Chemed Corp (CHE) 2005 Q3 法說會逐字稿

Good morning ladies and gentlemen and welcome to Chemed Corporation's Conference call for the third quarter of 2005 ended September 30, 2005. My name is Latisha and I will be your conference call facilitator today. [OPERATOR INSTRUCTIONS].

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 off factors including those identified in the company's news release of October 27th 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 27th which is available on the company's Web site.

With that, I would now like to introduce our speakers for today. Kevin McNamara, President and Chief Executive Officer of Chemed Corporation; David Williams, Vice President and Chief Financial Officer of Chemed; and Tim O'Toole, Chief Executive Officer of Chemed VITAS Healthcare Corporation subsidiary. I will now turn the call over to Mr. McNamara. Please proceed, sir.

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

In the third quarter of 2005, Chemed continued to generate strong fundamental performance. On a consolidated basis, our Q3 2005 revenue increased to $233 million. Our adjusted EBITDA was over $30 million, and our diluted earnings per share excluding certain favorable tax benefits and other items was $0.49. The Q3 2005 Roto-Rooter segment sales of $73 million was an increase of 9% over the prior year quarter. This revenue growth was leveraged into net income of $7.1 million in the quarter, an increase of 16%. Adjusted EBITDA was $11.6 million, up 20% from the prior year.

VITAS continues to expand its market penetration. In the third quarter of 2005 revenue increased 19% to over $160 million and our adjusted EBITDA was $21.1million, up 26% resulting in a third quarter adjusted EBITDA margin of 13.1%. VITAS' ADC, or average daily census, in the third quarter of 2005 was 10,259. This compares to an ADC of 8,949 in the comparable prior year period, an increase of 15%. Admissions totaled 12,375, an increase of 9.8% over the third quarter of 2004.

Our average length of stay for the quarter was 66.5 days. This compares to the first quarter of 2005 of 66.2 days and the third quarter of 2004 of 60.8 days. Our median length of stay in the quarter was 13 days. VITAS had an excellent quarter in terms of admissions, ADC and length of stay. We anticipate this trend to continue into the foreseeable future. Now I would now like to turn this teleconference over to David Williams, our chief financial officer.

Thanks, Kevin. As Kevin just noted, Roto-Rooter continues to generate solid operating results. Sales increased 9% to $73 million. Gross profit margins increased 30 basis points to 45.7%, and Roto-Rooter's adjusted EBITDA increased 26% to $11.6 million. This resulted in an adjusted EBITDA margin of 15.9% which is a 150 base point expansion over the prior year period.

Job count for Roto-Rooter owned and operated territories was 199,196 which was an increase of 2.4% over the prior year quarter. Components of this job count are a 12% increase in commercial plumbing jobs, a 5.5% increase in commercial drain cleaning jobs and a 6.5% increase in residential plumbing. This growth was partially offset by a 2.6% decline in residential drain cleaning job count. We anticipate the shift to higher revenue and profitable job mix to continue as Roto-Rooter proactively targets these sectors.

VITAS generated revenue growth of 18.7% over the prior year and 4.3% sequentially. Gross margins were 21.7% in the third quarter of 2005, which is a 10 basis point decline when compared to the prior year quarter. However, this decline is the result of our new start development efforts. The third quarter 2005 gross margin includes $1.7 million in startup losses, which is $300,000 higher than the $1.4 million in losses 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 the statement of operations totaled $14 million, including $300,000 in legal expenses related to the OIG investigation. Excluding these legal costs, central support expenses increased 8.3% when compared to the prior year quarter and increased 2.6% sequentially. This relatively low rate of growth in administrative expenses when compared to our revenue growth resulted in the expansion of our adjusted EBITDA margins to 13.1%. All of our base and new start programs are forecasted to have a Medicare cap cushion for the 2005 measurement period that ends October 31, 2005. Of these programs, only two are anticipated to have a cap cushion of less than 10% in the 2005 cap year.

The Phoenix acquisition completed in December of 2004 is forecasted to have a Medicare cap liability of $1 million to $1.5 million as of October 31, 2005. The potential of reaching cap in our first year of ownership of this program was considered as a risk factor during our due diligence with Phoenix. This estimated cap accrual has been accounted for as a contingent liability, assumed at acquisition and is not reflected in our 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 and our other programs.

