Chemed Corp

NYSE:CHE

Earnings Call Transcript 2018-Q4

[Operator]

Good day, ladies and gentlemen and welcome to the Fourth Quarter Chemed Corporation Earnings Conference Call. [Operator Instructions] And as a reminder this conference is being recorded.

I would now like to hand the call over to Ms. Sherri Warner with Investor Relations. You may begin.

[Sherri Warner, IR]

Good morning. Our conference call this morning will review the financial results for the fourth quarter of 2018 ended December 31, 2018.

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 February 20th 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 February 20th, 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, Chief Executive Officer of Chemed’s VITAS Healthcare Corporation subsidiary.

I will now turn the call over to Kevin McNamara.

[Kevin McNamara, President & CEO]

Thank you, Sherri. Good morning. Welcome to Chemed Corporation’s fourth quarter 2018 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 to questions.

Our fourth quarter of 2018 showed solid operational performance, margin improvement and overall financial results at both of our operating segments. In the quarter, Chemed generated revenue of $458 million, an increase of 6.8% over 2017 once revenue is adjusted for the 2018 revenue recognition accounting standard.

Our consolidated net income in the quarter, excluding certain discrete items, generated adjusted earnings per diluted share of $3.35, an increase of 44.4%. VITAS’ admissions were soft in the quarter, a slight increase over the prior year. Our average daily census expanded 7.3% and our adjusted EBITDA, excluding Medicare cap, increased 11.2%. Roto-Rooter continues to show excellent growth in our core plumbing and drain cleaning service segment as well as continued growth in the water restoration segment.

In addition, operating expenses continue to be effectively managed in our industrial segment, resulting in Roto-Rooter increasing its adjusted EBITDA margin to 24%, an increase of 98 basis points. Overall for the year, our adjusted earnings per share were up 40%, the stock was up 15%; and the overall market down 7% and the stock was up a little bit, 12% since December 31st, so overall a good year and a good start for this year.

With that, I’d like to turn this teleconference over to David.

[David Williams, EVP & CFO]

Thanks, Kevin. As most of you are aware, effective January 1st 2018, the Financial Accounting Standard Board or FASB mandated certain changes in revenue recognition under generally accepted accounting principles, otherwise referred to as GAAP. For Chemed, this accounting standard mandated the reclassification of certain costs within the 2018 income statement when compared to prior-year formats. This revenue recognition accounting standard was adopted in a modified retrospective basis. What this means is our 2017 operating results were not restated in our reporting using historical revenue recognition accounting standards.

These reclassifications had zero impact on EBITDA, adjusted EBITDA, pre-tax income or our net income. These reclassified expenses do impact comparative analysis between years on certain metrics such as sales, gross margin and selling general and administrative expenses.

This resulted in a reclassification of net room and board expenses associated with certain Medicaid patients residing in nursing homes to be reclassified from cost of services to revenue and effectively reducing VITAS’ 2018 quarterly revenue and cost of sales by approximately $2.2 million.

In addition, uncollectible accounts receivable, commonly referred to as bad debt expense, historically included in selling, general and administrative expenses for both VITAS and Roto-Rooter are also now netted in service revenue and sales. This reduced Chemed consolidated revenues and selling, general and administrative expenses by approximately $4.5 million on the quarter. The discussion and analysis of operating results on this conference call, as well as in our fourth quarter 2018 earnings release, recast 2017 as if the new revenue recognition accounting standard was applied in 2017.

This was done to facilitate analysis of 2017 and 2018 operating results in a format consistent with the 2018 revenue recognition accounting standard.

Now after that, let’s talk about the fourth quarter. For the fourth quarter, VITAS’ net revenue was $307 million, which is an increase of 7.3% when compared to the prior-year quarter. This revenue increase is comprised primarily of; a geographically weighted Medicare reimbursement rate increase of approximately 1.1%, a 7.3% increase in average daily census and a Medicare cap liability that reduced revenue growth by 0.4%. This growth is partially offset by acuity mix shift that reduced revenue 1% growth when compared to the prior year.

