Chemed Corp (CHE) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Chemed Corporation earnings conference call. My name is Eric. I will be your coordinator for today. At this time all participants are in a listen only mode. We will facilitate a question-and-answer session toward the end of the conference. (OPERATOR INSTRUCTIONS). I would now like to turn your presentation over to your host for today's call, Ms. Sherri Warner with Chemed Investor Relations. Please proceed.

Good morning. Our conference call this morning will review the financial results for the third quarter of 2007 ended September 30, 2007. Before we begin, let me remind you that the Safe Harbor provision 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 October 30th and in various other filings with the SEC. You are cautioned that any forward-looking statements reflect management's current view only and that the Company undertakes no obligation to revise or update such statements in the future.

In addition, management may also discuss non-GAAP operating performance results during today's call, including earnings before interest, taxes, depreciation and amortization or EBITDA and adjusted EBITDA. A reconciliation of these non-GAAP results is provided in the Company's press release dated October 30, 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; David Williams, Executive 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 Corporation's third quarter 2007 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. This will be followed by Tim O'Toole, Chief Executive of our VITAS subsidiary, for a discussion on some of our hospice metrics. I will then open up the call to questions.

Chemed had a solid third quarter in terms of revenue and earnings. Consolidated revenue in the quarter totaled $273 million, and net income from continuing operations was $16.9 million. This equated to diluted earnings per share from continuing operations of $0.69. If you adjust for costs associated with our refinancing and certain non-cash items or items that are not indicative of ongoing operations, earnings per diluted share were $0.74 in the quarter, an increase of 54% over the prior year.

In the third quarter of 2007 our VITAS subsidiary had revenue of $188 million and generated income from continuing operations of $13.9 million. Adjusted EBITDA for VITAS totaled almost $25 million in the quarter, equating to a 13.1% margin. Throughout 2007 we have seen excellent growth in the routine homecare hospice revenue. This level of care, which is provided in the patient's home, has expanded 12.2% on a year-to-date basis. Partially offsetting this strong growth has been relatively flat year-to-date revenue growth in our high acuity levels of care, inpatient and continuous care.

The higher acuity settings typically involve hospice care that is episodic in nature. What this means is that the majority of the days of care in the high acuity setting involve patients in routine homecare that have medical issues that require continuous or inpatient care for roughly three to seven days. Once the medical issues are resolved the patient would then be transferred back into routine homecare. As patients elect to enter hospice earlier and earlier into their terminal illness diagnosis, it does not necessarily result in an equivalent expansion of these episodic events.

Accordingly, we anticipate routine homecare to continue to grow at a somewhat faster rate than the higher acuity settings. High acuity care per diem averaged over $609 per patient day in the third quarter of 2007. This compares to our average per diem in routine homecare of $141. High acuity care represents only 8% of our patient days. However, given the significant differences in per diems, even modest variances in growth rates between levels of care settings will have a magnified impact on our overall revenue growth.

As I mentioned earlier, we receive on average over $609 in revenue per patient per day in high acuity care. High acuity care comes with extremely high labor and other direct costs. This results in low direct gross margins. VITAS's direct gross margins for high acuity care are approximately 35 gross margin points lower than routine homecare margins. If our third quarter 2007 revenue mix was consistent with the prior year quarter, revenue in the third quarter of 2007 would have been about $3.1 million higher than reported. Once we take margin differences into consideration this mix shift modestly impacted our net income by approximately $320,000 or $0.01 a share.

This mix shift has been moderating, and we anticipate returning to more historical growth patterns in all of our care settings in 2008. No conference call would be complete without discussing Medicare Cap. The current Medicare hospice reimbursement formula includes certain components that, in my opinion, unintentionally penalize hospice providers and ends up limiting access to hospice for patients and their families. Specifically, the Medicare hospice reimbursement structure penalizes established providers in high wage urban locations; patients whose care straddle two government fiscal years, as well as hospice providers who accept medically appropriate patients that had previously received hospice care from another provider.

These types of reimbursement issues result in all hospice providers being at risk of not being paid for critically needed care delivered to medically appropriate patients. I remain very focused on our need to continually demonstrate that Medicare billing limitation can be appropriately managed. With that said I am very pleased by our success in this regard over the past year.

Now let's turn to Roto-Rooter. Roto-Rooter had an excellent third quarter, generating $84 million in revenue, earnings of $8.9 million and adjusted EBITDA of $15.4 million, an increase of 19.4%. This equated to an adjusted EBITDA margin of 18.3%. David will go into more detail on the operating metrics, but suffice it to say Roto-Rooter's performance has been outstanding in terms of revenue, margins, profit and cash flow. Both VITAS and Roto-Rooter are operating fundamentally sound business models. Although there are risk factors impacting both segments, we believe these risks are manageable, and Chemed is well positioned to continue to generate strong revenue, earnings and cash flow growth over the next several years.

