Chemed Corp (CHE) 2005 Q2 法說會逐字稿

Good morning, ladies and gentleman. Welcome to the Chemed Corporation's Conference Call for the second quarter of 2005 ended June 30, 2005. My name is Bill, and I will be your conference call facilitator today. Please note that today's call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. [OPERATOR INSTRUCTION]

Before we begin, let me remind you that the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 applies 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 August 3, 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 August 3, which is available on the Company's website.

With that, I would like to introduce our speakers for today -- Kevin McNamara, President and Chief Executive Officer of Chemed Corporation, Dave Williams, 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 Mr. McNamara.

Thank you. Good morning, everyone. Welcome to Chemed Corporation's Second Quarter 2005 Conference Call. I will begin with an overview of the second quarter. David Williams will provide detailed financial metrics and updated earnings guidance, and Tim O'Toole will follow with specifics on our hospice operation. I will then open up this conference for questions.

In the second quarter of 2005, Chemed continued to generate strong fundamental performance. On a consolidated basis, our Q2 2005 revenue increased to $226 million. Our adjusted EBITDA was $29 million, and our adjusted diluted earnings per share from continuing operations was $0.45, exceeding the upper end of estimates listed by First Call.

For Q2 2005, Roto-Rooter segment, sales of $73 million, was an increase of 5% over the prior year quarter. This revenue growth was concentrated in our commercial business, with residential sales essentially flat with the prior year. This 5% revenue growth was leveraged into net income of $5.7 million in the quarter, an increase of 10%.

Adjusted EBITDA was $11.3 million, also up 10% from the prior year.

VITAS continues to expand its market penetration. In the second quarter of 2005, revenue increased 18% to $154 million, and our adjusted EBITDA was $19.5 million, up 21%, resulting in an adjusted EBITDA margin of 12.7%. VITAS' ADC in the second quarter of 2005 was 9,913. This compares to an ADC of 8,581 in the comparable prior year period, an increase of 15.5%, and 4.1% sequential growth over the first quarter of 2005. Admissions totaled 12,646, an increase of 10% over the second quarter of 2004.

Our average length of stay for the quarter was 66.8 days. This compares to the first quarter of 2005, of 66.2 days, and the second quarter of 2004, 60 days. Our median length of stay in the quarter was 12 days. VITAS' profitability growth is derived from three distinct initiatives -- organic growth, new starts, and acquisitions. Our organic growth is being generated from a combination of increased admission, increased length of stay, and increased Medicare reimbursement rates.

Fundamentally, long-term growth comes from increased admissions. However, in VITAS' largest programs, those programs that already have dominant market share, the majority of growth will be derived from life-of-stay expansion and our annual Medicare per-diem adjustment. This is reflected in our second quarter results.

In VITAS' six largest programs, revenue increased 11.1%. ADC increased 7.8% and admissions increased 2.2%. Although this rate of growth is slower than VITAS' average, it is sustainable. The current cap cushion in these programs provides the opportunity for length-of-stay expansion. VITAS' six large programs have an estimated aggregate cap cushion of $87 million for the 2005 cap year. This equates to aggregate revenue in these six programs being 32% below the Medicare cap.

VITAS had an excellent quarter in terms of admissions, ADC and length of stay. We anticipate this trend to continue into the foreseeable future.

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

Thanks, Kevin. As Kevin noted earlier, Roto-Rooter continues to generate solid operating results. Sales increased 5% to $73 million. Gross profit margins remained relatively constant at 44.5% and adjusted EBITDA increased 10% to $11.3 million. This resulted in an EBITDA margin of 15.5%, a 50 basis point expansion over the prior year period

The job count in the Company owned and operated territories for Roto-Rooter was 197,600, which was a decline of 3/10 of 1% over the prior year quarter. However, net in this job count is a 7.9% increase in commercial plumbing jobs, a 3.3% increase in commercial drain cleaning jobs, and a 1.5% increase in residential plumbing. This growth was offset by a 4.7% decline in residential drain cleaning job count. We anticipate the shift in job mix to continue, as Roto-Rooter proactively markets to the commercial sector and continues to expand the plumbing workforce.

