Chemed Corp (CHE) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Chemed Corporation's Fourth Quarter 2005 Conference Call. My name is Candace and I'll be your conference call facilitator today. Please note that today's conference 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 INSTRUCTIONS.]

I would now like to turn the conference over to [Sherry Warner] with Chemed Investor Relations. Please proceed, ma'am.

Good morning. Our conference call this morning will review the financial results for the fourth quarter of 2005 ended December 31, 2005. 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 the 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 February 21st 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 February 21st, which is available on the Company's Web site at www.chemed.com.

I would now 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 Fourth Quarter 2005 Conference Call. I will begin with an overview of the fourth quarter, David Williams will provide detailed financial metrics and 2006 earnings guidance and Tim O'Toole will follow with specific on our hospice operations. I will then open up this conference for questions.

In the fourth quarter of 2005, Chemed continued to generate strong fundamental performance. On a consolidated basis, our Q4 2005 revenue increased to $248 million, our adjusted EBITDA was over $37 million and our diluted earnings per share, excluding the class action litigation settlement, favorable tax benefits relating to earlier periods and other items, was $0.61.

The litigation settlement involved a wage hour class action case pending against VITAS in California. This case was filed in April 2004, shortly after the completion of the VITAS acquisition. We accrued a pretax liability of $2.3 million and accounted for this issue as an assumed liability on our opening balance sheet. Since the establishment of this accrual, there has been a significant increase in litigation, high settlements and unfavorable verdicts against companies involved in wage hour claims in California.

Recognizing this legal climate, we have reached a tentative agreement to resolve this matter. Generally accepted accounting principles do not allow for a period of more than 12 months post acquisition to finalize the quantification of existing contingencies on the opening balance sheet of an acquisition. As a result, VITAS' fourth quarter operating results include an after tax charge of $10.8 million, representing the portion of this preliminary settlement not accounted for on VITAS' opening balance sheet.

VITAS continues to expand its market penetration. In the fourth quarter of 2005, revenue increased 19% to $169 million and our adjusted EBITDA was $24.7 million, up 21%, resulting in a fourth quarter adjusted EBITDA margin of 14.6%. VITAS' ADC in the fourth quarter of 2005 was 10,412. This compares to an ADC of 9,134 in the comparable prior year period, an increase of 14%. Admissions totaled 12,487, an increase of 8% over the fourth quarter of 2004. Our average length of stay for the quarter was 70 days. This compares to the first quarter of 2005 of 66 days and the fourth quarter of 2004 of 64.1 days. Our median length of stay in the quarter remained at 13 days.

The Q4 2005 Roto-Rooter segment sales of $79 million was an increase of 10% over the prior year quarter. This revenue growth was leveraged into adjusted EBITDA of $14.5 million, up 21% from the prior year. Both of our operating segments had strong operating metrics that position us for a strong 2006. We will provide you with detailed metrics and our outlook for 2006 later in this conference.

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

Thanks, Kevin. VITAS generated revenue growth of 18.8% over the prior year period and 5.4% sequentially. Gross profit margins were 22.9% in the fourth quarter of 2005, a 50 basis point decline when compared to the prior year quarter. This decline is attributed to increased field level headcount, which is basically increased capacity in the field. VITAS is constantly hiring home care and admissions personnel to offset turnover and increased ADC.

In any given quarter, we have the possibility that our capacity expansion could get ahead of our ADC growth. When this does happen, it will have the effect of slightly decreasing our typical ADC to FTE or full time equivalent ratio, which will result in a decline in gross margin.

The fourth quarter 2005 gross margin includes 1.6 million in startup losses, which is equivalent to the losses from programs classified as new starts in the prior period. Accordingly, our start up program did not impact comparative margins.

Central support costs for VITAS, which are classified as selling, general and administrative expenses in the statement of income, totaled $14.1 million. Central support expenses increased 8.4% when compared to the prior year quarter and increased less than 1% 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 14.6% in the fourth quarter of 2005.

All of our base and new start programs are estimated to have generated Medicare cap cushion for the 2005 measurement period that ended on October 31, 2005. In addition, only one program has an anticipated cap cushion of less than 10% for the 2006 cap year.

The Phoenix acquisition, completed in December 2004, is forecasted to have a Medicare cap liability estimated at 2.4 million as of October 31, 2005. This 2.4 million includes 700,000 for estimated future fiscal intermediary adjustments related to individual patient cap allocations between provider numbers. The final Medicare cap liability for Phoenix may not be known for several years.

The potential of reaching cap in our first year of ownership was considered as a risk factor during our due diligence of Phoenix. 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.

We have forecasted single-digit cap cushion in the Phoenix program for the 2006 governance fiscal year. VITAS has generated this estimated 2006 cap cushion by increasing access to short pay patients and broadening access to inpatient and continuous care patients. This broad mix of patients is consistent with the clinical model provided by VITAS in its other programs.

Although we cannot guarantee the complete elimination of Medicare billing restrictions in the Phoenix market, based upon actual admissions and discharge trends from October 2005 through January 2006 and forecasted trends through the remainder of 2006, we do not anticipate the need for cap accrual in the Phoenix market. Certainly, any decline in our admission or discharge trends could still result in a cap accrual for the fiscal 2006 cap year.