VITAS' days sales outstanding or DSO's in the third quarter or 42.1 days. However, after adjusting for Medicare reimbursement lags relating to our new start initiatives in acquisitions, DSO's adjust downwards to 37.1 days. These issues related to new starts and acquisitions should be resolved and our aggregate DSO's will be normalized by the end of the fourth quarter when the Phoenix program billing becomes current. There currently is approximately $8 million as of September 30, 2005 relating to Phoenix billings. Bad debt expense continues to be calculated at 90 basis points of revenue.

Going into the fourth quarter of 2005 we anticipate VITAS to continue its methodical expansion of admissions and ADC. Operating margins are anticipated to expand as we leverage our accounting, IT and administrative central support costs over this larger patient base. Roto-Rooter is estimated to generate a 6% to 7% in revenue with full year EBITDA margin expansion of 150 basis points above those generated in 2004. Our effective consolidated tax rate excluding prior-year tax benefits mentioned earlier should approximate 39.2%.

Based upon these factors and a current diluted share count of 26.4 million, our expectation is that full-year 2005 earnings per diluted share from continuing operations excluding the early extinguishment of debt and other charges or credits not indicative of ongoing operations will be in the range of $1.87 to $1.97.

With that, I'd like to turn this call over to Tim O'Toole, our chief executive officer of VITAS.

Thanks, David. As Kevin mentioned earlier, VITAS had an excellent quarter. Driving these results was strong growth in all of our key metrics. In the third quarter of 2005 VITAS revenue increased 19% to $160 million. Average daily census crossed the 10,000 threshold to 10,259, up 15%, and admissions were 12,375, an increase of 10% over the prior-year quarter. We had 944,000 days of care in the quarter of which 9% were for inpatient and continuous care. Internal growth at VITAS which excludes the 2004 and 2005 acquisitions generated revenue increases of 15.4%, ADC growth of 10.7%, and admissions increases of 7.3% over the prior-year quarter.

We are in the process of finalizing a contract for an inpatient facility in the Phoenix market. This facility will offer six inpatient beds, two of which are currently serving VITAS patients under a short-term agreement. We anticipate expanding further our inpatient capacity in Phoenix as we increase our physician referral contacts. At the end of the third quarter of 2005, VITAS employed approximately 194 sales representatives. This is an increase of 34, or 21% from the 160 sales reps 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 38.3% of our third quarter admissions being cancer related, 18% neurological, 12.4% cardio, 6.3% respiratory, and 25% in the all other category. We currently have 11 programs classified as startups, eight of which are licensed and Medicare certified. In the third quarter of 2005, these startup programs had an average daily census of 291 patients with revenues of $4 million and operating losses of 1.7 million. In the prior-year quarter, these same programs had an average daily census of 61 with revenues of $556,000, and operating losses of $1.1 million.

As you know, South Florida was recently hit hard by Hurricane Wilma. VITAS has large operations in Fort Lauderdale, Miami, and Palm Beach that were all affected. I want to assure you that as a result of some incredible efforts by the VITAS caregivers and managers, all of our patients are being cared for. Our systems performed very well during and after the storm. VITAS resources from all over the country kicked in. Backup call centers worked very well as one example, and all of our programs are operational.

VITAS caregivers and managers also dealt with Hurricane Katrina and Rita in September and our staff acted courageously to protect and care for our patients in Florida but especially in Houston during the evacuation there. I want to thank all of our over 8,000 employees for all of their efforts. I want to assure our shareholders that VITAS is operating very well despite these difficult weather events. With that, I'd like to turn the call back over to Kevin.

At this point, it's the question and answer - or at least the question period, hopefully the answers - answers will be provided, well but - I don't know if anybody's in the queue or not.

[Operator Instructions]. Your first question comes from the line of Matthew Ripperger with Citigroup. Please proceed.

Oh hi, thanks very much. This is actually Jie Bao filling in for Matt Ripperger. Just a couple of questions here. The Roto-Rooter segment had a very strong performance, revenue growth accelerated to 9%. Can you maybe give some color in terms of is there any companies specific strategy that you have implemented over the last six months or so that contributed to this growth? Or is it just the underlying strong market growth?

