Addus Homecare Corp (ADUS) 2022 Q2 法說會逐字稿

Good day, and welcome to the Addus HomeCare Second Quarter 2022 Earnings Conference Call. (Operator Instructions)

I would now like to turn the conference over to Dru Anderson. Please go ahead.

Thank you. Good morning, and welcome to the Addus HomeCare Corporation Second Quarter 2022 Earnings Conference Call. Today's call is being recorded. To the extent any non-GAAP financial measure is discussed in today's call, you will also find a reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP by going to the company's website and reviewing yesterday's news release.

This conference call may also contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding Addus' expected quarterly and annual financial performance for 2022 or beyond. For this purpose, any statements made during this call they were not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, discussions of forecasts, estimates, targets, plans, beliefs, expectations, and the like are intended to identify forward-looking statements.

You are hereby cautioned that these statements may be affected by important factors, among others, set forth in Addus' filings with the Securities and Exchange Commission and in its second quarter 2022 news release. Consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. The company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

I would now like to turn the call over to the company's Chairman and Chief Executive Officer, Mr. Dirk Allison. Please go ahead, sir.

Thank you, Dru. Good morning, and welcome to our 2022 second quarter earnings call. With me today are Brian Poff, our Chief Financial Officer; and Brad Bickham, our President and Chief Operating Officer. As we do on each of our earnings calls, I will begin with few overall comments, and then Ryan will discuss the second quarter results in more detail. Following our comments, the 3 of us would be happy to respond to any questions. While Brian will give you a more detailed review of our financial results, I wanted to highlight a couple of items from our second quarter performance.

First, even with the labor challenges we are seeing in parts of our industry, our team grew revenue 8.7% to $236.9 million for the second quarter of 2022 as compared to the second quarter of 2021. This resulted in sequential adjusted earnings per share growth to $0.91 as compared to $0.77 for the Omicron impacted first quarter of this year. Second, we had a strong cash flow from operations of $56.5 million this quarter, which reduced our net leverage position to less than 1x EBITDA. While we expect our results to return to a more normal level following the decrease driven by the first quarter Omicron surge, it is nice to see our team actively manage the challenge and make it a reality. I am very pleased overall with our second quarter performance with favorable trends beginning around mid-February, continuing each month through the end of the quarter and further through July.

Even with the growing prevalence of the most recent Omicron subvariant our team has continued to perform. Let me discuss this latest COVID subvariant that we had started to see. Throughout most of the second quarter, we saw little effect from the COVID virus. During April and May, we saw a continued decline in the number of patients and caregivers who were in quarantine from the first quarter Omicron Wave. However, during June, we saw increased effects of the new Omicron subvariant primarily in our Personal Care segment. This newest wave has resulted in a slight increase in our consumer and employee quarantines, which so far has had a minimum impact on our financial results as total quarantines remain significantly below those we saw with the delta in original Omicron waves. We continue to monitor quarantine rates closely, but believe that we will be able to successfully work through these ongoing surges as we have historically.

As we discussed last quarter, the labor environment remains one of our most challenging issues. While we are still facing this issue across our company, we are starting to see improvements in our Personal Care segment with hires per business day for the second quarter of 2022, increasing approximately 21% over the second quarter of 2021 and approximately 9% on a sequential basis over the first quarter of this year. This improving hiring trend has continued into July with hires per business day running slightly ahead of our second quarter of 2022 performance. As we previously discussed, we are constantly evaluating our sourcing, hiring, and onboarding processes to further improve our personal care hiring numbers to meet the continued demand for our services.

While hiring in the hospice and home health business remains a challenge, we did see improvement over the last couple of quarters with an increasing ability to hire new clinicians as well as a modest reduction in our clinical turnover numbers. Overall, we feel the trend in both hiring and turnover is moving in a positive direction in all segments of our business. During this quarter, we started to receive more substantial funding from our states as they implement their plans to deploy funds provided to them under the America Rescue Plan Act or ARPA. With respect to our 3 largest states, Illinois used the funding to accelerate last year's rate increase by 2 months as well as fund the upcoming statewide rate increase, which will be effective January 1, 2023.

