Chemed Corporation (CHE) Q4 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2014 Chemed Corporation Earnings Conference Call. My name is Derrick, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Ms. Sherri Warner, Chemed Investor Relations. Please proceed.

Good morning. Our conference call this morning will review the financial results for the fourth quarter of 2014 ended December 31, 2014. 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 17, 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 17, 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 Tim O'Toole, Chief Executive Officer of Chemed’s VITAS Healthcare Corporation subsidiary. I will now turn the call over to Kevin McNamara.

Thank you, Sherri. Good morning. Welcome to Chemed Corporation's fourth quarter 2014 conference call. Chemed’s fourth quarter 2014 operating results were very solid in both operating segments. Let’s first start with VITAS. As we’ve discussed over the past year, certain admission coding changes initiated by the Centers for Medicare & Medicaid Services severely disrupted admissions patterns over the past several quarters. I reported to you last quarter that we believed we have resolved these issues and that our operating metrics improved in the third quarter and this would continue into the fourth quarter of 2014. This was the case and I’m pleased to report that the two key operating metrics, admissions and average daily census, grew nicely in the quarter. During the fourth quarter of 2014, VITAS generated a 5.6% increase in admissions; our aggregate admissions increased 6.6% in the second half of 2014. This is a significant turnaround when compared to the first six months of 2014, which had a 2.1% decline in admissions. Average daily census experienced a similar pattern, with ADC increasing 4.6% in the fourth quarter of 2014 and averaged 3.7% for the second half of 2014. This compares to ADC declining 0.09% in the first half of 2014 when compared with the prior year period. Based upon this improvement in the second half of 2014, VITAS is well positioned in the coming year. Now, let’s turn to our Roto-Rooter business segment. During the fourth quarter of 2014, Roto-Rooter’s plumbing and drain cleaning business generated sales of $105 million, a 13.7% increase over the prior year. This sales increase translated into $21.1 million of adjusted EBITDA, an increase of 14.5% and equated to an adjusted EBITDA margin of 2.1%. 2014 was a record year for our Roto-Rooter business, expanded full year revenue 6.5% to $392 million, gross profit increased 5.9% to $183 million and our adjusted EBITDA expanded to a record $75.1 million. We are optimistic that 2015 has the potential to be a record year in revenue and profitability. Now, let’s discuss Chemed’s use of capital. VITAS is purely focused on providing the best possible care and responsiveness to our patients and their families. Roto-Rooter is equally focused on providing our customers quick dependable service to resolve all their plumbing and drain cleaning issues. Being in these two service sectors, field based labor and related fringe expenses are by far away our most difficult cost. Capital expenditures typically are not a significant portion of our uses of cash, averaging roughly 2% of revenue. As a result, these labor intensive business models generate fairly predictable free cash flow in the range of 7% to 8% of revenue. Given Chemed’s strong cash flow, we’re continually evaluating the best use for capital to maximize returns and long-term shareholder value with an appropriate level of risk. Acquisitions are always a consideration when evaluating effective use of cash. Historically, this has been an excellent source of growth and profitability for Chemed. In our current high valuation environment, potential synergies are going to the seller and the timeframe to recover the cost of capital is as long as 20 years. And this is before any consideration that is given to integration and operating risk of these acquisitions. Given these economics, it should be no surprise that we concluded acquisitions currently are high risk, low return and not a viable growth strategy for us. Absent reasonable valuation of acquisitions, we have determined share repurchase and dividends are the best use of cash to maximize long-term shareholder value. To put this into context, since May 2007, Chemed has repurchased 11.6 million shares of Chemed stock, aggregating $707 million at an average share cost of $61.13. In addition, during this period, Chemed has consistently raised its dividend distributing over $85 million in dividends. Combine, share repurchases and dividends totaled just under $800 million over the past eight years, which is almost exactly the free cash flow generated over this period. With that, I would like to turn the teleconference over to David Williams, our Chief Financial Officer.

