Chemed Corp (CHE) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2014 Chemed Corporation earnings conference call. My name is Mark 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 Sherri Warner with Chemed Investor Relations. Please proceed.

Good morning. Our conference call this morning will review the financial results for the third quarter of 2014 ended September 30, 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 October 30 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 October 30, which is available on the Company's website at www.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 third-quarter 2014 conference call. The third quarter of 2014 generated solid operating results in both of Chemed's operating segments.

Let's start with VITAS. As most of you are aware, certain admission coding changes initiated last year by the Centers for Medicare and Medicaid Services severely disrupted admission patterns over the last several quarters. Fortunately, as a result of significant effort by our field personnel, we have resolved these issues. This is reflected in two of our key operating metrics -- admissions and average daily census, or ADC.

During the third quarter of 2014, VITAS generated a 7.5% increase in admissions. This admissions growth strengthened during the quarter, with the September admissions expanding over 10%.

Average daily census experienced a similar pattern, with ADC increasing 2.8% in the quarter, with the month of September AVC increasing 4.4%. Based upon this positive acceleration of these two operating metrics during the third quarter, I believe VITAS is well-positioned for excellent operating performance in the fourth quarter.

Now let's turn to our Roto-Rooter business segment. During the third quarter of 2014, Roto-Rooter's plumbing and drain cleaning business generated sales of $93 million, 7% above the prior year. This sales increase translated into $7.3 million of adjusted EBITDA, an increase of 6.8%, and equated to an adjusted EBITDA margin of 18.6%. Roto-Rooter is on track for another record year in terms of revenue and operational profitability.

Now let's turn to Chemed's use of capital. Both the VITAS and Roto-Rooter operating segments generate exceptional free cash flow. Capital expenditures typically are not a significant portion of our uses for cash, averaging less than 2% of our revenue.

Given Chemed's strong cash flow we are continually evaluating the best use for capital to maximize returns on capital and maximize long-term shareholder value within the 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.

However, over the past several years, the combination of significant liquidity within the investment community and exceptionally low borrowing rates on capital has resulted in potential acquisitions having been out of the reach of conservative investors. In almost all cases the multiples of these acquisitions were being transacted at vastly exceeded the multiple valuation of Chemed. And this is before any consideration is given to the integration and operating risks of these businesses.

Given these economics, it should be no surprise that we concluded acquisitions were not a viable growth strategy until valuations corrected relative to risk and return. Absent reasonable valuation of acquisitions, we determined share repurchase and dividends would be the best use of our cash in maximizing long-term shareholder value.

To put this into context, since May of 2007, Chemed has repurchased 11.5 million shares of stock, aggregating $696 million, at an average share price of $60.71. In addition during this period, Chemed has consistently raised its dividend and has distributed over $81 million in dividends. Share repurchases and dividends combined have returned over $777 million to our shareholders over the past seven years.

With that, I would like to turn this teleconference over to David Williams, our Chief Financial Officer.

Thanks, Kevin. Net revenue for VITAS was $265 million in the third quarter of 2014, which is an increase of $11.4 million or 4.5% when compared to our prior-year period. This revenue increase consists of a Medicare reimbursement rate increase of 1.4% combined with a 2.8% increase in our average daily census.

In the third quarter of 2014, VITAS reported $2.5 million in estimated Medicare cap billing limitations. This compared to $3.2 million of Medicare cap billing limitations recorded in the third quarter of 2013.

At September 30, 2014, VITAS had 38 Medicare provider numbers, of which two of the provider numbers have an estimated 2014 Medicare cap billing limitation. Of our 36 remaining Medicare provider numbers, 33 provider numbers have a Medicare cap cushion of 10% or greater for the 2014 cap period, one provider has a Medicare cap cushion of 5% to 10%, and two provider numbers have a cap cushion between zero and 5%. VITAS generated an aggregate cap cushion of $268 million in the 2014 government fiscal year. The third quarter of 2014 gross margin, excluding the impact of Medicare cap, was 22.7%, which is a 56 basis point decline when compared to the third quarter of 2013.

Our routine home care direct gross margin was 53.8% in the quarter, an increase of 130 basis points when compared to the third quarter of 2013. Direct inpatient margins in the quarter were 4.9% which compared to 1.7% in the prior year. Occupancy of our 36 inpatient units averaged 71.1% in the quarter, and compares to 68.1% occupancy in the third quarter of 2013.

Our continuous care had a direct gross margin of 17.4%, an increase of 260 basis points when compared to the prior-year quarter. Average hours billed for a day of continuous care was 18.7 in the quarter, a slight decrease when compared to the average hours billed in the third quarter of 2013.