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

Thanks, Kevin. VITAS had revenue of over $188 million in the third quarter of 2007, which is an increase of 7.5% over the prior year period. VITAS is generating strong growth in its largest segment routine homecare, with routine days of care increasing 5.3% and revenue increasing 9.1% over the prior year quarter. As Kevin noted earlier, this increase was partially diluted by flat revenue growth in our high acuity levels of care. Continuous care and inpatient days of care declined 3.1%, and the related revenue from this care declined 4/10 of 1% in this quarter over the prior year quarter.

VITAS did not have any billing restrictions related to Medicare Cap for its third quarter 2007 operating activity. As of September 30, 2007, VITAS has not accrued any Medicare billing restrictions for the 2007 cap year. The ability for VITAS to bill Medicare for 100% of the care provided to terminally ill patients is a result of improved admission metrics, relatively low median length of stay and the continued combination of various hospice provider numbers. All of VITAS's hospice programs currently have a cap cushion greater than 10% for the first 11 months of the 2007 cap year with the exception of two programs. These programs have a cap cushion of 3% and 6%, respectively.

VITAS has received notice from its fiscal intermediary for all of VITAS's Medicare provider numbers related to the 2006 Medicare Cap calculation. The fiscal intermediary determines Medicare Cap based upon a retrospective review of individual hospice programs, admissions and billing activities. This lookback measures Medicare Cap for the revenue period November 1, 2005 through October 31, 2006 and admissions for the periods September 29, 2005 through September 28, 2006. As part of this measurement the fiscal intermediary also prorates Medicare Cap for any Medicare decedent who received hospice care from more than one provider during the decedent's lifespan. This information is not available to VITAS and can only be measured by the fiscal intermediary upon the death of the Medicare beneficiary.

Based upon this retrospective review by the fiscal intermediary, VITAS has over accrued its 2006 Medicare Cap liability by $1.2 million. VITAS's Phoenix program, which was discontinued in December 2006, was over accrued by $1.9 million. This over accrual was partially offset by a $0.7 million under accrual in 2006 for Medicare Cap liability in three programs. These adjustments are recorded in the Company's third quarter 2007 operating results. VITAS measures its Medicare Cap cushion, or Medicare Cap liability, on a program by program basis. Cap cushion is defined as the difference between the maximum Medicare billing potential and the actual Medicare billings in a hospice program for a Medicare cap year.

Of the 36 programs VITAS had in place for a full 2006 government fiscal year, 31 programs or 86% received an increase or favorable 2006 adjustment to their Medicare Cap cushion, totaling $18 million. VITAS had five programs that either over estimated cap cushion or underestimated cap liability, totaling $1.3 million. At the end of the 2006 fiscal Medicare Cap year, VITAS had aggregate cap cushion in excess of $200 million.

Gross margin in the quarter, excluding the impact of Medicare Cap, was 21.7%, which is a 182 basis point improvement over the prior year quarter. Approximately 126 basis points of this margin expansion is a result of VITAS improving labor productivity. The remaining 56 basis points are the result of a $1 million of expenses that had been historically charged to cost of services that were centralized and are now classified as selling, general and administrative expense. VITAS had selling, general and administrative expense of $15.7 million in the third quarter of 2007. Adjusting for the reclassification expenses I just noted, third quarter 2007 selling, general and administrative expense increased 7.1% over the prior year period and declined 3.7% sequentially.

Our labor costs relative to revenue have improved significantly over the past year. However, given the unpredictability of patient census by program-by-program, as well as level of care needed, we anticipate a certain amount of variability in margins quarter over quarter. During the third quarter of 2007 VITAS's direct patient care margin for routine homecare was 51%. This compares to 49.1% in the prior year quarter and 51.1% sequentially. Direct inpatient margins in the quarter were 15.9%, which compares to 16.5% in the prior year and 18.9% sequentially.

Occupancy of our inpatient units averaged 79.2% in the quarter and compares to 78.2% occupancy in the third quarter of 2006. Continuous care, the least predictable of all levels of care, had a direct gross margin of 16.9% in the quarter, which compares to 17.5% in the prior year period and 17.7% in the second quarter of 2007.

Now let's turn to our Roto-Rooter segment. Net income for the quarter was $8.9 million, an increase of 5.1% over the prior year period. However, the prior year period included $927,000 of tax benefits that relate to earlier periods. Excluding this third quarter of 2006 tax benefit, Roto-Rooter's net income in the third quarter of 2007 increased 17.9%. Adjusted EBITDA in the third quarter of 2007 totaled $15.4 million, an increase of 19.4% over the third quarter of 2006 and equated to an adjusted EBITDA margin of 18.3%, an increase of 188 basis points over the prior year period.

Job count in the third quarter of 2007 was essentially equal to the prior year period. Total residential jobs increased 2.8% and consisted of residential plumbing jobs increasing 9.6% and residential drain cleaning jobs declining 0.4% when compared to the third quarter of 2006. Residential jobs represent approximately 70% of our total job count in company-owned and operated territories. Total commercial jobs declined 6.0% with commercial plumbing job count declining 1.0% and commercial drain cleaning decreasing 8.2% over the prior year quarter. A significant portion of the commercial job count decline is attributed to the continued elimination of low revenue, low margin commercial business. This mix shift has favorably impacted the average revenue per commercial job, which increased 11.7% in the third quarter of 2007 and has increased 11.9% on a year-to-date basis.