New Mexico and New York have provided funding for direct payments to providers to be used primarily to assist in recruitment and retention of caregivers. Several other states have been given either temporary or permanent rate increases, which should help us hire and retain more caregivers as the majority of these funds are to be passed along to our employees and wage increases. As for Illinois, our largest state of operation, we will receive a $0.70 per hour statewide rate increase effective January 1, 2023. However, on July 1st of this year, we saw an approximate $0.40 per hour minimum wage cost of living increase for our Chicago area of personal care caregivers, which will have a slight negative effect on our margins over the next 2 quarters until the upcoming rate increase occurs. Once we receive the statewide rate increase, we expect to be able to adjust wages for remaining Illinois employees, which we believe will continue to help with caregiver recruitment.

Now let me discuss our same-store revenue growth for the second quarter of 2022. For our Personal Care segment, exclusive of the New York City Pat program and the ARPA funds, our same-store revenue growth was 2.5% when compared to the second quarter of 2021. However, while our personal care hours were down year-over-year, we did see the first sequential growth in hours in a number of quarters. Our second quarter personal care hours were up 3.8% over the first quarter of this year as we continue to see improved hiring and lower quarantine levels. We have seen sequential growth each month this year since January in Personal Care starts of care, employees worked and clients served.

Turning to our clinical care operations, our home health segment same-store revenue was up 24.6% from the prior year and 36.4% sequentially. We continue to see improving home health admissions, which were up 25.2% over the second quarter of 2021. We are excited about our home health operation as it complements our personal care services, particularly where we participate in value-based contracting models. We will continue to focus our efforts on expanding these services into our existing personal care markets. As we anticipated on our last call, our hospice same-store revenue increased 2.5% over the second quarter in 2021. We also saw a sequential increase in our average daily census as our medium length of stay improved to 23 days in the second quarter as compared to 17 days for the second quarter of 2021 and 20 days for the first quarter of this year.

Overall, our hospice ADC increased to 3,333 for the second quarter of 2022 as compared to an ADC of 2,460 for the second quarter of 2021, inclusive of the ADC attributable to our Journey Care acquisition, which closed on February 1st of this year. As for our development efforts, over the past quarter, most of our deal flow has consisted of smaller acquisition opportunities across all 3 levels of care. We continue to have conversations with brokers and other third parties.

And based on the feedback we have received, we expect to see an increase in potentially larger transactions in late 2022 and early 2023. I do want to mention that with the proposed rate cut by CMS and home health, we are seeing an overhang related to different price expectations from buyers and sellers. We have seen some home health deal processes being put on hold while waiting for the publication of the final rule in late October. We expect there to be a lower level of transaction activity in the skilled home health sector until reimbursement is finalized. Once the final home health rule is published, we expect to see activity in this sector increase and believe we are well-positioned to take advantage of these opportunities.

While skilled home health activity may be slower in the short term, we are still very optimistic on our M&A outlook, and we will continue to build a pipeline, focusing primarily on personal care and home health. We continue to believe that acquisitions will remain an important part of achieving our 10% minimum annual revenue growth target, which we have exceeded for the past few years. As we have previously discussed, we are starting to see additional momentum in our value-based care efforts. Currently, we have 4 value-based contracts, which are now in 3 of our states. These contracts are focused on helping our patients avoids both unnecessary emergency room visits and hospital admissions as well as readmissions at various time frames following their hospital discharge. These programs currently cover approximately 4,700 of our personal care clients. An important component of each of these contracts is a focus on care quality measures and metrics. We feel this quality focus fits well with our overall mission at Addus.

To date, we have been able to show measurable improvements in this targeted goal, which is what we believe would occur as our personal care and clinical staff are able to closely follow these patients. To help us with data collection and analysis of our patient outcomes, we plan to invest in additional software tools, which will help us as we continue to scale these types of arrangements. While the revenue generated from our value-based efforts is relatively immaterial today, we continue to expect them to grow to a more meaningful amount over the next few years.

