Chemed Corp (CHE) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Chemed Corporation's second-quarter 2006 conference call. My name is Jennifer, and I will be your conference call facilitator today. Please note that today's call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Sherri Warner with Chemed Investor Relations.

Good morning. Our conference call this morning will review the financial results for the second quarter of 2006 ended June 30, 2006. 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 of factors, including those identified in the company's news release of July 25th 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 July 25th which is available on the company's website 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 Kevin McNamara.

Good morning, everyone. Welcome to Chemed Corporation's second-quarter 2006 conference call. I will begin with an overview of the quarter; I will then turn over the call to Dave Williams, Chemed's Chief Financial Officer for a detailed financial analysis as well as components behind our updated guidance. This will be followed by Tim O'Toole, Chief Executive of our VITAS subsidiary for a discussion of our hospice operations. I will then open up the conference call for questions.

As most of you are aware, in the second quarter of 2006 our VITAS subsidiary recorded a $2.3 million Medicare contractual billing limitation accrual, otherwise known as Medicare Cap. This negatively impacted our diluted earnings per share by $0.05, resulting in adjusted diluted earnings per share of $0.49. The Medicare Cap impacted two hospice programs in the second quarter of 2006 resulting in the $2.3 million reduction to revenue and pretax earnings.

Our Phoenix program recorded an estimated Medicare Cap billing limitation of $1.7 million, and a second program with an average daily census of approximately 250, recorded a $600,000 Medicare Cap. For the 2006 calendar year Phoenix has estimated to require an aggregate Medicare Cap accrual ranging from $2.5 million to $4 million. The other program, a 250 census program, is not anticipated to require any additional Medicare accrual beyond the $600,000 recorded in the second quarter.

A third hospice program is anticipated to reach a Medicare billing limitation in the third quarter of 2006. This program, with an average daily census of slightly less than 300, is estimated to have a Medicare billing limitation ranging from $1 million to $1.5 million for the full year of 2006 with the majority of this liability incurred in the third quarter.

First let me address Phoenix. When this program was acquired we recognized to avoid Medicare Cap, we would have to materially expand the referral sources beyond the assisted living facilities and penetrate the high acuity portion of the hospice market. To date our efforts to expand the Phoenix referral base have proved unavailing. We've been unable to generate a sustainable level of high acuity patient admissions adequate to offset the longer lengths of stay generally associated with assisted living facilities. Although Phoenix is a very competitive market we believe the community would be well served with VITAS' high-quality, cost-effective approach to hospice care. In that regard we have replaced the general manager of the program and are redoubling our sales, marketing and education efforts in Phoenix. We will closely monitor our progress and are prepared to do our level best to provide the Phoenix community with excellent hospice care at an appropriate operating margin.

The other program with a second quarter 2006 Medicare Cap accrual of $600,000 is not forecasted to require any additional Cap accrual for the remainder of the calendar year 2006. This forecast is based on improving metrics resulting from management's efforts to appropriately rebalance the patient mix.

A third hospice program is forecasted to reach a Medicare billing limitation in the third quarter of 2006. This program with an ADC of slightly less than 300 is estimated to have a Medicare billing limitation ranging from $1 million to $1.5 million for the full year of 2006.

I want to now take this time to describe the background of the Medicare Cap and how the Medicare hospice reimbursement program and billing limitation risk is managed within VITAS' operating model. In 1982 Congress established the Medicare hospice benefit. As with any new healthcare provision there was concern as to the total cost of this hospice benefit. To alleviate this concern a reimbursement limitation or cap was established. The cap was initially determined by examining the 1981 costs to treat a cancer patient in a curative setting and in the last six months of the patient's life. The Medicare hospice cap was set at $6500 which represented 50% of the average curative care costs of cancer treatment. This cap is adjusted annually for inflation based on the medical care expenditure category and the consumer price index. An aggregate Medicare Cap is calculated for each individual Medicare provider number. The hospice takes its total number of first-time Medicare hospice admissions in the government fiscal year and multiplies those admissions by the hospice cap amount which this year is estimated to be $20,585.

This amount is then compared to the total Medicare hospice billings for that program over a 12-month period. Basically a provider number has admissions with very short lengths of stay the individual cap amount for these short stay admissions is not completely used up. This excess will allow the hospice to bill longer on a per diem basis for other patients who may survive longer and whose services require reimbursement greater than the individual cap amount.

Now I want to describe how the VITAS business model was designed around this reimbursement program. Historically VITAS' operating model has been able to successfully navigate around Medicare billing limitation. This has been achieved by admitting a significant number of high acuity patients, those patients in the late stage of their terminal illness. High acuity or short stay patients can be directly measured in a program with median length of stay calculations. For VITAS median length of stay is typically 13 days or less. In other words half of the patients admitted to VITAS are discharged in 13 days or less after entering hospice. This is materially lower than the National Hospice and Palliative Care Organization's industry median length of stay which they calculate at 22 days. VITAS overall has a median length of stay which is 41% favorable to the industry average.

Typically VITAS hospice programs were the lowest median length of stay also have the greatest cap cushion. VITAS defines cap cushion as the difference between the maximum Medicare billing potential based upon total admissions and the actual hospice billings in a program. At the end of the second-quarter of 2006 VITAS had 42 programs, five large programs -- those with an average daily census of greater than 450 -- 17 median programs those with an average daily census from 200 to 450 -- 11 small programs, those progress with less than 200 average daily census but not considered startup, and nine startup programs, those programs that have less than 12 months of Medicare billings.

VITAS' five large programs represent 42% of VITAS' total census. All five of these programs have median length of stay of 13 days or less. VITAS' 17 median sized programs represent 49% of the total census. Three of these programs are anticipated to have Medicare Cap limitations in 2006 which I discussed earlier. Of the remaining 14 programs, 8 have median lengths of stay of 13 days or less and 5 programs have median lengths of stay between 13 and 18 days; all well below the industry average.