In the fourth quarter of 2018, VITAS did accrue $3.5 million in Medicare cap billing limitations. At December 31st 2018, VITAS had 30 Medicare provider numbers, two of which have an estimated 2019 Medicare cap billing limitation of approximately $13.6 million. Of VITAS’ 30 Medicare provider numbers on a trailing 12-month basis, 25 of these provider numbers have a Medicare cap cushion of 10% or greater. One provider number has kept cushion between 5% and 10% and two provider numbers have a cap cushion between zero and 5%. And as I mentioned earlier, two provider numbers have a Medicare cap billing limitation.

Average revenue per patient per day in the quarter was $189.06, which is 0.1% below the prior-year period. Reimbursement for routine home care and high acuity care averaged $164.98 and $741.21 respectively. During the quarter, high acuity days of care were 4.2% of total days of care, 31 basis points less than the prior-year quarter.

Fourth quarter of 2018 gross margin for VITAS excluding Medicare cap was 24%, which is a 13 basis point increase compared to the fourth quarter of 2017. Adjusted EBITDA excluding Medicare cap totaled $55.5 million in the quarter, an increase of 11.2% and adjusted EBITDA margin, excluding Medicare cap was 17.9% in the quarter and it’s a 59 basis point increase compared to the prior-year period.

Now let’s turn to the Roto-Rooter segment. Roto-Rooter generated quarterly revenue of $151 million for the fourth quarter of 2018, an increase of $15.6 million or 11.6% over the prior-year quarter. The revenue from the water restoration service segment totaled $24.3 million, an increase of $2.1 million or 9.7% compared to the prior-year quarter. Approximately 90% of our water restoration revenue is generated from residential customers and the remaining 10% is generated from commercial accounts.

Commercial drain cleaning revenue increased 11.6%, commercial plumbing and excavation increased 12.5% and our commercial water restoration increased 12.4%. Overall, commercial revenue was up 12%.

Residential drain cleaning increased 9.4%, residential plumbing and excavation increased 14.2% and residential water restoration increased 9.3% with aggregate residential sales expanding 11.4%.

Roto-Rooter’s gross margin in the quarter was 48.8%, which is a 6 basis point decline when compared to the prior year. Adjusted EBITDA in the fourth quarter of 2018 totaled $36.1 million, which was an increase of 16.3%. The adjusted EBITDA margin in the quarter was 24%, which is again a 98 basis point improvement over the prior year.

During the quarter, Chemed repurchased 130,524 shares of Chemed stock for $36.9 million, which equates to a cost per share of $282.77. As of December 31st, 2018, there was approximately $47 million of remaining share repurchase authorization under this plan.

Chemed restarted its share repurchase program in 2007. Since that time, Chemed has repurchased 13.9 million shares aggregating over $1.1 billion at an average share cost of $80.92. Including dividends over this period, Chemed has returned approximately $1.3 billion to shareholders.

Our 2019 guidance is as follows. Revenue growth for VITAS in 2019 prior to Medicare cap is estimated to be in the range of 5.5% to 6%. Our admissions are estimated to expand approximately 3% to 4% and average daily census is estimated to expand approximately 4% to 5%.

Full year adjusted EBITDA margin prior to Medicare cap is estimated to be at 15.9%. We are currently estimating $10 million from Medicare cap billing limitations in calendar year 2019. This forecasted calendar year billing limitation relates to two programs that are located in high reimbursement urban markets.

Roto-Rooter is forecasted to achieve full year 2019 revenue growth of 9% to 10%. This revenue estimate is based upon increased job pricing of approximately 2%, continued growth in core plumbing and drain cleaning services as well as continued but slowing revenue growth from water restoration services. Roto-Rooter’s adjusted EBITDA margin for 2019 is estimated at 23.7%.