While the COVID virus continues to be difficult for everyone, our team has been able to prove the value of taking care of elderly and disabled consumers and patients in their homes. The home remains one of the safest and most cost-effective places to receive care and is also the place for most elderly individuals and their families prefer to be. We believe the heightened awareness of the value of home-based care is favorable for our industry and will continue to be a growth opportunity for our company. As I mentioned on our last earnings call, we understand and appreciate that our operations and growth are dependent on our dedicated caregivers who worked so incredibly hard providing outstanding care and support to our consumers, patients and their families. I am thankful for each of our team members, and I am proud of the job they have done in the past and continue to do each day. It is important that we all focus on achieving our mission by putting our consumers and patients first.

With that, let me turn the call over to Brian.

Thank you, Dirk, and good morning, everyone. Addus had a solid financial performance for the second quarter. Our results reflect positive same-store growth trends in all 3 segments compared to the second quarter last year. We also benefited from our hiring and retention efforts and an improving labor market for our personal care business segment compared to prior quarters. Our home health business continues to expand and reflects the addition of the 2 acquisitions we completed in 2021, our Armada Home Health and Hospice and Summit Home Health. We are also pleased to see more historically normalized trends for our hospice business.

We experienced strong cash flows during the quarter and remain well-positioned in the current inflationary environment. As Dirk noted, total net service revenues for the second quarter were $236.9 million. The revenue breakdown is as follows: Personal Care revenues were $174.3 million or 73.6% of revenue. Hospice revenues were $52.1 million or 22% of revenue. When compared to the second quarter last year, Hospice care revenues include the addition of the hospice division of Armada, which closed on August 1, 2021, and the first full quarter of the acquired hospice operations of JourneyCare, which closed on February 1, 2022. Home Health revenues were $10.5 million or 4.4% of revenue. As noted, these results include the operations of 2 acquisitions, the home health division of Armada, which closed on August 1, 2021, and Summit Home Health, which closed on October 1, 2021.

We have a strong business model in place across our home care continuum and believe we are well positioned in all our operating segments. In addition to our strong organic growth, we have added $55 million in revenue to date in 2022 with the acquisition of JourneyCare. We continue to evaluate and pursue other acquisition opportunities and have a robust pipeline of potential transactions that meet our criteria. As Dirk mentioned, the overhang from the proposed reimbursement changes in home health and lack of visibility on the ultimate financial impact on potential acquisition targets has delayed the transaction process with respect to some potentially larger acquisitions in skill home health. We expect this to be a timing issue on rate information that will largely be resolved in the fourth quarter, and we continue to actively pursue other strategic acquisitions that meet our criteria.

Other financial results for the second quarter of 2022 include the following: -- our gross margin percentage was 31.9% compared with 31.6% for the second quarter of 2021 as we continue to see the benefits from a higher proportion of clinical services. However, we were negatively impacted by approximately 20 basis points during the second quarter from the initial reinstatement of Medicare sequestration with a 1% cut effective April 1st. We expect to see an additional 20 basis point impact in the third quarter with the additional 1% cut is implemented. Additionally, we will have a short-term headwind from the July 1, 2022, minimum wage cost of living increase in our Chicago market, which will have a negative impact of approximately 30 basis points through the end of the year.

We are scheduled to receive a statewide reimbursement increase in Illinois effective January 1st, 2023, that will offset this most recent minimum wage increase. We were pleased to see the recent announcement regarding the upcoming hospice rate adjustment with some recognition of the current inflationary market. This increase will be effective on October 1, 2022, and will benefit our consolidated gross margin by approximately 50 basis points. Like others in the industry, we continue to advocate against the proposed home health rule; although, our exposure is minimal as home health constitutes less than 5% of our consolidated revenues.

G&A expense was 23.3% of revenue, slightly higher than 22.1% of revenue a year ago and primarily due to a larger percentage of clinical services with a higher G&A profile and also includes the first full quarter of our Journey Care acquisition, which closed on February 1, 2022. Adjusted G&A expense was 21.3% of revenue for the second quarter compared to 20.4% for the same period last year and up slightly sequentially from 21.1% in the first quarter. The company's adjusted EBITDA increased to $25.1 million compared to $24.3 million a year ago. Adjusted EBITDA margin in the second quarter was 10.6% compared with 11.2% for the second quarter of 2021. Adjusted net income per diluted share was $0.91 compared with $0.90 for the second quarter of 2021.