Now let's turn to the Roto-Rooter segment. Roto-Rooter's plumbing and drain cleaning business generated sales of $93 million for the third quarter of 2014, an increase of 7% over the prior-year quarter. On a unit-per-unit basis, commercial drain cleaning revenue increased 3.1%, and commercial plumbing and excavation increased 1.3%. Overall, commercial revenue increased 5.2% including the other category.

Residential plumbing and excavation revenue increased 4%, but was partially offset by a 0.4% decline in residential drain cleaning revenue. Overall, unit-per-unit residential sales increased 9.4%, primarily driven by increased revenue in the other services category.

Now let's look at Chemed's consolidated balance sheet. As of September 30, 2014, Chemed had total cash and cash equivalents of $19 million, and debt of $174 million.

In June of 2014, Chemed entered into a five-year amended and restated credit agreement that consisted of a $100 million amortizable term loan and a $350 million revolving credit facility. The interest rate on this facility has a floating rate that is currently LIBOR plus 113 basis points. At September 30, 2014, the Company had approximately $238 million of undrawn borrowing capacity under this credit agreement.

Our capital expenditures through September 30, 2014 aggregated $31.7 million, in comparison to depreciation and amortization during the same period of $24.3 million. The Company repurchased $99.1 million of Chemed stock through September 30, 2014.

This equates to 1.1 million shares of Chemed stock repurchased during the year at an average cost of $91.51. Chemed currently has $22.7 million of authorization remaining under this share repurchase plan.

Our 2014 full-year guidance is as follows. VITAS revenue growth was constrained in the first half of 2014. This was primarily the result of a 2% Medicare cut implemented in the third quarter of 2013, as well as mix shift from high acuity care to routine home care. These factors negatively impacted revenue comparisons in the first half of 2014.

With that said, though, full-year 2014 revenue growth for VITAS prior to Medicare cap is estimated to be in the range of 1% to 2%. Admissions in 2014 are estimated to increase 2%. And full-year adjusted EBITDA margins prior to Medicare cap is estimated to be 14.5% to 15%. Medicare cap is estimated to be $3.6 million in 2014.

Roto-Rooter is forecasted to achieve full-year 2014 revenue growth of 4% to 5%. This revenue estimate is based upon increased job pricing of approximately 2%. Adjusted EBITDA margins for 2014 is estimated in the range of 19% to 19.5%.

Management estimates that full-year 2014 earnings per diluted share, excluding non-cash expense for stock options, non-cash interest expense related to the accounting for convertible debt, litigation and other discrete items, will be in the range of $6 to $6.05. This compares to Chemed's 2013 reported adjusted earnings per diluted share of $5.62.

I'll now turn this call over to Tim O'Toole, Chief Executive Officer of VITAS.

Thank you, David. As Kevin discussed earlier, the hospice industry's admissions patterns 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. Through a very detailed process of training, education and referral sources, our admissions personnel, doctors and nurses who are now admitting patients that traditionally would have been coded with a principal diagnosis of debility or failure to thrive under different specific diagnosis codes.

Admissions with the primary codes of debility or failure to thrive were less than 1% of our admissions in the quarter. This compares to 15.3% in the first quarter of 2013.

As you would expect, admissions under other principal diagnosis codes experienced offsetting increases. As of October 1, 2014, we have completely eliminated the utilization of debility and failure to thrive as primary codes to reach a terminal prognosis.

During the third quarter of 2014, admissions from hospital referrals increased 5.7%, home-based referrals expanded 6.8%, nursing home admissions increased 9.8%, and assisted living facilities increased 13%. Our per patient per day pharmaceutical costs averaged $6.64 in the quarter, which is 11.7% favorable to the prior year. Our medical equipment per patient per day cost in the quarter totaled $6.68 which is equal to the prior-year period.

VITAS's average length of stay in the quarter was 83.7 days which compares to 82.2 days in the prior-year quarter and 82.4 days in the second 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 1,346,833 days in the quarter, an increase of 2.8%. Non-nursing home routine home care days increased 2.8% in the quarter. And non-nursing home routine home care increased 3%. At September 30, 2014 we had one program classified as a startup, and this program is admitting patients and is billing under an existing provider number.

With that I'll turn the call back to Kevin.

Thank you, Tim. Now it's time for any questions, to the extent that they exist.

(Operator Instructions)

Darren Lehrich, Deutsche Bank.

I wanted to ask just a few things here. The first, I want to start with Roto-Rooter. Your revenue growth rate was probably about 5 or 6 percentage points above where we've modeled. Dave, you talked a little bit about some of the breakdowns of revenue growth. Can you just update us on some of the growth initiatives there? What's driving that growth, and particularly in the residential side?

