Chemed Corp Q1 FY2023 Earnings Call

Thank you for standing by, and welcome to the Chemed First Quarter 2023 Earnings Conference Call. As a reminder, today's call is being recorded. I would now like to turn the conference to your host, Holley Schmidt, Assistant Controller. Ma'am, you may begin.

Good morning. Our conference call this morning will review the financial results for the First Quarter of 2023 ended March 31, 2023. Before we begin, let me remind you that the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 apply to this Conference Call. During the course of this call, the company will make various remarks concerning management's expectations, predictions, plans, and prospects that constitute forward-looking statements. Actual results may differ materially from those projected by these forward-looking statements as a result of a variety of factors, including those identified in the company's news release of April 26 and in various other filings with the SEC. You are cautioned that any forward-looking statements reflect management's current view only and that the company undertakes no obligation to revise or update such statements in the future. In addition, management may also discuss non-GAAP operating performance results during today's call, including earnings before interest, taxes, depreciation and amortization or EBITDA and adjusted EBITDA. A reconciliation of these non-GAAP results is provided in the company's press release dated April 26, which is available on the company's website at chemed.com. I would now like to introduce our speakers for today: Kevin McNamara, President and Chief Executive Officer of Chemed Corporation; Dave Williams, Executive Vice President and Chief Financial Officer of Chemed; and Nick Westfall, President and Chief Executive Officer of Chemed's VITAS Healthcare Corporation subsidiary. I will now turn the call over to Kevin McNamara.

Thank you, Holley. Good morning. Welcome to Chemed Corporation's First Quarter 2023 Conference Call. I will begin with highlights for the quarter, and David and Nick will follow up with additional operating detail. I will then open up the call for questions. Our first quarter 2023 operating results released last night continue to show a return to a more normalized growth and operating results, post-pandemic. For VITAS, normalization involves methodically increasing capacity by expanding our staff of licensed healthcare professionals. In the first quarter of 2023, VITAS added 200 licensed professionals, 60% of which are licensed nurses. Since we implemented our hiring and retention program in July 2022, VITAS expanded licensed staffing by 475 professionals. Nick will provide more detailed information on this issue later in the call. Although we continue to see disruption in our referral patterns when compared to pre-pandemic admissions, these disruptions continue to dissipate and reflect methodical improvement in admissions, average daily census, and key pre-admit patient locations. Roto-Rooter had a solid first quarter, increasing revenue 7.9% over the prior year. Revenue in the first quarter of 2023 exceeded our internal estimates with January 2023 being exceptionally strong. March revenue was somewhat lighter than we anticipated, but still within normal patterns. Overall, demand for key services in both commercial and residential segments continue at levels significantly above our pre-pandemic demand. This is demonstrated with commercial revenue increasing 41% and residential revenue expanding 73% when compared with the first quarter of 2019. Roto-Rooter continues to be well positioned, and we anticipate continued expansion of market share by pressing our core competitive advantages in terms of brand awareness, customer response time, 24/7 call centers, and internet presence. With that, I'd like to turn this teleconference over to David.

