Chemed Corp (CHE) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Chemed Corporation's fourth quarter 2006 conference call. Please note that today's call is being recorded. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Sherri Warner with Chemed Investor Relations. Please proceed.

Good morning. Our conference call this morning will review the financial results for the fourth quarter of 2006 ended December 31, 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 February 20, 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 20, 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.

Thank you, Sherri. Good morning, everyone. Welcome to Chemed Corporations's fourth quarter 2006 conference call. I will begin with an overview of the quarter. I will then turn the call over to Dave Williams, Chemed's Chief Financial Officer, for a more detailed financial analysis as well as components behind our 2007 guidance. This will be followed by Tim O'Toole, Chief Executive of our VITAS subsidiary for a discussion on our hospice operations. I will then open this conference call up for questions.

Chemed generated record revenue and earnings in the fourth quarter of 2006. Revenue for the quarter totaled $272 million and net income from continuing operations was $19.3 million. This equated to diluted earnings per share from continuing operations of $0.73. For the full year 2006, Chemed recorded over a billion of revenue and generated over $131 million of adjusted EBITDA. This resulted in full year 2006 adjusted income from continuing operations of $58 million, an increase of 17.3% over the prior year.

In the fourth quarter of 2006, our VITAS subsidiary recorded record revenue of slightly over $186 million and generated record net income of $15.1 million. Revenue was modestly impacted by $700,000 for Medicare contractual billing limitations or Medicare cap. We are encouraged by our success in managing Medicare cap this past quarter. Medicare cap will remain a component of our overall cost structure that will be difficult to predict quarter to quarter. I'm also cognizant of our need to continually demonstrate that Medicare billing limitations can be successfully managed without detrimentally impacting the Vitas business model and long term profitability.

Roto-Rooter also had a record quarter, generating $86 million in revenue and producing record earnings of $9.7 million and adjusted EBITDA of over $17 million. Both VITAS and Roto-Rooter are operating fundamentally sound business models, although there are Risk Factors impacting both segments, we believe these factors are manageable and Chemed is well positioned to continue to generate strong revenue, earnings, and cash flow growth in the coming year. With that I'd like to turn the teleconference over to David Williams, our Chief Financial Officer.

Thanks, Kevin. VITAS generated net revenue of $186 million in the fourth quarter of 2006, which was an increase of 11.8% over the prior year period. Net income from continuing operations for the fourth quarter was $15.1 million. Medicare cap accruals negatively impact revenue by $700,000 and reduced net income by $400,000. Average daily census or ADC increased 9.4% to 11,174, admissions increased 7.4% to 13,291, and average length of stay expanded to 75.7 days. On a year-to-date basis, VITAS revenue increased 13% to just under $700 million. Admissions for the full year increased 5.5% and average length of stay expanded 4.5 days to 71.9 days, an increase of 6.7%.

Gross margins before the impact of Medicare cap, were 22.8% in the quarter and compares to 22.9% in the prior year quarter. This 10 basis point decline in margin is a result of VITAS carrying more staffing relative to average daily census than the prior year, substantially offset by a realignment of certain expenses incurred between cost of services and central support. Staffing had been running at a level above normal relative to average daily census prior to the fourth quarter. Given the inherent difficulty in hiring and retaining qualified healthcare professionals, management elected to retain current field based personnel and allowed normal attrition in overall growth in ADC to adjust staffing ratios and related gross margins to more historical levels. This approach resulted in the December 2006 gross margins improving 350 basis points over the October 2006 gross margin. In addition, the January 2007 margins which include significant unemployment taxes related to starting a new payroll year exceeded the October 2006 margins by 190 basis points. We're seeing a continuation of the improvement in our margins due to managing our labor costs.

Effective October 1, 2006, management realigned certain field based processes and expenses related to hospice program support such as recruiting and information technology. This resulted in approximately $1.8 million of fourth quarter 2006 expense being reclassified from cost of services. This positively impacted gross margins in the quarter by 95 basis points. Central support costs for VITAS which are classified as selling, general and administrative expenses in the consolidating statement of income totaled $16.4 million which is an increase of 18.1% over the prior year and 20.6% sequentially; however adjusting for the reclassification of the $1.8 million I previously mentioned, fourth quarter 2006 central support costs increased 5.4% over the prior year and 7.6% sequentially.