I'd say that it's underlying strong market growth but it is coming largely from the commercial side of the business. Over the last year and a half, we've really emphasized the commercial side of the business, implemented many sales programs that are really earmarked for the commercial customers and the growth is really just showing that it's continued to be - we've continued to be successful on the commercial side with the residential side of the business just firming up. So in the past we immediately saw good traction with our efforts on the commercial side, but there was some diminution on the residential side and that's just firmed up frankly and so the combination of strong growth in the commercial with that flattening has resulted in a kick up in the sales rate from let's say 5% to the 9% range.

Okay. And you said that the commercial side of the business is a higher margin business versus the-?

Not necessarily. Not necessarily. It's more predictable so it's a little easier for us to capture everything there, to schedule it, to just basically deal with it in an orderly fashion but it's pretty similar to the residential side. It's just basically we have a smaller percentage of the commercial side of the business and a little bit higher sales per job, but generally speaking, the real issue there is there's something we can do to drive the sales. On the residential side we're limited largely to making sure we have the biggest and best ad in the yellow pages and waiting for the phone to ring. On the commercial side, we really feel we can go out there and have an effect on the business we do the following week.

Okay. And on the hospice side, you mentioned that you continue to expect strong revenue growth in the second as going forward. Maybe if you could comment in terms of the components of that growth and how you look at it on the same-store - same program basis, startups, the maturation of the startup of programs which accelerated in 2004 and perhaps acquisitions.

David?

Absolutely. As we mentioned for the quarter, we were up on a same-store basis without acquisitions about 15%. There's no reason to think that that's not a good number to think about going forward on that basis. The growth comes really in several areas. Obviously, as our daily census -- our census of patients increases that's the volume increase, so to speak, we're very fortunate. We know now that we're looking at a price increase effective October 1 for all of next year of about 3.5% so some of that 15% clearly comes from price increase.

The other component in the last year has been increasing length of stay. We still have a length of stay that's now at about 66, 67 days. We think that will continue and show good trends. Our goal is to continue to increase length of stay and we all know that many hospice-appropriate patients do not enroll in hospice as early as they should or maybe as we educate everyone out there, this continuing trend of getting them in sooner will continue. We expect that. Hospice is expanding and people's understanding of end of life care, what they want, it's a topic that's much more relevant today than several years ago so we expect to expand. The volume is coming from the demographics that we know is still early phase and hospice is just well received right now as a critical component of the care delivery system.

We also, as you mentioned, have some opportunity to increase our revenue through the startup programs. We have 10 or 11, 12 of them happening now as they move over to the base operations which we move them after one year of billing for revenue. We're seeing probably two, three, 400 census will be added from that event to the base business so that's probably a couple of percent growth. Year-over-year it's probably 1% since we did the same thing in the prior year. And acquisitions we don't plan for them but there always are acquisition opportunities. We're always looking for them, and it's a key component for our strategy for growth. So that's where we expect the growth to come from.

Great, thanks very much.

Your next question comes from the line of Jim Barrett with CL King & Associates. Please proceed.

Good morning, everyone. Kevin could you - to get back to Roto Rooter just for a moment. Given how inflationary the environment is, does this give you an opportunity to take pricing up more aggressively than you may have in the last year or two?

It's something we look at in every market. I mean, it's key to the business. We believe we are the price leader in every market. Our competition very often are small mom-and-pop providers who don't know what their costs are, don't really track the costs of doing business. I mean, we have to do that for them and we have to very aggressively monitor that situation.

We do it when we can. Frankly, our costs of doing business in the Roto-Rooter segment -- I know you've been following Roto-Rooter for some time. A few years ago you heard us say that the costs of doing business in the, call it the home service segment, were expanding dramatically faster than the rate of inflation. That is costs for things like casualty insurance, healthcare insurance, vehicle expense. I mean, those costs were exceeding inflation factors.

Right now, they're tracking them. So we always look to increase pricing but it's something that our EBITDA margins have never been better on the Roto- Rooter side. It's one that we're on top of. We believe we're a premium priced service -- we want to be a premium priced service. A 24-hour seven day week service, we expect a premium. But it's one thing that the margins that you're seeing now at the EBITDA line are again, we think they're good portable sustainable margins but we don't anticipate them significantly expanding from their current rate.

