Chemed Corp (CHE) 2008 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Chemed Corporation's first quarter 2008 conference call. My name is Jahina and I will be your coordinator for today's call. Please note that today's call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. I will now like to turn the call over to Ms. Sherri Warner with Chemed Investors Relations. Please proceed.

Good morning. Our conference call this morning will review the financial results for the first quarter of 2008, ended March 31, 2008. 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 April 24 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 April 24, 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 first quarter 2008 conference call. I will begin with an overview of the quarter. I will then turn over the call to David 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 this call up for questions.

Chemed consolidated revenue in the quarter totaled $285 million, and net income was $16.8 million. This equated to diluted earnings per share from continuing operations of $0.69. If you adjust for noncash items, or items that are not indicative of ongoing operations, earnings per diluted share were $0.73 in the quarter which equals our prior year's earnings. I'm disappointed with VITAS net income for the quarter, specifically our field-based margins. As our ADC growth has moderated, leaving just two or three additional staff per hospice teams, is putting pressure on our margins. Clearly, we need to improve our ability to flex direct patient care labor on a daily basis to minimize inefficiencies. This tighter control of labor must be accomplished in an environment that insures a high level of patient care.

The logistics involved in tightly controlling labor on a realtime basis are complex. We currently admit over 15,200 patients and discharge at approximately 15,000 patients in a quarter. Our median length-of-stay is 13 days which means half of our admits will require implementation of an extensive plan of care and require significantly more business per day than our average patient. In a hospice team if we are overstaffed by as few as two to three FTEs on any given day, our margins will be negatively impacted on 200 basis points. With that said, it's imperative that we improve our consistency in managing labor and minimizing any overstaffing. This will involve improving our existing labor reports as well as evolving the culture within the field to provide quality patient care with an efficient cost management.

On a positive note, we had excellent admissions in the quarter, growing 7.8% to over 15,200 admits, and revenue growth of 7.9%. VITAS had revenue of $199 million and generated income of $13.3 million. Adjusted EBITDA for VITAS totaled $23.6 million in the quarter, equating to an 11.9% margin. Gross margin in the first quarter of 2008 was 20%. This is 257 basis points below the adjusted margins for the first quarter of 2007. This margin decline is a combination of increased expenses related to our strong admissions, as well as increased costs for direct patient care labor. VITAS has expanded its investment in the admissions process, increasing spending $2.1 million in the quarter.

At the end of the first quarter of 2008, VITAS had 252 sales representatives, an increase of 17%, and a total of 432 admissions coordinators and nurses, an increase of 19% over the prior-year period. Overall staffing and admissions process also increased 4.3% when compared to the fourth quarter of 2007. This increase in our admissions infrastructure caused a decline of 106 basis points in gross margin in the quarter. The payback on this increased staffing will be generated over the next several quarters as the additional patient census remain in hospice for the subsequent quarters. The remaining margin decline is due to an increase in direct patient care labor. This additional labor expense is a combination of salary rate increases for existing employees, as well as excess staffing relative to the current patient census.

In the first quarter of 2008, field salary increases averaged 4.2% over the prior-year period, which is largely commensurate with the local market salary requirements. This is above the 3.0% inflation per diem increase we received from CMS in October of 2007. Over the past several years, the CMS calculated inflation factor has been below the actual cost inflation on direct patient care costs, primary wages. Historically, we have been able to offset this inflation-adjusted shortfall through scale and in management systems, and infrastructure. We continue to refine the process of scheduling direct labor to allow for more daily flexibility with a goal of insuring proper levels of staffing, notwithstanding length-of-stay and census fluctuations. This involves more efficient utilization of field-based labor management tools, designed to meet and respond to hospice team staffing requirements.

We have begun using some of these tools and expect more efficient labor management during the second quarter of 2008 with margins returning to more historical levels in the second half of the 2008. We did not have any billing restrictions related to Medicare cap for the first quarter of 2008 operating activity. As of March 31, 2008 we have not accrued any Medicare billing restrictions for the 2008 or 2007 cap years. Of VITAS's 35 unique Medicare provider numbers, 30 provider numbers or 86% have a cap cushion greater than 20% for the 2008 cap year. Four provider numbers are between 10% and 20%, and one provider number has cap cushion of approximately 4%.

Roto-Rooter is being marginally impacted by the slowdown in the economy. Fortunately, our business model is recession-resistant through a combination of emergency work that customers find difficult to defer as well as a cost structure that's extremely variable through the utilization of plumbing and drain cleaning technicians that are paid exclusively by commission. In the first quarter of 2008, Roto-Rooter had an 11% decline in aggregate call volume, tracked in Roto-Rooter's two centralized call centers. We were able to increase our call conversion rate to paid jobs which mitigated a portion of this call volume decline, resulting in aggregate jobs declining 7%. There's also greater disparity and demand within the United States. The Southeast region has experienced a 14.1% decline in commercial jobs while the Northeast had a modest 1.8% decline in commercial volume. Residential demand is also following a similar pattern in the Southeast with job count declining 10.1% while the remaining regions have experienced a job count decline ranging between 4.3% and 6.7%.