Consolidated cash flows for Chemed were strong, generating over $90 million of net cash provided by operating activities for the nine months ended September 30, 2007. Our updated 2007 guidance is as follows: VITAS is estimated to generate full-year revenue growth from continuing operations prior to Medicare Cap of 8% to 9%. Admissions are estimated to increase 5%. Average daily census to increase 7.0% to 7.5%, and adjusted EBITDA margins prior to Medicare Cap will be in the range of 13.5% to 14.5%. This guidance assumes the hospice industry receives a full Medicare basket price increase of 3.3% commencing at the beginning of the fourth quarter of 2007.

Full-year 2007 Medicare contractual billing limitations, including the $700,000 of 2006 retrospective adjustments recorded in the third quarter of 2007 for continuing operations is estimated at $2 million. Roto-Rooter is estimated to generate an 8.5% to 9% increase in revenue in 2007. Job count growth between 1% and 1.2% and adjusted EBITDA margins in the range of 19.5% to 20%. Based upon these factors an effective tax rate of 38.7% and an average diluted share count for the second half of 2007 of 24.5 million shares, our estimate is that full-year 2007 earnings per diluted share from continuing operations, excluding early extinguishment of debt, expense for stock options and other charges or credits not indicative of ongoing operations, will be in the range of $3.10 to $3.20.

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

Thank you, David. VITAS generated 13,436 admissions in the third quarter of 2007. This was a 5.9% increase over the third quarter of 2006. On a year-to-date basis admissions totaled 41,204, an increase of 4.5%. If we can maintain our historical quarterly admissions pattern, admissions growth should average between 4.5% and 5% in 2007. October 2007 admissions are strong and should reflect about a 6% growth rate over October of last year.

Average daily census in the quarter increased 4.6% to 11,529. Our discharge growth rate continues to run slightly ahead of admissions, increasing 6.4% over the third quarter of 2006. VITAS's average length of stay in the quarter was 76.7 days, and the median length of stay was 14 days. Our days of care totaled 1,060,678 in the quarter. Our routine homecare days increased 5.3%. Inpatient days of care increased 3.3%. And continuous care days declined 7.6%.

We continue to focus on increasing admissions, managing staffing ratios and operating within Medicare billing limitations. Increased admissions are being generated from educating referral sources and the community to the benefits of hospice. VITAS tailors its approach to these communities based upon whatever unique issues may be impacting these individual markets. At the end of the third quarter of 2007 VITAS employed 252 sales representatives, 114 admission coordinators and 286 admission nurses. Our staffing in the admissions area has increased 10% over the prior year period.

Admissions by major diagnosis continued to be relatively stable with 38% of our third quarter admissions being cancer related, 18% neurological, 12% cardio, 7% respiratory and 25% in the all other category. As David noted earlier, we continued to effectively manage within the Medicare Cap. Through a combination of increased admissions, lowering our median length of stay in certain programs and merging hospice programs when opportunities allow, all of our programs have a cap cushion greater than 10% through the first 11 months of the 2007 cap year except for two programs.

These two programs have cap cushion of 3% to 6%. This should also approximate our final calculation for the 2007 Medicare Cap year. Our staffing ratios continued to stay in line with our historical levels. In addition, we continued to average more than 5.5 visits per patient per week, well above the industry norm.

Our nursing staff full-time equivalents remained relatively flat sequentially, totaling 3469 at the end of the third quarter. We currently have 194 hospice teams, which compares to 182 teams in the prior year quarter and 193 teams sequentially. Our turnover remains fairly constant at 24% on a trailing twelve-month basis. Salary increases remain in line with the industry and are averaging around 3.5% annually. We currently have five programs classified as startups; four are licensed, three of which are Medicare certified. These start-up programs had an ADC of 66 patients with revenues of $941,000 and pretax operating losses of $529,000. These same programs had an ADC of 5 with revenues of $47,000 and operating losses of $412,000 in the prior year quarter. The prior year quarter had operating losses of $982,000 for programs classified as start-ups in the third quarter of 2006.

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

Thank you, Tim. I will now open this teleconference to questions.

(OPERATOR INSTRUCTIONS) Matt Ripperger, Citigroup.

Question on your free cash flow generation, which continues to be very strong and well above our expectations; we've got you doing about $70 million of free cash todate. When you did the offering in May the expectation was you would pay down the entire bank debt by the next four quarters and it appears you are well ahead of schedule. I wanted to see if one, if you can comment on what your expectation is for paying down the remaining $35 million of bank debt? And two is once you've done that given that you're going to be generating about $95 million of free cash what is the anticipated use of that cash going forward?