Thank you, Kevin. VITAS' net revenue was $310 million in the first quarter of 2023, which is an increase of 3.8% when you compare to our prior year period. This revenue increase is comprised primarily of a 3% increase in days of care, a geographically-weighted average Medicare reimbursement rate increase of approximately 2.9%, partially offset by 200 basis points as a result of CMS reimplementing the 2% sequestration cut that was suspended at the start of the pandemic in 2020. Our acuity mix shift had minimal impact in the quarter when compared to the prior year revenue and level of care mix. Our combination of Medicare Cap and other contra revenue changes negatively impacted growth by about 10 basis points. In the first quarter of 2023, VITAS accrued $2.75 million in the Medicare Cap billing limitations. This compares to a $2.5 million Medicare Cap billing limitation in the first quarter of 2022. Of our 30 Medicare provider numbers, 25 of these provider numbers have a trailing 6-month Medicare Cap cushion of 10% or greater. One provider number has a cushion between 5% and 10%, and one provider has a cushion between 0% and 5%. Three of our provider numbers do have a trailing 6-month billing limitation liability. Our average revenue per patient per day in the first quarter of 2023 was $198.86, which is 100 basis points above the prior-year period. Reimbursement for routine home care and high acuity care averaged $173.39 and $1,042.06, respectively. During the quarter, high acuity days of care was 2.9% of total days of care, essentially equal to the prior-year quarter. The first quarter 2023 gross margin, excluding Medicare Cap and the hiring and retention bonus program was 22.5%. This is a 220 basis point margin decline when compared to the first quarter of 2022. VITAS' adjusted EBITDA margin in the quarter, excluding Medicare Cap, was 15.1%, which is 234 basis points below the prior-year period. These margin declines are the result of CMS reimplementing sequestration, which reduced our gross margin and EBITDA margin by 200 basis points. In addition, VITAS increased the licensed healthcare staff by 200 professionals in the first quarter of 2023. The net increase of 200 professionals hired throughout the first quarter is estimated to have negatively impacted gross margin and adjusted EBITDA margin by 50 basis points. Roto-Rooter generated quarterly revenue of $250 million in the first quarter of 2023, which is an increase of 7.9% compared to the prior-year period. Roto-Rooter branch commercial revenue in the quarter totaled $59.9 million, which is an increase of 10.1% over the prior year. This aggregate commercial revenue growth consisted of drain cleaning increasing 4%, plumbing expanding 10.7%, excavation increasing 26.2%, and water restoration expanding 7.4%. Roto-Rooter branch residential revenue in the quarter was $169 million, an increase of 7.5% over the prior-year period. The components of this aggregate residential growth rate of drain cleaning decreased by 2.9%, plumbing expanded by 3.6%, excavation expanded by 3.9%, and water restoration increased by 27.4%. Roto-Rooter's gross margin in the quarter was 53.1%, which is a 37 basis point increase when compared to the first quarter of 2022. Adjusted EBITDA in the first quarter of 2023 totaled $71.8 million, which is an increase of 9%, and the adjusted EBITDA margin in the quarter was 28.8%, which is a 29 basis point expansion compared to the prior year. I will now turn this call over to Nick Westfall, President and Chief Executive Officer of our VITAS Healthcare business segment.

Thanks, David. As we've mentioned in the past, we implemented a targeted hiring and retention bonus program at VITAS, effective July 1, 2022. This program is focused on licensed nurses, nurse managers, home health aides, and social workers. These one-time retention bonuses range from $2,000 to $15,000 per licensed healthcare professional. The total 12-month forward-looking cost of this program, including payroll taxes and government mandated overtime calculations, is estimated at $40 million. All retention bonus payments are individually cliff-vested and paid out after the employee has successfully completed 12 additional months of continuous employment. During the first quarter, we expanded this licensed healthcare professional staff by 200 employees, bringing the total licensed healthcare staffing expansion attributed to this program to 475. It is important to note the majority of this increase in staffing is for licensed nurses, including admission nurses. In the first quarter of 2023, our average daily census was 17,830 patients, an increase of 517 or 3% when compared to the prior year and an increase of 396 or 2.3% sequentially. The sequential monthly ADC growth within the fourth quarter of 2022 and the first quarter of 2023 is very encouraging, given the timing lag of increased staffing following subsequent admissions and census expansion. In the first quarter of 2023, VITAS' total admissions were 16,179. This is a 2.1% decline when compared to the first quarter of 2022 and a 9.1% sequential improvement when compared to the fourth quarter of 2022. I'm very encouraged by the last two quarters of sequential growth in admissions. A primary driver for our admissions growth is a result of our increased capacity expansion derived from our hiring and retention program. In the first quarter, our nursing home admissions increased 6.6% and assisted facility admissions increased 10.6%. Hospital-directed admissions declined 4.9% and home-based patient admissions declined 2.9% in the quarter. As compared to the fourth quarter of 2022, all pre-admit segments improved, with our nursing home admissions increasing 5.2%, assisted facility admissions expanding 13%, hospital-directed admissions increasing 8%, and home-based patient admissions improving 10.4% in the quarter. Our average length of stay in the quarter was 99.9 days. This compares to 104.8 days in the first quarter of 2022 and 103.9 days in the fourth quarter of 2022. Our median length of stay was 15 days in the quarter and compares to 14 days in the first quarter of 2022 and 16 days in the fourth quarter of 2022. To recap, what our team has recently accomplished, we have now generated three quarters of sequential growth in licensed healthcare workers, two quarters of sequential growth in both admissions as well as ADC. We have developed what I believe is a very sustainable path to building back our capacity and patient base to pre-pandemic levels and beyond. With that, I'd like to turn this call back over to Kevin.