VITAS generated revenue growth of 18% over the prior year period, and 5.3% sequentially. Gross profit margins were 21.4% in the second quarter of 2005, a 40 basis point decline when compared to the prior year period. However, this decline is directly -- the result of our new startup development efforts. The second quarter of 2005 gross margin includes $1.4 million in startup losses, which is $800,000 higher than the $600,000 loss from programs classified as new starts in the prior year period.

Central support costs for VITAS, which are classified as selling, general, and administrative expenses in our statement of operations, totaled $13.6 million, including $300,000 in legal expenses related to the OIG investigation. Excluding these costs, central support expenses increased 8.3% when compared to the prior year quarter, and increased 1.6% sequentially. This relatively low rate of growth in administrative expenses resulted in the expansion of our adjusted EBITDA margin to 12.7%.

As we noted in yesterday's press release, all of our base and new start programs are forecasted to have a Medicare cap cushion for the 2005 measurement period that ends on October 31, 2005. We have been closely monitoring Medicare cap limitations in our Phoenix acquisition, which was completed in December 2004. The potential of reaching cap in our first year of ownership for Phoenix was considered as a risk factor during our due diligence.

Admissions generated by VITAS for Phoenix in 2005 have exceeded the 2004 level. However, discharges of patients admitted to the Phoenix program prior to VITAS' acquisition happened at a slower rate than anticipated. Based on these factors, Phoenix is forecasted to have a Medicare cap liability of 1 million to 1.5 million as of October 31, 2005. This estimated cap accrual has been accounted for as a contingent liability assumed at acquisition, and is not reflected in the consolidated statement of income.

VITAS anticipates [creating] cap cushion in the Phoenix program in 2006 by increasing access to shorter stay patients and broadening access to inpatient and continuous care patients. This broadness of patients is consistent with the clinical model provided by VITAS in its other programs.

VITAS' days sales outstanding, or DSOs, in the second quarter of 2005 were 43.8 days. For the past 13 months, our DSOs have ranged from 35.1 days to 43.8 days. This is approximately 8 days higher than our historical average; 4 days of the increase is the result of delayed billings and acquisitions, 4 days for Medicare balances in certain states that have delayed payment, and 1 day for our new start activity. These issues should be resolved, and our DSO more normalized in the coming quarter. That expense continues to be calculated at 90 basis points of revenue.

Looking forward into the full year 2005, we anticipate VITAS to increase revenue in the range of 16 to 18%, with adjusted EBITDA margins increasing modestly in the second half of the year. This operating margin expansion will continue to be generated from leveraging our central support costs. Programs for field based gross margins are anticipated to track at historical levels and [inaudible] should average 1.5 million per quarter.

Roto-Rooter is estimated to generate a 5 to 6% increase in revenue in 2005, with operating margins that are modestly above those generated in 2004. Based upon these factors, a go-forward effective tax rate of 39%, and a current diluted share count of 26.2 million, our expectation is that earnings per diluted share for 2005, excluding costs associated with the early extinguishment of debt and charges of credit not indicative of ongoing operations, will be in the range of $1.77 to $1.82.

With that, I'd like to turn this call over to Tim O'Toole, our Chief Executive Officer of VITAS.

Thank you, David. As Kevin mentioned earlier, VITAS had an excellent quarter. Driving these results was strong performance in all of our key metrics. In the second quarter of 2005, VITAS revenue increased 18% to $154 million. Average daily census was 9,913, up 16%, and admissions were 12,646, an increase of 10% over the prior year quarter. We had 902,000 days of care in the quarter, of which 9.1% were for inpatient and continuous care.

Internal growth at VITAS, which excludes the 2004 and 2005 acquisitions, generated revenue increases of 14.3%, ADC growth of 10.9 %, and an admissions increase of 7.2% over the prior year quarter. This growth rate expands when we separate out our six largest programs, those programs with an ADC above 450 census. Under this comparison, revenue increased 17.7%. ADC was up 14.2 %, and admissions increased 11.5%.

As Kevin mentioned earlier, growing admissions is the cornerstone for long-term growth. This is accomplished on a program-by-program basis, by the hiring and retention of quality individuals who are focused on meeting and educating existing and potential referral sources. Complementing this is an admissions process that has focused on counseling, prospective patients and their families as to the benefits of VITAS hospice care.

At the end of the second quarter in 2005, VITAS employed approximately 185 sales representatives. This is up from 160 sales reps that we had at the beginning of the year. In addition, we now have over 300 nurses and other personnel dedicated to patient intake.