Our cash flow generation remains very strong. It was particularly strong in the third quarter based upon the timing of quarter end September 30th and receiving our PIP payment, which I believe [came] Friday, September 28 if my -- but within a couple days of quarter end was the PIP payment. So that actually accelerated the appearance of cash flow in the quarter. But on a year-to-date basis for the nine months cash flow remains very strong, about $90 million. So that strong cash flow and basically nothing sticks to our balance sheet. Everything kind of flows through. It has given us the opportunity to pay down our debt a little earlier than we thought. We are reasonably optimistic we can actually tranche down and eliminate that debt by, potentially by the end of this fourth quarter. So now the question is what do we do with the cash as we accumulate? We are optimistic acquisition opportunities will emerge on a go forward basis, although we see no change in the current landscape. So we are going to watch it very carefully, and it will be a combination of consideration of a share buyback, which we have over $50 million still authorized by the Board for share buyback, as well as accumulate cash on the balance sheet for opportunistic acquisitions, and we will evaluate that quarter by quarter. But without a doubt, share buyback is a real opportunity in 2008.

And just to review, the last sizable buyback you did, which was around the offering in mid-May was in the sort of 63, $64 range?

The largest chunk was $64.90, which was when we issued the convertible debt, and we had additional shares probably in the high 50s, low 60s.

Has anything fundamentally changed in your business from then to now to potentially sway you one way or the other related to a buyback?

Yes, actually the turmoil in the credit markets. The notion that the credit windows will always be open and when you need to access capital in the market that it will be available. In the short-term there is concern on that. So related to that, you would like to see cash on the balance sheet for opportunistic acquisitions if you don't think you're going to have readily available capital through the markets. However, hopefully the Fed will do their job and things will calm down and we won't have that concern in 2008.

Okay, great. And then second question is Kevin, in your opening remarks you commented about some potential technical fixes to the cap either legislatively or administratively. I just wanted to see if you could go through a little more detail about what the potential scenarios are and what the potential impact would be to you if those changes are implemented.

Okay, I will. I am going to let Dave take over because it is a subject that he is working almost around the clock on. But let me just say generally that it is -- I think there is a wide, widely held perception that there is some problems that need to be fixed with regard to the cap. But the timing of which we make no presumption with regard to when those might occur. But Dave, why don't you just spend a couple moments talking about some of the projects you're working on in that regard.

In general the Medicare reimbursement for hospice has worked remarkably well really over the past 24 years that it has been in place. However, the success of hospice has created some unintended consequences within that reimbursement. Ideally if CMS can collect all cost data related to reimbursement both direct and indirect, and based upon that the cost to provide care they could revise their reimbursement formula that would be very positive. However, until they have that data collected, I think we need to stay with the current reimbursement formula in place. But MedPAC probably said it best a couple weeks ago in their last meeting. There is some certain technical problems that are creating stress within hospice that are again largely unintended.

One of which is the Medicare billing protection we get per admission I think it is going to be $21,140 for this year, that is not indexed for high wage locations. So in Norfolk Suffolk County the per diem is 24% higher than the national rate. So basically there is 24 less days of care available for residents who reside in Norfolk Suffolk County. Areas like San Francisco, any high wage area is getting unduly penalized because basically it was forgotten to index the hospice cap per admission.

Another issue is patients who are admitted in the latter part of a cap fiscal year, basically patients whose care straddles two fiscal years hospice providers are unduly penalized by the fact that patients live into the next fiscal year. Because there is no concept to a portion or carryforward on utilized cap cushion from that admission. So that is creating stress on the current reimbursement formula.

And the third area is when we take an admission of a patient who is discharged from another cap program, maybe thirty days ago, maybe a year ago, and we take that patient in. Basically that provider is going to be unduly penalized. Odds are the provider who picks up that patient will get a very, very small amount of cap credit once that, the fiscal intermediary prorates that. So any hospice program that takes these patients who were in previously in a different provider number, probably will be penalized unless they are sitting on significant cap cushion.

So these are the type of technical problems MedPAC is aware of, and I think Congress, the Senate Finance are just becoming aware of it. There seems to be an attitude to give some relief to the hospice industry as long as it doesn't cap cost too much. And the intent of the hospice reimbursement scheme is kept intact. There seems to be an appetite in Congress, but there we are dealing with a lot of issues. So it is being looked at. We are optimistic that they might put these technical fixes in place to give CMS time to come up with a more rational reimbursement. But it will be a wait-and-see.

This would be something that could be attached to the year end physicians fix bill?

That's correct.

Is there any initiative to try to look at cap on a broader basis as opposed a market specifically, you look at it on a regional basis or anything like that?

No, that has been discussed, and that is a possibility. The states can manage it themselves. There will be a proposal put forth to Congress, but we don't know whether they will accept that. But that has been discussed, as well.

Great. And the last question for me is related to the discharge variability recognizing that it is something that moves around quarter to quarter and it's hard to predict, can you just comment on whether there is anything systemically going on in the industry or for your business that might be impacting the relative growth or change in discharges?