Okay thank you. And Tim, can you give us any update on the OIG investigation? Is there any light at the end of the tunnel there?

Really no news on our end that we could report on and as we've said before we're cooperating fully and really nothing to report at this point.

Only thing I'd say is to reiterate that there have been no developments. In other words they're in the information gathering stage and there's been no significant contact with them other than just clarifying what it is that they're -what documents they want, which we've done. As you see from the amount of dollars we're expending with outside parties to coordinate this effort it's substantial. Again, we feel very comfortable. The only comment I'll make on it is it seems to be dealing with long stay patients and we are not a statistical outlier in that regard - in any regard. So we'll continue to give them what they want and keep the public advised on any developments as they occur.

And $300,000 is about a sustainable quarterly expense?

We think that's a lot. We've done most of the work as part of the document production at this point but we don't anticipate going higher than that figure anytime in the near future. We expect it to go down.

Okay. Thank you very much.

Your next question comes from the line of Kent Oliver (ph) with S.G. Cowan. Please proceed.

Thanks. What is, I guess, the variation in the growth at VITAS geographically? Is it fairly balanced across the board once you take out the start-ups or are certain geographies outperforming the average by a noticeable margin?

Yes, Kent, there is really no big identifying factor there by geography. As we've mentioned before the way we see it is that we have multiple size programs. We have small programs, medium programs, and large programs and as you know we've said that we believe our medium and small programs have an opportunity to grow faster than the large ones because we have smaller market share. We're penetrating markets. We select markets based on where we see good opportunity to grow.

We have local market planning in every one of them. And in some of our very large markets, we have very hard market share so we're probably going to grow only as the market grows. So no geographic distinctions so to speak. Obviously the areas of the country where there is high elderly population and growth, such as Florida, such as the West Coast, such as some of our areas where we started up on the Northeast and the northern part of California are the areas where we selected because we see that as both the areas where demographics are going to help us and where we saw a competitive opportunity for us to move in. So I hope that gives you a little flavor.

That's very helpful. You all in the past have given some census data by program size. Do you have an update on that?

Well, we're going to release that in the Q, but just to expand on what Tim. Our large programs with a census of over 450, the revenue increased 13% and our admissions were up Q3 this year over Q3 of last year 7.7%. So continued strength we're seeing in our large programs, although our business model is basically premised on the fact that we're going to grow our small and medium programs at a significantly faster rate. But large programs continue to perform very well.

All right. Good. The second question relates to the inpatient unit in Phoenix. What kind of facility are you putting in that unit and what are you finding in general in terms of the availability of capacity for inpatient units across your markets?

Well, what we've said all along that is we knew going in and we know now that the Phoenix market is very competitive. There is a lot of hospices. There's a lot of long-term relationships with the inpatient facilities in hospitals. So what we are working on right now is a non hospital-based inpatient unit. It's actually in an assisted living facility and the challenge there is one to accomplish the relationship which we're feeling great about, but then also to have strong physician relationships. So when you have the inpatient beds available that they're going to be used.

If you have the physician contacts and you don't have the inpatient facility, it's hard to work with those physicians to get the patients on as well. So this is the first step. We're very happy about it. We think we're making good progress throughout the community of letting everybody know that we want broad based admissions. We will take all patients, even short stay patients. We have the expertise to do that, the desire. That's our mission and it's going to help our cap issue as well. So we're very excited about this initial inpatient situation and we know we're going to make progress there with other ones like it and through taking on more physician-related referrals.

Okay. And beyond Phoenix just looking out over the next year, do you have an estimate of how many additional inpatient units you're planning to open?

Well we're currently at about 25 or 6. They move around a little bit from time to time. I mean just as a general goal, I'd probably think that we will be at 30 or higher as we stand here a year from now.

That's great. Thank you.

Your next question comes from the line of Joe Barlussi (ph) with Legg Mason. Please proceed.

Joe?

Hello?

We might take another question here.

Your next question comes from Kevin Fishbeck with Lehman Brothers. Please proceed.