Now let's turn to Roto-Rooter. Roto-Rooter's plumbing and drain cleaning business generated sales of $86 million in the fourth quarter of 2006 and 8.2% higher than the $79 million reported in the comparable prior year quarter. Net income for the quarter was $9.7 million and compares to net income of 7.4 million in the prior year. Adjusted EBITDA in the fourth quarter of 2006 totaled $17.2 million, an increase of 18.4% over the fourth quarter of 2005 and equated to a record adjusted EBITDA margin of 20.1% which an increase of 173 basis points when compared to the prior year period. Job count in the fourth quarter of 2006 increased 0.5 of 1% over the prior year period, commercial jobs decreased 4.8%, and residential jobs increased 3.1%. Commercial plumbing job count decreased 5.4% and commercial drain cleaning decreased 4.1% over the prior year quarter. This was completely offset by residential plumbing jobs increasing 4.2% and residential drain cleaning jobs expanding 2.5% when compared to the fourth quarter of 2005. For the full year 2006, commercial jobs decreased 0.3 of 1% and residential jobs increased 1.1%.

Chemed's cash flow from continuing operations continue at a healthy rate generating $89.5 million for the full year 2006. Capital expenditures in 2006 totaled $22 million resulting in free cash flow of $67.5 million for the year. Our guidance for 2007 is as follows--For the full year 2007, VITAS is estimated to generate revenue growth from continuing operations prior to Medicare cap of 11% to 13%. Increased admissions of 5 to 7%, increased average daily census of 8 to 10%, and adjusted EBITDA margins prior to Medicare cap of 13 to 14%. This guidance assumes a Medicare price increase mix that will average a 3.8% in the first three quarters of 2007 and the hospice industry receives its full Medicare basket price increase of 3.5% in the fourth quarter of 2007.

Full year Medicare contractual billing limitations or Medicare cap are estimated at $10 million for 2007. Two programs are currently at cap. In addition, VITAS is closely monitoring three additional programs that have greater than 10% cap cushion on a trailing 12 month basis but less than 10% cap cushion based upon the first two months of the Medicare cap year commencing November 1, 2006. Roto-Rooter is estimated to generate a 7 to 8% increase in revenue. Job count growth of between 0.5 and 1%, and adjusted EBITDA margins approximating around 17%. Based upon these factors, an effective tax rate of 39% and average diluted share count of 26.1 million, our estimate is that full year 2007 earnings per diluted share from continuing operations, excluding any charges or credits not indicative of ongoing operations and excluding expense for stock options will be in the range of $2.45 per share to $2.60 per share. With that, I'd like to turn this call over to Tim O'Toole, our Chief Executive Officer of VITAS.

Thanks, David. VITAS is focused on three key issues during the fourth quarter. Admissions, Medicare cap management, and staffing ratios. Admissions in the quarter were ahead of historical trends increasing 7.4% over the prior year. We continue to focus greater resources on educating referral sources and the community to the benefits of hospice. In addition, these resources are being tailored for the unique issues that may be impacting individual markets.

At the end of the fourth quarter of 2006, VITAS employed 220 sales representatives, 104 admission coordinators, and 267 admission nurses. Admissions by major diagnosis continued to be relatively stable with 35.3% of our fourth quarter admissions being cancer related, 19.8% neurological, 12.7% cardio, 7.2% respiratory, and 25% in the all other category. We also made solid progress in reducing the impact of Medicare cap in the fourth quarter. The two programs impacted by billing limitations in the third quarter of 2006 were able to reduce their current exposure to Medicare cap to $1.1 million in the quarter, which was $500,000 below the third quarter. In addition, we have received all of our Medicare cap letters from the fiscal intermediary for the 2005 cap year. Based upon this final assessment, we were able reverse approximately $400,000 of Medicare cap accrual related to the 2005 cap year, resulting in a net $700,000 of billing limitations during the quarter. With the exceptions of the two programs currently in a billing limitations situation, all of our remaining Medicare provider numbers have greater than 10% cap cushion on a trailing 12 month basis.

Our staffing ratios have been challenging in 2006. This has been primarily due to the volatility or lack of predictability in terms of our admissions, discharges, and ultimately average daily census during the year. We chose to err on the side of ensuring we have adequate staffing in order to ensure quality care for our current and future patients. The lag time to recruit and hire professional healthcare workers also comes into play when determining appropriate staffing ratios. This resulted in VITAS carrying more labor costs relative to our average daily census than the prior year, which negatively impacted our margins and earnings. It was our expectation that normal patient census growth would with utilize this excess capacity and margins would improve. This did happen, late into the fourth quarter and continued through our January 2007 results.

Both December 2006 and January 2007 noted a continued improvement in managing staffing ratios and margins. We are also in the process of refining our scheduling and staffing process to more carefully balance our daily labor costs to our patient census. Our nursing staff, including regular and temporary employees decreased 2.1% sequentially to 3471. This is a combination of managing staffing levels and existing programs as well as the impact of divesting our Phoenix program. We currently have 186 hospice teams which compares to 175 teams in the prior year quarter and 182 teams sequentially. Our average visits per patient per week are currently at 5.1. Our turnover remains fairly constant at 25.9% on a trailing 12 month basis. Salary increases remain in line with the industry and averaged 3.6% as compared to 3.5% in the prior year.