VITAS' days sales outstanding or DSOs in the fourth quarter were 41.8 days and compares to 38.1 days in the prior year period. If you eliminate the impact of new starts and acquisitions, the Q4 2005 DSO is reduced to 39.3 days. Bad debt expense continues to be calculated at 90 basis points of revenue and our Medicare write offs continue to be a very favorable 0.2% of revenue.

As Kevin noted, Roto-Rooter continues to generate solid operating results. Sales increased 10.5% to over $79 million, gross profit margins were a healthy 46.6% and adjusted EBITDA increased 21.4% to $14.5 million. This resulted in an adjusted EBITDA margin of 18.3%, a 160 basis point expansion over the prior year quarter.

Q4 2005 job count in company owned and operated territories were 209,776 jobs, which was an increase of 3.9% over the prior year quarter. Components of this job count are a 10.7% increase in commercial plumbing jobs, a 5.5% increase in commercial drain cleaning jobs and a 6.2% increase in residential plumbing. This growth was partially offset by two-tenths of 1% decline in residential drain cleaning job count. We anticipate this shift to higher revenue and profitable job mix to continue into 2006 as Roto-Rooter proactively targets these sectors.

Looking forward in 2006, we anticipate VITAS to generate revenue growth in the range of 15 to 18%, an increase in admissions of 7 to 9% and continued expansion of EBITDA margins through the leveraging of central support cost. We estimate this leverage will provide a 50 to 80 basis point expansion of our adjusted EBITDA margins over the 2005 levels.

Roto-Rooter is estimated to generate a 5 to 6% increase in revenue in 2006 with adjusted EBITDA margins averaging between 16 and 17%, consistent with the 2005 levels.

Based upon these factors, an average diluted share count of 27 million shares and a full year effective tax rate of 39.1%, our expectation is that full year 2006 earnings per diluted share from continuing operations, excluding accounting for stock options, as well as charges or credits not indicative of ongoing operations, will be in the range of $2.20 to $2.35 per share. We anticipate providing updated guidance when we report our 2006 quarterly results.

With that, I would 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 fourth quarter. Driving these results was strong growth in all of our key metrics. In the fourth quarter of 2005, VITAS revenue increased 19% to $169 million, average daily census has expanded to 10, 412, up 14%, and admissions were 12,487, an increase of 8% over the fourth quarter of 2004. We had 957,897 days of care in the quarter, of which 9.3% were for inpatient and continuous care. Internal growth at VITAS, which excludes our 2004 and 2005 acquisitions, generated revenue increases of 16%, average daily census growth of 10.7% and admissions increase of 6.2% over the prior year quarter.

We have finalized a long-term contract for an inpatient facility in the Phoenix market. This facility provides us with the ability to care for high acuity patients. The development of such inpatient units is a key step to having a patient mix more like a typical VITAS program, which in the end, is expected to have a favorable impact on the cap issue and allows us to better serve the communities we operate in. At the end of the fourth quarter 2005, VITAS employed 197 sales representatives. This is an increase of 37 or 23% from the 160 sales reps we had at the beginning of the year.

Just as important, we continued to expand our admissions personnel. We now have 322 admissions nurses and coordinators dedicated to patient intake, an increase of 8% over the prior year. We are constantly hiring field based personnel to meet the needs of our growing patient base. At the end of 2005, we had 8,334 employees, 3,267 of whom are nurses. This compares to 8,073 total employees, including 3,165 nurses, at the end of the third quarter of 2005 and 7,159 total employees, including 2,840 nurses at December 31, 2004. Our 2005 turnover rate averaged 26%.

As David mentioned earlier, VITAS is constantly hiring licensed nurses, home health aids and admissions personnel to offset normal turnover and increased ADC. Our hiring quotas are based upon forecasted turnover and ADC. In the fourth quarter of 2005, our field based man par levels increased modestly, ahead of our actual average daily census. This had the effect of slightly decreasing our typical ADC to the full time equivalent ratios that resulted in approximately $1 million of higher labor costs, which equates to about 60 basis points of gross margin. I anticipate this expanded capacity to be fully utilized in next quarter as the ADC continues to expand.

Staffing levels are a critical component in preparing and executing our patients' plans of cares. VITAS' ADC to FTE staffing ratios are designed to provide significant patient interaction. These staffing ratios have resulted in VITAS caregivers averaging 5.3 visits per patient per week, resulting in over 23% more visits per patient than the National Hospice and Palliative Care Organization's calculation of the industry average of 4.3.

Admissions by major diagnosis continues to be relatively stable with 37.5% of our fourth quarter admissions being cancer related, 19.3% neurological, 12.4 cardio, 6.7 respiratory and 24% in the other category. We currently have 10 programs classified as startups, all of which are licensed and nine are Medicare certified. In the fourth quarter of 2005, these startup programs had an ADC of 238 patients with revenues of $3.4 million and operating losses of $1.6 million. In the prior year quarter, these same programs had an ADC of 58 with revenues of $341,000 and operating losses of $1.5 million.

In summary, VITAS had an excellent 2005. We admitted over 50,000 patients into our programs and provided 3.8 million days of care. The VITAS care model generated a 96% satisfaction rating from these families in 2005. This exceptionally high family patient feedback continues to reinforce to all of our VITAS employees the importance of providing quality care to each and every patient 24 hours per day seven days a week.

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

Well, at this point, we will entertain any questions.

[OPERATOR INSTRUCTIONS.]