The adjusted per share results for the second quarter of 2022 excludes the following: acquisition of De Novo expenses of $0.08 and non-cash stock-based compensation expense of $0.13. The adjusted per share results for the second quarter of 2021 excludes the following: the impact of retroactive Illinois rate increase of $0.07, acquisition of De Novo expenses of $0.11, restructure and other nonrecurring costs of $0.02, and noncash stock-based compensation of $0.12. Our effective tax rate for the second quarter of 2022 was 25.1% within the range of our expectation. For full calendar 2022, we expect our tax rate to remain in the 25% to 26% range. DSOs were 45.9 days at the end of the second quarter of 2022 compared with 52.4 days at the end of the first quarter of 2022. We continue to see consistent payments from the majority of our payers across all of our operating segments and expect to see this trend continue, especially in our key markets where the states currently have budget surpluses and a focused approach to payments.

Our DSOs for the Illinois Department of Aging for the second quarter were consistent with the first quarter at 43 days. Our second quarter net cash provided by operations was very strong, totaling $56.5 million, inclusive of a net $14.2 million in ARPA funding and based primarily on our strong collection activity. As a result, during the quarter, we were able to pay down approximately $60 million on our revolver, reducing the outstanding bank debt balance to $196.3 million and reducing our exposure to rising interest rates. As of June 30, 2022, the company had cash of $120.9 million, with capacity and availability under our revolver of $376.4 million and $168.4 million, respectively. While we remain focused on pursuing our acquisition strategy, we will continue to be opportunistic in further reducing our already low net leverage, which is currently just under 1x. This concludes our prepared comments this morning. We'd like to thank you for being with us.

I'll now ask the operator to please open the line for your questions.

(Operator Instructions) The first question comes from Brian Tanquilut with Jefferies.

Dirk, thanks for all the discussion on the value-based progress that you are making. But maybe if you can help us understand what you are seeing there in terms of the economics or maybe the margin profile that you are getting out of that business. And then your thoughts on how that could be scaled and what it would take for greater adoption with some of the managed Med Care plans and United Care Advantage plans that are looking to employ more personal care going forward?

Yes. Interesting, Brian, with the value-based care, it's something that we have seen continually become more important over the last few quarters. And as we see today, we have got 4 contracts and they now expanded in 3 of our states. The important part we see is that having personal care with clinical services is very important to these contracts. And so our ability to depending on the contract, and they are somewhat structured differently depending on who it is with. But our margin profile is basically consistent with what we have seen in the past. In some contracts, we get paid for our personal care service plus savings. In others, it is more of payment for our personal care services and then certain bonus payments based on what we are able to help accomplish that the particular payer wants to accomplish.

So again today, we've been in a couple of our contracts over a year. We are starting to develop outcome data, which I think is extremely important as we try to scale this up in the future. So I believe over the next 2 or 3 years, you will continue to see this grow to be a more material part of our business and one in which, honestly, we spent some money, and we are going to continue to invest some dollars as we are going to help develop software to help us with analytics and looking at what we have from outcomes coming from our patients. So generally what we are very excited about, again, not material today, but we think in the next 2 or 3 years, will become more so.

I appreciate that. And then I think just about organic growth, right? I mean, in the quarter, you did 2.5% same-store rent growth. Your long-term guidance has been 3% to 5% for a long time now, so just wanting to hear your thoughts on the opportunity to accelerate growth. I know you are still winding down the CDF business in New York, but maybe without going to guidance, just your thoughts on organic growth for the back half of the year and into next year?

Well, 3% to 5%, as you say, has been our target for a long time. And we have come through a very interesting time frame, as you know, with the COVID environment over the last 2 plus years. We have been able, in most quarters to hit that 3% to 5% range, largely due to rate increases over the last couple of years. It has not been as much focused on volume as it has been in the historical part of our business, if you look back historically over our business operation. We were excited to see this quarter, our personal care hours start to grow from the first quarter. That is exciting. Again, part of what we have been facing is not just as hiring caregivers that help us with this growth, but also some of our states and others being able to hire personnel to actually get through the authorization process to allow us then to have those hours to serve our clients.