The fourth quarter of 2006 had 1,027,968 days of care, this compares to 939,346 days of care in the fourth quarter of 2005, an increase of 9.4%. We currently have six programs classified as start-ups, five of which are licensed and Medicare certified. These start-up programs had an ADC of 118 patients with revenues of $1.6 million and pre-tax operating losses of $1.1 million. In the prior year quarter, these same programs had an ADC of seven with revenues of $40,000 and operating losses of $800,000. With that I'd like to turn the call back to Kevin.

Thank you, Tim. At this point, we're in the position to entertain questions, if any.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Darren Lehrich with Deutsche Bank. Please proceed.

Thanks, good morning, everyone. A few things here, I just wanted to start off a little bit on Roto-Rooter and the margin performance there. I guess the question here is what do you expect -- why should we expect margins to actually reverse to 17% and any kind of commentary you can give us on just the margin, how it will look longer term in that business would be helpful.

Okay, let me start and Dave, you can jump in. This is Kevin McNamara. I would say the fourth quarter is just plain and simply a quarter where nothing went wrong. Fourth quarter is always a quarter where to the extent that there's issues during the course of the year as far as accruals, there's the normal clean up, but it also, this goes a little beyond your question, but the issue of on a combined basis, why is Roto-Rooter exceeding our expectations with regard to margin, at least why did it in the fourth quarter, it's really pretty much a function that there are very few branches that are statistical outliers. Just to give you one, one of our management tools is to compile a bottom kind of branches, that is ten branches that for a variety of reasons need additional supervision or attention and at the current time, we only have six branches in the bottom ten, which really just goes to say that all the branches are operating at a pretty good level which tends to drive the overall average up a little bit without much room for improvement on the upside, but Dave, anything else you would want to say with regard to the particular issues that effected basically a record fourth quarter margin?

Yes. Actually, what I do, it's relative to our guidance. I wouldn't say necessarily I'm forecasting a decline in the EBITDA margin for Roto-Rooter. I said 17%, I didn't say 17.0. We averaged this past year at 17.4%, and the prior year was about 80 basis points below that at about 16.6, so I think we would still end up around 17%. What really has helped Roto-Rooter is we've had three years of just phenomenal expense management in three key areas and that's basically healthcare, our casualty insurance, and our workers comp insurance, and those have been running abnormally low, so basically, we can weather a spike-up even beyond our revenue increase in those areas and still come in within our guidance for Roto-Rooter. So could we anticipate four years of phenomenal expense management in those categories? Possibly but we don't necessarily need it to hit our guidance.

Okay. Very helpful and then just going over the core hospice business. Can you just give us a little flavor for the segmentation of your programs with regard to size and I'm sorry if I missed this in your, I don't think you mentioned that, but can you just talk a little bit about segmentation by size and the kind of growth levels you're seeing in some of your larger programs? Thanks.

Yes, and I'll also refer to -- we keep on our website an updated presentation material which we present at most of the conferences and that also includes a map which segments our small, medium, and large programs, recent acquisitions as well as de novos, but basically right now, we have in total, 20 small programs which are less than 200 census, by definition that would include our de novos. We have 15 medium programs defined as between 200 or more to 450, and we have six large programs with ADC greater than 450, and that fluctuates between five and six because we have one programming that's kind of right on the cusp. We continue to see the greatest amount of growth coming from our small programs, both in percentages as well as an absolute census. Our large programs are showing growth but that growth in terms of average daily census is in the basically the mid to upper single digits, which is also what we would expect, certainly our two largest programs at 1,300 census where we capture a significant market share, you can't expand that much but we continue to do great in all categories. The greatest amount of percentage growth will come from our small programs followed by our medium programs.

Great and then just last thing here and I'll hop off, Tim, your comments with regard to the margins improving, the staffing ratios improving as well in January. Can you just talk a little bit about where census was and then what admissions were like in the month of January?

Well, I think the trends that we've seen in the fourth quarter and talked about carried forward into January.

Yes. And normally we wouldn't make forward-looking comments about January but other than to say that we did make or we did issue guidance and it's a little early to tell obviously and even certainly for the year and even for the quarter but the point we wanted to make in that is that the improvements continue. December was not an aberration in any regard. The benefits of Tim's attention with regard to staffing levels and labor has continued to improve in January. So I mean, we don't want to be more specific than that because one month does not a quarter make, but again, the point being is that we wanted to emphasize December was not an aberration.