Our first question comes from the line of Jim Barrett of CL King and Associates. Please proceed.

Good morning, everyone. Kevin, could you touch upon the, your current capital allocation outlook for '06, '07? Are you seeing more acquisitions or less on each side of the business? And could you give us an update on how you envision investing the cash that seems to be increasing?

Yes. Well, let me start with the easy one and that is on the Roto-Rooter side. We are looking at a few smaller acquisitions that fall with our independent contractor side of the business, which we've been very happy with. Great return on capital invested. Again, we more or less field offers to sell and for us to buy on those. We're not aggressively pursuing those, but there are a lot of them out there. And to the extent that there's one that fits the right profile, we move on it. With regard to Roto-Rooter, that's-- as far as capital outlay, there's not a lot of other significant issues out there for Roto-Rooter. Real good free cash generation in Roto-Rooter.

With regard to VITAS, again we, as we've said, we're-- we have very high hurdles with regard to making acquisitions in VITAS. There's some specific things we're looking for with regard to the size and nature and characteristics and reputation with regard to some of the acquisition candidates. But, we're continuing to look in that regard. I wouldn't say that we're planning any breakthrough or groundswell of change with regard to kind of the pattern we've been on with regard to acquisitions on VITAS.

I'd say that we're spending-- with regard to capital outlay, I mean, we're spending a lot of dollars on IT, both with some improving some programs and some transition from some, just transition to some newer systems. But, it's again, in line with our expectations. David, any other summary with regard to on the VITAS side, as far as that IT spending?

No. I mean, basically, it's going to be a little bit frontloaded because to a certain degree, it was initially starved initially under capital constraints just prior to the acquisition. We didn't rush headlong into software projects initially. We wanted to assess what we needed. So, it's going to be frontloaded to a certain degree, but then, it should stabilize. So, about $25 million CapEx, may go as high as $30 million in '06, depending on progress. And then, it will quickly fall off from there to the low to mid-20s.

Okay. And Dave, the pending settlement in California, were you expensing much in the way of legal fees to defend the company in '05 on that?

No. This is Kevin McNamara. No. The answer is we took-- we had an accrual that we had taken at the time facing the opening balance sheet. The expenses were just starting to-- you know how these things go-- were just starting to explode as far as the month prior to this kind of agreement. I think our-- I believe the expense was $150,000, but they were not burdening our reported results. Those were going against the reserve we had taken with regard to that matter.

And let me just-- it may-- let me just jump in here on this because it was-- the question that would come to anybody would be how would we have a matter a litigation that goes from, on our books from $2.3 million pretax to $19 million. And let me just say that it was a matter that was, we became aware of very early on. It involved California, which is, in this regard, has some very specific wage hour legislation. And at the time we set up the reserve, we said, let's be very conservative and let's get an outside, a conservative upside outside number that cannot be exceeded. And we thought we had that in $2.3 million. And there was really just a real shift in California.

At the time this was done, this reserve was taken, the case basically involved one county and one type of employee. But, with the change in-- and basically, they had come up with just some former manager that was reputed to be tough on overtime that related to several, a period well before the acquisition.

Well, the law in California and the cases really came down to you didn't even need that. You basically, all a company would have to be alleged to have permitted employees to skip lunch or permitted employees to listen to emails after work. That was grounds enough for liability in California. And so, the case was expanded dramatically beyond one county and to cover basically all hourly employees.

And again, if you follow this type of matter, there are not many companies that have hourly employees in California that isn't facing an actual litigation or threatened litigation on this matter. VITAS is a particularly juice target because our hourly employees in the case of nurses are people who earn $53, $55 an hour. So, it became a case that was burgeoning out of control. And we just, on the advice of counsel up there, just said, let's get it to Vanguard and get it behind us. Tim, anything?

Well, I might add that since we had knowledge of that situation last April, we've been working very hard to assure we're in current compliance.

That's correct.

In the current system. So, right now, basically, we are in current compliance. We have mandatory codes that people must put in on their payroll records that show they've taken the lunch breaks. We don't have to pay for it. They're forced that they actually take them. We don't pay for it. If you can't prove that they've taken it-- this is the litigation historically-- then you have to pay them for the lunch break because you can't prove they did, even though, in many cases, we know they did.

But, the key thing for us is we know going forward, we're in compliance. We will have a rigorous training and education program around it. We'll have a rigorous auditing process around it. And any outliers will be corrected immediately. So, that also to us is a big issue. How is it going to effect us in the future? We do not think it will be a negative as far as our expenses in the future.

At the end of the day, this is just our documentation will be adequate to prove that lunches were taken. So, this does not impact margins on a go forward basis.

And the other comment I'd make with regard to that-- and the analysts should look at it-- it's not as though these covered employees did not have overtime pay in the period in question. I happened to look and for the two years prior to the acquisition, these covered employees were paid in excess of $3 million overtime, a significant percent on a, with regard to the covered employees. So, it's one that we just, again, when you do business in a, in some jurisdictions that highly regulate certain aspects of the business, you have to respond accordingly. And I think we have. And again, we-- it's not something new. Since the very onset of this case, we've been working very hard to make sure it doesn't happen again.

Okay. Thank you very much.

Our next question comes from the line of Matthew Ripperger of CitiGroup. Please proceed.