Admissions by major diagnosis continues to be relatively stable, with 36.6% of our second quarter admissions being cancer related, 18.7% neurological, 13.8% cardio, 6.9% respiratory, and 24% for all other categories. As part of VITAS' growth strategy, we are focused on increasing the market penetration of small and medium programs, as well as expanding a number of markets in which VITAS operates. We anticipate new starts will be the primary vehicle to enter these new markets. Although new starts negatively impact our current earnings, we view this portion of our expansion strategy to be cost effective and will provide a high return on capital.

We currently have 11 programs classified as startups, 8 of which are licensed, and 5 of these are Medicare certified. In the second quarter of 2005, these startup programs had an ADC of 244 patients, with revenues of $3.2 million, and operating losses of $1.4 million. In the prior year quarter, these same programs had an ADC of 20, with revenues of $300,000 and operating losses of $667,000.

With that, I'd like to turn this call back over to Kevin McNamara.

And now, we'll be able to take any questions that you might have.

Thanks very much, sir. [OPERATOR INSTRUCTIONS]

Our first question comes from the line of Mr. [Kevin Fishbeck] of Lehman Brothers. Please proceed.

Okay, thank you. Good morning. I had a question here on the Phoenix Medicare Cap issue. I just wanted to go over the accounting. It sounds like that you both have reserved. You are now booking the full amount of revenue for all of those patients in the quarter. If you could just clarify that, and then also, if length of stay does not come down like you expect it to, at what point would you start to accrue on the income statements?

You are correct. The full revenue was recognized. Again, basically, all services were provided for the patients that were in hospice the day we closed the program, and what really happened was again, we're very comfortable with our admissions intake. But, actually, discharges in the second quarter of 2005 dropped to a very unusually low level. So again, because of the way they make our cap, we continue to have to treat those patients with basically no revenue reimbursement the way the cap works, and this is viewed and is a contingent liability that we assumed at acquisition. As a matter of fact, it was specifically identified when we did our due diligence.

On a go-forward basis, what really happens is clearly, these patients will be discharged, and we actually anticipate and we've seen the patients that have admitted under our care actually have shorter lengths of stay. So we expect a large portion of this to be mitigated, and then long-term, we're going to expand the Phoenix Program to have the same type of census that we have in all of our other programs where we have very short stays that receive continuous care and inpatient, and of course, through traditional routine home care which tends to have longer stays.

And this is Kevin McNamara. Let me just also say that they said we referred to Phoenix as a fixer-upper. We knew the reason the owners were very motivated to sell was they had a cap issue staring them in the face. We got a very good price on it, and in fact, even when you look at the income generated from the cash and income generated from this acquisition since we've owned it, even after the accrual for the cap, our recurrent cap was still around 10%. So, it's something that we view as a fixer-upper. It's one where, if we didn't think we could operate things differently than the previous operator, we'd have a continuing problem in Phoenix, but our strategy is that we think that Phoenix will be just like the other markets we're in, and we'll have success in getting more admissions, shorter length of stay overall, and as a result of it, get what will be a real great price on the acquisition of Phoenix.

And Kevin, this is Dave Williams again. Probably very important to notice, Phoenix is unique to all of our other programs, where it started out substantially focused on assisted living patients. In no other program do we have this type of concentration on that specific type of patient from those referral sources, so Phoenix was unique. The base of their patients is unique, and then of course, our goal is to get rid of that uniqueness and have it more reflective of the census demographics we have in all of our other programs.

Okay. I think last quarter you had said that you had two caps that had less than 10% cap. [Inaudible] was one of them. Can you give us an update on the other one?

We actually -- of course, this actually changes as we get closer to the wall, which is basically October 31, 2005. Beyond Phoenix, we have 3 programs with less than 10% cap cushion, but they do have cap cushion that looks like it's going to hold very comfortably to the end. We don't anticipate any cap problem beyond Phoenix in any program for this year.

Okay. And then, one last question. It looks like the other income was a bit higher than where I would've thought. Can you kind of go over what was in that?