Okay, thank you. I just wanted to ask about the Phoenix facility. It sounds like you guys are putting things in place to reduce cap exposure going forward, but I was wondering if you could comment during the third quarter what your experience was there? It looked like you're basically assuming the same level sequentially, I wanted to see if there was a stabilization, whether things got better but the lower Medicare cap kind of kept you where you were as far as your estimate or just kind of how things were trending during the quarter?

Again, we estimated where we would be in the third quarter with the sum of money we put aside in the acquisition accounting that Dave mentioned earlier. The program in Phoenix we feel very good about. The program is very stable. It's around 200 census, and we're basically again growing our referrals. We're taking on patients that are not necessarily only in the assisted living area where we they have targeted historically and we're building a very strong group of marketing representatives and salespeople.

We're building an admissions team that can respond very quickly to the needs of the referrals for the type we're looking for. We are still getting referrals from all sources. So the company is very stable. It's making a good operating margin for us. And when we get the cap which we expect to be in a situation of no cap as we move into this future year, we're going to have higher opportunities there. So we're feeling very good about it. It's stable. We believe it's moving in the right direction.

Actually - it's Dave Williams - actually, your question is also perceptive because fundamentally, with the cap ending up at 19.777, all things being equal you would have expected that number to go up a little bit. And the fact that it remains stable is overall things did improve relative to the metrics that are used to calculate cap. It still is a moving target and we're going to have to take an estimate in the fourth quarter relative to goodwill accounting for those legacy patients. The patients we acquired on December 15th of '04 and for what I'll call the final acquisition accounting related to the cap liability we inherited.

And let me just also remind everybody - this is Kevin McNamara that the bottom line is yes we we're making progress with Phoenix. I mean there's a chicken and egg issue and that is we can't really be where we want to go until we have a full inpatient facility. The problem with that is the chicken and the egg. Just having the facility itself doesn't help until you get the referrals to fill it and whatnot and you can't get those referrals until you have one and we're making progress on the first aspect of that. But the fact I just wanted to remind you even at this current cap exposure, the Phoenix operation is very still very profitable. A return on investment on it is double digit. It's still a good operation for us. What we're really talking about here is dramatic upside from that operation and ones like it.

Okay great. And Dave I'm assuming it was an oversight but in the guidance you talked about VITAS revenue growing 16 to 18%. That's what you've been talking about the last couple of quarters. There was no discussion in the guidance this time about VITAS growth for 2005. Is it still in that 16% to 18% range?

Because it bores me to put all the exact -- I try to change a little bit.

I figured as much but I just wanted to make sure. And then the last question was we've seen some investigations at the major companies and now one of your competitors announced a central decertification of a couple of their sites. I mean how would you guys characterize the regulatory environment as it is right now?

Well the regulatory environment we have not seen any big changes there in the last, I mean, several years. It is a highly regulated industry so both from your Medicare providers which generally speaking all hospice companies are to the various state agencies that have oversight, there is high review. So we haven't seen anything new.

I mean the situation -- it's one of the reasons that we do think through how we want our licenses to be located by program in case you do have a problem at any program. You do not want to have it affect necessarily other ones. On the other hand, in your startup programs you want to have the opportunity to get billing quickly so sometime you do these step out satellites and that's one of the considerations. Generally speaking that is a small program though. So for VITAS we're a big company.

But to answer your question, we're not seeing any big change in the regulation area. The review -- we basically have a complete compliance program internally to respond and we believe that we're not seeing any change but we are looked at constantly at both the state and federal level and we see that continuing in the future.

Another thing I want to add, knock on wood when I say this. We see this area as a huge competitive advantage for us. We see so many of our very tough competitors, not-for profits out there that are barely hanging in the current regulatory environment to the extent that it continues to ratchet down a bit. We're prepared to deal with that and I think some of our not-for- profit competitors are not. We'll see that again. It's something that can still jump up and bite you, but overall we think that type of event can overtake anybody. We think we have a competitive advantage in dealing with.

Okay, great. Thanks.

Your next question comes from the line of Joe Garmasi (ph) with Legg Mason. Please proceed.

Hello, can you hear me?

Yes.

Actually, it's Eric Donald, I don't know how they got that name. How are you guys doing? I had a question. Manor Care recently announced on their earnings that they acquired some hospitals in Chicago. I am interested on your thoughts on what you're seeing in the acquisition environment and maybe a little bit about valuations for acquisitions. Do you see the multiples coming down or have they really remain flat? Just some spots there.