Based upon the above, full year 2019 adjusted earnings per diluted share excluding non-cash expense for stock options, tax benefits from stock options, cost related to litigation and other discrete items is estimated to be in the range of $12.65 to $12.85. This 2019 guidance assumes an effective consolidated corporate tax rate of 25.2%. For comparison, Chemed’s 2018 reported adjusted earnings per diluted share was $11.93.

With that, I’ll turn the call over to Nick Westfall, Chief Executive Officer of VITAS.

[Nicholas Westfall, CEO, VITAS Healthcare Corporation]

Thanks, David. VITAS had another solid quarter in the fourth quarter, both financially and operationally. Our average daily census in the fourth quarter of 2018 was 18,149 patients, an increase of 7.3% over the prior year. Total admissions in the quarter were 16,579, a slight increase when compared to the fourth quarter of 2017. On a full year 2018 basis, our average daily census has expanded 7.2% and our admissions growth increased 2.5%.

During the quarter, admissions generated from hospitals, which typically represent roughly 50% of our admissions, increased 2%. Home-based admissions increased 2.5%. Nursing home admissions declined 5.1% and assisted living facility admissions declined 7.4% in the quarter.

Our routine home care direct patient care gross margin was 53.9% in the quarter and it’s equivalent to the margin reported in the fourth quarter of 2017. Direct inpatient margin in the quarter was 3.9% and compares to a margin of 8.5% in the prior-year quarter. Occupancy of our 27 dedicated inpatient units averaged 65% in the quarter and compares to 70.3% occupancy in the fourth quarter of 2017.

Continuous care had a direct gross margin of 18.4% and compares to a margin of 16.8% in the prior-year quarter. Average hours billed for a day of continuous care was 17.3 in the quarter, a slight decline when compared to the 17.5 average hours billed for continuous care patient in the fourth quarter of 2017.

Our per patient per day ancillary costs, which includes durable medical equipment, supplies and pharmaceutical costs averaged $13.58 and are 5% favorable when compared to the $14.30 to costs of these items accounted for in the prior-year quarter. VITAS’ average length of stay in the quarter was 92.6 days and compares to 91.4 days in the fourth quarter of 2017. Median length of stay was 16 days in the quarter and compares to a median length of stay of 17 days in the prior-year quarter. Median length of stay is a key indicator into our penetration in the high acuity sector of the market.

Before I turn the call back over to Kevin, I wanted to highlight VITAS was recently awarded a Certificate of Need from Florida’s Agency for Healthcare Administration to operate in Martin, Okeechobee and St. Lucie counties in southeastern Florida. I’d like to thank the agency for healthcare administration for their selection of VITAS and we look forward to servicing these patients and their families in those communities in 2019.

Last, within the past few weeks, we’ve successfully opened up inpatient units in both Florida and Texas. We began taking care of patients here in Q1 of 2019.

With that, I’d like to turn the call back over to Kevin.

[Kevin McNamara, President & CEO]

Thank you, Nick. I will now open this teleconference to questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Joanna Gajuk of Bank of America. Your line is open.

[Joanna Gajuk, Bank of America Merrill Lynch]

Thank you. Good morning. So first on the guidance, so when I use the different pieces of the guidance that you provide here in terms of the revenues and margins by segment and assuming a little bit of growth in the corporate overhead, I’m coming up with annual EBITDA -- adjusted EBITDA of $580 million. So is that in the ballpark here?

[David Williams, EVP & CFO]

We haven’t been giving guidance for consolidated overall EBITDA, but that’s in the ballpark.

[Joanna Gajuk, Bank of America Merrill Lynch]

All right, because that obviously includes the $10 million Medicare cap and I guess you flagged this related to two of these urban locations here. So can you just tell us what’s going on there in the market? Is it length of stay that’s creeping up and I know the reported numbers suggest that. So is it driven by a couple of these locations and that’s what’s happening why the cap -- the Medicare cap limitations is going to be so much higher this year versus prior years?

