Chemed Corporation — Q2 2013 Form 10-Q
Business and period: Chemed operates VITAS, a hospice-care provider, and Roto-Rooter, a plumbing and drain-cleaning business. This unaudited report covers the quarter and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $357.2 | $354.2 | $723.8 | $707.1 |
| Operating income | $25.9 | $39.5 | $64.7 | $74.5 |
| Net income | $14.6 | $21.3 | $36.9 | $41.7 |
| Diluted EPS | $0.77 | $1.10 | $1.94 | $2.16 |
| Adjusted EBITDA (non-GAAP) | $52.9 | $48.2 | $104.2 | $94.5 |
| Adjusted EBITDA margin (non-GAAP) | 14.8% | 13.6% | 14.4% | 13.4% |
Q2 revenue grew 0.9%; six-month revenue grew 2.4%. Net income fell 31.3% in Q2 and 11.6% year to date, primarily reflecting the Roto-Rooter labor-litigation settlement. Reported diluted EPS declined 30.0% and 10.2%, respectively. Adjusted net income was $27.2 million for Q2 and $53.4 million for the half-year; adjusted diluted EPS was $1.44 and $2.81. These are non-GAAP measures and exclude specified items.
Q2 gross margin was 28.5%, versus 27.3%; for the first half it was 28.2%, versus 27.2%. Roto-Rooter’s gross-margin improvement reflected higher revenue and lower health-care, casualty-insurance, and field-operating costs. VITAS after-tax earnings were nearly flat in Q2, while Roto-Rooter after-tax earnings declined to $1.4 million from $8.1 million.
Cash, debt, and liquidity
- Cash and cash equivalents were $113.0 million at June 30, up from $69.5 million at year-end 2012.
- Six-month operating cash flow was $84.7 million, compared with $54.7 million. The increase was driven mainly by lower receivables and higher other current liabilities. Capital expenditures were $12.2 million.
- Convertible notes had a $187.0 million principal amount and $179.2 million carrying value. They were reclassified to current liabilities because they are due in May 2014. The notes’ reported fair value was about $199.0 million.
- A new five-year, $350 million revolving credit facility was entered into in January 2013, with a $150 million expansion feature. Approximately $317 million was available to draw, excluding the expansion feature; $33 million of standby letters of credit reduced availability. Chemed reported compliance with debt covenants and no variable-rate debt outstanding at quarter-end.
- Six-month financing included $18.4 million of share repurchases and $6.8 million of dividends. The quarterly dividend was $0.18 per share, up from $0.16 a year earlier.
Business developments, outlook, and risks
- VITAS: Q2 revenue decreased 0.6%, while six-month revenue increased 1.7%. Average daily census rose 4.0% in Q2 and 4.7% for the half, but reimbursement-rate reductions, care-level mix, and weaker continuous-care and inpatient revenue affected results. A $0.855 million Medicare-cap charge was recorded in Q2; the six-month period included a net $0.018 million reversal, versus $2.6 million of cap-related revenue in the 2012 period. More than 90% of VITAS revenue came from Medicare and Medicaid.
- Roto-Rooter: Revenue rose 5.3% in Q2 and 4.4% for the first half. Management attributed growth to pricing and mix, drain-cleaning job growth, and contractor operations, including four acquisitions completed in 2012. Plumbing job counts declined in both comparable periods.
- Management outlook: For 2013, VITAS forecast revenue growth before Medicare-cap effects of 0.5%–2.0%, admissions growth of approximately 2.0%–4.0%, and adjusted EBITDA margin before cap effects of 14.0%–14.5%. Roto-Rooter forecast revenue growth of 4.0%–5.0% and adjusted EBITDA margin of 19.0%–19.5%. Management expected operating income and cash flows to support operations and commitments. These are forward-looking estimates, not guarantees.
- Unusual expense: Chemed recorded $14.8 million of Q2 operating expense for a tentative Roto-Rooter wage-and-hour settlement of $14.3 million plus payroll taxes; the stated after-tax impact was $9.0 million. Court approval remained pending.
- Regulatory and litigation exposure: The government filed a False Claims Act case in May 2013 alleging improper Medicare billing and hospice eligibility practices at VITAS; other related investigations and qui tam cases were also pending, with government intervention in certain matters. The government sought treble damages and statutory penalties. Chemed said it would defend the claims, but could not estimate their timing, outcome, or a probable and estimable loss. Investigation-compliance costs were $1.0 million for Q2 and $2.0 million for the first half. Management also cited potential defense costs, management distraction, and adverse publicity.
- Medicare reimbursement rates for hospice services were reduced by 2.0% effective April 1, 2013 due to sequestration, following a 0.9% rate increase in October 2012; management stated the net rate decline was approximately 1.1%. Changes affect a substantial portion of VITAS revenue.
Most important facts for investors to verify
- Progress toward repayment or refinancing of the $187 million convertible-note principal due May 2014, and continued covenant compliance.
- Developments and potential financial exposure in the VITAS False Claims Act cases and related investigations; the filing provides no clear estimate of potential losses.
- VITAS census, care-level mix, Medicare reimbursement, and Medicare-cap liability trends against management’s 2013 outlook.
- Whether Roto-Rooter’s operating improvement persists after excluding the one-time settlement expense, and how non-GAAP adjustments reconcile to GAAP results.
- Quality and sustainability of operating cash flow, including the effect of working-capital timing and settlement-related liabilities.