I'll turn it over to Tim but let me start by saying that what hospice census they're not all equal and I think that people are really starting to see that generally speaking - and Tim can go into some specifics -- but generally speaking the right size hospice in the right market is still very valuable. I think we see a lot of hospices for sale where we say - it's not all positive. They're too small. We don't like the market. It exists. It might give a one-time benefit to some of our numbers, but not really - we don't want to scatter our shots too widely in markets that where we're not going to get a lot of bang for the buck but that's a general comment. Now Tim.

We don't see big changes in the acquisition opportunity or the valuation. I think maybe they're coming down slightly because you can see there have not been a lot done. There might belittle stalemates out there and pricing is not going higher - the valuations are not going higher and as Kevin mentioned, every census in every company is different. So we look at them very differently.

I think the situation with Manor Care it's great to see. It shows that there's great growth opportunity in our industry. They're a major player. Obviously Manor Care along with many others - and acquisitions are going to be part of everyone's strategy if you're a consolidator like they or we will be. The acquisitions to remind you, we still see the new starts as just an incredible opportunity. So we always balance our acquisition goals with the new start opportunities. We see the new starts as we control our destiny. We built the VITAS culture. It takes a littler longer than an acquisition, but when we're done we have a very solid business, the capital investment is minimal compared to the upside down the road and so we always have these new start opportunities, many new places to go. But acquisitions we look at a lot and they are available. We expect it to be part of our program going forward.

This is in the real world is what has happened several times over the last six months, we have been in negotiations with medium to small hospice opportunities and we just get to the point where we feel we would be better off with a startup here. If we walked away from the lot just for the dynamics that Tim's referred to. It's just that the opportunity is when you get into the warts and difficulties in any acquisition that sometimes that tips the balance and which speaks more to the benefits and opportunities of new starts than it does with problems with one hospice opportunity.

The thing I would add is so when we do complete acquisitions like the few we've done over the past year, we have a pretty high hurdle and expectation of a program the quality of care provided so you do know when we do complete an acquisition we fully vetted it and we have a lot of confidence it's going to perform well within the VITAS culture.

Great and correct me if I'm wrong. You said you had two programs that were within 10% of cap but that's actually down from last quarter, isn't it?

That's correct.

Excluding Phoenix from that discussion.

Right, excluding Phoenix and what you say to people who think it's only a matter of time where maybe some of your programs as you expand the length of stay you may reach your - or hit a wall like some other operators? I guess what I'm looking for, what do you think makes you guys different than some of the other operators? What systems to you have in place to make sure that you don't run up against cap in any program? It appears that you've done a good job of that, but I'm curious as to what makes you different?

Tim, do you want to start with an answer?

You bet. I mean, again it goes back to some of those things that we have been talking about for several years and the broad VITAS model of going into markets where we've strived to take all kinds of patients, all types of settings, all types of medical diagnoses, short stay patients, patients that need care over months and some that need care over days, that broad model really protects you from the cap issues.

Also we have marketing reviews of each program and we understand the cap and certain programs where we see that we're heading towards that direction, we basically modify to a small degree the programs that we have in place and we would ramp up, for example, physician referral opportunities as opposed to an assisted living opportunity because the physicians are more short stay and they impact your cap in a better way than the longer stay patient.

We don't go after patients that way. We go after all patients because we want to serve those communities and we want to serve them broadly but we do have marketing plans that have to bring the cap into play, and so we try to model them into the future. We try to have programs -- and keep in mind, the cap goes up every year by cost of living, by mechanisms. So unless you fall backwards in your admissions or unless you fall backwards in only taking on long stay patients which we've never wanted to do and don't do, you should be okay with the cap.

One other thing I wanted to add is you have got to remember the way the cap works. It's not a disaster to gradually approached the cap. That is just maximizing your opportunities. It tells you that your growth is going to be limited to more of these mechanical increases that come every year. But the problem with cap comes when you have a situation where burgeoning admissions is covering up a underlying flaw in your business model. That is too many long stay patients not a good balance.