Hi, thanks very much. Just a couple of questions. First, for Dave, in your guidance for '06 of $2.20 to $2.35, is there any assumed use of cash in terms of the cash that you've got on your balance sheet now or the strong free cash flow that you're expected to generate next year, so in terms of any kind of buybacks, debt pay down or anything like that?

There is not. We're assuming status quo on our current debt level, which is about $83 million in that term loan and $150 million fixed right now. So, all that debt is assumed to stay on the books. We're earning about LIBOR in our overnight funds, about 4.5%. Of course, debt is dialed in to our guidance.

But, with respect to guidance, when we came up with the $2.20 to $2.35, we developed that guidance very much how we developed the prior year. If you recall, a year ago at this time, we had estimated guidance of $1.65 to $1.75. And we developed this with a very high probability of hitting our guidance, even if we encounter minor turbulence during the year. We developed the 2006 guidance with the same thought process in mind.

And let me-- this is Kevin McNamara. Let me add one other thing. And this is just human nature, but it's just, related to the relatively minor seasonality in the VITAS business. For a lot reasons, January and February are VITAS' toughest months and some of the labor issues and unemployment and taxes and whatnot and it's always been most difficult to develop year long guidance in your two toughest months, during your two toughest months always, which always will explain one element of conservatism that is, I think, well founded, rather than just-- we have no-- we want to be accurate. We don't want to just, we don't want to under-do any guidance. But, it's just, it's more a question of almost the time of the year as it relates to the VITAS business when we're developing the guidance. So, I don't know. We think that it's solid guidance, but it's guidance we think we can deliver on.

Yeah. My question was just in terms of the free cash flow and the cash position at the end of the year. With $30 million of CapEx, should we assume free cash in the range of sort of $50 to $60 million for '06?

Basically, yeah. Our free cash flow is going to approximate our EPS with $27 million shares out there.

Okay, great. And then, the second question is how many locations do you have right now? Is it in the 40 range, thereabouts?

Thirty-nine locations.

Thirty-nine.

Okay. And 10 of those are startups?

Correct.

Right. And so, based upon the ADC number that you gave, I think the startups account for only about 2% of your ADC. Is that correct?

Yeah.

And so-- and the ADC of those startups went from 58 a year ago to 238. So, you added about 18 ADCs per location. I guess, going forward, is that a good growth trend that we should expect for startups or will the incremental volume additions at those locations start to ramp up more meaningfully?

No, those are good comparisons. Keep in mind, what we do is once we have a startup location that's been building revenue for a year, we move them to the base operation. So, some of the ones that moved a year ago, obviously, are much higher than that and adding value to base. But yeah, the trend of seeing 10 locations move from 50 to over 200 during the year is very much in our expectations and you should see that similar kind of thing in the future.

Okay. And then, how much ADC do you have in Florida right now?

It works out to be about 35% of our total census. I don't have the exact calculation in front of me.

Okay. And a third question is just, in your 7 to 9% in mid-growth for '06, how much of that is driven by de novos or new startups versus just pure same store growth in mature centers?

It would be about 1% of that number, of the 7 to 9. About 1% of that is from the new start locations. The rest is from the base.

Okay. And then, the last question I had, David, Medicare was talking about taking 40 basis points off the update for next year. I guess my question is specific related to how that might impact the acquisition environment out there and whether you're starting to see any sort of rumblings from smaller not for profits or regional players as to potentially selling, given maybe a slight change in the Medicare look at this industry?

Yeah. Actually, I'm glad you brought that up because for the first time ever, kind of hospice fell into the radar of the examining of the entire Medicare budget where hospice nationwide represents a little over 2% now of the Medicare budget. And as everyone knows, what's being proposed is we'll get market basket minus 40 basis points, which 40 basis points was the minimum amount of reduction that any healthcare player was going to receive. So, to a certain extent, we're paying the price of hospice is now its own healthcare platform. It's kind of being acknowledged as an entity until itself. So, it's kind of welcome to the big leagues.

But, the flip side is exactly what you're talking about. I mean, Med Pack and CMS, everyone operates the assumption that there should be some efficiencies as healthcare expands. This 40 basis points is basically acknowledgement that the larger efficient providers should be able to more than weather getting market basket inflation less 40. And you're absolutely right. The inefficient providers, certainly the smaller players who don't average say 5.3 visits per patient per week like we do, they're at 4.3 or lower, those are the ones that are going to be squeezed. Those are the ones that are going to, in some cases, the not for profits, which is 70 percent of the providers out there, they're going to have to go into the fundraising market to try to make up that gap.

It's going to be-- again, 40 basis points is pretty modest to the industry, but it does put additional pressure. And I think it's the beginning of a squeeze on the inefficient providers. But, by no means, is that going to be enough to trigger what I'll see as a noticeable increase in consolidation. But, we believe it's the beginning over several years of pressure.

Great. Thanks very much.

Our next question comes from the line of Kevin Fischbeck of Lehman Brothers. Please proceed.

Okay. Thank you. Good morning. I guess if we could talk a little bit more about the Phoenix facility. I guess, I still have a hard time reconciling the dramatic increase in the cap accrual for prior periods, but then the comfort that you have that you won't have cap exposure [inaudible] the inpatient you mentioned. Could you just kind of give a little more color there?