Thanks a lot.

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

Okay, thank you, good morning. Your guidance, I have a couple questions on the guidance. It kind of implies that trends will improve in '07 versus 06. For example, you're forecasting ADC growth of 8 to 10% even though ADC growth rate has been declining for several quarters and it was only 7% in Q4, and you're also looking for admissions to grow 5 to 7% compared to 5% in 06. Can you talk about what you see as kind of reversing those trends and why '07 should be an improvement off of '06?

This is Dave Williams. I'll comment briefly and turn it over to Tim, but when we talk average daily census, we have to keep in mind it consists of three factors to go into our average daily census. Admissions, discharges, and length of stay, any one of which can overcome any softness in the other two categories, and during 2006, obviously Q2 and Q3 was a very abnormally low admissions quarters, which we, it's always possible to repeat but we consider those outliers, but without a doubt we've acknowledged admissions have slowed in 2006 say over 2005, but we don't expect to see the kind of volatility in 2007 that we did for those middle two quarters. And we are also somewhat surprised by length of stay didn't expand as much, as well in Q2 and Q3. It was relatively flat. We also considered that somewhat abnormal so when we developed our 2007 guidance, we took in consideration what happened in Q2 and Q3 as abnormally low. We don't expect that to happen for two quarters in '07 and we expect length of stay to continue on at its more moderate growth rate. So all of those kind of factored into what we anticipate in terms of our census and revenue for '07. Tim, any other thoughts?

Well, I would only add, I guess the first thing I would say let's be clear. VITAS I believe has just an incredibly excellent group of managers in the field and throughout the Company. I also believe that the need for hospice is growing and accelerating as we all know, we see just huge need out there, now at the end of life people think about hospice all the time.

Specifically, I believe we've done a better job with our selling efforts in the last couple of the quarters and it's beginning to add momentum. I think we're doing a better job of putting together and executing our local marketing, planning, and efforts. I think we've done a better job of training our sales reps even quicker than before and getting them out into the communities, better trained, better knowledgeable, better able to educate the referral sources and work in the communities. We have community liaisons that we've accelerated to educate sources in the community that maybe wouldn't be the normal referrals, church groups, community groups, elderly groups. We believe education is the key to hospice and we're accelerating those efforts. We're trying to turn referrals into admissions even quicker than ever before by putting more resources there, making sure we follow-up, making sure we have access available, whether that's the need for continuous care or in-patient. We get the equipment to them quickly, the medical equipment in their home. We have a great pharmacy program with our national network of Omnicare.

I think we've accelerated the team selling approach where all of our people sell now, not just the sales reps. We do team visits to nursing homes and walk the floors and make sure they understand if there's any problem, not just the sales person but the manager of that operation and the CEO is available if they need help. We're marketing to Medicare advantage plans aggressively. As you know that's a big advantage for us because we're the one national player really out there as we develop our platform and the Medicare advantage plans obviously are where the Medicare beneficiaries are. They come to us. It's really best practices for the Medicare advantage companies to work with us and then we bill directly to the government under our program.

We also have enhanced our advertising program. It's our view that the market is very competitive and when the market is competitive, you must advertise and enhance your brand further. You must sell better so we're doing all that with both local print and also for the first time ever, we've had TV commercials go on in our Florida markets and we think that's going to be a big plus for us in the future as we roll those out in the Company. As I said we have in-patient units available and continuous care and our team is executing very well right now, so I think it's just the strategies are working. We're executing well.

Kevin, let me add, this goes, I talked to a few of you guys last night and you really need to update some of your charts in terms of pulling Phoenix out of some of the operating metrics, so basically for the full year 2006, our ADC increased 10.1, excluding Phoenix consensus from the prior year numbers and by definition that's not in at the end of this year. So if you exclude that I think you'll see the growth rate pop about 200 basis points from what you could calculate.

Okay, that's very helpful. I appreciate those comments, Tim. I guess the other kind of follow-up on that, you guys mentioned that you thought Q2 and Q3 was abnormally low but at the same time in the prepared comments you talked about low visibility as far as the variability in admissions discharges and coming up with the right staffing model. Do you think that you have more visibility now or is this still uncertain, but you just see the long term trends heading in the right direction so you are just kind of using that as the trend line with potential swings from quarter to quarter.

We're moderating the trend lines. Obviously if you have a break in trend line by definition that's volatility. We still consider Q2 and Q3 abnormally low, obviously we've moderated the growth rates on a go forward basis, but we think the range of guidance on the operating metrics take this into consideration.