Thank you, Nick. Now it's an appropriate time for considering questions.

Our first question comes from Joanna Gajuk of Bank of America.

Could you discuss how the quarter performed compared to your internal expectations? You mentioned that Roto-Rooter exceeded revenue expectations, but what about VITAS? And how do you assess the quarter on a consolidated level?

Yes, I'll take it on a macro basis, Joanna, and then flip it to Kevin and Nick for more detail. But no, our internal estimates, both Roto-Rooter and VITAS exceeded them. So we were very pleased on a macro basis with the quarter in both segments.

What I would say is, the quarter showed positive results overall. At VITAS, we saw ongoing enhancements in a crucial area Nick is focusing on, which is increasing the number of licensed healthcare professionals. We are recruiting more of them with the goal of outpacing the average daily census for a couple of reasons. One reason is to stay ahead of demand, and we want to create a buffer for the end of the retention program. This aspect is progressing well according to our plan. Regarding Roto-Rooter, the beginning of the quarter was very strong, but there was a slight slowdown towards the end compared to earlier periods. We've received some questions about whether this indicates a slowdown in the economy and if some of Roto-Rooter's non-emergency activities are being affected. This might be true to a small degree. Ultimately, it depends on our ability to leverage our experienced management. We're still facing challenges in Roto-Rooter due to many of our managers being recruited by private equity for different services. We've made progress in retaining our talent, but we are still feeling the impact of those losses from the previous year. Overall, the feedback is positive, with some known expenses at VITAS related to the conclusion of sequestration, alongside the hiring process. In Roto-Rooter, we want to ensure the phones are ringing and respond effectively to those calls, which is an ongoing challenge. But overall, I'm satisfied with the results. Nick, do you have anything to add?

VITAS is in just one level deeper. When you think about the expansion of clinical capacity that continues to be a result of better performance, both from a hiring and turnover improvement, which is very encouraging. On the admission side, as I referenced on sequential admissions growth compared to the fourth quarter. Every segment was up high single digits to low single digits on a percentile basis, and the resulting days of care expansion are coming in line to beating some internal expectations. So really pleased with a lot of the granular pieces that result in some of the metrics we report.

On the last point on improving capacity, adding the staff, it sounds like you're going faster than you initially expected. So if you continue at this pace, right, does that change your view in terms of when you expect to be back to pre-COVID census levels? And I guess what's your latest view on that?

Let me start by saying that it appears we are likely to return to pre-pandemic levels sooner rather than later, though it's difficult to be exact about the timing. Given the current environment, having the right staff increases our ability to attract patients. During the pandemic, VITAS' internal metrics deteriorated month by month, making it clear that our average daily census (ADC) was going to be impacted. We believe that improvements in ADC will follow, contingent on staffing. While we haven't conducted precise calculations regarding when we will reach our pre-pandemic ADC levels, we could develop a good estimate if we chose to invest in an algorithm. However, we feel that such an estimate may not be particularly useful. It's worth mentioning the contrast with Roto-Rooter; while we are striving to regain our pre-pandemic position, Roto-Rooter has seen residential sales increase significantly during the same period. This highlights the different trajectories we're experiencing, but Nick and the team are making solid progress.

Yes. If you were to ask whether things are moving faster today than we expected four or five months ago, I'd say yes. The key is our ability to attract talent thoughtfully, which we have the demand for in order to care for patients. It's now a matter of how we keep progressing. As long as we can maintain this momentum, whether it’s 200, 250, or 150 new hires per quarter, our teams in many of our markets are currently achieving great success. This success positively impacts our existing staff and their satisfaction, as well as our contributions to the community. I'm truly excited about the growing morale and cultural benefits that come from this.

As it relates to the expansion of staff and its impact on census growth, you've observed this nice sequential growth. Would you say that this growth is happening at a faster pace? You haven't provided guidance for the full year, and previous comments suggested that more census growth is expected in the latter half of the year. Was the 3% year-over-year growth this quarter better than anticipated, or more in line with your earlier expectations for the full year?