Thank you, Kevin. The net revenue for VITAS was $274 million in the fourth quarter of 2014, which is an increase of $18.2 million or 7.1% when compared to our prior year period. The revenue increase is comprised of average Medicare reimbursement rate increase of approximately 1.4% combined, a 4.6% increase in the average daily census and the favorable comparison relative to the Medicare Cap billing limitation. In the fourth quarter of 2014, VITAS reversed $500,000 in estimated Medicare Cap billing limitations. This compares to $3.8 million of Medicare Cap billing limitations recorded in the fourth quarter of 2013. At December 31, 2014, VITAS had 35 Medicare provider numbers, with 1 provider number having an estimated 2015 Medicare Cap billing limitation. The fourth quarter of 2014 gross margin, excluding the impact of Medicare Cap, was 24.3%, which is a 12 basis point decline when compared to the fourth quarter of 2013. Our routine home care direct gross margin was 54.9% in the quarter, an increase of 110 basis points when compared to the prior year period. Direct in-patient margins in the quarter were 7.2%, which compares to 5.0% in the prior year. Occupancy of our 34 in-patient units averaged 74.7% in the quarter and compares to 71.2% occupancy in the fourth quarter of 2013. Continuous care had a direct gross margin of 18.2%, an increase of 210 basis points when compared to the prior year quarter. Average hours billed for a day of continuous care was 18.6 hours in the quarter, a slight decrease when compared to the average billing hours in the fourth quarter of 2013. Now let's discuss Roto-Rooter. Roto-Rooter's plumbing and drain cleaning business generated sales of $105 million for the fourth quarter of 2014, an increase of $12.6 million or 13.7% over the prior year quarter. Roto-Rooter utilizes a universal calendar of four 13-week quarters equating to a 52-week full year reporting period. Then in accrues for an additional one or two days of operating results in the fourth quarter to equate to a full 365 or 366-day year. In the fourth quarter of 2014, Roto-Rooter had 14 weeks of operating activity during the quarter. Roto-Rooter’s revenue increased 10.7% when you exclude the impact from the net result of the universal calendar true up. Roto-Rooter’s gross margin in the quarter was 46.7%, a 59 basis point decline when we compare to the fourth quarter of 2013. Adjusted EBITDA in the fourth quarter totaled $21.1 million, an increase of 14.5%. Adjusted EBITDA increased 9.8% if you exclude the impact of the universal calendar I noted earlier. The adjusted EBITDA margin was 20.1% in the quarter, 15 basis points higher than the prior year. On a unit-per-unit basis, Roto-Rooter’s commercial drain cleaning revenue increased 14.5% and commercial plumbing and excavation increased 10.5%. The other commercial category, which is approximately $2 million, increased $1.3 million over the prior year. Overall, commercial revenue increased 16.9%. Residential plumbing and excavation revenue increased 9.7% and residential drain cleaning increased 8.4%. The other residential category which generated approximately $7 million in revenue in the fourth quarter of 2014, increased $6.1 million over the prior year period. Overall, unit-per-unit residential sales increased 21%. The expansion in the other category for both commercial and residential is due primarily to revenue from additional service work related to the removal of water and water soft materials after flooding and sewer backup. We refer to this as water restoration. For Chemed, our 2015 earning guidance is as follows: full year 2015 revenue growth for VITAS, prior to Medicare Cap, is estimated to be in the range of 3% to 4%; admissions in 2015 are estimated to increase 4%; and full year adjusted EBITDA margin prior to Medicare Cap, is estimated to be 14% to 15%; Medicare Cap billing limitations for calendar year 2015 are estimated to be $5.5 million. Roto-Rooter is forecasted to achieve full year 2015 revenue growth of 3% to 4%. This revenue estimate is based upon the increased job pricing of approximately 1%. Adjusted EBITDA margin for 2015 is estimated in the range of 19% to 20%. Based upon these metrics, management estimates that full year 2015 adjusted earnings per diluted share, which excludes non-cash expense for stock options, costs related to litigation and other discrete items, will be in the range of $6.50 to $6.70. This compares to Chemed’s 2014 reported adjusted earnings per diluted share of $6.07. I will now turn this call over to Tim O'Toole, our Chief Executive Officer of VITAS.