One program has a median length of stay of 26 days. We've been carefully monitoring this program and consider it stable. It has an average length of stay of 75 days and an estimated full year cap cushion of over 50%. In addition, this program is in the process of expanding its inpatient capacities to meet growing demand within its market.

VITAS has 11 small non startup programs that represent 8% of the total average daily census. These programs have median length of stay ranging from 7 to 20 days, again all below the industry average. So outside of Phoenix which was an acquired turnaround situation, the real question is how did we have two programs that will dip into a Medicare Cap situation in 2006? To a certain degree our most successful highest growth programs run an inherent risk of touching caps during a program's rapid expansion phase. In most VITAS programs the median length of stay averaged, median length of stay, average daily census, admissions and discharges are relatively stable with constant growth gross rates making them relatively predictable quarter to quarter. However, programs that are experiencing exceptionally strong growth rates are inherently more volatile and have significant fluctuations in these metrics. This volatility increases the potential for a sudden shift in metrics in any given month or quarter.

A severe decline in admissions or discharges could result in a program having suboptimal patient mix and potentially reach Medicare billing limitations. To accept these programs have a sustainable level of high acuity patient admissions, the program's patient mix can be rebalanced and continue to contractually build Medicare for 100% of the services provided. Programs close to but not exceeding Medicare Cap, are maximizing revenue, profitability and operating margin for that program. The industry trend has been towards individual patients entering hospice early and earlier in their terminal illness diagnosis. This is resulting in longer lengths of stay resulting in expanded Medicare billings on a per patient basis. This trend does reduce overall cap cushion resulting in hospice programs with increased potential of being in a Medicare Cap situation. However, VITAS' relatively low median length of stay on a program by program basis provides us with a competitive advantage in terms of the ability to rebalance patient mix and minimize the financial impact of Medicare Cap. As well as limit the duration of a program at the time a program remains in a Medicare Cap situation.

It is our goal to demonstrate that we have the ability to rebalance programs out of the cap situation. This is not to say that Medicare Cap accruals will be eliminated. Theses types of accruals from time to time are inherent in the current Medicare hospice reimbursement program. Rather we need to desensitize stake holders -- in other words Medicare Cap -- and demonstrate that Medicare billing limitation can be successfully managed without detrimentally damaging the VITAS business model and long-term profitability. This will allow VITAS to continue to provide excellent care to our hospice patients and their families and deliver to our shareholders sustainable, revenue and profitability growth.

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

Thanks, Kevin. VITAS generated growth of 12%, revenue growth of 12% over the prior year period. This growth rate was negatively impacted by 152 basis points as a result of the Medicare Cap accrual of $2.3 million. Admissions increased 3.3%, and average length of stay expanded 1.2 days to 68 days in the quarter. On a year-to-date basis VITAS revenue has increased 13.6% to $341 million, admissions have increased 5.4%, and length of stay has expanded 3.9 days to 70.3 days, which is an increase of 5.9%.

Gross margins before the impact of Medicare Cap were 20.7% in the quarter and compared to 21.4% in the prior year. This equates to a 70 basis point decline in gross margin and is driven by a 6% increase in drug cost per patient per day, slightly lower occupancy at our inpatient units and increased field administration expenses. Partially offsetting these costs was a 20 basis point increase in routine homecare margins to 49.6% and increased continuous care margins climbing 80 basis points to 20.3% when compared to the prior year quarter.

Central support costs for VITAS which are classified as selling, general and administrative expenses in the consolidating statement of operations totaled $13.7 million, including $342,000 in OIG legal expenses. Excluding the OIG expense from all periods central support costs increased 1.4% when compared to the prior year quarter and increased 2.1% sequentially.

Now let's turn to the Roto-Rooter business segment. Roto-Rooter's plumbing and drain cleaning business generated sales of $78 million for the second quarter of 2006, 6.8% higher than the $73 million reported on the comparable prior year quarter. Net income for the quarter was $7.0 million and compares to net income of $5.9 million in the prior year. Adjusted EBITDA in the second quarter of 2006 totaled $12.7 million an increase of 12.5% over the second quarter of 2005, and equated to an adjusted EBITDA margin of 16.4% which is an increase of 80 basis points when compared to the prior year period.

Job count in the second quarter of 2006 increased 0.6% over the prior year period. Commercial plumbing job count increased 4.2% and commercial drain cleaning increased 1.6% over the prior year quarter. Residential plumbing jobs decreased 1.3% and residential drain cleaning jobs expanded 0.1% when compared to the second quarter of 2005. Overall commercial jobs increased 2.4%, residential jobs declined 0.3%. This is a favorable shift in job mix and since a commercial job will typically average 30% more revenue than a residential job, accordingly, this multi-year trend of expanding our commercial focus has a positive impact on our aggregate revenues.

After analyzing the intra quarter results from April May and June of 2006 we have fine-tuned our guidance per share for the full year of 2006. This guidance takes into consideration VITAS' current run rate of admissions growth, a slight moderation and expansion of length of stay and the current VITAS revenue mix between routine homecare, inpatient care and continuous care. Accordingly, VITAS is estimated to generate full-year revenue growth of 13.0 to 15.5% in 2006.

The component of this revenue growth consists of admissions increasing 5 to 6%, pricing and revenue mix increasing 3 to 3.5% and length of stay impacting revenue by 5% to 6%. The revenue guidance assumes a Medicare price increase that will blend to a 3.5% increase in the fourth quarter of 2006, and includes an estimated full year Medicare contractual billing limitation between $4.0 million and $6.1 million resulting in a forecasted VITAS adjusted EBITDA margin between 12.5 and 13% for the calendar year.