And one thing, one additional thing that if you look at what's different this year than last year, one thing that we definitely saw last year which we didn't know, we saw but we didn't know quite the effect that it would have on us, but hospital occupancy in Florida was abnormally low last year, maybe it was tied to the effects of hurricanes, expectations, what have you, we'll let somebody else speculate to that but it had an effect on us and our major Florida programs. We're not seeing that. We're not seeing those same levels, so that's one of the other biggest factors that figured into our projections over the second and third quarters.

Okay, and then I guess two quick questions on Roto-Rooter. Can you talk a little bit more about what was going on there. You talk about volumes being down 0.5 percentage point and mix shift to residential jobs which I believe are generally lower paying--.

They are higher margin though.

They are higher margin but I guess if revenue grew 8% but volume was down half a percent and there was mix shift to lower revenue, residential versus commercial, what's the other factor in that that's leading to the difference between the 8% revenue growth and the 0.5% volume growth decline?

Well, basically it's still going to be mixed within categories. For example, you could have an excavation job on the residential side that could run you $9,000 versus an average plumbing job of a couple hundred dollars, so mix comes into play, still, as well as mix within categories and then region by region.

And excavation was very strong throughout the year and quarter, and again the answer to your question is obviously price increase, which we've been able to have great success in passing along price increases.

We are taking a careful look at the commercial job count because it has declined really two quarters in a row. Fortunately, nicely offset by some residential growth, and we did change our strategy a little bit during 2006, focusing on some of the larger accounts. We have accounts A through E and I think we're going to go back to focusing on the complete spectrum of heavy users versus moderate users, because we believe, but we're still looking, there might be a little too much leakage on the lower end because we didn't give them the attention in the field, the moderate users, commercial accounts that will use us 1 to 3 times a year instead of 7 to 10 times a year, and we're in the process of reviewing that.

And we've already, when you say the process of reviewing, we've already put in place a revised commercial marketing approach which is already up and running for this year.

Okay, and is that, I guess my second question, and last question, was are you talking about Roto-Rooter growing 7 to 8% and historically you kind of kept bring everybody's longer term expectations down to 5%. Is this the reason why you think you are going to grow better than that, your new commercial focus or anything else going on that might lead to a little bit faster growth in '07?

Literally, a trend line I've been saying for three years, can Roto-Rooter keep up the phenomenal performance in an industry that is barely growing at all. I guess I'm getting more optimistic as I can't argue against the trend line. I will also tell you though, our guidance takes into consideration, we can still hit our guidance at the low end of the sales volume.

Okay, great. Thank you.

Your next question comes from the line of Kemp Dolliver with Cowen & Company. Please proceed.

Hi, thanks. A couple questions. First, for this year, what's the number of new locations in VITAS that you expect to have by year-end?

Well, we mentioned that we have six right now and what that means is they've not been billing for more than a year for Medicare, and it's uncertain exactly as the year rolls out. I mean, we're excited. We're building a big base in the Washington D.C, Virginia market. We've opened up in Detroit and also Cleveland in the last several months and we think those big cities offer great opportunities for us. We're changing our strategy a little bit to instead of having a market based approach just to go to where the locations are. We're covering the whole country pretty well now, except for some areas, so we're branching out with a lot of satellite office openings and having some new starts that will be building from our existing locations just down the road so to speak, and the big issue there will be licensure and where we can do it quickly and with certainty, so I wouldn't be surprised to see six new openings between now and the balance of the year.

Okay, that's super. Thank you. The other question is with regard to expense management, you talked about two themes. One is tighter staffing and then number two, it sounds like more spending on training, et cetera, and also some adjustments to certain functions being more controlled at the corporate level. I guess thematically could you all talk about just how you are, I guess, making those decisions with regard to managing those costs?

Well, let me try to take on that one. I mean, let's face it. On the training side, we're not talking about a lot of increased training dollars. We've accelerated the training in the Company, the training budget over the last couple of years so we're really talking about specifically in the sales area as an accelerated training program with more emphasis on what we believe needs to be done for sales reps to get out there quickly and do their job. When you look across-the-board in the area of training for nurses, for home health aides, for chaplins, for bereavement, for all of the programs we have, that's already built into the Company. It's been accelerated over the last several years and I think we're just beginning to get the benefit of some of those new programs that have rolled out. We do computer based training where we can hopefully have it more effective, so I don't think we're going to see a big increase in the dollars, just do it better.

As far as the staffing, we're just going to get smarter about it. We have to look at staffing levels weekly now, which is really some tools we've put in that will allow us when we do have fluctuations in the census to where the census does not reach our goals, we just make sure that we're not adding people that we don't need on a more timely basis, so the use of outside agencies for certain part-time employees versus full-time, we're putting better tools together to analyze that, so it's really a matter of trying to manage the business on a weekly basis instead of a several week lag and getting those staffing levels the appropriate way we need them to get in the right level of visits to our patients and the support they need but just not to be over staffed and do it on a more timely basis so I do not see the expenses in those areas increasing.

