Addus is Home Health care service provider operating in a commodity market with beaten down stock price hanging from its ongoing class action lawsuit filed after allegedly misleading investors through guidance statements provided in the IPO prospectus. Following this, the stock price currently down 49 percent from its listing price of $9.4 (Oct. 28, 2009) to its current price of $4.8. With Mkt.Cap of $51mm, debt of another $50 mm and with very little cash the stock is trading at 6.7x LTM EBITDA. This might not seem like a bargain on the face on it but given the long-term prospects of the business and some hidden assets, Addus is a good business to invest at its current price. 

Thesis:

1)      Accounts Receivable 1.5x Mkt. Cap, Total Debt: Addus has about $76 million in accounts receivables (net of allowances), which is more than its current total debt ($51 mm) or market cap ($51 mm). Most of it is owed by fed and state government and so for all good reasons default free. Though this will not drastically reduce in the near future, things are looking positive. DSO has reduced and IL has increased state taxes which should help reimburse these services more quickly. Because this value is not captured in the EV number, the trading multiples look high and financial ratios look bad.

2)      Potential for top line growth by transitioning to a Sales Organization: From its inception in 1979 to 2009 when it did its IPO, the company was essential a mom and pop shop, which took orders and did not have a sales team in place. The Company is currently trying to transition from its traditional practice to being a sales organization. Current Efforts in this direction are a) Sales team in place and new sales manager positions created (2nos). The sales reps are still amateur and will take a couple of months to show true potential. b) New CRM system in place 3) hired senior level sales consultants to form sales strategies.

3)      Better standards of Operations: Company has added new COO position to increase profitability, drive growth and full realization of integrated model.  On Jan 5,2011, Addus announced  that they hired Daniel Schwartz as Chief Operating Officer, effective January 19, 2011. Daniels bio looks good and suited for the position.

Bio from news article: "Schwartz joins Addus with more than 20 years of experience across a broad range of healthcare operations, including assisted living, senior housing, skilled nursing, and home health care. For the past 15 years, Schwartz has held positions of increasing responsibility at Sunrise Senior Living.  Most recently, Schwartz served as Senior Vice President of North American Operations at Sunrise, where he oversaw the assisted living community operations in the U.S. and Canada and had full P&L responsibility for North America, which included 400 communities and more than 32,000 employees.  Throughout his career at Sunrise, Schwartz successfully increased profitability of the units for which he was responsible.  Schwartz began his career at Life Care Services Corporation, a leading developer and manager of senior living communities, in 1990.

Schwartz earned both his Masters of Health Care Administration and Bachelor of Arts, Psychology from TheGeorge Washington University.  Schwartz is a founding member of the Indiana Assisted Living Association and the National Associated for Private Duty Home Care, and a founding Board member of the Pennsylvania Assisted Living Association. "

4)      Integrated Model: The Home & Community and Home Health integrated service model has huge potential and can be a huge revenue source without additional expenses and can also drive margins higher. (details included in business section). The integrated model is currently in R&D stage because of which the revenues on the Home Health side are fluctuating.

5)      Recent stock purchase by CEO - Mark Heaney and new CFO - Dennis Meulemans: Though the stock purchase quantities have been pretty small ($100k total), I was like it to see officers buy part of the business that they run.

6)      Long -Term business prospects: Home health care is not an exciting and dynamically changing business but this is a business which will continue to do well even in the worst of economies. Plus, given the increasing healthcare costs and pressure on Fed and State governments to reduce budget deficits the focus is to move patients from hospitals and institutions and have them treated at home.

7)      Macro factors: Fed and States trying to reduce healthcare costs, general inclination is to move towards home health care; the cheapest source of care. Growth in aging population, increased life expectancy etc.

Business:

Addus provides in-home social and medical services to the elderly and disabled individuals who are at the risk of being institutionalized or hospitalized. Addus operators in 19 states through over 134 locations ( 101 home and community locations and 33 home health). 

Business is divided into two segments. 1) Home & Community 2) Home Health.

1)      Home & Community: Services provided are social in nature and includes personal care, home support service and adult care. These are provided by paraprofessional staffs - homecare aides on an as-needed and hourly basis.

-          Personal care: include bathing, grooming, mouth care, skin care, assistance with feeding and dressing and medication reminders.

-          Home support service:  meal planning and preparation, housekeeping and transportation services.

-          Adult care: Addus has five day care centers in Illinois. Services include social activities, transportation services to and from the centers, the provision of meals and snacks, personal care and therapeutic activities such as exercise and cognitive interaction.

State and local Medicaid programs are the biggest payor of the Home & Community services and accounts about 95 percent of the reimbursements. Rest are privately paid or covered through some insurance programs. Medicare does not reimburse for personal care.

The operating model of Home & Community business is simple. They treat on an average of about 21,000 individuals at a given point of time. These consumers are treated about 11 to 13 hours a week and reimbursed at about $17 an hour. Addus pays their paraprofessionals an average of about $10 plus transportation and other benefit expenses, which leaves Addus with a gross of approx $4.5 (25%). The best part of the business is that they treat these consumers on a long-term, continuous basis (average 20 months) and hence the business is very predictable in the near term. 

2)      Home Health: This is the traditional form of home health where professionals provide medical services to patients at homes usually after acute illness or a surgery. These services have to be prescribed by physicians by visiting the patients home or during discharge from hospitals, institutes etc.  The services are offered by skilled and professional people like nurses, therapists, medical social workers etc.

Addus gets around 18 - 20 percent of their revenues from Home Health service.