So as this continues to move forward and if we continue to see the trended growth that we have seen over the last few months, we expect that 3% to 5% to be a solid number. And hopefully, we would believe we could get towards the higher end of that towards in the next couple 3 quarters, especially as you see, again, the rate increase we are going to get from Illinois in the first part of the year, which will be very helpful.

The next question comes from Joanna Gajuk with Bank of America.

Yes. So I guess 2 follow-ups. So one is you mentioned the improved hiring in personal care. So can you give us a little more color there in terms of what's driving that improvement? And I guess, and how would you contrast this with what you are seeing in hospice and home health?

Joanna, this is Brad Bickham. Well, on the personal care side, we have seen a nice trend and increase in hiring for Business Day, which is a metric that we follow. I think from a kind of the reasons behind that, I think, one, you have seen the federal stimulus money kind of play out. It really ended kind of at the end of the last year. The unemployment benefits went down. You have also seen kind of a higher inflationary environment.

I think people need to work more hours and also potentially in other looking for maybe a second job. And that is something that personal care is set up for very well that we have quite a bit of part-time employees. I mean, that is primarily what our workforce is based on. And it allows people that if they just need to pick up some extra hours, they can do that readily. When you contrast that on the home health and hospice side, we have seen it is certainly a more challenging environment than we have on the personal care. That being said, we have seen some kind of improvement.

There is still certain markets that are little tighter than others where we have more challenges to retain staff and to recruit new staff. But it does seem to be improving a little bit, just not as readily available obvious as the personal care side, where we have seen a nice pickup in hiring.

No, definitely good to hear about that on the first one first side and just a follow-up, talking about value-based care. I just want to ask your opinion and I guess, how meaningful this could be because I want to say a couple of weeks ago already, where CMS published the first quality measure set for home and community-based services, where they try to encourage the use of some sort of consistent quality measures within and across different states that participate in the program. So what are the implications for you? And kind of would this be helping the shift with value-based care kind of a shift with value-based care?

Yes. This is kind of something that we have been pushing forward. And I think the industry has as well to have some standards out there on the personal care side. And if we look at on a value-based contract in particular, actually track some of those same metrics that the CMS is looking to implement. So I think our value-based contracting that we have today is going to position us well we will win those metrics, if and when those get formally adopted, but it is certainly something that I think the industry as a whole and Addus, in particular, we've been kind of pushing on. I think it should be helpful for us going forward.

Next question comes from Scott Fidel with Stephens.

First question, just wanted to follow up on the cash flows and really maybe get some feedback or guidance for you on thinking about modeling operating cash flow for the back half of the year. Obviously, a really strong print on cash flow in the second quarter, Brian, you called out some of those ARPA funds that did contribute to that. How you are thinking about, I guess, the ARPA fund flow through continuing in the back half of the year and then any other sort of notable working capital items that you would call out for the back half of the year?

Yes, Scott, I think it was definitely a great quarter for us. I think as we noted in our first quarter call, we had some timing differences with payroll and some of those items that we normally would see. I think we got some benefit from a working cap perspective in the second quarter just on that timing. But the ARPA funding is net about $14.2 million; I think we are still expecting to get additional funds later this year. We have not received all the funding that we have been scheduled to receive yet. You will still see some of that come through. But at $56.5 million for the quarter, you back out the $14.2 million in net ARPA, we are right at $42 million for the quarter. I think it is $48 million net of ARPA year-to-date. I think our expectation is thinking about kind of ARPA be a full year projection.

Our conversion rate from an adjusted EBITDA perspective is in the upper 60s, close to 70%, so that would put us in that kind of mid to upper 60s range for a full year target, and we are tracking at $48 million kind of year-to-date through the second quarter, so nicely ahead. I think we have definitely seeing DSOs come down as a big contributor during the quarter. Obviously, we would not expect to see continued movement in that regard, getting out into the 30s. But I think definitely, we have seen strong collections year-to-date, and we expect to see consistent payments going forward.

