Chemed Corporation — Q2 2016 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2016, compared with the same 2015 periods. Chemed operates VITAS hospice care and Roto-Rooter plumbing, drain-cleaning and water-restoration services. Amounts below are in millions unless noted.
Financial performance
- Revenue: Q2 revenue was $390.4 million, up 2.2%; first-half revenue was $780.8 million, up 2.9%. Q2 VITAS revenue rose 0.8% and Roto-Rooter revenue rose 5.9%; first-half increases were 1.9% and 5.7%, respectively.
- Profit and EPS: Q2 operating income was $38.4 million versus $44.6 million; net income was $24.9 million versus $27.0 million; diluted EPS was $1.48 versus $1.55. First-half operating income was $82.8 million versus $85.2 million; net income was $49.7 million versus $51.5 million; diluted EPS was $2.93 versus $2.96.
- Adjusted results (non-GAAP): Q2 adjusted net income was $30.2 million and adjusted diluted EPS $1.80, versus $29.7 million and $1.71. First-half adjusted net income was $58.0 million and adjusted diluted EPS $3.41, versus $56.5 million and $3.25. Adjusted EBITDA was $58.5 million in Q2 and $113.0 million for the first half; margins were 15.0% and 14.5%, compared with 15.1% and 14.6%.
- Margins: Consolidated gross margin was 29.2% in Q2 and 29.0% for the first half, slightly above prior-year periods. VITAS gross margin declined to 21.5% in Q2 and 21.3% year to date; Roto-Rooter improved to 48.5% and 48.0%.
- Cash flow: First-half operating cash flow was $73.4 million, versus $69.6 million. Investing used $19.8 million, including $20.0 million of capital expenditures. Financing used $50.9 million, primarily reflecting $94.3 million of treasury-stock purchases, partly offset by net borrowings.
- Liquidity and debt: Cash was $17.5 million at June 30. Total debt was $147.5 million ($60.0 million revolver and $87.5 million term loan), compared with $91.25 million at year-end. The company reported $252.6 million of available revolver capacity after letters of credit and compliance with debt covenants. Current liabilities exceeded current assets by approximately $20.5 million.
Material changes and operating drivers
- Roto-Rooter growth was led by water restoration, up 32.7% in Q2 and 25.5% for the first half, alongside gains in plumbing and drain cleaning.
- VITAS total days of care rose 4.4% in Q2 and 5.5% for the first half, but revenue growth was constrained by less favorable acuity mix and Medicare reimbursement changes. Under the 2016 Medicare hospice payment rebasing, management estimated VITAS revenue was 2.1% below the previous methodology for the first half; VITAS reported a 25/75 routine-homecare days-of-care ratio and about $1.0 million in service-intensity add-on payments.
- VITAS after-tax earnings fell 14.9% in Q2 and 8.5% year to date. Roto-Rooter after-tax earnings rose 9.8% and 9.1%, respectively.
- Q2 results included $4.5 million pretax ($2.8 million after tax) of costs related to the early retirement of VITAS’s former CEO. Management identified these costs as a principal reason reported net income fell despite revenue growth.
- Chemed repurchased 780,134 shares for $102.3 million in the first half and had $50.2 million of authorization remaining. The increase in debt was mainly associated with share repurchases.
Outlook, risks and contingencies
- 2016 outlook: VITAS forecast revenue growth of 1.5%–3.0% before Medicare cap, average daily census growth of approximately 4%–5%, and adjusted EBITDA margin of 14%–15% before cap. Management estimated Medicare cap billing limitations of $2.5 million. Roto-Rooter forecast revenue growth of 4%–5% and adjusted EBITDA margin of 20%–21%.
- Management expected operating income and cash flows to be sufficient for operations and commitments and described liquidity as satisfactory for foreseeable needs. These are forward-looking estimates and subject to risks.
- VITAS is appealing CMS’s “as if sequestration had not occurred” Medicare-cap methodology, which the company says could require $1.9 million repayment for two programs. No reserve was recorded for this potential exposure. The reported Medicare-cap liability was $0.5 million at June 30, 2016.
- A federal False Claims Act action alleges improper hospice billing and patient eligibility practices. Chemed said it could not estimate the probability or range of loss and intends to defend the matter. Related regulatory and investigation costs were $3.5 million in the first half of 2016.
- Shareholder derivative litigation remained unresolved; a proposed substitute plaintiff sought to proceed with an amended complaint. The company warned that legal matters may entail costs, management distraction, publicity and potential payments, and could adversely affect it.
- More than 90% of VITAS service revenue came from Medicare and Medicaid. VITAS also relied on two providers for over 90% of its pharmacy services. Variable-rate debt exposes the company to interest-rate changes. The filing reported no material change in previously disclosed risk factors.
Important facts for investors to verify
- Track VITAS census, patient acuity, Medicare reimbursement effects, Medicare-cap estimates and the outcome of the $1.9 million CMS appeal.
- Monitor the False Claims Act and related regulatory matters, including defense costs and any change in the company’s ability to estimate potential losses.
- Assess whether Roto-Rooter’s water-restoration growth and segment margins can sustain the company’s outlook.
- Review the effect of share repurchases and additional borrowing on leverage, liquidity and interest expense; confirm covenant compliance and available credit.
- Compare reported GAAP results with adjusted non-GAAP measures and consider the effect of CEO-retirement and other excluded costs.