Roto-Rooter's forecast to generate a 6 to 7% increase in revenue in 2006, job count growth between 50 and 100 basis points, an adjusted EBITDA margin ranging between 16.5 and 17%. Based upon these factors an effective tax rate of 39% and average diluted share count of 26.7 million for the second half of 2006, our expectation is that full year 2006 earnings per diluted share from continuing operations, excluding any charges or credits not indicative of ongoing operations and excluding $0.03 for stock options, earnings per share will be in the range of $2.13 to $2.28.

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

Thank you, David. In our first quarter of 2006 earnings call we discussed our staffing levels, available capacity and the impact this excess capacity had on our routine homecare margins. It was our expectation that normal patient census growth would utilize this excess capacity and direct routine homecare margins would normalize. We are happy to report this did happen during the second quarter of 2006. Our routine homecare margins increased 210 basis points over the first quarter of 2006 to 49.6% and are slightly above the routine homecare margin generated in the second quarter of 2005.

Our nursing staff increased by 3.7% sequentially to 3,456 and is 11% above the prior year quarter. We continue to manage staff levels and capacity, and importantly the number of patients per homecare team increased in the second quarter to 59, up from 56 in the first quarter. Also our average number of visits per patient per week averaged 5.8 during the quarter, up from 5.6 in the first quarter, and up from 5.4 in the prior year quarter. Our turnover remains constant at 26.5% on a trailing twelve-month basis.

In the second quarter of 2006 our caregivers provided 992,281 days of care. This compares to 905,052 days of care in the second quarter of 2005, an increase of 10%. At the end of the second quarter VITAS employed 205 sales representatives. This is an increase of six sales personnel sequentially from beginning of the quarter. Just as important, we continue to expand our admissions personnel. We now have 349 admission nurses and coordinators dedicated to patient intake. Admissions by major diagnosis continues to be relatively stable with 35% of our second quarter admissions being cancer related, 19.6% neurological, 13.2% Cardio, 7% respiratory and 25% in the Other category.

We currently have nine programs classified as startups, six of which are Medicare certified. These startup programs had an average daily census of 167 patients with revenues of $2.5 million and pretax operating losses of $902,000. In the prior year quarter these same programs had average daily census of 17 with revenues of $90,000 and operating losses of $872,000. Importantly, VITAS remains well positioned for future growth. In most of the VITAS programs we serve large urban markets, have a healthy cap cushion and a healthy mix of admissions and good growth opportunities.

With that, I would like to turn this call back over to Kevin.

At this time we are in a position to entertain questions.

(OPERATOR INSTRUCTIONS) Darren Lehrich, Deutsche Bank.

A few questions here. First, thanks for additional detail based on your programs by size. I guess the question I have here on that is your cap cushion by your definition changes dramatically with your assumptions around readmission rates. So I guess I'm just wondering if you can discuss readmission trends and how that is changing if at all in your portfolio and just confirm that that is one thing we should be thinking about.

I will turn it over to Tim for his thoughts, but let me start by saying no, we don't think it is changing in any significant respect. We think that one of the things that makes Phoenix a little bit tougher is that the readmission rates -- it varies from market to market -- with Phoenix being four to five times higher as far as the reimbursement metrics as far as what you have to calculate for loss of the admissions credit. But I guess the point is it varies from market to market but I don't really -- I don't see (indiscernible) it changing --

I don't believe it is changing. As Kevin pointed out, Phoenix, we highlighted it there and we also highlighted that in Phoenix our major base of business is in the assisted living area. And as everybody knows the assisted living patient generally has a longer length of stay and one of the inherent issues in a longer length of stay patient is they are with the program longer and in certain cases they do transfer. In certain cases they readmit, they may just move to a different geographic area. That would be different than the history of having a lot of very short stay, for example, cancer patients that are with you less than ten days; you just don't have that situation with the transfers and readmits as much. So we look at it by various markets, and again by the type of patient and the setting, but we don't see any big changes in those trends. The main driving factor is admissions; your current admissions in the current period compared to your base of business and the trends of length of stay in the base of business. So the key to not having Cap exposures to grow your admissions rapidly, and the readmit is just a nuance to that.

Darren, let me expand on that what we are going to do on a go forward basis. We do have IT systems. The systems work great, as well as you're willing to ask the questions for the system producing the information. On a go forward basis, we are really going to track now all admissions, either a first-time Medicare admission, again, we track this but it (indiscernible) report out. It was a first-time Medicare elector who is a transfer in from our provider number, who is a transfer in from someone else's provider number, and who is a non Medicare basically hospice patient. And that is going to blow up to better capture the precise amount of protection on billings we have on a program by program basis. That's not to say those numbers won't shift quarter to quarter, but we expect it to be fairly stable.

And we expect to release as we refine the information, we release on admissions. An admission is not equal to -- all admissions aren't equal, so we are working on ways to make public release of the differences in those admissions and the growth of various admissions.

And although we talk about median length of stay as one of the key components for tracking how a program is doing, again to try to stay on point, the number of other metrics we track at the same time, is average daily census of that program going up and down? Is the Cap cushion fluctuating within that program? What is the average length of stay of in-program patients in addition to median length of stay and in addition to all of the actual first-time Medicare elections? So all of that is being looked at monthly and quarterly.

And then if I could just ask a couple more things with regard to margins, you've cited occupancy as an issue on the inpatient side for lower margins. I guess just hoping you can give us a little bit more detail on what's driving that. And then also just give us a little bit of color on how concentrated are your beds in the inpatient side? I guess based on your disclosure here there is about 510 inpatient beds through the system and I just want to get a sense for how well spread out those beds are.