[Kevin McNamara, President & CEO]

Well, I’d just turn over to Nick but basically, the biggest -- I’d tell you kind of in a layman’s perspective. There are highly reimbursed urban areas, a couple of them with -- based on the wage index and what have you, the reimbursement -- that reimbursement, you hit the cap at about 100 days of service as opposed to 165 to 180 days in the rest of the country.

So I guess when we have two strong growing programs in an environment like that, you’re just metal against metal. And to the extent that you have little bubbles and it’s not something that overly concerns us, it’s something we watch, it’s an opportunity, both positive negative for us, but something we watch carefully but both of the programs we’re talking about are still very profitable.

But Nick, anything you’d like to say as far as boots on the ground and what not?

[Nicholas Westfall, CEO, VITAS Healthcare Corporation]

Yes. Joanna, to answer your first question with it, that number does have that cap estimate inside of it. And then to just piggyback off Kevin’s conversation with it, this has always been the case and the way in which the methodology of the cap calculation is performed. So going back to -- just reinforce some of Kevin’s comments, in a higher reimbursement market where the routine home care day maybe $242, $245 per day, that equates to about 120 days roughly for first-time Medicare admit before you’d reach the global uniform cap rate for fiscal year 2020, which is $29,205.

And so all that really means and that has always been the case is that inside of those markets, we account for that in terms of our strategy where we just continue to take all appropriate patients and those -- and focus on those relationships with systems and referral sources that are going to have a full complement of patients that come on service.

So it’s not indicative of anything related to a longer length of stay inside of those markets, it just highlights the short-term sensitivity that can happen at the first part of growing [indiscernible] program that’s operating very healthily inside of those markets.

[Kevin McNamara, President & CEO]

And then let me also say that to the extent that you look at these numbers, when you add to the fact that in every one of VITAS’ operations, their full-service hospitals -- hospices with high acuity treatments, I mean when you figure high acuity in there, it takes those numbers down to closer to 100 days.

[David Williams, EVP & CFO]

That’s right.

[Nicholas Westfall, CEO, VITAS Healthcare Corporation]

So historically we’ve put an estimate of $5 million into our forecast. We increased that to $10 million for this year but are continuing to execute on our strategy here as we move into 2019 just to continue to service those markets and have a cap management philosophy embedded inside of those as well to take the full complement of patients across the market.

[Kevin McNamara, President & CEO]

And there’s also just a [indiscernible] a couple moving parts here, but in addition, the accounting for Medicare cap liability has changed this year. So that’s about -- that’s another factor we said that we might change the way we look at potential cap liability, this time of year, that’s what we’re talking about is potential cap liability, but the accounting is a little more rigorous with regard to taking -- looking at the current estimate and booking it, basically.

[Joanna Gajuk, Bank of America Merrill Lynch]

Okay. That’s very helpful. But in terms of the length of stay, so obviously so this year it was up year-over-year for the quarter, for the year. So what is your assumption for 2019 for length of stay or average length of stay assuming it’s going to continue to creep up or you kind of assume it’s going to be flattish? I know it’s hard to predict but what’s kind of embedded in your guidance here?

[David Williams, EVP & CFO]

Our guidance is basically flat length of stay although historically it has gone up above 1% or 2%.

[Joanna Gajuk, Bank of America Merrill Lynch]

Right. And then within that, if I may, last one on the VITAS guidance where that implies the margin will be slightly down year-over-year before the Medicare cap obviously. So anything to kind of flag here? Any issues you’re having with the labor costs creeping up? Because you would think with this kind of pretty good revenue outlook for VITAS, I would expected a better kind of margin there, especially because of the Medicare rate [indiscernible] supposed to be somewhat better and seems like maybe acuity is less of a headwind. So can you just flag to us why the margins, because calling for flattish or maybe slightly down on Medicare -- I mean, margin for VITAS? Thank you.