No, we don't believe there is anything systemic or particular to the industry. I think to the extent that we are aggressively growing our business, our admissions are doing well as you know up around 6% year-to-year. We are taking all patients in all of our markets. We have basically seen no change in the admission pattern as far as diagnosis. So it is really just patient specific, and I think from time to time we see discharges become higher than they were historically and from time to time they are lower than they were historically. And we would think that at some point we would revert back to the norm and see the discharge rate slow down a little bit. So nothing systemic. We are just taking the market as we find it, and the patients actuarially it is not a big variance but it impacts your ADC modestly when it goes up.

And based on your comments about October and the relative pickup in admission growth, is it fair to say that the relationship between admissions and discharges probably has improved in October relative to third quarter?

No, I wouldn't necessarily say that. We don't have the analysis of the discharges, but we are not seeing any major change in October from that historical rate or what we've seen this year, let's say.

Matt, I guess really we've looked at it. We just don't know. But there are certain ways we bet and I guess we bet that discharges will retreat to the mean. There is no reason we are aware that they won't.

And the interesting thing because we are running about two percentage points higher on the growth rate of our discharges and our admissions, but our median length of stay has been very stable. Our average length of stay has been very stable. Our live discharge rate has been stable, which really reflects as Tim said, this is just kind of across the board and an unusual pattern that we would expect to correct going into the next several quarters.

Thanks very much.

Darren Lehrich, Deutsche Bank.

Just a couple of things here. I did just want to follow-up a little bit here on this capital related question. It sounds like you will be doing buyback over the short run, and I just wanted to kind of rule out whether you guys see the opportunity to pursue a third line of business within the holding company, just given the amount of capital that you are generating.

Darren, we are always looking at that, and historically we have. But we have a pretty high hurdle at the current time on what type of business that would have to be. We want it to be something that healthcare analysts could know and understand because that is certainly our orientation. And we look at -- we are constantly thinking in that regard but again, there is a fairly high hurdle. There is a lot of expansion geographically that we are looking to do with regard to VITAS and then picking our spots on the Roto-Rooter side. But the answer to your question is yes, but there is still at this point a high hurdle.

To give you an example, within the Company starting with Tim O'Toole, there has been a lot of experience and knowledge with regard to the home health care, the general home health care field. If we thought that business (inaudible) had better prospects, we would think that would be a natural, and we would have a lot of knowledgeable people at the ready. But again, we just are not there. So to answer your question, yes, but again, there is nothing on the horizon.

Okay. It looks like you really have done a great job in managing the cap. I do want to just explore a little bit more with regard to your ADC growth, more from the standpoint of the size of the programs and what you are seeing in some of your larger programs and whether some of these smaller programs are ready to be kind of moved up into that midsize bucket. So I am wondering if you can just go through that for us, help us understand the growth rates that you are seeing by various program size. And I guess just Dave, the question about cap really is you have embedded some in your guidance probably the conservative thing to do, but you are just not seeing anything at this point that would suggest you should have a cap accrual in the fourth quarter. Is that fair to say?

Before I turn it over to Tim to talk about ADC let me say -- (inaudible) the answer is yes, we've been pretty consistent all year that everything looks good on cap. We want to consistently have some number in there to because it is a volatile issue. And actually when we talk about changes and proposed changes that we are working with Congress and lobbyists to fix at this point, the major issue that we are working on is the volatility in cap. But as long as there is that volatility there is a placeholder for Medicare Cap exposure. But the answer to your question really is no, it looks good for this year, and you've heard us say admissions are looking okay to good as long as that is the case, as long as it is fairly even, our cap cushion should expand. But go ahead, Dave, and then turn it over to Tim.

With that said, there is a number of locations in the United States that are underserved by hospice. But given the current limitations or what I would call the technical problems in the Medicare reimbursement, we are reluctant -- I think actually all providers are reluctant to provide care in those locations because of cap. So we have definitely cooled our de novo strategy because of concerns the way the unintended consequences of cap. So that is cooled a little bit of our adding small programs. But with that, I will turn it over to Tim's comment on growth by ADC by category.

You guys have heard the figures before we categorize our programs into small, medium and large based on a census breakout of small being under 200 and medium under 450, but above 200 and everything else large. And we are seeing the trends that we've seen in the historical numbers are small programs are growing at a higher rate than the large programs. And it basically tracks out this quarter with the small programs growing about 16% on the revenue line and the median about 7 and the big ones about, the large about 3. And similar growth rates on the ADC and all the metrics that we track. So this is what we've expected.

And the big opportunity is to see the smaller programs that are 100 or 150 census double in size over the next period of time. And that is our big focus. In the large programs we've saturated the South Florida market to some degree. You all know we are concentrated there. We are doing very well there. We are seeing good growth across the board. We are adding good sectors of care, strong in inpatient units. And we grow our home care business as you know we've told you we are growing our home care business at a higher rate than the other lines of business. Historically what we've found is you push your home care business and over time that leads to more inpatient opportunities and continuous care. So I think that will occur over time. But to answer your questions the small programs are growing nicely fitting in line with what we've expected and told you about, and we would expect that to continue. And across the board we are doing quite well in the large and medium ones, as well.