We have adjusted our guidance for the remainer of 2008, taking into consideration current April 2008 run rate and factoring in a slight decline in demand. Both VITAS and Roto-Rooter continue to operate fundamentally sound business models that we believe are well-positioned to weather the current economy. Although there are risk factors impacting both business segments, we believe these risks are manageable. In addition, given our strong balance sheet and capital structure, a difficult economy may provide opportunities relative to our competition. With that, I would like to turn this teleconference over to David Williams, our Chief Financial Officer.

Thanks, Kevin. Net revenue for VITAS was $199 million in the first quarter of 2008, which is an increase of 7.9% over the prior year period. This revenue growth was a result of increased ADC of 3.4%, a Medicare price increase of approximately 3%, and a favorable shift in revenue mix from routine home care to high acuity care. Average revenue per patient per day in the quarter was $186.67 which is 3.5% above the prior-year period. Routine home care reimbursement and high acuity care averaged $145.42 and $633.10 respectively, per patient per day in the first quarter of 2008. During the quarter, high acuity days-of-care was 8.5% of total days-of-care. Quarterly high acuity days-of-care had averaged between 8.0% and 8.4% in 2007. Any shift in revenue mix will have a noticeable impact on overall revenue, given the significant disparity and reimbursement per diems. However, given the relatively low profitability on high acuity care, this favorable mix shift had minimal impact on gross profit and net income in the quarter.

Selling, general and administrative expense for VITAS was $16.1 million in the first quarter of 2008 which is an increase of 1.5% over the prior year. Adjusted EBITDA totaled $23.6 million, a decline of 9.3% over the prior year and equates to an adjusted EBITDA margin of 11.9%. During first quarter of 2008, VITAS's direct patient care margin for routine home care was 49.5%, this compared to 50.8% in the prior-year quarter. Direct inpatient margins in the quarter were 19.3% which compared to 20.1% in the prior year. Occupancy of our inpatient units averaged 80.7% in the quarter and compared to 80.8% occupancy in the first quarter of 2007. Inpatient margins have ranged between 15.9% and 20.1% over the past six quarters. Continuous care, the least predictable of all levels of care, had a direct gross margin of 16.5% in the quarter which compares to 20% in the prior year. Continuous care margins have ranged between 16.5% and 20% over the past six quarters.

Now, let's turn to the Roto-Rooter segment. Roto-Rooter generated $87 million in the first quarter of 2008, 0.3% higher than the $86 million reported in the comparable prior year quarter. Net income for the quarter was $9.1 million. The first quarter net income includes $0.4 million after-tax charge for settlement of litigation related to a 2003 fire that for unique reasons was not covered by Roto-Rooter's secondary insurance carrier. Excluding the settlement, net income in the first quarter of 2008 declined approximately 0.6% over the first quarter of 2007. Adjusted EBITDA in the first quarter of 2008 totaled $15.9 million, a decrease of 2.7%, over the first quarter of 2007, and equated to an adjusted EBITDA margin of 18.4%.

Job count in the first quarter of 2008 declined 7% when compared to the prior-year period. Total residential jobs declined 6.4% and consisted of residential plumbing jobs decreasing 4.9%, and residential drain cleaning jobs declining 7.1% when compared to the first quarter of 2007. Residential jobs represents approximately 70% of total job count. Total commercial jobs declined 8.4%, with commercial plumbing declining 4.9%, and commercial drain cleaning decreasing 9.9% over the prior-year quarter. Consolidated cash flow remains strong with Chemed generating $40 million of net cash provided from operating activities in the first quarter of 2008. Capital expenditures aggregated slightly less than $4 million, resulting in free cash flow of $35.6 million in the quarter.

Our 2008 earnings guidance is as follows. VITAS is now estimated to generate full-year revenue growth from continuing operations, prior to Medicare cap, of 8 to 10%. Admissions are estimated to increase 5 to 8%. Full-year adjusted EBITDA margins, prior to any Medicare cap, is estimated to be 13 to 14%. EBITDA margins are anticipated to improve sequentially throughout 2008, with an adjusted EBITDA margin averaging 13.5% to 14.0% in the second half of the year. This guidance assumes the hospice industry receives a whole Medicare basket increase of 3% in the fourth quarter of 2008. Full calendar year 2008 Medicare contractual billing limitations are estimated at $3.75 million.

Roto-Rooter is estimated to generate revenue totaling $343 million to $349 million, basically flat with the prior year. This guidance assumes a second quarter sequential revenue decline of about 3%, resulting in a forecasted revenue of approximately $83 million to $85 million in the second and third quarters of 2008, and assumes revenues of approximately 90 to $92 million in the fourth quarter of the year. Adjusted EBITDA margins for 2008 is estimated to range of 18.5% to 19.5%. Our effective tax rate has been increased to 39% in 2008, about 50 basis points higher than the prior year. This consolidated tax rate is being impacted by volatility in the stock market and its related impact on tax accounting for certain retirement plans. Based upon these factors, and average diluted share count of 24.2 million shares, our estimate is that full-year 2008 earnings per diluted share from continuing operations, excluding noncash expense for stock options and charges or credits not indicative of ongoing operations, will be in the range of $3.05 to $3.20 per share. I will now turn this call over to Tim O'Toole, our Chief Executive Officer of VITAS.