Yeah. What I'll do is I'll comment-- this is Dave Williams. I'll comment on how we came up with the $2.4 million. And I think Tim will talk about the operations side of it. Originally, we were estimating $1 million to $1.5 million based upon the trend line we saw. But then, we're in the position of wanting to make sure we're fully accrued for any potential look back that the fiscal intermediary is going to have relative to patients who are live discharge.

We're very conservative in our approach. We made the assumption-- remember, any patient that's live discharge, if they enter a different provider number on a look back basis, the fiscal intermediary is going to allocate the cap that went with that patient for their initial admission. We made the assumption that 100% of all of our live discharges will enter a different provider number and CMS will basically take away half of the cap that admit brought to our cap protection in Phoenix, so a very conservative basis.

So, we picked up 700,000 for that. So, we basically turned around-- and again, I did not want to have to go back and talk about Phoenix related to the acquisition here. So, we were conservative on the accrual. Now, I'm sure Tim has comments on the development of the market.

Absolutely. Well, I mean, just keep in mind, the inpatient facility we're talking about at the current time is for four beds and we hope to expand that over the next several months to 6 or 8 or even 10 because it's becoming successful. When you have a four bed unit like that and generally your length of stay may be as short as two weeks in a facility like that, an inpatient unit. So, just keep in mind, that's eight admissions a month under that theory. Eight a month is over 80 or 90 a year.

So, it makes a big impact on the business where we're looking at 500 or so admissions over a year that are necessary to move us in the right direction for dealing with the cap. So, an inpatient facility like that can make a big improvement on the go forward picture.

And in addition, we've made numerous changes in the marketplace to make contacts with physician referrals as opposed to the assisted living market and we're making progress in that area. And we're optimistic as the year unfolds, we'll be able to announce additional inpatient units in the Phoenix market.

But, it has a big impact. It's a very tough market because as you know, most of the hospital inpatients units there are tied up with the one big not for profit that has half the market there. So, it was difficult. It shows that we've made great progress. I think our business that we're running in Phoenix, the program is a very strong program that made great progress compared to when we bought them. And we expect good things in the future there.

And let me-- this is Kevin McNamara. Let me just really respond. No, there's nothing that has deteriorated in that situation with regard to Phoenix. We think that it's, we're to the point where if current trends continue, we'll get it behind us and never mention it again. We just want to, again, maybe we know more information and we just really are in a better position to make a conservative change in the entry related to really the cap exposure for the past period. But, as Tim says, if the current trends hold and it doesn't take a lot. If we had a census of eight short pay patients in our inpatient facility, that's basically all we need under current trends to not have that issue.

And as we've said previously, if we get to that position, our profitability of our Phoenix, it will move to the top of the chart as far as profitability for us among our programs. It's already-- it's fine now, even with the cap accruals. That is for the first year we owned it. It'll move right to the top of the charts if we can get the cap issue behind us. So, there's really nothing dark or negative that has occurred with Phoenix.

Okay. And I think you guys said that one side was hitting, had less than 10% cap cushion. Was that the Phoenix side or was that--?

--That's right. That was on our established programs. So, right now, if we look at our forecast through the end of January, two programs will have less than 10% cushion, Phoenix and one other. And as you've pointed out that that one other is completely different than three quarters ago. So, people rotate in and out as we rebalance our patient mix on less than 10% cap cushion.

Okay. And then, I guess, switching gears to the Roto-Rooter business, I understand sequentially Q4 is strong, but this is now two straight quarters of almost 10% year-over-year growth. And you would think that in the first half of next year, at least the, for 2006, the comps get, if anything, a little bit easier. I guess, why don't you think Roto-Rooter will be able to continue this 9 to 10% growth, at least for the next couple of quarters and why does it go back to 5 to 6% growth?

Well, this will give you an idea. This is Kevin McNamara. One of the things that I think we see happening with regard to Roto-Rooter is we're, with our current employee force-- that is, the number-- let's focus on plumbers now-- we're getting to the point where we've gone from 70% employed as far as keeping them busy to 84%. I'm making those numbers up, but they're order of magnitude right.

And it's a question of-- it's the question that if we want to see continued strong growth, we're going to have to grow the number of those plumbers, which is difficult. I mean, I think I would characterize the business the last 12 months for Roto-Rooter as like hitting on all cylinders. But, to really have strong sequential growth on top of that situation, we're going to have to add more plumbers. And it's been-- that's been a daunting task.

I mean, job one was making sure that we got the most possible that we could out of them. And we've been able to do that with some of the changes we put into effect the previous couple of years, including regional call centers and changing some of the operational aspects of the business. Before we could really predict strong sequential growth on top of that is we have to be able to predict the ability to hire significantly more plumbers. And again, the efforts there, until we see the results, we'd be reluctant to make that prediction. David, anything to add to that?

The only-- I mean, we will pass a price increase-- we have passed a price increase in December that's going to average about four percentage points and change and we anticipate job count growth. However, there are certain other costs relative to healthcare, insurance and other things that definitely-- yellow page cost-- that definitely squeeze our earnings.

So, when we talk about the growth rate for '06, to the extent that '05 was strong, that's going to come a little bit out of '06, '07 growth. Also, the growth we're talking about for Roto-Rooter we believe is sustainable. So definitely, these metrics-- if I had to apply for '07 guidance, I'd be using roughly the same metrics, as well. But absolutely, it is a very, very mature industry with very low unit volume growth job count. It's management of expenses, some of which are out of our control, gets factored in. We had a great healthcare year in '06 or '05. Will that continue in '06? We're hoping to, but maybe not.