Thanks, David. As Kevin discussed earlier, the hospice industry's admissions pattern had been severely disrupted over the past year for patients who traditionally would have been admitted with a principal hospice diagnosis of debility or failure to thrive. So as of October 1, 2014, we have completely eliminated the utilization of debility and failure to thrive as primary diagnosis codes. Patients who in the past would have been admitted with a primary condition of debility or failure to thrive are now being admitted utilizing a primary code which in our physicians’ judgment represents the single most significant condition that contributes to a terminal prognosis. In some instances, our physicians need to factor in additional conditions of the patient beyond the primary disease in reaching a terminal prognosis. In these cases, sub-coding in provided for these underlying conditions. During the fourth quarter of 2014, admissions from hospital referrals, which represent over 50% of the source of our admissions, increased 8.3%, home-based referrals rose 1%, nursing home admissions increased 5.9% and assisted living facilities increased 1.1%. Our per patient per day pharmaceutical cost averaged $6.90 in the quarter, which is 8.5% favorable to the prior year. Medical equipment per patient per day cost in the quarter totaled $6.41, which is equal to the prior year period. VITAS’ average length of stay in the quarter was 82.7 days, which compares to 82.6 days in the prior year quarter and 83.7 days in the third quarter of 2014. Average length of stay is calculated using total discharges during the period. Median length of stay was 15 days in the quarter. Median length of stay is a key indicator of our penetration into the high acuity sector of the market. Our days of care totaled 1,365,139 days in the quarter, an increase of 4.6%. Non-nursing home routine home care days increased 4.8% in the quarter and nursing home routine home care increased 4.6%. At December 31, 2014, we had one program classified as a startup, and this program is admitting patients. This new startup is Medicare certified and is billing under an existing provider number. With that, I'll turn the call back over to Kevin.

Thank you, Tim. I will now open the teleconference to questions.

[Operator Instructions] And our first question will be coming from the line of Darren Lehrich, Deutsche Bank.

Just a few questions I had. First, just in terms of the Roto-Rooter revenue guidance and the outlook for 2015 of 3% to 4%, I understand you've got the extra week in the 2014 numbers. I guess I just was curious to get your thoughts on whether you think the 3% to 4% in the context of some of the other services you've talked about and a little bit of a bigger recovery economically is the right framework for 2015?

The universal calendar, remember we were pruning for revenue as well in prior years, and billed not too many who actually leave the books open for that extra week in the fourth quarter. So it impacted, but the numbers I reported just a few minutes ago factored that out. So it’s not going to be a significant impact on a comparable basis.

I think the question is, does that sound conservative given our growth of the other water restoration.

No, I understand. But I would say there is no noticeable result that’s going to happen from the universal calendar impact. We are being conservative with little to overall revenue growth and that’s primarily because we want to see if there’s a continuation of revenue growth due to the water restoration, we’ve done very well, we’ve penetrated the market. There’s a lot of self referring that happens when we come out to do the new work, where we do the water restoration. But it’s right in a very difficult for us to gauge. We think that we’re optimistic there’s some upside, but we remain conservative until we have really a couple of years of track record on water restoration do we see how sustainable and how much growth we can generate. The other point is it also has a slightly lower margin than our typical business, which is why you’ve seen a slight decline in our EBITDA margins in the fourth quarter than we typically would have had.

Just to confirm, Dave, you gave us the numbers but that new service offering added roughly 2 percentage points to your 2014 revenue growth? Is that the right way to size it?

I haven’t done the wrong math on that, but I think the contribution in the quarter incrementally was about $4 million to $5 million. So $4 million to $5 million in the quarter incremental.

Got it, okay. So it's probably even a little higher than that. On the CapEx side of things, obviously the investment has moved up a little bit. Can you just frame for us your CapEx outlook for 2015? It's been running more like 3% of revenue in the last few quarters versus I guess we were more in the kind of 2%, 2.5% range for some time. So should we be thinking more 3% and is most of the incremental spend in these new areas that you're talking about?

