customer acquisition, top line growth and translating that into actual income to be able to address them up for sale. And I think we're starting to see that. It's not unexpected. As Kevin always says, we're running a marathon, they're running a sprint. We're in this for the long term. I think that '26 is going to prove to be a much better year for us.

Is there enough loss leader? I mean, you have your own history of experience there, is doing what they're doing makes sense because...

I mean we go back to the '90s, Roto-Rooter was fairly active in purchasing and starting HVAC businesses thinking that they were compatible. We did not see the symbiotic relationship developed between the 2 businesses, and we tried it in different fashions. We tried it under the Roto-Rooter service mark. We tried it under a new service mark. We tried it under keeping the original names of the acquisitions. We tried it in different sectors of the company, country and a conclusion at that time, based on how we were doing it, and we think we were -- we had skilled operators handling it. We just didn't see it. We didn't see the long-term benefit from it, and we got out of all. We sold them all. And so our experience suggests the jury is still out at best.

Okay. And the idea of you trying to go in and consolidate this is...

I think that's a good suggestion -- we've had that a couple of times today. There are areas, okay? Just because we failed that it once, doesn't mean that it's an idea that will never come or put this way. There are areas throughout the Southwest, particularly where air conditioning is a big business and it's still -- maybe there's still enough because of the -- not necessarily a desert, but there's still good plumbing businesses. I'm using Phoenix in my mind as an example, where we would have an open mind to at the right price, buying one of these aggregators that maybe is tired of it, but they would still have -- it's one of the most important elements you have. That is plumbers. To the extent that they hired a good group of plumbers, we can usually find work to keep them busy usually. And would air conditioning be antithetical to us? No. but we don't kid ourselves. We probably have to buy expertise. We don't have the internal expertise to think we can do everything, let's put it that way.

And what type of return profile would you look for if you're going to do a deal like that?

One that had a substantial amount of plumbing, okay? It couldn't just be an add-on. And the one thing we've seen with our plumbing business is, we would want them to have a -- on the plumbing side, the possibility of doing ancillary services. But every point of can do under the right circumstances with water restoration. Hard to imagine in this day and age to have a big success without excavation, at least the way we do it. On the HVAC side, we would like -- we like businesses that were a business at least 10 months a year, okay? We're not in the -- we haven't been in the industry of managing part-time employees or seasonal employees.

Right. So that keeps you in the sunbelt basically. Yes. On the -- going back to the hospice since we are a health care conference. The total admissions were up, I think, 5.6% year-to-year in 3Q ADC was up 2.5%. It seems like we're basically back to nice trajectory for hospice. Is that put aside the cap issue. Do you think we're sort of all the pandemic volatility is pretty much done? And we're -- I mean, it seems like most of the people that have exposure to hospice are showing pretty good trends here.

Yes. I think the fourth quarter, as we've indicated multiple times today, fourth quarter is really going to be a strong indicator for us, but we do believe that we had purposely manage the census growth so that it was not at the previous year's growth rate and that we could then work on mitigating strategically the cap liability. We feel we've met that point, plateaued and are beginning to be able to responsibly begin to grow that Medicare census again.

The admissions exceeding ADC in the third quarter, like you mentioned, that was specifically, as Joel said, as a response to making sure we balance the Medicare Cap. Going forward, I think we'll see admissions and ADC growth going more hand-in-hand...

And what is the market growth now roughly, you think?

Overall growth, I think we have no concern returning back to previous growth rates in the 4% to 5% range. But again, the fourth quarter is going to be a key indicator for us to determine really where we can focus on in '26 from a growth rate expectation.

Here's what -- I'd like to build on how we build that up. We look at what has been the model for the previous 20 years for being Chemed before the pre-pandemic, okay? We've gotten price increase of 3% to 4%, let's say, 3%. We have average length of stay trending up a little bit. Let's use -- we don't like significant increases in that, but good ratable increases of a couple of percent, okay? -- which helps ADC. And you grow admits at 4% to 6%. You put those all together, you're at high single-digit top line growth. And not only is that sustainable given Medicare cap limitations in the various programs, it's a healthy growth rate. And I say, given its cash flow characteristics and Chemed being a public company, that's kind of all you need for what is -- I mean in Chemed's case, as I already made reference to it, a 20-year period, the stock price was up 18%, pretty consistently, 18% per annum and without taking a risk, right?

Over the longer term, CMS has indicated that hospice probably from a demand standpoint is going to grow 8% to 10% a year because of the baby boomers right now. So there's a chance we could even outpace our historical averages. It's just, again, we need to make sure we balance the short stay and the long-stay patients because we can't get out of balance there. But we could grow top line, like Kevin said, high single digits, maybe even low double digits for the foreseeable future.