Joanna, this is Dave. It's gone better than I expected. As you remember, when we developed the business plan, we conservatively estimated we would add a net increase of 25 licensed healthcare workers per month, 75 per quarter. We've been exceeding that in all three quarters, and our hiring and retention program almost tripled what we did in Q1. What we're trying to avoid is having a specific point in time identified for when we return to normal. However, I will cautiously suggest that if the current rate of capacity expansion continues, we could see an increase of 50 to 75 licensed healthcare workers per month, totaling over 200 per quarter in 2024, allowing us to return to our pre-pandemic census. But that depends heavily on maintaining the current pace of capacity expansion.

And Dave, it's interesting because of the lag we’ll be at our pre-pandemic licensed healthcare professional level months before we reach this census level.

Yes. And that's what's straining our margins now is we have to build capacity before it contributes to census, and then that census is negative margin until they've been in the program for about 30 days or longer, that incremental piece. So that's why we're having margin pressure today because we're building back capacity. But that capacity, as Joanna, you pointed out, is getting to work pretty quickly in subsequent quarters, much faster than we first anticipated when we put this program in place in July of 2022.

So nothing changes regarding timing expectations inside of the year related to that, but really excited about getting off to a very fast start.

Got it. There's definitely good traction there. I want to bring up another topic regarding VITAS and Medicare. The recent proposal only includes a 3% market basket year update, which is lower than the 4% we saw in 2023. What are your expectations for this? Last time, you mentioned you were expecting something closer to 5%. Clearly, this is much lower. Do you have any reasons to believe the final rate update might be better, similar to what occurred last year, or should we anticipate minimal improvement and prepare for the 3% market basket?

And what I would say, Joanna, as we talked to a number of shareholders and analysts, we put a number out in the fourth quarter what we think the minimum should be given inflation within the hospital wage index basket and what the hospice industry is experiencing. CMS has basically been caught using what I would call forecasted data that maybe historically forecast and actual turns out to be pretty similar in terms of inflation by component. But with the spike in inflation that happened over the last 18 months, it appears from our perspective that CMS uses forecasted data that is badly below actual inflation, and they never true up from forecasted to actual inflation measurements as done by the Bureau of Labor and Statistics. So CMS has been caught lagging the increase, and it really hasn't been noticed though because forecast in actual have been running pretty low 2.5% historically for what, a decade plus. Now inflation is running through healthcare more significantly. And CMS, I think, has been caught, not passing through true inflation, and that's why MedPAC issued two separate reports in March of 2023 and April 2023, frankly, pointing out how badly flawed the market basket CMS is utilizing because they are not accurately measuring appropriate inflation in healthcare models. And it is a problem. And we will do just fine. We have scale, so we have leverage. So we end up with the upper quartile of adjusted EBITDA and gross margins. Most of the competitors in hospice are small not-for-profit hospices, many in rural markets, who lack the scale to have really good margins, but to provide needed care they're getting squeezed, Joanna. And if CMS does not fix this issue of not passing through appropriate inflation reimbursement increases, capacity for some of our small competitors will shrink, and access to hospice in rural markets specifically will be limited. So we are pointing out painfully if CMS does not start approaching hospice in giving increases in inflation, the smaller hospices will struggle and probably go out of business.

We do not expect a significant change from the preliminary number at this time. It simply informs our direction. In the fourth quarter, we attempted to communicate to CMS and the market our observations regarding the inflation factor for hospice. However, the adjustment mechanism seems poorly structured. The estimate comes out to about 2.8, which doesn't accurately reflect the inflation factor in the wage market for hospitals and hospices.

Only other piece to highlight is, I think it is better understood inside of DC now being openly advocated for and debated, not only within the hospice segment, but just as importantly, within the hospital segment and those trade associations since we're paid against that hospital market basket index, as everybody knows.

This proposal, and there were other things included in there around increased service more oversight. Some questions there from CMS and also even higher penalty for those not submitting the quality data. So in that context, how is VITAS positioned there? Do you expect to look at some assets, maybe that would be there to be acquired as they look to kind of to your point, scale up? And would VITAS kind of act on that? And I guess for this increased services and other things in the rack, I guess, also how VITAS is positioned there?