And very good general liability--.

--General liability. I mean, insurance cost relative-- our experience is down, our claims are down. That will probably hold. But, if you had to take the over under, it'll probably inch up in '06. All of that kind of contributes to pretty reasonable low, but probably firm established expectations of Roto-Rooter. So, keep it in the single digit, guys.

Okay, great. Thanks.

Our next question comes from the line of Kemp Dolliver of Cowen and Company. Please proceed.

Hi. Thanks and good morning. A couple of questions. First, the guidance didn't discuss options expense under FAS123R. And I think your Qs have indicated that pro forma expense would be about $0.18. Is that a good estimate or what are you thinking on that front?

Yeah. Well, one, no, it's not really a good estimate because right now, we don't have any more options to allocate under following the accounting pronouncement. So, we do anticipate putting a proposal on the proxy for a new stock option plan and restricted stock grants that it's up to the shareholders to approve. But, right now, there aren't any options issued out there that would have an EPS cost. But, we do anticipate basically in late May, a program may be developed. But, its impossible to predict what the impact on our EPS will be. But, as of now, there are no options that-- there aren't any options outstanding that will impact EPS on a go forward basis.

Okay. And if the plan that you're, I guess, planning for the proxy, if that's implemented, does that-- would that kick in in '07 or could it possibly kick in in the latter part of '06?

It will be up the Board of Directors and basically the shareholders to put a plan in place and I'd like to defer that to Kevin.

I'll defer it back to --but, yes, if it gets approved by shareholders, the anticipation is there would be some option to authorize shares and options authorized, there would be a grant at about that time of-- again, we're not-- we're just planning on paying the dividend in line with our historical tactics. But, I don't know the accounting effect of that, but--.

--Actually, it will probably be a little less than historical numbers and more a restricted stock as has just been discussed, but-- because that's already buried in our amortization.

Right. Well then, that-- again, I'm just saying that, yes, we would expect an option grant at that time, but just in line with historical characteristics.

Okay. Second question relates to Roto-Rooter. And did you have a normal level of yellow pages ad drops this quarter or was it below normal? What should-- how does it look for first quarter?

There's no change on the yellow page policy. I-- Dave, you can go to the actual expense on the side of it. But, I'll answer by saying the ads, and that is we're seeing improvement on yellow pages positioning and placement, largely because in a lot of key markets, we're seeing some of the, our competitors, who are by definition not as large as we are, are falling back a bit as far as the two and three page advertisements. So, we see-- we're happy to see some improvement with regard to placement. But, with regard to expenditure and whatnot, it's very stable. I know the accounting part is a little unusual, but--.

-- Right. And I'll give you-- roughly, we spent-- I don't have this number in front of me, so I'll give it directionally correct. About $14 million was the total yellow page cost in our P&L and about a little under 700,000 pre-tax was kind of an adjusted for in our adjusted EBITDA. Now remember, under GAAP, when a book, yellow page book is dropped, you get hit with 100% of the expense even though that book will be in circulation for the next 12 months and used by our customers.

So, the difference between direct expensing, which is GAAP, versus amortizing over the life of the yellow page book, typically 12 months, that difference was about, actually $691,000 out of about $14 million. And that typically just represents the cost escalation, the inflation in the books that we are currently in, so a pretty modest adjustment.

Okay. But, in terms of say a year-over-year comparison in the fourth quarter, the numbers really didn't change?

No, they did not.

Okay, that's super. With regard to VITAS in the quarter, your length of stay went up a little bit, which is something you all have said you wanted to do. But, I was just curious if, given the other comment from one of your peers that the number of deaths was actually up for them this quarter, did you see an uptick in deaths this quarter yourselves?

Discharges?

Yes.

There are two types of discharges. That number is based-- is calculated on a discharge basis. There's two types of discharges - live discharges and deaths.

We see nothing unusual in that regard in the fourth quarter.

Okay. And just finally on Phoenix, I just want to be sure I understand the situation there correctly. With Phoenix, it sounds like it has just taken longer to implement particularly the inpatient strategy or capability than versus your original expectations and that's probably been the biggest source of the stubbornness of the cap?

No question about it. I mean, keep in mind that death is the biggest issue and we, it's a total unknown. There is a very tough competitor in the Phoenix market, a not for profit. And about 30 days after the announcement of our purchase of that hospice, there was an announcement in the Phoenix paper that that very tough competitor had signed for contracts for six additional inpatient facilities, basically just tying up all the likely candidates for our inpatient facility. I mean, it's that type of tough competitor that we're talking about here.

And it's just a matter of time. We can't really say we had a particular timetable for improving. And it's a little chicken and egg. In other words, you-- in order to get the short pay patients, you have to have the facility to take care of them. If you have the facility, but no patients, that's its own set of-- presents its own set of problems. So, it's all coming into the wind. And again, with regard to our return on the capital employed for the first year, we did well. I mean, Phoenix was a-- we were happy with the acquisition as the first year unfolded.

And again, it would have been-- had better position under the cap or that is would I have preferred 20% cushion at this point? No question about it. We're not there yet, but that's the trend.

Yeah. That's very helpful color. Thank you.

Our next question comes from the line of [Jim Lean] of Northstar. Please proceed.