So to the extent that when VITAS is twice the size as it is now do I expect it to be right at cap? I would hope that they have several programs that are right at cap if only that'll mean they've maximize their potential in those. Our margins will go up dramatically to the extent that we have programs that gradually approach cap. It just means you're getting everything out of your program that you can be getting the opportunity that is there. It's not the end of the world to as I say to gradually approach the cap situation.

Great. Thank you.

Your next question comes from the line of Debra Fine with Fine Capital Partners. Please proceed.

Good morning. Congratulations on the strong results. Could we go back to your comments on the non-profits regarding investigation? I think you were saying that it was a competitive advantage that some of those folks might not be able to manage investigations or - I wasn't clear on what you were trying to say

My point is not as investigations but as regulations increase. That is there's more follow-up. More Is to dot and Ts to cross. That depends on having good systems and they just don't have the systems we do. To the extent that as this business because more difficult and as the whole delivery of medical service is, I mean - the one -- the more agile performer is going to do a little bit better as things change and as things get ratcheted up. I mean, that's my point. It's really not focused on the investigation side. I have no reason to think they are more likely to be investigated than anybody else. I'm just saying to the extent that - in our case, to the extent that we were, our systems were such that we could put our fingers on the documents and the information that the OIG wanted. And, again, it sends a good message to them that we're on top of our business, I hope.

Okay, that's clear. Are you seeing any increase in trend of non-profits to sell out to for-profits or any new growth on either side of the business from private - public or private for-profit companies or incremental non-profits being formed?

I don't know. Tim, do you --

No, there's no changes in trends. There haven't been a lot of deals done lately. I mean, you guys track them like we do. There's no big sea change in the non-for-profit as far as the number coming onboard. The number of hospices are still growing and still the great majority are non-for-profits. I think what you are seeing out there are some for-profit large regional players being developed. So there's a handful now of companies that are -- 1,000 census companies in regions that are for profit and honestly they may be the ones that are the best acquisitions opportunities at some point.

Over the next 12 months, those would be prime acquisition opportunities for our company like VITAS. No question about it at this point.

Okay. Two questions as a follow-up to that. Are you seeing in any of your markets any increased competition for patients that is concerning to you?

Nothing new. There has been incredible competition in hospice ever since I've been involved and we've been involved since 1990. So we're seeing nothing new. From time to time there's new players developing in given markets, but there is no big industry trends that certainly I think we need to call anyone's attention.

At this point in the hospice, the way the competition as long as you get patients by giving the best quality service.

That sounds like a good way to do it.

Right. And -- in this market, it's tied to that because we have a good model. That's why there have not been any changes. There's nobody that's come and invented a better mousetrap with regard to the delivery of that service so we haven't been seeing that type of problem.

Okay. And then when you were talking about buy versus build on the same issue, for a steady state census when it's reached its correct capacity, do you look at valuation per census to figure out what the optimal return for you is? And is that still below the buy - I assume it's below the current buy prices and is that around 50,000 census or-

The startup opportunity at a certain number of census, say, 100 census for example, when you develop a 100 census program, we would have much less capital invested in that the than if we went to buy 100 census program if that's the question.

It's just a matter of time. And I'm not sure that's the issue but if time were not a factor, we would do nothing but startup but just the fact that you want to leaven your growth with the right acquisition - getting more things done at once, that's an issue. But separately, again, we have a pretty high hurdle - as Dave mentioned earlier -- pretty high financial hurdles and operational hurdles when we make an acquisition and so the ones we make you can assume that generally speaking we would rather build rather than buy and so if we buy it's one that we're pretty happy with.

Debra?

Yes?

I would avoid using a single metric to determine valuation of a program and census certainly is one and one we look at, but a number of other things come into play so the fact that you paid 60,000 a census or 35,000 a census in and of itself is almost dangerous just to look at. You want to look at opportunities within the market. You want to look at the mix of patients, referral sources and all of that gets played in for the final valuation.

Okay, thank you. That's very helpful. And I just have one final question regarding nursing homes. There's been some talk lately about the regulation within nursing homes and how nursing homes are compensated when they are running their own hospices business. Have you seen any developments on that front?