Actually, that's a very good question. There was $600,000 of other income that was included in our statement of operations, but there's actually a couple things going on. The most important is of that $600,000, $354,000 is income from a [Rabi] trust, and the way that works is it's a deferred compensation program. So what happens is, as the trust gains in value between equity gains and interest, we book $354,000 of higher compensation expense in our selling and general administrative line item, and that's directly offset by $354,000 of other income. It nets to zero on a pre-tax basis, but GAAP accounting requires you to gross up your SG&A, and gross-up your other income. So really more than half of the $600,000 was due to that. And then the remaining amount, about $263,000, is just a modest amount of income on our cash balance that again, should continue on a go-forward basis. So if anyone is doing the modeling exercise, your choice is to assume $354,000 continued for [Rabi] trust. Our SG&A was higher and our interest income is higher, or you can net it out. But, basically, that $600,000 is a very sustainable number quarter-to-quarter.

Okay. And so the increase in the [Rabi] trust, is that determined upon your stock price or the market in general?

No, it's outside investments, but with a fair amount that can be -- it was changed to be exclusively Chemed's stock and just for economy, it was totally switched over.

This is pure basically mutual fund balances.

Okay. All right. And so if that amount is net out, then, yes, you may line to zero?

That's right, and it goes the other way, too. If there's a loss -- if, for whatever reason, the market has a downturn and you lose $354,000, that'll be shown as an extent in other income expense, and it will actually reduce our SG&A, but the key point in this one is it always nets to zero. I guess we do this in the interest if clarity for GAAP accounting.

Okay. Thanks very much.

Thank you much. Ladies and gentleman, your next question comes from the line of Matt Ripperger from Smith Barney. Please proceed, sir.

Hi, thanks very much. Just a couple questions. Going back just to the Phoenix question, I just want to clarify. If I recall correctly, when you purchased that small little [holding] acquisition, it had sort of in the range of a couple hundred patients at best. Is the ADC contributions in that market less than a couple percent of your total Company?

Hello, this is Tim O'Toole. The ADC is -- you're correct. It was around 200 when we acquired the business, and it's similar to that today. It's a little higher. As we mentioned, because of the length of time that the patients stayed on compared to the new admissions, the census went higher, and so it's very similar to when we bought the Company today.

And it's primarily routine, so it's got a higher percentage of routine than the rest of the Company?

That's correct.

So on a revenue basis, it's probably like a percent of revenue?

It would be a smaller percent than just dividing the census, yes, because the average revenue per day is smaller because they do not have inpatient or continuous care there right now.

Okay. So it's pretty minimal.

And that -- this is Dave Williams -- just to give you a feel for what happened, it did stay -- the census stayed constant about 220, a hair above, and really what happened is in the second quarter, it actually spiked to about a peak of 265, reflective of low discharges, and actually, it's coming down at this point. We actually are probably being conservative at the 1.5 million estimate forecast because census is coming down with discharges, but, yes, it did spike up because of that.

Okay. Second question is you've done a couple of fold-in acquisitions like Phoenix. I think it was Atlanta and then also Pittsburgh. I just wanted to see if you could give us sort of a broad overview in terms of how those smaller deals are going, and then as you look at sort of future acquisitions, should we expect similar types of deals, or is there an opportunity for you to do some of these larger regional hospice deals where you find a not-for-profit system that has a real density in a specific market?

Matt, this is Tim. I mean, the three deals, you're right, Atlanta, Phoenix and Pittsburgh, we're very pleased with all three of those. The Phoenix issue we've discussed quite a bit. We know Phoenix is a big market. We're a 10% market share player there, and we know we'll get the business looking more like VITAS in the future and it will be a great one for us, as Kevin mentioned financially, as well as we know it's going to be a good program.

Atlanta was really a running start. We had a program there that we started with under 20 patients. Today, we're over 60, somewhere between 60 and 70. So, we made very good progress there. We're still reporting modest losses in that one because we're building it, building the sales structure, building the office and the caregivers there, but we're very pleased with Atlanta. We think it's a great opportunity in that market and I think as we move forward, we'll be able to expand in other areas of the city with other offices, so we're very happy with that.

Pittsburgh is relatively new for us. It's hitting its targets. The census there is under 100, and it's really looking like a good opportunity to expand throughout the Pittsburgh area and, again, we've invested. The strategy was to invest in the marketing sales reps there, and we're doing that, and it's a good solid program, so those have worked out about as we had hoped. The census is doing well. We're growing them all.