First of all as far as trends we did see some softening of the utilization in the second part of the recent quarter ended June. And we believe that was related to trends in the hospital census areas that we've seen. We also had a couple of new inpatient units that we started up that didn't have capacity building yet. And you know, it has been noted by the hospital industry that census was a little soft in the recent quarters. But the main point that we want to make is not only are we seeing the census still up in the hospitals again, but we are seeing as we move into the July period that our occupancy rate of our inpatient units overall is back to the higher historical levels of 82, 83, 84% as opposed to where it had dipped a little below 80% in the second half of the second quarter.

So the concentration is not unusual. Our normal inpatient unit would be something in the range of 12 to 14 beds. And we haven't concentrated those in any given markets. In fact, our three or four most recent inpatient units have been around the country in markets where we in many cases didn't have them before. And have been very helpful to keeping the programs on track with where we want to go to both serve the community broadly and as well as the Medicare Cap issue. So nothing other than a minor blip for about a month and a half period, not concentrated anywhere. We think it was related somewhat to census issues. We also think it was related to us building our continuous care program which in certain aspects competes a bit with inpatient. But the good news is we are back on track to our historical capacity levels, and we hope we can improve from there and the inpatient units we have 26, 27 of them. And I know we are working on many more that will be in the markets where we need them for all the right reasons. So we feel pretty good about it.

Thanks a lot.

Jim Barrett, C.L. King and Associates.

Good morning, everyone. Kevin, can you give us a sense as to what the median length of stay is in Phoenix?

It's very high. I will ask Dave whether he --.

70 plus days.

70 plus days.

That's the median length of stay?

Not the average, the median.

And Tim the other two programs that have interim cap issues, any sense as to what the median length of stay is there as well?

We're looking it up.

Okay. Then Tim, just a more broad question, why beyond the inpatient occupancy issue which seemed like it was a blip, is there any other reason why you're seeing a slowdown in your growth in admissions?

I think the slowdown that we've seen, and what we mentioned several quarters ago -- obviously in our bigger markets in Florida we do not expect the growth rates to be as high as it has been historically. But in our other big programs we are seeing good run rates of admissions, and our New Start programs are adding admissions as well but we haven't added as many New Start programs to the scheme as we have historically. We slowed it down a bit but we're getting ready to accelerate again as we feel we are in good shape there and the ones we have been working on are starting to show good progress. So I don't think there is any major overall trend. The market for hospice is competitive, but that has been that way for certain a long time, and the situations that we see in certain markets like Phoenix is a very competitive market.

So we are seeing certain markets where characteristics such as hospital zoning their own hospices with no alternatives for freestanding, very large non-for-profits that have large market share and they are very aggressive, those are markets where it is becoming difficult to grow. And I think that will just lead us in the future to be cautious about certain markets and go into the big urban markets where we have much opportunity to take market share from other companies, as well as opposed to going into the medium-size market. So no overall changes, but the hospice market is competitive, has been competitive; but we don't see any big changes there. It is really our own efforts we need to execute better in certain cases.

And Jim, I think you put your finger on something that is a very significant element in the second quarter, was admissions coming in overall about half -- 3% plus instead of 6% plus, as far as growth. We like to say here that a rising creek covers a lot of stumps. A creek that is declining a bit a few stumps jump out at you. And I am sure somebody is going to have a question later on that at least people are thinking about it, but boy, I mean a quarter ago you thought things were pretty good with regard to the non Phoenix related branches as there has been a deterioration. That is just the way the accounting for the Cap. It is based on projections, and we had some significant changes in trend for admissions in a couple of those programs which we don't think are, as you've heard us say, we do not think they are going to be continuing. But it affects the projections, and it was really part and parcel what that yield is much slower admissions than we expected in the second quarter.

But as I think Tim alluded to, other than just some competitive situations in a few markets that have, can have an affect, we only have 42 programs. We are not talking about something that -- some of these are -- we're dealing with relatively small numbers or one or two programs with a dislocation can have a fairly significant impact on the number. But it is a key metric for us, one we are watching but we feel good about it. It really explains -- that number really explains why there could be with regard to the two non Phoenix branches that have the lowest on a Cap cushion, when you have slower admissions and you project that same trend, that's what leads to the accounting issue.

Okay, Kevin. Thank you very much.

Jim, to follow-up on your question about the other two, the median length of stay is in the 25 to 30-day range there, and it bounces around from month-to-month, quarter-to-quarter. But those are just some ranges, much lower obviously than Phoenix and not that much higher than the normal programs we have.

I think the key, beyond Phoenix, the key on those programs like all of our programs, beyond Phoenix all of our programs have a fairly sustainable rate of high acuity intakes. And that makes this significantly more easier to rebalance a program and pull that program back into a situation where you can bill it for 100% of the services provided. And that is a key distinction on all of our programs outside of Phoenix.

Matthew Ripperger, Citigroup.

A couple questions here. I guess given some of the challenges you had in the first half of the year, what is your de novo strategy now, how many new centers in the pipeline? Just want to get an update on your de novo operations.

Right now we have nine in the operation, and as you know we define those as ones that have been billing for less than one year. So we have nine that are in that category, and we have two or three that would roll out of that group in the next couple of quarters. And we would expect to replace those with at least three, probably four or five. So we hope as we talk to you next quarter in the several quarters in the future, that number will be higher. So I think that number will move from 9 to 11 or 12 on an ongoing basis. We feel very good about where we are heading, and as I said we will be heading to large urban markets where we intend to plant our flag and take market share because of our model and resources we will bring there.

Okay, all right. And a follow-up question on the Medicare Cap issue, the data that you provided you gave the ADCs for those programs, does it make sense for you to also provide the admissions basis as well, given that admissions tend to be the leading indicator for the cap exposure?

The short answer would be no. One, it is not going to be -- it is still on these programs because of the volatility. The admissions are growing actually very nicely in both of those programs. They are very profitable programs even without the Medicare Cap; but by definition it is going to be fairly volatile as they are growing out. I don't think it would give you any more visibility, and I think it would be -- it would probably be misread.