[David Williams, EVP & CFO]

Yes, I’ll turn it over to Nick but what Joanna is talking about is, if you look at overall EBITDA margin was in 2018 and our guidance for 2019, I think it’s down about 10 basis points. And we would just call as -- as we look at all the pieces that just kind of where we thought the model, the midpoint of our EBITDA margin would turn out.

With that said, we’ve been talking about for years, when we get an increase from the federal government, for example our national rate was up 1.8% [indiscernible] average 1.1% for this past quarter, but really the government is giving less than inflation in our care and business model. So we have be more efficient in other areas to turn around and maintain margin. And I think those 10 basis point decline in margin, although it’s very modest, it’s just reflective of, in real dollars, the government is actually paying us less and less every year.

So I’ll turn it over to Nick and any comments on the wage pressures, but our shareholders should anticipate modest declines in margins, all other things held constant, because of the reimbursement from the federal government lags inflation.

[Nicholas Westfall, CEO, VITAS Healthcare Corporation]

Yes. And there is no undue pressure that we’re feeling regarding the labor market. It’s always been that case, we’re always out there trying to recruit the best people and feel we do a pretty good job of that and are competitive from a wage perspective.

So just to reiterate Dave’s point, even though it’s a 10% decline, it’s just balancing -- 10 basis point decline, it’s just a reflection of the reimbursement rate balanced with continuing to grow the Company and becoming more efficient in certain areas as well.

So we feel good about that guidance, good about our ability to achieve the guidance and hopefully, we’re able to potentially even improve that no different than how we’ve done it throughout every quarter here in 2018 but time will tell over the course of 2019.

[Kevin McNamara, President & CEO]

And just for the people listening, keep in mind, when we are talking about [indiscernible] we haven’t had [indiscernible] we haven’t had anything that has changed our retention rate of employees, put it that way. But at the same time, this has got to be important, the tough job of telling that labor force they shouldn’t expect a pay increase more than 1.1% because that’s what our reimbursement is going up and that’s a tough job.

[Joanna Gajuk, Bank of America Merrill Lynch]

Right, obviously because the margins are still -- 15.1% is still pretty good because I guess ‘18 came out much better margin than what the initial guidance was right, like 15.4%. So you’ve obviously beat that guidance. So yes, I’m not saying that the margin is weak, I’m just trying to parse out the different pieces impacting that. So I guess I’ll go back to the queue. Thank you.

[Operator]

Thank you. Our next question comes from the line of Frank Morgan of RBC Capital Markets. Your line is open.

[Frank Morgan, RBC Capital Markets]

Good morning. I guess I would -- on the subject of guidance, staying inside of VITAS. Just curious about the -- what you’re seeing out in the marketplace obviously with expectations of good admission growth in 2019 versus what you came out in the fourth quarter, anything you’re doing differently that gives you confidence in that ability to drive that kind of growth after kind of what you saw at the end of the year, any new initiatives? Any other changes in the marketplace that you’re seeing out there?

[Nicholas Westfall, CEO, VITAS Healthcare Corporation]

Frank, what I’d point out is sort of two things. And one, the starting point becomes steady as it goes, we always have a variety of different initiatives that are being phased out. What gives us optimism and confidence in our guidance is sort of this multi-year path we’ve been upon where we’re able to continue to just improve our ability to partner and educate with patients, families and referral sources out in the community.

And that combined with just sort of the tailwind inside of the overall healthcare industry where everyone continues to recognize the value of the hospice benefit allows us to help to leverage some of the tools, transparency and education that we have, combined with our ability to provide comprehensive care for every type of patient in every market just makes us a very attractive partner.

And we have been doing a pretty good job of fulfilling all those obligations with all of our partners across the country. And so we’re just going to continue along that trajectory and continue to also try to capitalize on the opportunity we now have where some of our partners are engaged in inbound to say we understand the value of the hospice proposition, can you explain to us why VITAS? And why we should make sure you’re one of the top recommendations when patients and families are making -- have the right of choice for the provider?