As far as future deals, yes, we can look for small fold-ins like that. We also do still expect to have a lot of discussions about acquisitions. That's still part of our strategy, as Kevin mentioned. Right now, there's nothing eminent, obviously, and we're very enamored by the new start opportunity. We're going to move on that aggressively and expand it, and acquisitions, they're hard to predict -- kind of like catching lightening in a bottle. So, sometimes, you don't know when they're going to happen, but I can tell you there's a lot of activity, with both the small ones and some regional players that could be larger for us. So all the strategies with the acquisition program look pretty good. But the opportunity for new starts, we're very excited about, so we're expanding in that area.

This is Kevin McNamara. The only thing I would add is to amplify Tim's point, and that is that, yes, we're very committed to new starts. The financial under-pinnings of those are hard to question, but there's no question. The pot of gold at the end of the rainbow from a fast expansion, there's no question to the extent it's not for -- large not-for-profit that, for various reasons, might become available. They're usually very similar to our business model; kind of take on all comers. The average length of stay is very similar to ours. Those are the ones we would think would move very, very easily into our systems. We'd immediately give them better systems. Almost without exception, their EBITDA margins would improve dramatically in those operations. That's the pot of gold at the end of the rainbow. There are a variety of factors that could potentially lead the not-for-profit to [seek] out of VITAS. Again, we're not seeing it yet, but that is, no question, something that we're constantly pushing and working on.

Okay, great. And just on the hospice regulatory side, if I could, there were some regs that came out a few months back that seemed to imply that you could expand the service area around a provider number and maybe could get some sort of leverage from your specific provider number, rather than having to open an adjacent branch or something like that. I just wanted to see if you could give a little color on that specifically, and anything other in terms of hospice regulatory nuance that might be benefiting the outlook going forward?

Matt, you're referencing the conditions of participation that were recently put out.

Yes.

And they're going to have a lot of comment. We've given a lot of comments both from our Company, as a national organization. Hospice and [inaudible] care organization has given a lot of comments. We've worked at the state levels through all of our grass roots efforts at all of our programs to get the appropriate comments in. The specific one about the satellite and using the license at the satellite, not so sure exactly where it's going to come out. It really comes down to the view of the regulators in each state, and we've heard some people that have read that and focused on it. We're not sure there's a big change there. Right now, there's flexibility. Every state is different and every fact pattern in every state is unique, because they just don't want you to have operations too far away from where the records and regulatory oversight is. So I don't think that's going to be any big change for us. We're finding pretty good flexibility, and in many of our new start opportunities, where we're clustering new starts in regions, we are using satellite opportunities to build sooner than we could otherwise. And that's really something we're accelerating that model, because if you just go out there in an independent place, you sometimes run the risk of the state coming to survey you, so the satellite works well.

Other areas in the conditions of participation, we do not feel we'll have huge changes to the Company. They're tightening things up, giving better definitions, and keep in mind, once those are finalized, my understanding is it's several years, I think, 3 years before they become operative, so just to comment on your point specifically.

Okay

Matt, this is Dave Williams. Clearly, what the proposals of participation with CMS is clearly telegraphing is their desire to have these provider numbers cover a larger geographic area because of the limitations that the current cap model creates, and to the extent the states want to have hospice providing these more difficult real markets, they're going to have to buy into CMS's desire to have larger regions covered under a single provider number. So it's a very good indication of where CMS's direction is going, but clearly, things have to be worked out.

Okay, great. And then the last question, just -- you're sitting on about $18 million of cash, pretty under-levered at 1.8 times. It looks like you're going to generate strong free cash flows for the remainder of this year. Absent an acquisition, is there any other use of proceeds that we should take into account?

At this point, we'll let the cash accumulate on the balance sheet. In a little over a year and a half, anywhere interest rates are, it could be to our advantage to do something with our fixed rate notes without a premium, but at this point, we're going to accumulate the cash on the balance sheet because we fully anticipate opportunities. Even if they don't develop in '05 for acquisitions, they will happen in '06.

Great. Thanks very much.

Thank you very much, sir. Ladies and gentleman, your next question comes from the line of Mr. Eric Gommel of Legg Mason. Please proceed.

Hi. Good morning. On the plumbing business side, have we reached sort of a normalized kevel of performance, or is there still room for improvement? And as such, what is the possibility of a sale of that business at this point?