Great question. So over the last several years, our depreciation and amortization has averaged between say $27 million and $30 million and typically our CapEx has been averaging between $27 million and $30 million. Last year, 2013 and 2014, we deviated, in 2014 I think we ended up in the low $40 million, about $42 million of CapEx or about $12 million higher than you would have expected. And that is almost exclusively due to increased investments in water restoration for Roto-Rooter and a little bit increase in VITAS, but only a couple of million dollars relative to durable medical equipment. We don’t expect that to be as high in 2015, we think we’re going to be more like low 30s, say $32 million, $33 million, and then we expect to get back on track where the procession and amortization and CapEx are more closely aligned.

Okay, that's real helpful. I guess just last thing from me here, I'll jump back in the queue, we've seen about $2 million of annual expense in your supplementals in just the investigation expense, which I guess has sort of been level throughout the last 12 months each quarter. Can you just give us an update on the level of activity that you're seeing and any kind of updated thoughts on what you think the status is of that overall situation?

I’d just say no significant developments proceeding slowly as these things are expected, very much the discovery phase, there are some activity in similar cases that we think is very interesting, but again, it’s pending before different courts. It has limited applicability to us, so I hesitate to say of real significance, but I guess we’re spending about $500,000 per quarter in that in our estimate.

We exclude those from relative to our estimate in terms of the earnings per share, the $2 million.

As far as our guidance, I mean as far as what we internally estimate.

Yeah, the only thing we say is that comes in very lumpy during the year, Darren, and it’s really almost impossible to predict. The DoJ, things would be very quiet and there’s a flurry of activity that produces legal billings, then it dies down again. So it’s very difficult to predict.

And let’s say, virtually at every meeting I’m asked to comment on it and I think that it’s proceeding in a professional manner by both sides, I mean, we have a very experienced counsel and I think that the federal government, they have a tough job in that they kind of pick it up and go from scratch in no matter what the industry is, the deals with the federal government and there’s a learning curve for them as well. And the discovery, given that, the discovery stage is more than just both sides taking our positions, it’s really, for our purposes, it’s really crawling and putting a lot of information in a way that we think makes sense and puts our best foot forward with regard to federal government, their understanding a new industry from scratch. So when I say it’s proceeding slowly, that’s not because of any foot-dragging by either parties.

Darren, the DoJ has a very important job to make sure in terms of the Medicare system, everyone is playing by the rules and of course the DoJ has to make sure they have a thorough understanding of what the rules are and how the industry works. Although we’ve been watching with great interest, a number of other government agencies have been looking at hospice. And the questions they were asking relative to quality of care, the number of visits patients are receiving, hospices that don’t provide any high acuity care, zero continuous care or zero in-patient, the number of high life discharges when high acuity care isn’t provided. So we think there’s a greater appreciation among a number of government agencies that have a responsibility to make sure quality of care is provided within the Medicare system and they’re asking all of the right questions and how the industry is behaving, particularly small hospices that may not have the capabilities of providing all levels of care, even though it’s required. So actually we’re very positive on the long-term impacts hospice can have on Medicare, quality of care and spending. We’re very optimistic that the government is asking the right questions right now.

And then it really comes down to, we have got to take the long-term view, but to the extent that the government makes everyone play by the rules, that’s going to run down to our benefit. I mean, that’s certainly our intention and has been and the people who we can’t compete with are the unfair competitors. To the extent that the government roots those unfair competitors out, ultimately the more efficient provider will win out. And I think when you give us our size and some of our benefits of good systems and professional management, we usually do pretty well in that situation.

Your next question is from the line of Jim Barrett, CL King and Associates.

Tim, I just had a couple of questions for you. Continuous care days were up in the second half, up 5% in Q4. Should I infer from that, that referring physicians, admitting physicians, are once again comfortable referring patients for continuous care? I realize it's still below the level you achieved in 2012, but how should I think about that process?

Continuous care is up because our average daily census is up. We’re still seeing the same rough statistical mix of when episodic events are there. That we’re providing that, between in-patient continuous at about 7% of our census, so when the average daily census goes up, you can expect about roughly equivalent change in all levels of care.