Medicare is the biggest payor and reimburses about 60 percent of the Home Health Care services. State and local programs reimburse 20 percent by. Insurance programs 10 percent and rest by private payors.

Unlike personal care, which is reimbursed on hourly basis, home health is reimbursed on per episode basis. (Episode is basically a 60 day home health care service provided by the agency per the doctors predetermined schedule.) The per episode rates for Medicare are fixed by Medicare Prospective Payment System (PPS) and these are revised annually. Per episode rates increased by about 1.75 percent in 2010. An average payment per episode in 2010 was $2313. The Gross Margins in Home Health are much higher and about 45 percent but currently the fixed G&A expenses are high, which makes the Pre-Corp EBIT margins volatile based on top line revenues. Also, since consumers are treated for a relatively short period of time, more expenses go towards replacing the consumer.

Integrated Model: Currently, a home health consumer is identified usually after post-acute treatments, when a physician certifies that the patient needs home health care and refers the patient to different agencies. To attract these patients/consumers, the normal sales procedure is to knock on doctors doors and convince them to refer patients. This market is crowded by highly competitive. The biggest advantage for a personal care provider like Addus is that, it can target the consumer pre-acute. This is how the process works; personal care paraprofessionals while providing continuous treatment to the consumer can identify changing needs of the consumer and can report cases with pre-acute conditions to its home health segment. The Home Health Staff can then have physician examined the patients at home and get them certified for home care. At this stage, chances that the patient selects Addus's service for Home Health care are more. On the part of Addus, the effort/expenses required to get a new consumer registered to its Home Health Service via this route is much low. Medicare and the patient also save money from identifying and treating the patient without hospitalization.  In most cases Addus can end up providing dual (personal and home health) care to the patient.

Addus realizes that the integrated model is a huge potential market and is currently beta testing their integrated model at selected home health locations. This is still in its R&D stage and during this process their Home Health revenue numbers have fluctuated a lot. The recent hiring of their new COO - Daniel Schwartz should help things move in the right direction.

Industry:

According to National Association of Home Care & Hospice (NAHC), there are about 12 million individuals receiving home care services. Annual spend of about $75 billion or 3 percent of healthcare expenditure. According to NAHC estimates it cost about $6200 per day for a patient vs. $622 per day for skilled nursing and $135 per visit for home health, which is why fed and states are trying to push home health

The industry is highly fragmented with about 10,500 Medicare certified agencies - proprietary (for-profit), governmental, non-profits etc. Most of these firms are very small private firms with revenues less than $3 million. Unlike the Skilled Nursing Facility (SNF) industry, which is populated by large public companies, the personal care industry is void of these big firms. The home health industry is basically a commodity industry where you do not have barriers to entry but the pie is too big for everyone to participate. But the key to the game is to keep expenses low, provide better service with a long-term consumer focus and try to grow by increasing presence, which will in turn help reduce major fixed expenses.

The current state budget deficits faced by majority of the states have had a huge impact on the personal care business. Reimbursements are made on much delayed basis. State of Illinois pays Addus approximately after 150days from providing the service. This has caused huge cash-flow problems for small mom and pop shops providing personal care business. The difficulties in financing their business have driven many shops out of business. While this is not great news for Addus either, Addus is seeing increasing inflow of these consumers from other providers gone bust.

Growth estimates- The fed and other programs have been highly promoting home care because it is the cheapest form of treatment and the industry is estimated to grow at about a CAGR of 8 percent. 

Valuation:

The home & community care is a much easier business to predict and has been growing steadily through last couple of years through acquisition and organic growth.  The long term Home Health business revenues are not easily predictable owing to the ongoing implementation of their Integration Model. From a sustainable business model estimates Addus is currently trading at 5.6 times free cash flows.

Though I do not want to throw a price target for the stock, on a scenario based calculation the Stock can trade at $5.4 to $8 in the near future.

       (Assuming 80% revenues from Home & Community and 20% from Home Health)

Class Action Lawsuit:

The complaint asserts claims against the Company and individual officers and directors that the Company's registration statement was materially false and/or omitted the following:

(1) That the Company's accounts receivable included at least $1.5 million in aging receivables that should have been reserved for; and

(2) That the Company's home health segment's revenues were falling short of internal forecasts due to a slowdown in admissions from the Company's integrated services program due to the State of Illinois' effort to develop new procedures for integrating care.

On Sep. 2010, Addus filed a motion to dismiss the complaint on behalf of the defendants saying that the claims are without any merit and intends to defend the litigation vigorously.

Glancy, Binkow & GoldBerg LLP is acting as attorney on the behalf of investors. More details can be found on http://www.glancylaw.com/amazing_case.php?caseid=267

Risks:

-          Short term liquidity issues, ebitda can fall below requirement, which can create issues in drawing from revolving credit lines. This unnecessary revolving debt to operate their business is impacting the bottom line.

-          The lawsuit goes against Addus causing it to pay substantial amount of cash.  

-          Ongoing healthcare reforms and the mounting pressure on fed and States to reduce deficit have made the states and fed take one or more of these actions (from annual report)

•  Limiting increases in, or decreasing, reimbursement rates
•  Redefining eligibility standards or coverage criteria for social and medical programs or the receipt of homecare services under those programs; 
•  Increasing the consumer's share of costs or co-payment requirements;
•  Decreasing the number of authorized hours for recipients;
•  Slowing payments to providers;
•  Increasing utilization of self-directed care alternatives or "all inclusive" programs; or
•  Shifting beneficiaries to managed care programs.