Got it. And then just my follow-up question, just wanted to revisit on the M&A dynamics and that was helpful sort of framing that Dirk had given just around some of the dynamics with the proposed home health rule. I guess sort of I have 2 just sort of follow-up questions on that. The first one would be just you had mentioned some of the larger deals getting deferred maybe to later this year into next year. I just want to confirm, is that specifically in home health because of the uncertainty around the proposed home health rate or is that some of the other markets as well, like personal care and hospice. So that would be the first part.

And then, Dirk, just when you had mentioned some of the differentials between buyers and sellers on valuation. Is that just that the sellers are actually still wanting the same values despite the proposed home health rule -- or is it just simply too hard to determine intrinsic value right now until we get those final 2023 home health rates?

Yes, Scott, as part of the first part, what we have mainly seen in the larger transactions that we have been a part had been home health. Realistically, as we talked about in the last couple of quarters, we are focused more on home health and personal care acquisitions today than hospice. It does not mean we would not look at hospice, it was appropriate in markets where we had strong personal care coverage. But so far this year, we have really focused more of our efforts in the other 2 segments. And couple of processes we were in were well underway and when the proposed rule came out.

And at that point in time, they went into a holding pattern waiting for the publishing of the final rule later on this year as we would talk about somewhat of the overhang because of the differences in valuation lots between buyers and sellers. I think it really goes most of what we're talking about there is in the home health. I think the sellers believe that the rule is not really going to be a big deal and that we should be willing to pay a value regardless. I think buyers are looking and saying, great, if that is the way it works out in October, November, and when the published rule comes out, we would find. I think if that understanding comes out the same way, then the value between buyers and sellers and home health, I do not think is really that much of a disconnect. I do think there is still somewhat of a disconnect between sellers of hospice programs and buyers. The markets seem to come down. The public multiples have come down. I do not think all of the sellers thought process has quite come down to that level.

And then to Personal Care, a great thing about Personal Care, it stays pretty consistent. Smaller deals, as Brian has said in the past in the 6, 7x range, larger deals maybe 8, 9, and really large deal that is very strategic might be 10%, but those are all very reasonable multiples that we, I think, would agree with. So realistically, the rule is probably the biggest impediment right now to signing deals in the home health market.

The next question comes from Tao Qiu with Stifel.

This is Seth Canetto on for Tao. I just had a question on the Personal Care. You mentioned earlier the improvement in the hiring and the labor improvement there. But the volumes were a little bit lighter than we had expected. How much of an impact is labor still having on personal care volume? And as the labor force continues to improve, how much acceleration could we see into the second half of '22?

Yes, Seth, this is Brad. I think really what you saw and we experienced a pickup in the COVID quarantines. Clearly, that last week in May, carrying over into June that dampened our June results and I think that is what had kind of more of an impact on the numbers rather than the hiring numbers. The hiring numbers, like I say, we are been very robust. And so we are still seeing some case counts that are still a little elevated. But again, nothing like we experienced in Q1 or in back in the fall with the Delta variant. So optimistic that those numbers should start coming back up for us, and we should see some better volume numbers towards the back half of the year.

And then my last question was just on the American Rescue and funding. I think you guys received $14 million in the second quarter. Do you still expect to receive the full $20 million or so in benefit funding that you alluded to last quarter? And if so, when should you expect to receive those remaining funds?

Yes. We still expect to receive the additional amount that schedule. I think it is just timing of when we are receiving those fundings from the state. But I think we expect to see most of that money, to be honest, through the third quarter.

The next question comes from Matt Borsch with BMO Capital Markets.

Could you just touch on as you talk about potential acquisitions, what you think is motivating sellers here? Is it retirement of the key owner or some sense that there is scale disadvantage. I do not know if you know that motivation. But also, if you just combine with that question on how high you would be willing to go on your debt leverage to do a larger acquisition.