Darren, this is Dave. It was primarily driven in the other category, in terms of -- we're doing some -- mostly residential work that's getting some insurance reimbursement. And we had billings to the insurance company for some water damage related to flooding. So, that was the primary reason that we had an increase. It was about $5 million in the quarter.

Okay. Is that a recurring type of business? And how should we think about that particular piece?

We've seen this area gaining some momentum, so we think it actually has legs, and it could very well be a permanent service offering on our part. But because it's still in an early growth stage, it's difficult to predict.

But we would definitely call it recurring -- as Dave said, recurring, and growing. It wasn't a result of one big job or anything like that.

Right. I wanted to try to distinguish that between some of the excavation work that was lumpy on a more historical basis, as I recall. It just stood out, so I did want to ask.

There's no question about it. It's certainly significant from an operational standpoint for the Roto-Rooter segment.

And if it keeps gaining at the current rate, we anticipate it being broken out separately sometime in 2015.

Okay. That's very helpful.

The other question I wanted to ask -- Kevin, you talked about capital deployment. I think it's been pretty clear what your priorities have been. From an M&A perspective, are you seeing anything in the environment that's of interest? Particularly in the hospice side, is there anything that piques your interest, now that maybe some of the valuation expectations have reset a little bit?

I would say the answer to your question is, no, in a word. But I just haven't seen that much. And it's not like we've seen a lot of prospects that are just a little too high in their expectation. We just haven't -- there's just nothing that looks hot.

I think we try and be very active, and have a presence with regard to anything that does come up for sale, because we want to be ready to move if an opportunity's out there. But I certainly would be remiss if I said that there was anything that was even near or remotely near a go. Really, it's not the question of a few dollars more; it's just nothing close.

Okay. That's great.

The next question is for Dave, and probably something we can pick up offline, but for the benefit of maybe the audience and the call here, just given the refinancing, I'm wondering if you can just help us think about the mechanics of taking out the convert. I know there was an unusual add-back related to a GAAP rule that you had been making in your pro forma calculations. If possible, can you just help us think through the mechanics of the refi, and how that's going to look?

Sure. For GAAP purposes, even though the coupon on the convertible debt had a face value of $187 million when it hit redemption -- although it was a 1 7/8% interest rate, we actually had, I think it was like 6.5% was the GAAP required interest expense. And the difference between the 1 7/8% and that 6.5% -- that was a non-cash -- I would almost call it a phantom incremental interest expense that we always stripped out. It would never be paid.

So, now, obviously, taking out that $187 million of debt, and we basically utilized our cash, and then we have a $100-million term note, plus a little bit of utilization on a revolver, and that is actually at LIBOR plus 112.5 basis points today. So, the interest rate environment we're in -- we took out convertible debt with a coupon of 1 7/8%, but expense at 6.5%, and now we have less debt, but basically add about an interest rate of 1.5% to 1.25%.

When you say we stripped it out, we stripped it out for our adjusted --

Adjusted GAAP.

And it will no longer appear in GAAP.

Yes, we're certainly lapping that issue now.

Yes. Got it. Okay, that's all I had. Thanks very much.

Jim Barrett.

Tim, a couple questions for you: That was an impressive rebound in admissions. Any sense as to what the admission growth was in your markets during the recent past or in Q3?

Jim, I'm sorry, I don't really understand. We announced --

Did we take market share, Jim, is that the question?

Yes.

I would assume we probably did. We don't have real-time market data. We see numbers being released from some of the public hospice companies that -- from what I've seen, most of them are not growing at all. So, we're growing at 7%. We're probably taking market share.

I think what's happening is that the marketplace needs hospice services more than ever. The people we work with -- large hospital groups, insurance groups -- all of the things that they're focusing on are quality care with hospice, but also eliminating hospital re-admissions, and re-admissions into nursing facilities that have extreme penalties for them under their reimbursement. And, really, they need to work with a big hospice company that has a lot of resources to help them manage that. So, that's working very, very well for us.

Makes sense. And then, on a semi-related point, what is your outlook for startups going into 2015? You have one currently. What's the opportunity on that front?

We don't think that would be a material issue. The one is in Florida, and it's been very successful because it's an extension of where we operate now.

We look at all kind of markets, and we could have a couple of startups in some markets next year. But we look at them. If they're doing well, we'll move ahead. If markets are available, we'll move into them. If we have small programs that we've been in a market for a few years that's not doing well, we'll eliminate those.