Let me just give you one insight with regard to staffing as we get more into it. It's not, it might sound easy where we're seeing are we going to go out and hire two people in a program where census is fairly stable? It's not that simple. With so many part-time employees, it really comes down to the fact that you might have a nurse that's hard to find, hard to keep happy, who wants to work 30 hours a week and that's very comfortable for her and that's what fits in her schedule but if the need is for her to work 25 hours, that's the manager's job is to make sure that's put into effect and keep everyone pushed on the same side of the ore and not leaving for greener pastures. That's the alchemy that's involved in running a branch and making sure you come up with the right labor cost. It's not just function of counting headcount one at a time. But we've had, with emphasis, we've had greater success on a branch by branch basis doing that.

And Kemp, this is Dave Williams. Let me just kind of comment on one thing because we're going to be talking about this for the next three quarters in '07. Our cost of services for VITAS, what our philosophy and goal is basically that's just a roll off of individual program costs so costs that are unique to each program are charged to that program, add them all up and we get costs of services. But then what happens for example is if one program starts an initiative on HR and a better way to recruit, that may very well then take on a life of its own, it's a great idea and it starts being rolled out to other programs and an infrastructure develops, so multiple programs now are getting -- utilizing kind of this new initiative and what happens, it dwarfs from going unique to a program to multiple programs and then of course human nature being what it is, maybe HR back in Miami has been charging the field but that now kills the philosophy of having each hospice program sit in its own bucket and all of those costs hit cost of sales. So what happens is October 1, some of those costs are mounting so we basically pulled that $1.8 million of cost which had been historically hitting the field goes back to central support costs. It's just a shift of dollars, not an increase in dollars, but that's going to make the comparability of the 2006 central support to 2007. It's going to look like about an $8 million increase in central support during '07 and it's not. It's just a shift of dollars. It's not increased spending.

And an ongoing basis we're looking at those areas a lot more carefully so that every October we don't come with a new group of expenses that we've said -- have grown like topsy and now have to be central support. We're being a lot tougher on that so those hit at the central support level from day one.

That's very helpful. Thank you.

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

Good morning. A couple of questions. One, on stock option expense. I mean, what should we be looking for in 2007 related to options expense?

Well, let me say this. Dave and I talked about this before we gave guidance. We just thought for management that it's presumptious to talk about what we expect our Compensation Committee to -- they are going to do in the future. Our expectation is that it's going to be similar to last year and Dave, if I remember correctly is that about just under 375,000, $300,000 a quarter?

That's right, that we're currently doing.

I wouldn't expect it to be different, but again, we did include the guidance more for the optical effect of not appearing presumptious to our Compensation Committee. Don't want to get those guys mad.

Right, and then my bigger picture question, so the improvement over the last quarter, is this really just a function of where were management's, the operational management's focus before? Was it just a refocus to sort of the nuts and bolts of what you need to be doing to manage this business? I'm just trying to understand what changed really here in the last few months and where was the management focused before? Is it just a better system that are managing labor better, therefore you're getting the better margins?

I'm going to turn it over to Tim, because -- but let me say a couple things. First of all when we look at some of the improvements during the quarter, I would say very clearly with regard to cap programs and programs that were in cap, the supervision of those branches took on a whole different nature, the people in the headquarters were working with the people at VITAS headquarters and then the regional people to make sure that any improvement that could be made was being attempted with regard to just overall labor and I'll turn to Tim to say what specifically he did but it's basically a situation where there was -- previously as long as someone had a argument that the census was going to be growing in the future, we better grow the staff to take advantage of it, that type of argument was not shot down. Previously there was a lot of quarters where we were playing catch up with hiring and admissions and census stopped growing as quickly you tend to catch up pretty quickly and then to the extent you keep hiring and it starts having the effect but those are my observations. Tim, anything in addition?

I don't think there's a lot of detail to go into other than it was -- if you look at the history, we've shown very rapid growth in the sales line and the ADC line over the last two, three years. As we moved into the spring and Summer of '06, we mentioned earlier the Florida programs softened a little bit because of the slowdown in the census and discharges from hospitals. We had a lot of our new start programs that were moving out of 50 census to 75 census and 100 but still we're investing in those to grow them to hopefully two and three and 400 size programs, so we were in the mode of continually hiring so many nurses and caregivers per month, and at a program that was, ADC was growing and we didn't react quickly enough to adjust that on a real-time basis. So I think we saw that, we now as I mentioned before, we're looking at data and sharing it with the management in the field and have to put an infrastructure in of managers to look at this weekly, the focus is there but also I wanted just as much focus to be put into the selling effort so we don't have that happen again, so we don't have the admissions slowdown so we want to have a bigger selling effort which we've got a better selling effort but there were a lot of issues that went into it.