Well, let me start by saying that I think that we're very pleased with the level of certainly profitability on the Roto-Rooter business. The margin is in excellent shape. We've probably explained about the fact that our attrition rate among plumbers and drain cleaners is at a historic low, which has a lot of good things. People make more money. I mean, we're not training people -- spending a lot of money training people; we're not cycling through people. It allows us to keep a little bit lower staffing because everyone's more experienced, which means that people get more jobs; they make more money; everyone's happy. It's self-propagating.

The margin of Roto-Rooter, I think, is very good to the extent that we see two things happening, which are good in the business, and that is residential jobs stabilizing, and when you couple that with strong growth in the commercial market, it makes for an increasingly good picture. I mean, I don't want to really speculate too far into the third quarter for Roto-Rooter's business, but the second quarter, which was good, is not going to be an anomaly. The business remains very strong, but again, to answer your first question, yes, it can get a little better. The commercial business can continue to get stronger. We're putting a lot of effort in it. Residential -- flattish is the best we're hoping for on the residential side for jobs on the Roto-Rooter business, but with that combination, I think we'll still show moderate growth sales line with good management expenses, good net income growth.

Now, with regard to -- are we likely to sell it at this point? Again, don't have a good use of proceeds. It's a business that still has geographic growth opportunities with buying in other Roto-Rooter acquisitions. We're in -- the discussions we're in presently tend to focus more on the smaller one now, the smaller opportunities that we're putting into our contractor business, which is going excellently. So really what we're really just saying still for our larger multi-location franchisees, look, we're doing well, probably better than they are. And to the extent that we are a buyer out there, but just still not a motivated buyer until there was some reason, that is -- in the past, I've said a potential one might be that if opportunity to buy several very large not-for-profit hospice opportunities, yes, we might have a use of proceeds, but now we would just -- again, the same issue of solid business, no reason to seek a sale out now and just pay a lot of tax

Okay. Is there any new information on the civil subpoena at this point?

No information. I mean, I would characterize it as the same characteristic I made last quarter at this time, and that is we were still in the information gathering and responding stage. I was personally happy to say that at least the first thing that -- the first determination I made, which is did we have our i's dotted and our t's crossed, and generally we did. We don't have anymore information from the OIG, and we've just about completed all the information that they've requested and again, we'd -- rather than just make it a document dump, we have annotated and explained virtually every case file by a medical professional to help them understand what's there. So a lot of effort has been put into it, and we have no idea as far as what their -- the source of their inquiry, where they end up, where they're going. No information to go on other than I would just say, again, we're -- we think that with regard to operating our business, we have the documents that support out billings and what-have-you, and I guess I feel good that we wouldn't have that without the systems that we have and that shows we're getting something for all the money we're spending on systems.

Okay. And then my last question and I'll get off. On the acquisition side, just circling back there, you talked about how the Phoenix owners were compelled to sell the business because of cap issues. Could you make a comment on what you think maybe Medicare cap going forward might have on other providers? Do you think that's going to spur more sales? And then one other thing on the acquisitions. Could you talk a little bit about what kind of multiples you might be seeing out there?

Let me answer the first part and then maybe I'll turn over to Tim for the second part. On the first part, I think it's unavoidable. If they do not change the Medicare cap provision, there's already a substantial percentage of all hospices that are in cap. I guess Dave is saying that they come in with 10% of all providers that are already in the cap situation. When you look at what's going on when you have these other disease states to be hospice appropriate, and the effect that's having on length of stay, and the fact that more information is having with regard to patients on length of stay, again, there's going to be canaries in the mineshaft that are going to be affected by it. And to the extent that we can prove that we can take these programs, use the VITAS business model to alleviate the cap problem, it's going to be a great opportunity.