Let me talk about what we are seeing with some of the sellers, I believe, and then Brian will talk about our leverage. But I think if you look at the 2 particular deals we have been looking at this year that has now been kind of placed on hold. I think the motivation of the seller might be twofold. One, I think, in a lot of cases, the last couple of years of operating through the COVID environment has been very tough. It has been a difficult environment and I think some of the owners of these companies as they have gotten really towards the end of, hopefully, the major effect of the COVID surges on business, see an opportunity to say, look, it may be time that we ought to see if we can get some value out of the business. I think the other motivation is some of these sellers are at a point in their life where they are looking to do other things, whether that be retirement or other businesses. And it is time for them to see about monetizing what they put into the companies for a number of years. So that's really, I think, the motivation we have seen so far.

Yes. And I would just add to that quickly, Matt. I think the one skilled side particularly, I think, obviously, private equity has been very active in putting assets together with a return in mind with the market the way they have been the last couple of years have done very well. So we have seen quite a bit of those instances where private equity would be a via platform put together several acquisitions, then get those things integrated and look to sell those. We see more of that on the home health and hospice side.

On personal care side, where we see more of what GERC was alluding to with more individual providers that have kind of run those businesses and looking forward and exit strategies. So I think on leverage, I think, obviously, we are very well capitalized today. I think we have said historically in the past and we would be very comfortable the other 2.5x to 3x range. We would be willing to go higher than that for the right deals that made a lot of strategic sense for us if we saw a path to kind of bring that leverage down through cash flow on the other side. And I think that is pretty consistent with our thinking today we can find the deals that could put us into that range.

The next question comes from John Ransom with Raymond James.

So Dirk, the home health companies have been struggling with these transitions to Medicare Advantage. And one of the big companies has been publicly talking about changing the economics to something more of a case rate versus per visit. And so my question, I know this is like a hypothetical on top of line. But as you look at home health assets, you would be big enough to go and to see United Healthcare; Humana had and say, "Gosh, go, I'd like to be paid differently on less book the business?" Or is that something that you would just have to fight through that transition of provinces and a lower margin and put that in evaluation?

John, this is Brad. I think when we are thinking about Medicare Advantage and trying to migrate from per visit to more of a case rate or episodic type payment. I think a couple of factors. One, when you think about size, we are not that large in home health yet. We are certainly intending to grow that platform and get more scale. But we do have a very large personal care component and most of those payers have Medicaid plans. And so I think we have the ability to leverage the personal care size and scale to have those conversations with United or in Aetna.

And then secondly, I think you also have to look at one thing has scale nationally, but probably even more relevant as having scale in a regional or localized market, I think, is important. And that is where kind of our philosophy is we are not looking to put pins in all the states for having locations. We are really more focused about getting density in specific geographic areas, which I think would help us with those negotiations.

Okay. And then just as a follow-up, this might be unfair, but once your Chicago rate goes into effect and we look at kind of 1Q '23? How does your rate per day compare to, say, 2019 versus your cost per day once everything is kind of normalized out, just thinking about the business over the COVID Valley.

Joe, this is Brian. I think if you look at where we are this quarter compared to last year, maybe as a good proxy, on average across our personal care business, our bill rates are up a little over 5% year-over-year. Most of our states are increases over the prior year. Wage rates, I think, have slightly outpaced that growth with some of the inflationary pressures and things that we have seen this year. I think going into '23, seeing any further activity and things that we do not expect from a COVID perspective, etcetera.

I think with the next rate increase, obviously, still being our largest market that is going to bring us probably between $9 million and $10 million in additional kind of new annualized revenue starting Jan 1 at kind of our normal margin, which is going to be in that probably upper 20% range. It is going to be very helpful. I think we have seen that dynamic in the last couple of years. I think we are going to see another benefit in early '23 from that will be impactful. But I think our expectation going forward is we should see those level of where you're not going to see wage rates outpace reimbursement. I think that was more the fact of what we have seen over the last year, but we would not expect to see that going into 2023.

The next question comes from Matt Larew with William Blair.

This is Madeline Mollman on for Matt Larew. Circling back to M&A. I know that you said right now you are having some trouble finding common ground with sellers. But wondering in general, after a couple of years of higher funding levels, higher reimbursement, the sequestration suspension, would you expect home health valuations to come down as separate from the CMS rule as sequestration phases back in? Like what do you expect long term for home health multiples?