So, we'll have some startups that make sense, but it will not be material, and it's not material right now. We had a 25 census in the quarter.

Just one thing to keep in mind, that they're -- Tim mentions Florida -- Florida's a CON state. We obviously apply -- pretty much any CON in Florida we could make sense out of.

There's two that are coming up. We'll apply for them. It tends to be a longer process.

From an investing public's point of view, those are really a long run because not only is it a long process to get the CON, and then you've got to go from 0 to 110 before it's breakeven. That's a longer process for planning purposes. And I'm with Tim in saying, to the extent that we're looking for other, call it, grassroots startups, there's no major metropolitan area that shows a lot of need at this point. So, it would have to be a special situation for us to do anything that would have much significance to the investing public.

Understood. And then my last question, Kevin, for you, as it relates to your government litigation, is your point of view not to settle, even if the financial risk/reward might appear attractive? How do you view that whole process?

I would say that, as much as I would like to say that, boy, I can't imagine settling, there has not been, in my mind -- and I'm certainly not objective -- there hasn't been any type of claim that could be extrapolated over multiple patients, let alone multiple programs. As much as I would say, boy, that would be difficult and whatnot -- and Dave would be quick to say, as to the extent that these settlements usually involve an agreement to refrain from some type of behavior, which, again, I don't know what that behavior under the current set of facts would be that we would refrain from.

Even having said all that, I'm realistic, and I look and say that if you look at whistleblower cases, there have only been a couple in the history of whistleblower cases that have actually gone all the way through, not just a trial but through appeal and to a final judgment. If you just go by the numbers, you say, at some point, obviously most people in my position do what makes the most sense from an overall risk, financial, get-it-all-behind-you point of view.

So, we'd be very reasonable. We're not doctrinaire on this situation. It's certainly not in the posture. I can say one thing: There have been absolutely no settlement discussions between the parties, not because the parties have dug their feet in the sand. It's been that there's been nothing really to discuss. The issues haven't been framed, from my perspective, from a settlement standpoint.

We don't know what the true argument -- we don't know any -- you can read the complaint. Anybody that reads that complaint would say that -- for instance, if you read the complaint, the issue is that we suggested that a program be more efficient in their provision of continuous care. Hardly a complaint there; but the memo specifically says that their profit margin was too low. I know -- what does that have -- they're doing it inefficiently. What do we do from that? Hard to frame an issue on something like that -- to come up with some kind of settlement discussion.

But to answer your bottom question, we are not doctrinaire. No one thinks that if you settle one of these things, that that's an admission that you're a bad company or whatnot. It's like a cost of doing business. We approach it that way, but whatever we do has to make sense, not just sense from getting it behind us, but sense on a go-forward basis as well.

That explanation is helpful. Thanks.

Frank Morgan, RBC Capital Markets.

You spoke earlier in the call about looking at valuations; valuations being too high. But just on a fundamental basis, when you look at these targets that are out there available today, how do you really assess the health of the industry? Do you see lower margins? What do you see when you look at these companies that might be affecting your view toward valuation?

Frank, I'd say a couple things. First of all, I don't want to suggest that there's a lot of them out there that we are looking at right now. I don't really get that sense.

When I look at them, I'd say a couple things when I say: What's the first thing I look at? I look and see that a lot of the ones that are for sale have been put together. They have programs that are in a relatively small town that have a 45 to 60 census. They do almost no high-acuity work. They are structured to never do any high-acuity work, so that they have a relatively low break-even point.

To the extent that we're a full-service hospice, we look at a program like that and say -- it's 45 census; if things went great and they took market share, it might grow to a 75 census in two years, three years. Well, we say that's still below our break-even point, given what we think is a full-service hospice. They want to be paid for that program. There's no chance of making a profit on it.

So, the first thing that jumps to me when I look at those is: What are the size of the programs and the potential size? If they have programs that don't have the potential to grow to an average daily census -- and I'm picking a number, but it's pretty close to this -- 300 -- it's just not of much financial interest to us.

Frankly, there aren't many hospice acquisition possibilities that fit our profile, as it were. Let's say you have one that has enough aspects that make it somewhat profitable or somewhat favorable, then you quickly get to Dave Williams and his financial department that says -- wait a minute, that multiple is 3 turns higher than what Chemed's selling for. So, it's just hard to put all that together.

But I guess what I'm really saying is: When you talk about the future and margins -- we don't look at the operating company's margin. We look at: What would that census do under our system? And that is, we're pretty confident that if it's in a major metropolitan area, has, for instance, aggressively treated cancer patients, we're going to have a situation where there's going to be a healthy mix between high acuity and home care. And if it's in a major metropolitan area, it's going to be at a reasonable reimbursement level.