So Joanna, regarding that topic, many aspects can be categorized under program integrity. We support the trade associations that have made joint recommendations to proactively guide the government in supporting the industry and long-standing, mission-driven providers. The main issue is the misuse of licenses that are not providing care in local markets, which is largely concentrated in four states, including California. Some of the recommended penalties, such as a 4% increase, are not applicable to VITAS. We have always complied with regulations from the beginning. Additionally, some providers affected by these penalties might not be attractive acquisition targets since they are not submitting data or caring for patients, which diminishes their strategic value for acquisition. There are steps that can be taken to enhance the perception of provider expansion without negatively affecting community members. Many of the measures being discussed are not indicative of problems with the benefit itself or concerns about the quality of care from long-standing providers who are dedicated to patient care in the community.

Our next question comes from Ben Hendrix of RBC.

I was hoping you could give us your thoughts on the Medicare Cap runway. You had shifted your referral strategy amid staffing shortages, which you noted could eventually press Cap limitations. Any update on the Cap trajectory overall now that hiring capacity is opening back up?

Yes, this is Dave Williams. During the pandemic, we navigated the situation without encountering significant Medicare Cap issues. Although our admissions and revenue both decreased, this resulted in a reduction in high-acuity care due to capacity constraints. The reduction in high-acuity care allowed us to stay below the Medicare Cap billing limitations. We managed well during the pandemic, and several programs even expanded. However, we recognize there are limits on length of stay, which is why we saw our average length of stay drop to below 100 – from 99.9 to a median stay of 15, which aligns well with our historical range of 14 to 16 pre-pandemic. In summary, the decline in admissions helped us avoid Medicare Cap billing limitations, but now that admissions are growing again and we are enhancing our presence in hospitals for referrals, we expect to further increase admissions while remaining well below billing limitations. If we hadn't started expanding admissions alongside capacity, we would have faced challenges. This approach has been in place for three quarters now. Overall, the risk associated with Medicare Cap is diminishing, except in California where reimbursement rates are exceptionally high, although the Medicare Cap protection is standardized nationwide. High reimbursement areas still carry some risk regarding Medicare Cap billing. However, even with this concern and the two programs we are monitoring, we find them to be very profitable and don't foresee Medicare Cap becoming a significant issue, especially in 2023.

And just to reinforce it, I want to go back to sequential admissions growth in the hospital pre-admit segment. Fourth quarter to first quarter was up 8%. So while we talk about it from a community access, we still are servicing all of our key partners in the market, including the hospital segment. That helps to provide a data point and a full agreement around lack of concern. Correct.

And clearly, better-than-expected progress on the hiring front. Any change in your thoughts on how retention shakes out on those new hires? And any chance that you could re-up your retention program with more funding to address that?

Let me begin by stating that we have been transparent about the purpose of the program, which was designed to address unprecedented circumstances. As an accountant, I would categorize these as one-time events, and we do not foresee establishing a permanent retention program. Our perspective was that this was meant for a specific moment in time. We implemented the system at that point, and it was very successful. However, at some point, it becomes self-sustaining. As Nick mentioned, having more staff contributes to overall satisfaction, as employees perceive the company as performing better and not facing significant issues. Given these dynamics, we do not plan to continue the program. That said, I cannot envision any circumstances under which we would maintain it. I don’t want to appear dogmatic about this; if a compelling reason arose to reinstate a program, we would consider it, but we currently do not see the conditions aligning for that—though it remains a possibility.

Just a little more color with that, Ben. I don't see that as a need, while we talk about it on these calls, as though it's a singular item driving it. There is a large subset of well north of a dozen plus other complementary pieces that also contribute to a lot of the metric improvement. And obviously, we track both hiring turnover satisfaction on a bunch of different layers. And all those things are directionally improving. And so that tells me the program itself has been very beneficial. But in the same regard, getting back to a lot of our more normalized pieces, but also making sure there's sufficient time being spent, recognizing, rewarding, celebrating employees, highlighting the mission of why people join hospice, but also what makes VITAS special in that situation is all the real compounding effect that's helping these things in a substantial way and makes it sustainable. That's why I can use the word confidently sustainable on a go-forward basis.

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to Kevin McNamara for any closing remarks.

Well, I just wanted to thank everyone for their kind attention, and we're very comfortable with the results, and we'll get back about three months from today and report on what's going on presently. Thank you.

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.