We'd have to give you a lot of information; that is the kind of thing I mentioned earlier we are kind of looking at, even internally we are doing a lot on segmenting the various form of admissions. All admissions are not created equal, and they have a different effect on the Cap. It does not have too much impact on anything but the programs close to Cap, obviously. And we are looking at that. It is volatile. We will try and give the best guidance we can, and we don't -- again look at the stock price; people don't like to be surprised. That's what we are warning against making sure that much information, reliable information is disclosed so that there are no surprises.

Okay, and one last question just related to the updated guidance versus a couple weeks ago. Maybe can you just go through exactly what has changed? Is it that you see the length of stay admissions trend slowing more than expected for the month of July, or you just wanted to be more conservative relative to your previous guidance?

Yes, and when we issued the pre-announcement on earnings our first and foremost was to get to the market as much information as we had to actually not create any unnecessary uncertainty and have you dial into the thought process on what our earnings are on a go forward basis. Our primary concern was Medicare Cap, but try to give you a realistic guidance for the full year. But in between the time we issued our preannouncement, really through last night -- really dove into the quarter, trends in the quarter -- the likelihood, again any four quarters we typically have one fantastic admissions quarter and one relatively weak admissions quarter. And we had first quarter was pretty good at 7%; we have our weak quarter of admissions, so I kind of look at that and say how strong do I feel that we will have two fantastic admissions quarters Q3 and Q4? That's possible, but we want to give guidance that is realistic.

So we looked at what the admissions would be for the second half of the year, we looked at the way the patient mix ended up at the end of Q2 between routine homecare, continuous care and inpatient, inpatient took a dip. It could very well be a statistical anomaly but we kind of dialed that in our thought process on a go forward basis of when that changes back to normal levels. So really I fine-tuned the revenue relative to VITAS, took a look at the overall margins we've been generating. And what I would say is I literally tweaked the range; without a doubt I pulled down the high-end $0.03, expanded the bottom net a little bit but at the same time provided a very realistic guidance that a few things can go wrong. We could have some fluctuations in our margins and still have an exceptional degree of confidence of falling within that range. And literally I would call it fine-tuning the thought process and nothing more. Anyone that reads anything more into it is probably getting carried away.

I would say that one part of your question is but it changed within a relatively brief period. I would describe that is more in response that we made in something unusual for us, and that is we made a pre-release of earnings. And we just, because the Cap issue seemed to overwhelm all, and I'm surprised we didn't want trading in the stock that was going to be based -- possibly based on some information that hadn't been released to the market. So we just haven't had an opportunity to go to the same level of forecasting and estimating the rest of the year that we would normally do by the end of the quarter. So it was just something very unusual for us, and it had the effect of making a change during that period which is disconcerting to a lot of people. But that is the way it is.

Our philosophy on guidance is don't sugarcoat anything; at the same time don't put out numbers that you know you could blow out of the water and easily exceed. We put together a realistic estimate of where we think the business is, where it is going, and we put our guidance that we think we have a high probability of achieving and (indiscernible) guidance we would anticipate to be definitely at the midpoint or slightly better than that guidance. And that will be our philosophy on a go forward basis, as well. We will release as much information and thought process as we can to the Street so you can adequately develop your own models and understanding. And we will do that every quarter and every year.

Thanks for the clarification.

Kevin Fischbeck, Lehman Brothers.

I had a question I guess on the guidance, as well. It appears that the lower revenue guidance for VITAS is driven primarily by a reduction in the estimate for admission. Now I wanted to get a better sense for why that is. One would think that if you're hitting the cap admissions look relatively the same, but since you're targeting shorter length of stay patients, the benefit from length of stay would actually keep going down rather than admissions. Instead you are forecasting basically the opposite that your ADC growth will continue to benefit by the same amount from higher length of stay but that your admissions are down.

Kevin, it doesn't quite blend out that way. For example, the two programs, Phoenix programs, that will have a cap issue in Q2 and then Q3, they are having great admissions growth. So you can't really take any macro metric for VITAS and try to apply to what I will call the micromarket, the individual program locations. So you definitely can't read into it too much relative to that. Really the guidance pulled down to a degree -- admissions were a little soft, but again, once in any four sequential quarters we typically have one soft quarter. But it was also the mix of revenue. We were a little disappointed with our inpatient revenue and occupancy. That translates although it has lower margin, the dollars are significant at $600 per patient per day. So all of that kind of dialed into a slight softening of top-line, which we literally fine-tuned earnings but definitely can't read into the admissions overall and to any specific program.

Okay, and I guess you seem pretty upbeat that at least outside of Phoenix that the rest of the sites will be at relatively minimal cap, and it sounds like you might think another site might dip into Cap at some point but overall you don't expect the cap to really continue to be a problem. We've seen other providers have a really difficult time dealing with the cap -- usually costs more money and taken longer to deal with it than they originally thought. What gives you comfort that you're going to be able to deal with these issues so quickly?

Let me start by saying with regard to the two branches other than Phoenix, the major issue is both of those programs have pretty good sustainable levels of short-term stay for high acuity patients. And so there is something to work with that. And the amounts involved are relatively minor with regard to the Cap exposure. I won't bore you with it but with regard to one, it is again relatively small numbers, executional issues, a change in some of the -- in one of the top sales people, it is those type of executional issues that we are confident that we'll be able to overcome. They are non-institutional. With regard to Phoenix, Phoenix is a tough one. We haven't developed the referral sources in the short-term stay patients. We are making major changes in the way we are managing that. That has been a management failure starting right at the top. We are making major changes in how that is managed with the personnel involved, and the activity involved with that branch. Let me just say, though, I think if we ceased business there today in some fashion the amount of total write-off would be about $2 million as far as from the balance sheet perspective.