[Kevin McNamara, President & CEO]

And Frank, I also say, you’ve been listening to the story for a while. Admissions are something that kind of wax and wane and -- but if you go over the last 15 years, it tends to just -- admissions tend to stay in that 2.5% to 4% range over several quarters and there is nothing [indiscernible] nothing that we’re observing that would change that multi-quarter observation.

[Frank Morgan, RBC Capital Markets]

So nothing like more entrants into the marketplace overall, more agencies opening up in any of your markets or no impact from things like this palliative care movement which seems to be picking up speed that there might be a substitution, any thoughts there?

[Nicholas Westfall, CEO, VITAS Healthcare Corporation]

Yes, I mean Frank, that we’ve seen that in the market for, gosh, the last two to three years at a minimum. We actually -- we provide palliative care as well. Palliative care when done right is actually very additive to the hospice benefit, it doesn’t cannibalize it necessarily. That would be my personal argument, some of the industry leadership’s argument as well. But all in all, nothing in 2019 that we see that’s any different that occurred in 2018, which is why we feel good about the guidance and we’ll just continue to strategically improve our overall operations and our ability to be a good partner to every provider in the markets in which we operate.

[Frank Morgan, RBC Capital Markets]

Got you. Maybe a Dave question here, obviously with the strong cash flow and a low leverage, a lot of potential uses for capital, you have not been very active on the acquisition side. So just any kind of color there on your thoughts on acquisition and overall marketplace there and then alternative uses for capital?

And then my obligatory Roto-Rooter question would be, now that it looks like water restoration was obviously a pocket of growth for you in that business, any other new programs or service lines that you’re thinking to add there that might help sustain the growth on that side of business? Thanks.

[David Williams, EVP & CFO]

I’ll talk about the capital and I’ll turn the Roto-Rooter question over to Kevin. But no, you’re right, Frank. And actually our priority on deploying capital hasn’t changed. Of course it’s all about our risk-adjusted return. There’s only so much hard assets, fixed assets we can put out into the field. So the reality is, acquisitions, we look at next, but the valuations are 12 times, 14 times, 15 times EBITDA, which doesn’t seem leave enough upside for the shareholders given the risk of an acquisition.

So then we turn around, pay a dividend to expand our shareholder base and then share repurchasing. Even at today’s stock prices, it’s still accretive at our borrowing rate and what we earn in overnight money to buy in shares, obviously we last [indiscernible] at $315 than it was at -- what we bought last quarter at $272 a share, but without a doubt, we’ll be opportunistic on dollar averaging and repurchasing but certainly not getting ahead of our skis. And then for a Roto-Rooter, I’ll turn it over to Kevin.

[Kevin McNamara, President & CEO]

Yes, and then before I do that, also say -- point out that last year we did make two nice acquisitions, the biggest Roto-Rooter acquisition ever in the West Coast and a nice not-for-profit in Florida, we continue to look at things like that. They’re not major company-turning type acquisitions, but they’re nice additions. But with regard to Roto-Rooter, no, we don’t -- we think the biggest change we’re going to make this year is to really capitalize on something we’ve talked about in the past and that is really compared -- most of our competitors are small regional or smaller competitors and we’re basically -- with regard -- we’re winning the Google war with regard to those competitors.

We have regional call centers that do a great job both taking the call and dispatching and analyzing the calls as they come in. Frankly, we have something called a lost revenue report that was climbing all last year as we continue to get such a strong level of calls. This year, the job one is to hire more technicians to take advantage of that businesses there. So that’s our focus rather than a new service to roll out by the Roto-Rooter technicians.

[Frank Morgan, RBC Capital Markets]

Okay. Thank you.

[Operator]

Thank you. And I’m showing no further questions at this time. I’d like to turn the conference back over to Mr. Kevin McNamara for the closing remarks.

[Kevin McNamara, President & CEO]

Okay. No significant closing remarks other than good solid fourth quarter for us and a good launching pad for this year. And thank you very much for your attention.

[Operator]

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may now disconnect. Everyone, have a great day.