Yes. I think this year, our expectation that we want have talked about it in the last couple of calls is valuations in home health with some of those pressures; we expected to see it be a more rational market time this year. I think a lot of us have been kind of waiting for more that influence a smaller organizations coming to market. I think you mentioned that is kind of kept some of those guys at float. But to your point, those things have come to an end sequestration coming in in Q2, now in Q3 is going to put more pressure. I think when there is some more clarity on the rule and how that is going to impact, I think that definitely is going to probably help rationalize margins a little bit as well, depending on how that turns out. I think our view is, like he mentioned some of the larger processes, they have kind of put themselves in a holding pattern. Some of the smaller processes where maybe the proposed rule would not be as impactful, I think we are still willing to have conversations and trade. So I think we still got some opportunities there. But I think overall, our expectation is that home health multiple is probably a little bit lower on the other side of this than what we saw maybe a couple of years ago.

Okay. And then one other question. You mentioned that you were building out a personal care version of home care, home based. Just wondering how that was coming along and how it would integrate with the traditional home care home base.

Yes. I think when we got into this project with Homecare Home-based type, I do not know if they fully realize the complexity of personal care. And when I say the complexity as compared to the skilled side where Medicare is a predominant payer. Personal Care is a totally different animal from the standpoint that you are dealing with multiple states, different types of programs within those states. So the reimbursement codes, all that sort of thing is a lot more complicated. All that being said, we have been pleased with the progress.

We anticipate as being able to roll out some pilot sites kind of Q1 of next year. But the main thing is we want to make sure that we have a product that we are satisfied with before we go forward with it. And I think they have certainly indicated their willingness to put those resources to develop that product. And just to the second part of the question regarding integration with the Homecare Home based to clinical side. Just think about it from a standpoint that all of those patient records will be in one system that we will be able to access through. And so we think that, that is really kind of an important component of really recognizing the benefits of the value-based contracting potential on the personal care side. And then also just when you think about referrals coming from personal care to home health into hospice, really helping facilitate that on a larger scale.

(Operator Instructions) The next question comes from Mitra Ramgopal with Sidoti.

I was just wondering if you could provide some additional color in terms of the new hiring and retention strategies to combat the tight labor markets you are seeing, especially on the clinical side.

Yes. So if you think about it on the clinical side, it is really putting more recruiting resources to the clinical side. Again, that is a little more challenging. If you think about personal care versus the skilled components kind of a different recruiting environment. We have kind of corporate recruiters that focus on filling positions on the clinical side plus the kind of your general administrative positions, whereas our recruitment efforts are predominantly on the PCS side are at the branch level. But it is certainly on the clinical side of a challenging environment. When you look at Personal Care, we have got the ARPA funds that really we have not tapped into it in a meaningful way yet. I mean those programs and retention programs that we are putting in place to both help keep caregivers, encourage caregivers to work more hours and also help with our recruitment efforts. That is really just getting started on the PCS side.

Okay. That is great. And then, Brian, there was a significant debt reduction in the quarter. I was just curious in terms of the capital allocation priority, if it is more a question of trying to overcome the higher interest rate environment versus maybe a shift in priorities?

Yes, Peter. I do not think there is a shift of priorities. I think we still prefer to use that capital toward M&A when those are available. I think in the absence of that and some of the overhang currently, particularly in the home health segment, I think you guys probably heard us talk on our last call, more of our pipeline with Selena that direction. So during that period of kind of call it a delay, we try to be opportunistic and at least limit our exposure to the rise in interest rates. So I think it is going to be meaningful savings and interest expense for us. So I think we will continue to do that until we see M&A pick up and then with the access to being full revolver now, not a term loan. We have that ability to draw that and use that at the time that we need it. So that will be kind of our focus over the next couple of quarters.

This concludes our question-and-answer session. I would like to turn the conference back over to Dirk Allison, Chairman and CEO, for any closing remarks.

Thank you, operator. I want to thank you for your interest in Addus and for you being a part of our earnings call today, and hope you have a great week.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.