And with that, Darren, just for example Broward County has about a 1300 average daily census. Based upon my calculation of released data from the government, about 40% of all deaths in Broward County happen within our hospice. So we are doing a great job of capturing all the need in that location. So by definition we are going to have relatively low growth in average daily census.

Let me just add one other comment. Most people on this call have been with the story for the last several years. And one thing we observed was the first year and a half the larger programs exceeded our expectation as far as growth in census and revenue. And we said at that time it kind of surprised us that was, that couldn't go on forever and again, what we are seeing is good, solid businesses with great cash flow. But you can't reasonably expect those to grow faster than 3% to 5%. It is not -- the demographics aren't there.

Right, just so we are clear on sort of where the growth will be coming from, Tim, the number of small programs, the number of medium programs, you have at this point, can you just remind us what those numbers are?

The total number would be 22 small and 15 medium and 6 large. So again, the magnitude of the small programs is a result of the aggressive de novo rollouts that we've done in the last two years, and they are all proceeding very well. So again, those are big opportunities. In many cases we have small market share in those locations. And as we add to our stature and our expertise and our knowledge of the market, and add stronger sales effort and cover broader territories and add patient care teams there we are beginning to pick up momentum in many of them. So we are very encouraged by that, and again, we can still open new de novos over time. We are planning on that. We are doing that, as you know. And we've also implemented a strategy of having numerous satellite offices that are adjacent to some of our large programs, which have penetrated these territories even further. And that is one way we've been able to continue keeping up reasonable growth in the large programs. But we think we are making very good progress on all fronts. We think we are growing pretty much in all markets at a higher rate than the other competitors in that market. And to the extent we continue to do that I think good things will continue to happen.

And Darren, your question was focused on average daily census, but our large programs still has a median length of stay basically around 13 to 15 days. So half of our admissions in our largest programs are dying within 15 days or less. There is still significant opportunity to expand length of stay in those programs which would have a much greater impact on our revenue growth. And we obviously have cap cushion in our largest programs.

Thanks very much for all the answers, guys.

Kevin Fischbeck, Lehman Brothers.

I have a question about the longer-term expectations for the hospice business. It looks like the last couple quarters you've been bringing down expectations for growth for VITAS due to mix shift initially and I guess some issues this quarter around discharges. How much of those factors are factors which should kind of reverse themselves, and how much of that is kind of going to be a recurring issue going forward into '08 and beyond?

Both of those factors we believe are short-term driven. Said differently, we fully expect the mix shift to stabilize, certainly by the beginning of 2008, as well as we don't believe the discharge pattern can hold the way it is. We consider that unusual. So correct for those two issues and I think we end up with a top line revenue growth pattern within VITAS with the current reimbursement in the high single, low double-digit. The 9 to 11% is not unrealistic for revenue growth for the next couple years.

Okay, and just to confirm I understand what you mean when you talk about mix shift, your expectations are that we've seen home care will grow faster than the other two. It's just that the other two are actually combined anyway to declining, and that is the unusual aspect of it.

That's exactly right, and we expect to start lapping that in the fourth quarter and first quarter of next year.

Okay. Does the fact that the higher acuity volumes have been declining, does that worry you at all in regards to Cap exposure? It seems like a lot of the initiatives of the companies who have cap exposure are really trying to get into those types of businesses to bring down their length of stay, etc.

No, actually just the opposite.

Higher revenue, if you are close to a cap, you don't have much cap cushion it can lead to (inaudible) higher revenues in the bigger exposure.

Since our median length of stay hasn't fluctuated, so it is not like we are getting less patients. We are direct to admitted to say the inpatient and the dying in that level of care, is really primarily related to the transfers from routine home care. So we are still getting more than our share of high acuity; again if our median length of stay is 13 to 14 days, the industry is about 23 days, so we are still getting more than our fair share of the higher acuity, which is your biggest protection relative to Medicare Cap. But the fact is by having a slightly lower average reimbursement per day, that helps on the cap situation.

Okay. That makes sense. So if your length of stay jumped up, then you might be concerned but since it is staying flat, you're not really that concerned about it?

That's right.

Okay, and then going through your guidance you made some adjustments and you really have not changed your assumptions at all regarding margins on your business line. In fact, you brought it up a little bit on Roto-Rooter. Are there any costs that you would look at and say this line-item needs a little bit more improvement or you feel comfortable there and getting back to the growth is going to be driving the top line again?

One, we are very happy with -- let's take two pieces at a time. VITAS, there is always pressure on wages within our nurses and home health aides. We've been very successful at keeping it around 3.5% and managing productivity. So we don't see anything significant there. In general there is pressure relative to fuel costs. There is pressure relative to health care benefits for our employees. And those will probably grow faster than our increases relative to pricing from the government or on the Roto-Rooter side. But there is significant opportunities for greater efficiency on the SG&A side that should more than make up for it. So that is a long way of saying is we expect to see improving margins at VITAS from efficiencies in IT, accounting, human resources maintaining the same level or increasing level of care at the patients' bedside. And we expect to see increased efficiencies at Roto-Rooter through leveraging our phone systems and our fixed costs within that area. So there is room for margin improvement; probably a little bit more on the VITAS side than the Roto-Rooter side. But we are very optimistic for slightly expanded margins.