It is not -- that is not the type of major continuing problem that I think that some of the other hospice companies have been running into at some of their branches. We haven't given up on Phoenix market. We think its demographics would suggest it is a good market with real tough competition, and we haven't had the right formula there and it is important to us to demonstrate that we can develop that. They haven't -- you can see that when we talk about what the median length of stay is and the nature of the referral sources in Phoenix. We haven't been able to turn it into a more traditional VITAS model yet and we are going to have a different team of people who are going to be attempting that post-haste.

With regard to our confidence level as far as do we believe that we are looking at some howling disasters, no we don't think so. In fact one of the -- the one branch that had the Cap exposure for the second quarter, if you look at the metrics now and you say that you look at what looks more like a blip for the second quarter, it was a program that had rapidly expanding admissions, rapidly expanding sales, it had just in the second quarter you saw a big hard to predict drop in admissions with revenues continuing to decline. And that is a Cap situation when you're close to the Cap. That is a rugged situation. And when you look at the metrics were that already as we suggested, we don't anticipate any Cap exposure for the third quarter for that. So there is all sorts of reasons why we have that confidence level, which we feel pretty strongly is not wishful thinking.

And relative to again, to focus, to almost be redundant on the median length of stay, if half of all of our admissions are discharged in 13 days or less than the vast majority of our programs, if you think about it, each new admit brings 20,600 Cap protection dollars. Half of our patients just use a small fraction of that 20,600, and those remaining dollars are freed up for the statistical outliers, the 10% of patients who live beyond six months. So relative to our mix of patients, half of all of our patients just use a fraction of their Cap protection is what makes our business model much more sustainable in terms of profitability. And that is why we took so much time to release those individual metrics by small, medium and large programs. That is a key discriminating factor between our business structure and some of the other providers.

The other factor is you have to look at geography to the extent that when you look at the geography of where the Cap problem is, we feel that the short stay patients are in the market. It is a question of having the right mix of inpatient facilities, the right connections to the right discharge planners and what not. But just geographically where we have those issues are ones that would suggest that the right executional strategy should be able to be successful.

I want to reinforce your question on other providers; we remain very different from the other providers. We're not in a lot of small markets. We are in the large urban markets. We have a lot of flexibility in many of our large markets even where we have multiple licenses, to do adjustments between one program to the other, merge licenses. These two programs that are not, that we talked about other than Phoenix, we just for various reasons do not have that flexibility. The thing about those two markets is as Dave and Kevin have said, I want to reinforce, there are many opportunities there. VITAS is putting many resources in these markets, and we will continue to put a higher level of resources there. And I believe we will make great progress in the very near-term. In fact, I look forward to reporting over the next several quarters over our progress there.

How exactly will that show up? Are we going to see an increase in the sales reps, or are we going to see some of these de novos be ADSs?

In the current markets where we are maximizing our revenue and have modest Cap issues, yes we will increase the sales effort, we will look for ways to get in the community, have more opportunities for inpatient settings. That is really the opportunity to get the shorter stay patients and affiliate with physicians and hospital groups. And again we continue as we've been working on in the last year understanding that these things were possible; if those were not achieved we've been putting a lot of resources -- when I say resources I mean selling. I mean communications with any hospital systems, communications with regional practice groups and other big players that understand our services can be regional and national versus just local. So I think we're making progress.

Sometimes progress takes some time but you see movement and you expect things to happen so I expect good things to happen. I want to reinforce I do not expect these to be continuing problems. We can manage in and out of Caps. Phoenix is one that we have to take a hard look at. We've changed management, and I know we can have a better operation there as well. But to reinforce we are not like the other hospice companies that have had many, many small markets with a dearth of short stay patients, because there is no hospitals there. We are not in that situation, and we have much flexibility, and I know we're going to make very good progress in these areas that we are having the problems today.

Okay. Thank you.

Eric Gommel, Stifel Nicolaus.

Fourth quarter is a key quarter from an earnings perspective because you have the cost of living update for hospice. What is the assumption you are using with respect to the cost increase? In the sense of how much does that drop to the bottom line in 4Q? Do you look at half of that cost -- half of the price increase dropping into the bottom line or is it 100%, or how do you look at that?

We anticipate the number is 3.5%, and the assumption of that is about 80% plus of that will drop to the pre-tax line.

Okay, and then on the stock options expense, you talk about a $0.03 impact. In absolute dollar terms how does that look on a quarterly basis? I mean like in third quarter, fourth quarter, --

550 a quarter.

Just bigger picture question, the Phoenix acquisition has really not turned out very well. How does this change your appetite for acquisitions? How about -- I guess the Pittsburgh program was another acquisition -- how do you look at acquisitions at this point as a growth strategy?

I will turn it over to Tim, but this is Kevin McNamara. Let me start by saying we've always described is the hurdle for acquisitions is high within the company. The grass-roots startup program is a very compelling financial and strategic way to expand our geographic footprint, and that has always been at the forefront. We sought to supplement our growth under the current operating conditions with acquisitions. Before I turn it over to Tim let me first give you a direct answer to your question. The hurdle is higher. We have not demonstrated to ourselves that we can do, we can get enough out of that. We thought that the acquisition the size of Pittsburgh, Atlanta were largely running start ups. In other words, we were buying a license, a few referral sources, relatively small ADC programs. It was just the way to jumpstart growth in what we thought were some nice geographic markets.

Phoenix was a different situation. It was a fixer upper, and again, there were management failures all the way to the top. There were some major problems in the field with regard to that. And management did not get to the bottom of those early enough. And so we wasted almost two years in developing the referral sources that we need to make that program viable. But I just wanted to say that in advance. And Tim, but with regard to acquisitions, yes, we still look at the right type of acquisition we'd still like to buy. It would have to be fairly large in a metropolitan area. We would still have an appetite for those. But again with regard to a fixer upper or with regard to far-flung enterprise that has seven programs with 60 census in each of the seven in less than large markets, no, we are not interested. That is from the Chemed perspective, now Tim, you have --

I think I just want to reinforce what Kevin has said, there is a need for us to demonstrate that if we're looking at an acquisition that has Cap exposure or a situation where it would move to Cap exposure over the next several years, based on expected growth a situation in that market. We must feel we can impact that in a positive way before we would bring that to the table. I think that is why it is critical that we show that we can make progress on these units we've talked to you about today, and I'm optimistic we can in the relatively near-term.