Well, will it push? As we get from -- go from 34 programs to 54 programs, will it be more likely we have one or two programs that get near or close to cap? Yes. Everyone is being pushed closer to the wall. Luckily, in most of our programs, we have a very significant cap cushion, and we also think we have the policies, procedures and systems that will allow us to make the best of these difficult situations. So yes, to answer your question, no question. Internally, we view that as a fantastic opportunity as long as -- we don't want it to be a trap for the unwary or a fool's paradise. We think we can deal with it. We think that a lot of other people will have no ability to deal with it, so we're not really pushing for changes in the Medicare cap provisions right now because we think we're going to be the net winner as a result of them, but in regard to what people are looking for --

As far as the opportunities out there and the pricing of them, they're all across the board and many times, you don't know the proper [string] you're buying, certainly, or what it's going to look like right away. A lot of people look at the census and you can look at the acquisitions that have been done in the last year or two from all the companies that's public and see that type of pricing. We look at a couple of opportunities. The smaller they are, the more we might but an opportunity just to get the license in the area and compare that to a new start. The bigger the deal we're looking at, we're a pure financial buyer. I mean, we're going to look at the numbers and it's got to make sense. You're going to look at issues like what's their cap issue? So, a company may be very profitable, but it they're right up against the cap, that's much less attractive to us from a buy perspective. So we're looking at all kinds of issues. Bottom line, we're a financial buyer, but if it's a small deal, we sometimes make strategic decisions for those opportunities.

Okay, thanks.

Thank you very much, sir. Ladies and gentleman, your next question comes from the line of Jim Barrett, C.L. King Associates. Please proceed.

Good morning, everyone. Tim, I had another question for you on the hospice side. When I look at your start-ups going forward ideally into '06, considering your management team and the sort of managers you put into start-ups, is there a general -- a finite number of start-ups you think VITAS can handle at any given point in time?

Well, I think the mode we're in is modestly growing the number constantly that we can handle. Right now, we have 11 going, similar to what we had in the last 6 or 9 months, but some of them have graduated and new ones have come on. We've enhanced our staff a little bit in that area. We're learning from what we're doing but no, there's no number. We'd like to see the number expanding, but we'd also like to understand the run rate of those investments, and as we've told you, about 1.5 million a quarter. So we basically look out constantly to see if we're on budget and the opportunities to expand, and we're trying to expand very aggressively. So I think to answer your question, Jim, I think we've maybe said in the past, I could see a scenario where instead of doing 11, we're doing 14 or 15 a year from now.

And no question -- this is Kevin McNamara -- that's one thing we're looking at internally. Are we pushing those fast enough? I mean, we don't want to strain the organization, but we want to keep adding all the -- the king needs more horses and more men to do a good job of it, because we have not had -- VITAS has not stubbed their toe significantly with any acquisition -- any start-up rather, and we don't want to add that possibility into the calculus. And we're pushing fast; we're giving more resources to that department, as it were, and we just want to make sure we're ultimately -- in 3 years probably the biggest complaint against the business is maybe we didn't move fast enough, because there's a lot of opportunity out there, Jim.

Good, Kevin. And Tim, the competition for managers who are skilled in the start-up area, has that stayed the same? Is it getting more competitive? How would you characterize that?

Oh, I don't think there's been any big change as far as competition. We see from time to time, in various regions or a various city, where someone will start a small company with some special contacts that they have, or special relationships with a few referring physicians, or a certain group of nursing homes or so forth, but I don't think we've seen that accelerate. Part of the barrier to entry, as you know, is having to have your license, and then take on patients that you're not billing for, for some period of time before you get your Medicare billing survey. And that can be a big barrier to entry, so we haven't seen any change, so to speak. From time to time, we have an internal situation where we lose a person and sometimes those things happen. There's no big movement there. There hasn't been any problems there, so we don't see any big change in that really.

Okay, thank you. And finally, David, if you could just talk about the legal expense related to the OIG investigation? Given that you've apparently documented most of what you need to document, is that legal expense going to start to decline, or how should we look at that?

I'd just say I think our assumption will be, it will run about a little under $300,000 a quarter. We don't think -- we disclose -- if we knew the question would actually come up right now, we consider it still a pretty immaterial amount.

Okay. Thanks, all of you.

Thank you very much, sir. [OPERATOR INSTRUCTIONS] Our next question comes from the line of [Gene Fattori] of Lazard Capital Markets. Please proceed.

Gentleman, congratulations. My questions have been answered. Thank you very much.

Thank you from Lazard.

You're welcome. Thank you for the [inaudible].

Okay. Well, if there's no more questions, we'll go back to work, and we'll just hopefully deliver another good third quarter, and I thank you all for your kind attention.

Thank you very much, sir. Thank you, ladies and gentleman, for your participation in today's conference call. This concludes the presentation, and you may now disconnect. Have a good day.