We did see, Jim, the high acuity levels did grow at a lower rate year-over-year, which is what we would expect. We have a lot of systems and checks and balances in for when continuous care is necessary for the patient. And as far as the physicians that are referring, I think they’re very comfortable with hospice in general and they’re not necessarily into the detail of the levels of care. We communicate, educate them about it. But as far as the issues with continuous care needing to be around a crisis event, I think people in the industry are working well with that. And as far as the need for high acuity care, the in-patient care, the continuous care, it is certainly one of the reasons we do well with large referral sources that need these type of things to bridge individuals and to transition away from high acuity hospitals and they need to know that they’re not going to be readmitted based on the current rules and guidelines and hospice is the number one way to have that happen effectively with good quality care. And some component of that care will need to be continuous care and inpatient care when our doctors’ judgments perceive that that’s necessary. So as far as the marketplace gotten back on track, the answer to that is yes. You can see by our growth and I think hospice, out of care hospice, transition care programs are very much in the vogue. Hospitals need them, ACOs need them, everybody needs them and the number one company that can perform these services across the United States is VITAS. So we feel very good about it.

And Jim, you’re also referring to the fact that the human nature issue, when the first thing hit and allegations of fraud, it’s human nature to think that the physicians who make this call, not the business people, would just be guiding their I’s and crossing their T’s and maybe have a slight impact on their designations. And we saw that in a very limited respect. It’s kind of reached its echo point. A couple comments that, only two comments I’d like to leave you with as far as continuous care is, first of all, it was kind of interesting for me to see just showing how separate that determination was a year ago in the fourth quarter, we had a large California unit that was in cap, which basically meant, and you can pick it, the very high cost continuous care, we were basically providing for free. Okay. With no reimbursement on a net effect because we were already at our cap for revenue. And you might say if the business people were running that unit, you’d have less continuous care. In the fourth quarter, we had just as much continuous care in that unit as we did in the previous quarter, showing that the disassociation between the medical decision and kind of the business decision. The second thing I’d say, always keep in mind whenever you see that number and compare it to everybody else, you got to remember that over 50%, more than 50% of our referrals come from hospital discharge planners, so a significant number of our patients come right from the intensive care unit. Are they going to have more continuous care especially in the early stages as they adapt to a – from the highest acuity setting into a relatively normal setting in maybe in their – back in their apartment or home? Yes, of course. And when you compare that to a hospice with just a nursing home system with a captive hospice business that has 0% coming from hospital discharge planners, you can see those differentials. But yes, when we think of continuous care, we think it as part of a high acuity offering. We don’t make a big designation between continuous care and in-patient. That’s up to the patient, their family to choose and to the extent that one pops up a little bit one quarter or the other one goes down, we react to it. It’s not anything that we push one way or the other.

And Jim, just to put that in perspective, continuous care as a percentage of our total days of care was 3.82% in the quarter compared to 3.79%. So barely up. And then again overall high acuity was compared, 6.7% in the quarter to 6.8% in the prior year quarter. So it really runs at a comparable level.

That's helpful. And then my second question, you're guiding to 4% admission growth in 2015. When you look out long term, for argument sake, three to five years, is that a reasonable expectation for admission growth as I look out beyond 2015 given what you're seeing?

The only thing I’d say, and Tim you can jump in here. I would say, yes, we think that’s kind of in a little bit, if we said that we expect the industry to be between 2% and 4%, that’s a solid number, 2% and 5%, that’s a solid number at 4%, as we say. And you got to remember also a significant percentage of our business is in Florida where we basically have the lion’s share of the market in the programs we’re in. It’s hard to do anything other than just demographic growth in those programs, which means you have to do a lot better in the other programs in the country to overachieve and do better than the overall national numbers. So it’s a number that we think, given the Florida orientation, when we look out in the short or medium run, that’s an aggressive number for planning purposes.

All right, I don’t see any other questions. Failing that, I’ll just thank everyone for their attention and we’ll reconvene in about three months with reports of our first quarter 2015.

Ladies and gentlemen, that concludes today’s conference. We thank you for your participation. You may now disconnect. Have a great day.