So as Kevin mentioned, the better opportunity for us would be maybe a regional play that has some big city opportunities that we can go into that we're not in today. And there are some of those available but again we're not aggressive looking to value those or -- but we're looking at everything. VITAS remains a leader in the industry and when companies are for sale we're generally in the discussion. So they are available. We are looking closely, but we've got to feel like we can move them forward. We feel very good, though, that we don't have any pressure to do that. As we've told you before, we are comfortable with our New Start program. We are going to accelerate that. We are adding value.

If you just look at the results we reported this year we've increased -- in the nine programs that we have right now -- we generated over probably incremental growth of 170 or 180 patients in a year, and that is adding a lot of value long-term in these markets. We also are accelerating our extension program where we are basically forming satellite offices in some of our large territories where we just are looking for coverage of outlier areas now for growth. And this is another way to generate growth in almost a de novo way. So again acquisitions, we are looking. We got to demonstrate we can do a better job of managing them and impacting the Cap. I think we can do that, and those opportunities will be there for us in the future.

Great. Thanks.

Kemp Dolliver, Cowen & Co.

Thank you. One question relates to your discussion regarding the length of stay outlook. Over the last couple quarters you well know it has, the numbers bounced around a bit. So when you talk about I guess a 5% revenue contribution for length of stay, what kind -- which base are you thinking when you give that forecast?

I'm not quite sure I understand the question, Kemp.

I think earlier you said that you were expecting about a 5% contribution of VITAS' revenue from length of stay.

Yes.

Which would imply that it is lengthening. Now you have had some volatility in length of stay the last few quarters from the upper 60s to the low 70s. My question is where do you think length of stay is going to settle out? Is it because it could be in the high 70s or in the low 70s just based on which quarter or time period you want to use, just --

I understand your question. A couple things before I directly respond is length of stay is a pretty big lag indicator, because by definition it is only calculated from your discharge patients. So in half of those discharges are people that admitted to our program 13 days or less as well, so it is a combination of the mix. It is an indicator, but you can't get too excited over a quarter to quarter, but we look at it carefully. But with that said to a certain degree it is the law of larger numbers. When we were turning around we were at a 51, 52 average length of stay and obviously moving up 5, 6 days you are talking 10, 11%. So we are still moving up several days but law of large numbers says now when you're dealing with mid to upper sixties, average length of stay moving up four days is a smaller percentage. And that is literally our thought process behind it.

Okay, that's great. And I guess a more broad question on given some of your comments about your business, how do you think your results say mirror in the marketplace? Do you see some of these smaller startups or the hospitals or the like really having an impact in the market, or do you sense that there is a just general maturing of the market going on, too?

Tim, I will turn this over to you. Again, I will start by saying I don't see any cataclysmic shifts. The biggest effect of hospitals in a market to the extent they have a hospice program, is it makes it hard to get an inpatient facility at that hospital if they have their own hospice program. And that is something that if we have a smaller, medium-sized program that has an effect on the pace that we grow, that to profitability and to the extent that having a good low median length of stay, it has that type of effect. But absent that is another competitor. The hospital is just another competitor. They generally speaking are the type of competitor that has some operational issues in dealing with far-flung patients. That is, they are used to dealing with inpatient populations.

But there again, it varies but it is that type of competitor that has that orientation. So I'm going to turn it over to Tim but I am going to just tell you that my reaction to it is we don't see any major changes other than again, it is tough, it is not like shooting fish in a barrel. It's tough. We have every expectation that we will continue to grow our admissions into kind of our expected rate. In that 6% to 7% range. And we had a quarter where we didn't but that is what we're looking to do.

I will reinforce as Kevin says, it is no seachange. We probably have seen in the last several years as everybody knows based on our success and the whole industry gaining more stature, I think people have seen that it is a niche that they're interested in. So yes, hospitals have probably been a little more interested in maybe having their own inpatient unit in the last several years but I think that is abating. I think what is beginning to happen right now is that people are seeing that the Cap issues that are there, the regulatory scrutiny of the industry is high, which is frankly good for us because we spend a lot of money on making sure that we are tight in that area. So I think people are seeing that it is an opportunity, but it is not just something you do and have no risk.

So many hospitals are moving in the direction of having internal palliative care programs, and part of that is affiliating with a hospice program, just bringing up the hospice discussion earlier. So that is not a bad thing at all, and they are realizing if they don't have a broad-based homecare program than just to have an inpatient unit in their hospital creates another set of problems for them with an inpatient Cap issue. So we have many opportunities to work with hospitals, and I think we've made good progress there but I do not see any seachange where we're going to get locked out of any other current opportunities that we have. And I think with the Cap issue surfacing, the regulatory environment surfacing, that actually it is going to go our way in the future.

That's great, and just one last broader question. Given your cash flow and the gyrations in the securities markets for your securities, at least and your general view on acquisitions, how do you -- how are you thinking about your use of cash flow at this point?

Let me start by saying maybe there is an implication in that that I'm presuming, perhaps is would we consider stock buyback program with some of our excess cash. The answer is yes, we have one. There are some limitations we face with regard to our borrowings, but that is one, at these prices it seems like a pretty good use of cash. But again, we are good cash flow generators. We want to keep our powder dry; we believe the type of things that are going on in the market are going to lead towards consolidation rather than away from it, and we want to be prepared for that opportunity. But in the meantime at these prices stock buybacks are accretive, very accretive. And that, over our history, that has been something that under the right circumstances we have been active in.