Okay, and the opportunity SG&A is more growing the top line and keeping that relatively flat or actually cost cuts opportunities on the SG&A?

The opportunity is to have your central support costs grow at a lower rate than your top line.

Okay.

And to the extent you get that leverage -- for VITAS it is a big enough number that you can get some significant leverage.

And central support got a little ahead of us this year. At the same time it was held to a very low growth rate the past three years, and again we are still developing our business plan. But we expect the growth on central support to slow to more historical levels in 2008.

And the increase is really investment of the business, is basically IT.

Yes. IT is going to be a critical core competency and competitive advantage for VITAS on a go forward basis because it is the IT systems that allow us to deliver more care to the patients' bedside for the same dollar of reimbursement.

That makes sense. Last question regarding the cap and how you guys account for it. Can you just remind us how you treat the patient transfers and from an accounting perspective and then, how does the fact that you've had a prior period accrual here, has that changed your assumptions at all as to how you're going to accrue for the cap?

No, one, we consider our method very, very conservative. Basically for billing protection we only count first-time Medicare admits. So the beneficiary that is electing hospice for the first time ever. We only count. And then our assumption then is when we take in a readmit, someone who was in a different provider number at some previous time, we don't assume we get any cap protection for that patient, as well as when we have live discharges we assume there won't be any penalties so those basically are admits, readmits and our discharges offset each other. We were correct 86% of the time in 2006, basically 31 of our programs had a nice increase.

In fact, the net increase -- to show you how conservative it was -- the net increase in cap cushion was over $18 million.

And so we basically, if you set aside Phoenix, we did get -- we got hit by about $700,000, which is the equivalent of 35 admits out of about 53,000 for the year. So that is about as close as you can get and be good.

That makes sense. So I think your live discharges are running around kind of 12%, so you are saying that your transfers in are around 12%, as well?

No, because a lot -- a significant portion of the live discharges will either reenter our provider number or not enter hospice. Based upon -- we had an outside party review 100% of hospice Medicare beneficiary data for really the 2004 and 2005 year (inaudible) 100% of the data. They actually only saw about a 2% transfer between provider numbers. But that 2% can be significant if that is not average, some provider numbers get hit with more or less. But it can be critical when you are turning around and when you are close to the cap. But it is not material and again, most of those come back to the same provider.

Okay. Thanks for that.

Jim Barrett, C.L. King & Associates.

Tim, if the industry does receive cap relief, how would that change your thinking in terms of what you pay for acquisitions, and how do you think broadly speaking that changes your competitive position?

Well, two questions. Our competitive position it would help everyone so I think it wouldn't change the landscape that much. We would -- we haven't been penalized dramatically by it. We've had to make some marketing plan modifications in some of the programs where we've had to have that on the radar screen. So I think it would be very good; at the same time it won't change our view that much about where we head because we are not in limitations right now. We are managing it quite well.

As far as the acquisitions, it would be a very healthy thing if we could see where Medicare Cap relief was put in because numerous of the acquisitions we do look at have a looming Medicare Cap problem facing them, which makes it very -- we are very uninterested when we see that. So Medicare Cap relief will be great for the industry, great for us and I think it would help us in the acquisition area.

What we are working on is something that actually is pretty consistent with what the government is probably looking to do. And that is we are not just looking for unrestricted, more revenue in the hospice industry. We are not looking to help the niche providers. We are looking for, making sure that the full-service hospice provider can get paid for the services provided with a lot less of the volatility and risk that is currently there. To the extent that over the next couple years that can be achieved by a few of these, what we call technical corrections and fixes from a competitive standpoint. That is great for us. We are not looking to have a seachange where a lot of financial players are drawn into the industry. And do we think that is (inaudible) likely will occur and the government isn't going to make that kind of change.

To kind of give you an example, again looking at the '05 and '06 data for all providers, actually '04 and '05, really if a program or provider number is deep in the cap they are not going to get out. But there is a significant number of providers who do enter cap and then get out of it. And then it is kind of an unfair penalty. And we saw a lot of that where a cap was hit in 2004. The provider got out of it in 2005 by changing the mix of patients. But they had a huge financial penalty related to that. So most of the technical fixes we would be looking for is just kind of allow a provider to even out that volatility. But if you are deep in the cap in one year you are still going to have a cap problem the following year.

Understand. And could you comment on a separate subject in terms of Roto-Rooter, whether currently or as we look toward '08 what kind of pricing would you anticipate if any for that business? And has any been implemented already the last couple months?