Yes, I just had a follow up question. I was hoping you could maybe discuss your appetite for acquisitions, just in light of the further due diligence on the Phoenix entity that you acquired? And if you could comment on whether or not the cap issues that you see there in Phoenix, do you think that creates more opportunity for future acquisitions given that it seems like some of the smaller entities may be struggling with managing cap more than larger entities like Chemed? Thank you.

Yeah, let me just start. This is Kevin McNamara. No question about it. I mean, one of the real upsides to the Phoenix acquisition is that what we saw there is a niche player, somebody, a good operator who had some good contacts in the assisted living care and long, nursing home industry, set up a program, had-- was able to sign some contracts, make-- get some good relationships. Had a lot of patients, but weren't well balanced. They were longer stay patients, which-- to the extent you're building that base very quickly, that doesn't present a cap issue. But, the first time, the first year your admissions don't grow at double-digit rate, you're going to be looking at a cap problem.

This particular operator didn't have the wherewithal to broaden out and broaden out their patient mix. And again, we, I think, we got a great deal. Do we have-- that's our stock and trade is broadening out that patient mix, particularly on the lower length of stay kind of patient.

So again, it creates great opportunity for us. There are a lot of niche players, very profitable niche players out there who are going to be forced to do something that they haven't developed any expertise in. And that's where we come in. Tim, anything to add to that?

Well, I would say, I mean, your question is, as the acquisition candidates are approaching the cap length of stay issues, does it make them more willing to sell? Probably the answer is yes. But, that makes them less attractive to us--.

--Unless we think we can--.

--Because they still haven't faced up to the issue frankly that if they're in that situation, they're not entitled to maybe the valuation they're seeking.

Well, just as a follow on then, I would imagine that going forward, you would factor in this experience in Phoenix from a valuation--.

--Absolutely, we would. So clearly, we are looking for acquisition candidates that are more balanced, ones that have broader programs and inpatient units. And those are the ones we're seeking. But again, we look at all. And if someone has a blemish, that affects valuation. If they're not willing to accept that appropriate valuation, then we don't have a deal. But clearly, as these problems accelerate for them and they do not have the expertise to do the inpatient care or the higher more difficulty cases which require medical care for different diagnosis, then sooner or later, they're going to realize that they've got to take the lower valuation.

In addition, no other companies are positioned like we are with our national platform. So, we are very well positioned for the next wave of opportunity that's coming in the future to deal with regional and national managed care, disease management, physician practice groups. These are all things again that will begin to be negatives for the small local players that will over time reduce their valuation and our valuation will continue to do well. So, we're positioned very well.

Let me put one other context to the Phoenix acquisition. We talk about our experience. Basically, it's been-- our return on capital employed has been order of magnitude 10% pretax. Again, we're thinking it's going to be 20% pretax. And again, to the extent that we-- to give you the context that we're talking about, yes, we've struggled, but we're certainly within the range of what we thought was our expected return on the capital employed for that type of acquisition.

The price that we paid for Phoenix anticipated the cap problem would potentially arise and would be fixed. And we got it at a very good EBITDA multiple. So, it was a risk known. And we valued what we paid for this acquisition with that risk in mind.

Thank you. Very helpful.

Our next question comes from the line of Eric Gommel of Stifel Nicolaus. Please proceed.

Good morning. I was curious-- I might have missed this, but how many new startups are you expecting in 2006 or did you give out a number on that?

I don't believe we gave out a number. I think our goal is to increase them from the level we have now, which is about 10.

So, maybe another 10 or--?

--Well, as we go through the year, about half of these existing 10 will roll out of the new start program into the base because they've been new starts for over a year. And so, if five of them roll out and we add seven new ones between now and the end of the year, we'd have 12 at the end of the year, so to speak, is how it works. And we'll pace the number of new starts that we're basically going to work on the balance of the year based on what we're seeing with the current ones and just really market opportunities that we see.

And again, our strategy is to make sure our new starts are positioned to penetrate the markets deeper than most. And it takes a little longer to get them where we need to be before we move onto the next one, that'll be a better long-term situation.

And just to answer-- again, a question we may not be answering. Our limitation as we look at this is, by and large, the capacity for our staff to deal with them in the way we want to deal with them. I mean, sitting in the headquarters, we could snap our finger and say we don't want 12, we want 18. Yeah, there are 18 good markets for it. But again, we-- as far as to do them the way we'd like to do them, we run into the human bottleneck first.

And then, my next question is really related to labor. And Tim, maybe you can help me with this because you've been around the hospice business for a long time. Is it becoming more competitive to recruit and retain hospice nurses? And are you seeing any greater increases in wage rates than say maybe two years ago? And what is sort of your outlook for the labor market because these are specialized nurses? I'm just curious if you're seeing increased competition for this pool of nurses?

I don’t think we're seeing any particular increased competition. There's always local market situations. California, in particular, has been very difficult because of some of the laws they've put in for standards on nursing ratios in nursing homes, hospitals, etc. But, we've been dealing with that.

As we do more continuous care, that requires more nurses. And we do more than most and we expect to do even more in the future. So, we're being very successful actually in hiring them. We look at our merit increases in our nursing salaries year-over-year have been 3.5%. So, we're not seeing the increases are out of line. When we do hire new nurses, we're clearly seeing that some of them are higher than the ones we have now.