That's great. Thank you.

Joshua Fenton, GAMCO Investors.

It has been VITAS, VITAS, VITAS all morning; I just wanted to just highlight that, I think one of the reasons is when you guys laid out your original plan in 2004 you sort of set yourselves up as doing everything better than everybody else, and now you have sort of been caught and trapped in the same trap as everybody else, and look forward and have confidence you guys will fix it. But there has been enough about VITAS -- I am not going to dig deeper into it.

On Roto-Rooter, numbers continue to be very very strong there. And we haven't heard a lot about the franchises that you were looking at in California for a while. I want to know what your thinking is as far as expanding into some of those larger franchises that you had been looking at a year or so ago.

Very simply, and I would say that we retain an interest. I would very fair to characterize previously that we were a very motivated buyer of franchises with regard to those. Frankly at this point -- and we overpaid -- it's like we were just an aggressive buyer. We are still in a period with regard to those franchises we have -- our two largest multi-site franchise or franchisees have sales in excess of $70 million, to give you idea of the total. Two of them as far as size.

We are interested in purchasing those franchises, but we're still in the stage where we are basically lowering price expectation. And again, their approach is well, maybe I will continue to grow my business and I can still get what I used to. Now with a bigger business I can get the price I was kind of hoping for three years ago. So we're still in that space. We are interested, but there is nothing, there is ongoing discussions but nothing hot.

Are those franchises as far as you can tell growing faster than what you have?

Slower.

Slower, okay. And could you just talk a little bit about the income leverage you're getting at Roto-Rooter and really what is the future potential for that? Is that going to continue, or are you guys -- you're getting close to 20% growth on 7% revenue growth. How do you see that in the next couple years?

I will turn it over to Dave for his technical response, but I would say that it is a business that is hitting -- when you look at our operating margin for a service business, it is hitting on all cylinders. It has, we have some relatively nice additions to the business with regard to repurchase of relatively small acquisitions that we are putting in our contractor division, which is doing very well. We continue to make those type of small acquisitions on an almost quarterly basis. We look at pushing into the commercial side which is limited only by our ability to retain and attract plumbers. Basically. And we are doing an increasingly good job at that. So the answer to your question is we don't expect too much from the business. That is what we are seeing now is slightly exceeding our expectations, but at the same time we believe that it is fairly sustainable.

And you're committed to keeping that as part of Chemed for now?

Yes. Someone would have to, there would have to be a reason to make a change. Right now I would characterize it a little bit as what the doctor has ordered especially given the fact that we expect the use of the cash from Roto-Rooter, the free cash flow, to largely be put into building really a national VITAS business.

Okay, I appreciate it. Thanks.

Darren Lehrich, Deutsche Bank.

I just had a couple things here. I guess given the Florida law change that we all saw earlier in July, guess I just wanted to give you a chance to comment on that. It would seem like the CON process there may still be the more important barrier, but I just wanted to get your sense as to how that changes the business environment for you in the competitive landscape in Florida.

I will turn it over to Tim, but the answer is going to be not much.

Yes, we do not see any change from that, Darren. As you mentioned, the law changed to allow companies to come in in a for-profit manner, as opposed to just non-for-profit, but they did not change the certificate-of-need laws. So basically still no one can come into the State of Florida anywhere until need is shown in one of the regions. Generally speaking about every six months they review that, and one or two regions are opened up which is currently the situation right now. Then companies file to see whether they -- four or five companies usually file, one is selected and one or two new providers come in the state. And when that is available in an area where we are not today, we're one of the people that apply and we have a high reason to think we might be able to achieve expansion in that way.

As part of the legislation that changed the for-profit status, they basically indicated that they see no expectations that the CON laws will be changed anytime soon. They are doing some studies to determine whether anything should be changed or what not. So we don't see any big environment change. As you know, people could pretty much come in the state before with this structure of a non-for-profit subsidiary -- (multiple speakers) But they still had to go through CON, and just couldn't come in. So really that is a no change situation.

All right, and just the last thing for me here on Roto-Rooter again, I guess can you just refresh us in terms of how the housing market has impacted your business. In terms of a cyclical change with the housing market? And I guess with the commercial business now being a big driver, does that change that equation?

I don't know really if there has been any big change. I think gradually we've seen over the last eight years our residential jobs have been down. Now the good news is the last year and a half they've stabilized. But the previous seven years, industrywide you'd see the number of jobs on the residential side of it going down, and that was industrywide, and it was observable. It was more usually more than a couple percentage points per year. That can be described as -- has been described to me by various experts as a change in the nature of the way pipes are manufactured, change in building houses in kind of wide-open areas as opposed to old-growth suburbs.

But the real issue is that job the residential job growth situation for us has stabilized, we think industrywide it is still (indiscernible). If you look at a fairly representative group of 500 franchisees it is still ticking down. The fact of the matter is the commercial side has been a real boon to the Roto-Rooter business, it's getting a lot of effort from our people and that is the side of the business that is relatively exciting. Limitless growth, as I said before, almost tied to hiring and retention of plumbers to do the work.

And Darren, we have zero new construction in our numbers.

Thanks very much.

This concludes the question and answer period. I would now like to turn the call back to Mr. McNamara for any closing remarks.

The only closing remarks I have is a couple allusions to the fact that we have traded some very lofty multiples, lost some ground, and it is a function of restoring confidence that both the predictability of not only what numbers we achieved, but what we're going to do and how we're going to do it and in what timeframe, and we are committed to restoring that confidence. And we will spend time, next quarter we hope we have a much more pleasant story to tell. And with that I will conclude, and wish everyone well.

Thank you for your participation in today's conference; this concludes the call, and you may now disconnect. Have a good day.