We also needed to put some new in-patient units in in last summer to manage the cap issues that we talked about and those weren't as full as we thought so we had a margin issue there and certain cases we've adjusted those to use only contract beds which is more effective now. So I think we were learning how to manage a business of the size we have, how to manage a business that clearly will have some slower growth than faster growth, but it was on the edges but the plan right now is to accelerate the admissions and the sales line which we're doing and to manage the labor weekly instead of on a lag basis and we're putting even better tools in today than we had last quarter to do that. So I'm optimistic, but we'll always err on the side of keeping our staff, and always err on the side of having the staff for future admissions to grow or else they won't grow so that's our view.

And then my last question and I'll get off. So when we look at '07 in growth, should we look at this as more maybe a more methodical approach to growth, I don't want to say less aggressive but I mean the approach you're taking in '07 is maybe a little bit more labored in that sense or you're taking it slower at all or if you could help me there?

I wouldn't say so, no. I mean, our goal is to capture every appropriate hospice patient that needs end of life care where we're at, to provide this high care to our patients and support to families and to provide a great place for our employees to work and provide this care. That's our mission and I don't see that changing and there will be situations in the market from time to time where given market opportunities change because of competition or situations that are overall trends. We just have to react to it but as I said earlier, I see the need for hospice accelerating. I see the acceptance of the general public as very high and accelerating, and I think the people we work with know that we provide this very valuable service and I see the future is very strong.

And I want to make an overall comment as far as our growth. The issues that we had and we're dealing with in the second and third quarter of last year and some of the other hospice companies, some of the problems they reported and they are dealing with, they are real. We've had some focus, we've had some success in dealing with them. But they are real and throughout the hospice industry, we see -- well, we believe we're the most efficient provider of hospice, quality hospice service and again, I think over the next two years, you can pick the date, a good measure of our growth is going to come from some of the maybe not for profit hospice programs or smaller for profit hospice programs. Failing to cope with some of these issues that are going to continue to face them, so I mean, again, we're looking, part of our growth, we're looking to take market share from some of these programs that aren't as efficient, that aren't able to deal with some of these very difficult problems that you've heard the other hospice programs talk about that we've talked about from time to time that we hope that we're nimble enough to deal with. Stay at least one step ahead of them.

Great, thanks.

Your next question comes from the line of Matthew Ripperger with Citigroup. Please proceed.

Great. Thanks very much. Dave, first question is in regards to your $10 million estimate for your Medicare cap accruals for '07, can you just comment on how you came up with that number and how much is related to the two problem markets that you've highlighted before and how much is related to an estimate for new programs going into cap?

Yes. We kind of went around and around on what to do about the estimate for '07 for Medicare cap and originally I was thinking of a range, but if I came up with a range, it would be a pretty wide corridor between the high and low of our EPS guidance so basically we picked a point. If you just look at the--.

And Dave, let me just jump in here and say, it's certainly possible that it's zero. We wouldn't plan on that but that just shows you how broad the range is but nothing is -- there's no program that would be impossible to fix during this period.

That's exactly right and if you just take the raw economics of the fourth quarter ignoring the favorable trend for the 2005 cap year, we had 1.1 million hitting our fourth quarter in Medicare cap, obviously pre-tax, that annualizes out to 4.4. We put in ten. We're obviously want that 4.4 as Kevin points out to go to zero. It may or it may not.

There's a lot of -- some of these issues are out of our control but we fully, there's certainly going to be one or two programs who today, if you look at all of their metrics don't have a cap problem, could have a change in trend line and they could dip into a cap. It's possible. Our attitude is we think we can manage it and keep it immaterial but we don't want to shock the Street and from what we did from Q2 to Q3 how quickly some metrics change. So we're a little gun shy. We picked a number we think is a high end but not so conservative it's ridiculous but if we had to take an over/under on the ten, we would definitely take the under, but as Kevin said earlier, to a certain degree it's a very unpredictable amount, but in our guidance is the assumption other programs may touch on the cap during the year and we'll manage it out of it.

Great. And then in the two problem markets that you've highlighted before, Tim, could you just comment on whether you've had any success at expanding in-patient relationships in those markets or if it is something else you're doing that's really affected the change?

Tim O'Toole - Chemed Corporation - CEO VITAS: Well, we've had some minor progress on the in-patient activity. We have actually a facility where we have some contract beds that are allowing the in-patient category of patient to be brought into there. We hope that could expand to actual in-patient facility. The other thing I think we all are working on here is we may build our own in-patient facilities, freestanding in certain locations where we see that as helpful so we're not limited.