So, I don't think there's more competition. I think in general, there probably is, but we've done a lot to increase our recruiting. We're working with schools at both the vocational school level, as well as the university level. We work, for example, with some of the premier schools in Florida. And that gives us a first choice at recruiting some. So, there's a lot of things we're doing.

We basically have programs in the company where we're encouraging home health aids to take tuition programs and encourage them to become a nurse. We want a nurse at a certain level to go to school and we'll pay for it to be a higher level nurse. And we're being brighter about what tasks can be accomplished by different type of caregivers as opposed to a nurse.

So, we don't see any big change there. It's been tough for a long time. We get some leverage in some of the other positions in our interdisciplinary team where there's not as much crunch for the hiring. So overall, we feel like we can manage that labor cost. And right now, we're gearing up with a lot of new nurses because we want to have in our continuous care program, which we do well over $100 million a year, we want to have as much of that as possible done by our own nurses instead of outside agencies. And that'll make the program better over time. And we're working hard to do that right now. So, we're able to recruit them. And retention is okay. But, we've got a lot of programs in place that we think can help improve that actually.

And just the one thing that I would add to that is, as you can see based on what Tim said, there's one advantage we have, at least on a comparative basis, as we increase capacity and that is the extent we hire-- to the extent we're gradually adding capacity, we go to agencies and there's a higher cost for a nurse to us when you're paying the agency and the nurse. To the extent that we then have the stable repeating business and we're adding a nurse on our payroll, of course, the agency fee disappears. So, that gives us the one advantage as we grow as it relates to this type of, this aspect of the payroll expense.

Thank you.

Our final question comes from the line of [Peter Jickering] of Deutsche Bank. Please proceed.

Hi, thanks and good morning. A couple of quick questions for you. I was curious about looking at the guidance for VITAS, revenue growth [inaudible]. I was curious sort of how that was broken down into in terms of performance, acquisitions and de novos.

Well, there's no acquisitions in that figure and there's about a 2%, 2% of that would be from the de novo startup program.

Okay, great. And then, are there any strategies that you're looking at to help drive average length of stay in census in 2006? Specifically, are we seeing a trend of increasing census by neurological diagnosis? So, on the point, I was curious if they were going to sort of target those people directly or if the strategy was to do that?

Tim O'Toole. Yes. No, we do not have any strategies to target any particular type of disease state - for example, neurological. We target the entire communities and we take basically the patients and we have these services and the expertise to deal with them all.

As far as increasing length of stay, our game has always been to continue the education of the referral sources, that basically, many, many patients when you look at them after the fact probably could have used hospice sooner. All the independent studies show that. All the independent studies show that people that have gone through hospice see it as a good thing and probably would have liked it sooner. So, the length of stay we hope will increase because the referral sources sense that. And we will do everything we can to educate them. We'll do everything we can to make the admission process more seamless and more easy for everybody involved.

But really, it's just an overall function of the general public understanding and knowing more about hospice. All the information you're seeing shows that they want more, not less. And that means they'll be coming to us sooner.

And if you bank our median length of stay, which is improving, which is one of the things we're working hardest on, but it's still 13 days. In other words, half of our patients are with us 13 days or less. So, just to give you a-- when we talk about those patients should be with us sooner, what have you, I mean, it's half our patients are with us a very brief period.

And-- Dave Williams - as Tim mentioned, we target the entire community. So basically, what you see relative to our metrics on average length of stay is running very, very close to the national average published by the NHPCO. So, it's just a phenomenon people are aware of hospice. And the trend is to enter hospice earlier rather than later. That's really driving our length of stay is the overall awareness, not any specific targeting in any specific community.

Great. And then, the last question for you is on the continuing markets that you're seeing, a lot of a lot of competition on the hospice side, that are leading to reduce census counts in the specific markets that we should be aware of?

I'm sorry. Repeat that please.

Yeah. On the continuing markets that you're seeing a lot of competition from on the hospice side, in terms of census growth we should be aware of just to--?

--Geographic?

Yeah, from a geographic.

No. The only thing I would say is that what I alluded to earlier this discussion. [BCOS] started in Florida. Florida is a great state for hospice. It's been a highly regulated state. There's some unusual exclusionary issues in Florida - certificates of need, there's limitations against new for profit companies dealing with it. I mean, that's-- to the extent that those, that environment changes at all, it's still a significant one for us. But, it's one where again, for every change that you could deposit, we're potential beneficiaries for a balancing one. So, it's-- I would say that taking Florida away, which is an unusual market for us, no, we see good developments across the board.

Peter, Dave Williams. Really, to kind of connect your question also to Matt Ripperger's earlier question, in every one of our markets, there's inevitably at least one, if not multiple, pretty decently well run not for profits. That's the real competition. They're 70% of the industry. And again, to the extent that we have, we're spending over $50 million in back room infrastructure, to the extent that that allows us to have our caregivers be more efficient and provide more patient care, that efficiency will be what will give us the opportunity as those not for profits are squeezed because of lower reimbursement or changes in reporting requirements, that's going to create our opportunity relative to competition. But, our competition is on a market-by-market basis. Inevitably, it's the well established, well regarded not for profit.

Great. That's it for me. Thank you very much.

Okay. Well then, that's our last question. I want to thank everyone for your attention to this call and we'll be back in about three months.

Thank you for your participation in today's conference. This does conclude the presentation and you may now disconnect. Have a great day.