First of all I would say it is on a market-by-market basis. I am reluctant just to make a blanket statement because they really do, and they go by line of service. But I would say generally pretty good pricing environment out there. We are looking for 3 to 5% on average. But in some markets they are going to be even more aggressive than that. And they believe they are going to get it without affecting demand for the service at all.

And Kevin, do you see that as a margin enhancer or is that simply going to offset some higher expenses in that business?

Margins right now are very high for Roto-Rooter. It is hard to believe, we are always reluctant to talk about anybody building a model with premised on enhancements of that margin. I think it would be -- right now on you've heard us kind of allude to the fact that on the cost side things are going pretty darn well for Roto-Rooter. Turnover is at below what any reasonable person would have projected. Insurance, casualty and health care are in pretty good control. The price increases I would say would be more covering some of the stumps that might jump up in front of you. But again, I wouldn't rule out a slight margin improvement. But I would not build a model based on it.

Thank you very much.

Dawn Brock, JPMorgan.

Just a quick kind of more color, I guess, around the increased scrutiny on the high acuity levels of care both continuous and inpatient. Is the government tending to go after those admits that come in as high acuity, or are they going after the episodic patients that come in from routines?

Tim, why don't you start?

Well, as far as the government going after I don't think the government is going after anything. The business has been highly regulated since we've been involved in it in the early '90s, and there is always close scrutiny based on the intermediary reviewing your work, as far as special work that they do do. So the major focus seems to be not on the admission side, but are on patients that are with you for a long period of time. And basically, as you know, there is a process that people are relooked at every so many months. And we just try to make sure that we do an excellent job of looking at the patient at a point in time and making sure if we are keeping them on the service, that they fall under the guidelines of someone who is terminally ill at that point in time that is expected to live for less than six months. So what we are trying to do is do a better job of making sure that our doctors and the team documents everything around the patient so when they are looked at by a surveyor, an auditor that they understand the whole situation instead of just a file that is not complete.

And as you know, at this point in time when you do discharge someone for extended prognosis they have the right to administrative review of that situation and the administrative review can say you shouldn't have been discharged. So there is a lot of give and take going on there. But it is our job to be an advocate for the patient because we know that we are right the great majority of time about our expectations on term of diagnosis. So again, there has been a higher scrutiny in the last year, year and a half. It is public information that the intermediaries are looking at long stay patients as well as patients in nursing homes. They are also looking at levels of care you provide. And this is something we are very comfortable with. We believe our huge investment in systems and training and the processes we use have basically helped us look good in that environment. So again, we don't see any big change from where the industry has been historically, and we are comfortable with our mechanisms for supporting everything in our files.

And let me add one point because one thing that you are alluding to but let's focus on continuous care. VITAS is one of the relatively few hospice organizations that have the wherewithal and systems to successfully bill for continuous care. And accordingly, the percentage of all continuous care payments is higher than our overall market. That we get as the percentages are higher than our overall market share. And it is just human nature to the extent that you have someone, a program manager who knows that with 20/20 hindsight somebody is going to look in and potentially could say that patient isn't going to get continuous care reimbursement on average for us $609 a day. They are going to get $141. Well, to the extent that makes that person a little bit on the margin a little more reluctant to put them in continuous care, that is the type of human nature decision that happens at the margin that can have some effects. But it is not really -- there is no change in policy. The policies and rules and regulations are always the same, and to be honest with you we have an incredible success rate in getting paid for what we bill. Because we think there is good support for it.

That is exactly the question that I was asking because you have been the one provider that has been successful on that front, and while I understand that catching patients earlier in the disease state and getting them into hospice is going to boost that routine volume, I think the question is with your success rate and particularly in continuous care, are the decisions being made internally that increased scrutiny is kind of making doctors shy away from pushing that patient into the right level of care, i.e. continuous or inpatient. Because they are a little bit more skittish about the scrutiny?

Let me say that is not the environment. Our doctors are not skittish, and we are not concerned about the patient we have on continuous care. Sometimes it is difficult when you look at the total figures and you look at the numbers and you look at the length of stay and different categories. But when you see a patient who is on routine homecare which means they are getting four to five visits a week and their situation deteriorates were they need 24-hour care because of the critical condition they are in, the decision becomes quite easy that they need either continuous care or to be put in an inpatient unit. And when our plan of care shows that, that is exactly what happens for the patient and exactly what we will do and our doctors know this situation. They know when it is necessary. They write the appropriate description in the file, and that is what we will do. So there is no one concerned at VITAS about the situations, the government is reviewing it.

One of the things that happens, you talk about taking on patients sooner in the process. We also are a company that believes on taking on patients later in the process. So many of our admissions are people that are only with three or four days. And many of those people definitely have to have continuous care or they are not able to come onto hospice. We are one of the very few hospices that are capable of providing that care, and we do it. We are proud of it. And it has been incredibly valuable service for these individuals. And I think the government realizes that. So we think we are in very good shape.

Excellent. Thank you very much.

I believe that is the end of our questions, and I appreciate everyone's attention. And we will talk to you at the end of the next quarter. Thank you.

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect, and have a good day.