The biggest issue that we've worked on in these units is to bring in the right kind of activity that will bring in patients that are very -- high acuity patients that might have shorter length of stay than for example, a program that simply brings in neurological patients and that's all you're focusing on, increasing your length of stay so it's really been an education effort to the salesforce. Certain -- not necessarily as much sometimes as what you do do, sometimes what you don't do, so all I would say is an incredible effort on selling. We've doubled the sales representatives in both of those locations in the last year, and -- but no rocket science. Just being careful about the business and we haven't done anything that can't be repeated elsewhere, where we do touch on it and maybe I'll just summarize by -- we have said before, it's important to maximize your opportunity for growth and when you do that, you do want to be near your Medicare cap limitations, so for us to be near them and click over for a minor issue and any one but still produce a very high margin is probably the right strategy which we've talked about before and that's why we're heading there.

Great. The second question I had is coming back to an earlier one. Historically you've had seasonality going from the fourth quarter to the first and I think margins have been down over 200 basis points for the last two years. Should we read from your comment about January to October comparison, that this year you're not going to have any seasonality sequentially?

I mean, let me first mention that the big issue in the first quarter, a big part of the issue is the unemployment taxes that we absorb fully in the first quarter and I believe that's about 100 basis points for the quarter. So that's one of the issues. As far as seasonality, we did see the same trends around the holidays late in December and early in January that we've seen historically and that is that you have fewer admissions early in January. There's less activity in the hospitals, and more people for the holidays that are deferring those decisions, so we saw an incredibly similar kind of actuarial drop in the census and increase over a two week period we track that so we've seen nothing unusual, so but the major trends on the margins are the unemployment and we do start off January low on our census because the census usually falls by 300 or 400 over a two week period and that happened but we've recouped that.

Yes, and if you remember last year, we had an abnormally long tail on discharges that ran really into early March. Again, and the quarter is not over yet. It doesn't look like the discharges is going to be as severe but the quarter is still in progress.

Great. And last question I had is the topic of spinning off or separating the businesses has come up from time to time.

Not by us.

Well, I guess you answered the question but can you update us on your current thought about that as an initiative?

Well, the update is that there is no -- again, as we have talked about one of the major issues has been a tax issue as far as the low basis and a lot of tax that occur on a spinoff at this point, and again it would just put, we would have to have a heck of a use of proceeds in order for it to make sense and again, it's the time as far as the next question says well what about a tax free spin-off to shareholders? We wouldn't qualify for a couple more years for that even if that made sense at that point but again, there doesn't seem to be a discount in the market for the combination of two very disparate businesses. The cash flow characteristics of Roto-Rooter, I think, are going to be very helpful to us as we look ahead and not just on expanding the VITAS business but also in some of the financing alternatives that we're looking into. So to refinance some of our existing debt. So to answer your question, it's something we look at. We're going to have an open mind to it but there's nothing that jumps out at us. I mean, frankly, some of the other competitors in the home service market have been struggling so mightily that we're doing fine but they've been burned and the ones burned twice shy, I would think that they might be a little reluctant to jump back into it. I'm thinking Service Master here is a prime example of that, but again, so we're watching it but we haven't moved any closer to thinking that's a good idea.

And then the last question just on Roto-Rooter. Have you seen any change in the franchise acquisition opportunity in that market?

I'll tell you where we've had some good success has been in the smaller markets, that then enter our contractor-side of the business which has done -- our return on capital employed in that has just been through the roof. It's rare we don't have one that's in some form of activity. With regard to let's say our four largest multi-location franchisees, the answer is, no, I think that we're really trying to -- we're still going through that period where we're dampening down their expectations as far as what we would be willing to pay. We've technically, or frankly, we overpaid in the past and made it up over time with good growth. I mean the fact of the matter as I say with our four largest multi-location franchisees, three of them are pretty good operators. We wouldn't expect to see the same type of rapid improvement in the results that we've seen historically with, I always use the example, Tampa, a huge market, growing market that when we bought it I think they had three trucks, and so you just don't see opportunities like that on the franchise repurchase side but again, we are, I think we will be the purchaser of those franchises, but again, their price expectation is probably still a little bit too high at this point for us to move aggressively.

Thanks very much.

Well, I guess that's it for the questions. We're happy with the quarter. As we've mentioned and we're loathe to do it too much to talk about the first quarter after one month and I just want to emphasize that things continue to go well and we think we've made a lot of progress and we'll see you in about three months and thank you for your attention.

This concludes the presentation. You may now disconnect and have a great day.