No, there's nothing new that I am aware of and basically nursing homes that run their own hospice are treated the same as if it's a third-party hospice. The basic opportunity in a nursing facility is there. What we find is that, again, it's a local situation -- if we provide care that meets the needs of their patients -- we even do a lot of work with nursing homes that own their hospice maybe in different regions or different cities. And so there's nothing new there and from a regulatory perspective there's always been a question about the nursing home area ever since hospice benefit first went in and the only issue is that the hospice provider is truly providing extra care for that person.

And at VITAS what we do is we track that separately and we basically show with our data that we provide very similar levels of care, number of visits, et cetera to nursing home patients as to any other settings. So we look at those items just to make sure and we can share that with third parties that have any questions about the nursing home area which we do dialogue a lot with government agencies about that.

We basically -- on the proposed rules of participation that was put out recently we basically already followed that model in a number of areas.

Okay, great. All right, thanks, gentlemen.

Your next question comes from the line of Andrew Gatlin with Thomas Leidel. Please proceed.

Hey, congratulations on a good quarter, guys. Looks really good. Just one quick question about the cap cushion in some of your older programs. You had really good same-store growth at your older centers this quarter and I was just wondering was that -- most of that from increasing length of stay and how much longer can you keep doing that?

Actually our cap cushion in our older programs - larger programs that's where a significant amount of our cap cushion resides. Our largest program also has the largest amount of cap cushion. And that's just more, as Tim mentioned earlier -- it covers a broad geographic and a large population area because we've got a very balanced group of patients, our oldest programs, our largest programs, have the largest absolute dollar and even as a percentage, hospice cap.

Said differently, at the current rate of growth of length of stay, in those programs we could go several years all other things held constant without worrying about the cap. Another issue is - and Tim brought this up -- the cap grows generally at a greater rate than our reimbursement level. Typically there's a 200 to 300 basis point differential. This year was an exception because of CMS correcting a prior year error but actually there's room for expansion on length of stay just because the cap rate goes up at a greater level.

And to answer your question also is how can we -- obviously something that is helping the growth in those large markets is increase in length of stay. The only thing I can say is to the extent that - our median length of stay is 13 days. One of our major programs is to get those same patients significantly earlier in the process. It's still on average - or at least on a median basis we're getting the patients very, very late in their battle.

That's good to know, and I have two quick follow-ups. On would be in the two programs were you have less than 10% cap cushion, are those new programs or were those the ones that already close to the cap and what kind of trends are you seeing there? And finally just what are your priorities for your cash flow? Thanks a lot.

It does change. One of the programs was definitely in there from the prior, because that's been just a stabilized market. The other one, I think, is a new one, but I would have to double check. But what I'd say in general, programs flow in and out as we adjust the mix as Tim mentioned earlier and how we do that. So it does change basically if you look at today versus three quarters ago. In terms of cash flow, excluding acquisitions which we never forecast in, clearly we're building cash on our balance sheet. You can see we had a cash balance of about $38 million. I expect our cash at the current run rate to be running between $40 million and $50 million per year, including utilization of our dividend. And that'll build up on the balance sheet. There are no plans for debt repayment. It's basically a war chest between -- on our cash as well as our revolver for potential acquisitions.

Thanks a lot.

Your final question comes as a follow-up from the line of Kent Oliver with SG Cowan. Please proceed.

Thank you. Is there anything new from CMS or NHPCO regarding the fiscal 2004 cap and is there a point in time at which if nothing comes out of CMS you can safely assume that the issue is dead?

Well, let me start by saying that there is nothing definitive out there but it has no effect on us really. So it's not -- the issue is not one that we're out front on. Let's put it that way. I mean, what we say at this point would be largely -- we don't have a dog in that fight. We're largely - we're speculating and we're not the best party to comment on that. Anything further on that, Tim -- ?

I think that's correct. They have not announced yet whether they intend to enforce, so to speak, the lower cap because of the miscalculation. We believed it would have no impact on VITAS if they put in the lower cap. We also -- to speculate a little bit we know it would impact a lot of companies. We don't know what they're going to do. It does not affect the go-forward year and the good news for us is even if they go at the lower amount, it does not affect us in any negative way.

That's great. Thank you.

Well, at that point there are no more questions, I want to thank everybody for your attention and we'll come back to you a little more than three months from now. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now all disconnect. Good day.