Those factors -- those are necessary factors for us given our current system. We've talked about developing a, quote, VITAS-like, unquote, maybe for markets that don't have those characteristics, but it's been just talk at this point.

Tim, anything that I'm missing in regard to your -- your thought process?

I would reinforce what Kevin says. You ask a question about the marketplace, the healthy industry. The industry's very healthy. It's a service that everybody wants and needs.

I think the small providers are struggling with all of the increased regulatory pressures, the pressures that are being put on them by the referral sources that they just can't meet, and we can. So, total transparency is what's going on in the industry on eligibility, levels of care, quality statistics, which we encourage. And we just think the larger players are doing fine, and we don't need to pick up a company in a market we're at. We're growing very well.

In another market, as Kevin said, there could be a unique opportunity, but we have to look at what it would do for us, transition risk. But the way the industry's moving, it's working very well for VITAS's future, so we're very encouraged.

Frank, if you asked me, I'd say -- having heard all that, if you said, well, Kevin, is there any chance that VITAS's footprint is going to be substantially larger than it is today, over the next several years? I'd say probably not through acquisition. I see it more from referral source.

I'll give you an example. Tim has suggested -- the healthcare landscape for hospice is changing. The downside for these hospital systems to make bad referrals to somebody who's going to provide treatment that leads to a readmission or whatnot, changes the calculus a little bit.

To give you an example, if some of the big, national players said: Boy, we really would need you in Seattle, for instance -- we'd get our critical mass just from that referral source alone as a service to that referral source. That's more, if you ask me, long term what would drive an expanded footprint, not just the idea of -- let's expand the VITAS empire, build it and hope they'll come. We're unlikely to do that. We would want it referral-driven rather than just making ourselves available and hoping the business will come.

Okay. Thank you.

One follow-up -- maybe for Dave on the guidance. I was curious if you could give us a little color around where you think cash flow from ops may end up on the year -- some guidance there. I know there's been a lot of fluctuation over the course of the year because of some swings in AR. So, maybe just talk a little bit about DSOs and swings in AR and how you think that working capital dynamic will play into the cash flow from ops for the year. Thanks.

Roughly, and what we've been saying, which continues to hold true, on average we produce about $100 million of free cash flow per year. And our definition of free cash flow is cash from operations less capital expenditures. But then you add volatility you can have from year to year.

For example, at December 31, 2013 -- so, this past December -- our receivables were abnormally low. And that was largely driven by the government's PIP payment, the prospective payment, was basically funneling too much cash to us, given us our shift in high acuity, as well as sequestration didn't slow down the PIP payments quick enough. So, then, I think we were like at 21 days on hand of receivables at the end of December for VITAS. And then we built up that.

So, the long and short of it, I think we generated, what, $150 million of cash from operations in 2013 and $135 million in 2012 before CapEx. So, it's going to be lower than the $100 million just in the discrete 12-month period for 2014, but primarily because we had frontloaded some cash flow. Long way of saying is we probably anticipate somewhere in the neighborhood of about $50 million to $60 million of cash from operations within the 2014 year.

One other thing that impacted it also is: We accrued about $20 million-some-odd for litigation settlement. That was as a payable at the end of 2013. We paid that out in 2014. And we always carve those discrete items out from our cash from operations. So, a long way of saying it's going to be lower this year because it was so high in the prior year.

The other thing I would say is -- typical, so you can guess this -- to us, the cash flow from the businesses are very predictable and consistent. You only see four snapshots, which blurs the picture a little bit.

But, like I said, the cash characteristics of both of the businesses remain exceptionally strong. And I would expect 2015 -- we're going to generate $100 million of free cash flow.

Because all that PIP will have normalized, all that would have flown through the cash flow statement by then.

That's exactly right. In any one year -- if you end a year, and the following day you're going to get a PIP payment -- so, on January 2 -- your cash flow will look weak. If all of a sudden you ended the year on the day you receive the last PIP payment from the government -- you're talking $35 million -- cash flow looks strong. And you really have to smooth that noise out.

Okay. Thanks much.

I would now like to turn the call over to Kevin McNamara for closing remarks.

Okay. Thank you, everybody. I think some of you probably understood from the discussion here, we were very comfortable, happy with the results in the third quarter. Looking ahead to the fourth quarter, we think we've got a great jumping-off point, strong metrics in both businesses, and we're looking for a very smooth landing in the fourth quarter. And we will again meet to discuss those results in mid-February. Thank you for your attention.

Thank you very much. This concludes today's conference. Thank you for your participation. You may now disconnect. And have a great day.