And what about the availability of the labor for that? What's happening with that? And what's your wage increases looking like and so forth?

So during the pandemic, we faced significant headwinds from a labor perspective. We, as Kevin indicated, had turnover in the high 20s, instituted multiple strategies to improve that. And going back to March of '23, we're able, unlike a lot of our competitors to add clinical capacity every single month. We have now begin to manage that down a little bit because of the circumstances associated with Medicare Cap, but we are facing no headwinds from a labor perspective. We've absorbed the increases associated with what the pandemic brought forth, but we're seeing those high levels come back to a more reasonable amount. So we do not anticipate a labor headwinds for '26.

Your turnover rate, new hires, those are all sort of consistent with what they would have been pre-pandemic.

Correct.

Turnover rate, I think, is a little better than pre-pandemic. Some of the things that Joel mentioned that we did to address the labor shortage, we continue to do. And I think turnover is they were good practices.

Good employer employee practices, we've just maintained them.

And the average wage increases, something like 3-ish percent or something or...

Yes, this previous year, we were in the 3% to mid-3s as an increase. And we've -- we're selected as a best workplace in '25 in the health care setting. So I feel like we're in a good position looking at retention and where we go then in '26.

And going back quickly on Roto-Rooter on the residential versus the industrial, anything to call out there or...

So commercial, I think, is a real opportunity for us. We're hiring commercial business managers whose only job is to focus on that. But one of the things we like it, as Kevin had talked about some of the pressures with Google and with competitors, our competitors really don't focus on that space. And as a commercial business customer of ours, you're going to get either our general manager's direct dial phone number that you're going to get our salesperson's phone number. And so they don't go to the Internet to try and find us. So we're doing all kinds of things on both the commercial and residential side to avoid people going to the Internet. But ultimately, we feel like commercial is something we can control with our management activity. Residential, again, we're more optimistic now than we have been, I think, from a competitive standpoint on the residential side. But commercial, I think, has some definite upside in the near and medium term.

And would you look at potentially broadening out the offering there as well or like you're talking about in the residential or stay focused on what you're already doing?

The thing we're broadening out is we only -- at the moment, we have commercial business managers in about 15 of our 51 owned branches. We're going to spend the next year expanding that program to pretty much, I think, almost every branch. And so the difference between the 15 branches that have commercial business managers, the revenue over the last couple of quarters has been up 20% in those 15 branches. It's been basically flattish in the other 36. And so we're going to expand that program quickly, taking advantage of that. And I think there's some upside -- obviously, some upside in '26 as we put more of those business managers on our.

Is that a significant investment? Or is that just hiring people?

It's hiring people, but it's hiring the right people.

It's hiring the right people. I mean you like to say, it sounds like the results are good enough, you should do it next week. The reason it's been successful is because we've hired identified the markets that we think they're more likely to succeed. We spent some time getting the right people, and it's been a big success.

We spend a month or 2 training them so that we don't just send 40 people out to do something that 20 are successful and 20 are not. I mean it's not a huge investment. It just maybe $100,000 a person and then obviously, some commissions on top of that and things.

You get asked this periodically, but it was always described like you did at the beginning that the 2 businesses are grinded out, blocking and tackling businesses. There has been some divergence here in the last couple of years. Does that make you take another look at what to have these 2 businesses together?

Well, the answer is we always have an open mind, okay? If it creates value, that's fine. I think that number one, from one perspective, during the pandemic when Roto-Rooter -- when VITAS was struggling, Roto-Rooter was booming. We get some hedge. Now we get the reverse. Now this year, we had a tough one because even though VITAS was booming, it boomed a little too much and had a Medicare cap limitation, okay? But overall, that's a balance. Now the question is, does the fact that -- does that create any -- is there a loss of value because of the connection. It's something we look at very carefully. One of the things we mentioned early day when that question was asked, I said, well, look, it's hard to look at comparable valuations for 2 years. Number one, the -- both of these businesses for their sectors are huge, okay? It's a huge stand-alone company. Roto-Rooter is huge and the only national plumbing drink care company. So somebody getting involved, it's drinking from -- getting a drink from a fire hose in some respects. So they're very big. It's hard to look at the multiples paid for a contamination of smaller programs and carry out the same multiple. The other thing, as I said, I made reference to the fact that we had a major issue with the warning on the Medicare Cap limitation. Stock price fell 100 points, over $1 billion was taken out for something that looks like a onetime event. So I guess my point is now is probably the wrong time to assay the respective valuations and what have you. But having said that, if somebody came in and offered enough money for either company, this is capitalism, at least in this state. So we're -- it would be all for it.

All right. Well, with that note, I guess we'll wrap it up. I appreciate Chemed being part of our conference again. And I hope everybody has a great afternoon.

Thanks, A.J.