Thank you, David. VITAS generated 15,212 admissions in the first quarter of 2008. This was a 7.8% increase over the first quarter of 2007. April 2008 admissions continue to run strong and are currently showing an increase of nearly 6% over April of 2007. Our discharge rate has begun to moderate in the first quarter of 2008, growing at a rate of 6.7%, 110 basis points below our admissions growth rate in the quarter.

Over the past year, we have significantly increased our resources dedicated to admissions. On an incremental basis, this increased our field-based cost $2.1 million when compared to the prior-year period. To a certain extent, a material uptick in our admissions rate put some downward pressure on our current quarter's margins. This is a result of our low median length-of-stay which is currently 13 days. What this means is half of our admissions are discharged, primarily through death in less than two weeks. These patients are extremely ill and require significant resources to admit, establish a plan of care, and deliver such things as durable medical equipment, supplies, and meds on the first day of admission. In other words, an uptick in our admissions growth rate does put some pressure on margins.

With that said, I'm disappointed with our process of flexing patient labor to more closely match our daily change in patient census. Our need to manage labor effectively is critical to sustaining appropriate operating margins. Hospice teams that are overstaffed by as few as one or two employees can materially impact our margins. I am focused on improving the scheduling of direct labor to allow for daily flexibility, with the goal of ensuring proper levels of staffing, notwithstanding length-of-stay and census fluctuations. This involves more efficient utilization of field-based labor management tools designed to meet and respond to patient-care staffing requirements.

VITAS' average length-of-stay in the quarter was 71.5 days which compared to 76.9 in the prior year quarter, and 75.7 in the fourth quarter of 2007. This decline is related to our expansion in our admissions and has resulted in our median length-of-stay dropping one day to 13. Our days-of-care totaled 1,063,859 in the quarter. Routine home care days increased 4.4%, inpatient days-of-care increased 7.7%, and continuous care days increased 3.6%. We currently have three programs classified as start-ups, three are licensed, two of which are Medicare-certified. These start-up programs had an ADC of 37 patients with revenues of $311,000 and pretax operating losses of $485,000. These same programs have effectively zero ADC and revenue with operating losses of $296,000 in the prior-year quarter. With that, I'd like to turn the call back over to Kevin.

It's now time for us to consider questions from the assembled multitude.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Darren Lehrich of Deutsche Bank.

Thanks. Good morning, everyone. A few questions on Roto-Rooter and a few questions on VITAS. As far as Roto-Rooter goes, I would be interested to know if you could comment a little further on call volume in April or what you are seeing at the present time, just to give us a feel for the outlook there. And how closely that gaging call volume.

We don't have a call volume. We don't expect that to change appreciably. The current run rate of April, and if you just extrapolate throughout the quarter, it's actually above where our guidance has it. Sales are running stronger than our guidance, but just given the volatility we have seen and the impact there, I would say the recession is having, we're conservative. Basically, April is running a little stronger than our guidance. We are anticipating a 3% drop in the second quarter of 2008 for Roto-Rooter's revenue over the first quarter. But without a doubt, if the recession runs extremely severe or it spreads well beyond the West and the South, it could impact Roto-Rooter's numbers, but we're not seeing that in April.

Okay. Then just as far as your geographic dispersion. You commented obviously about the West, and California and Florida having some exposure. Can you just give us a sense for your footprint and your revenue concentration, maybe broad geographic swathes just to help us have a feel for that?

Well, let me just -- just say that we don't have much of a presence in California. I'm not -- that's a tough market. It just turns out that several of our multi-location franchisees exist in California. It's basically --- most of the metropolitan -- most of the major metropolitan areas east of the Mississippi, I would say that is where we are. Then west of the Mississippi the -- again, we have a presence, but it's a little more scattered. Clearly, the concentration is Northeast, Southeast, Midwest.

And Darren, if you go to our website at Chemed.com, and you look at Investor Presentations, we keep our presentation that's updated, and you will actually see a map that has the footprint of Company-owned territories in the United States. Some of those are owned and operated. Some of those are independent contractors. But you will see where the concentration is. And you will see a significant concentration in the state of Florida.

Yes. Sure. And then, I guess just want to get your perspective on the downturn. Are you -- is it your sense that people are deferring things? Is it more do-it-yourself? Can you just give us a little bit of a feel for what you think is going on out in the field with Roto-Rooter?

If I -- I will just tell you that it's my sense of it is that, it's a deferral. On the -- I will tell you something that definitely happens on the commercial side. To the extent that you have new construction starts at a standstill, you have a big influx of plumbers into --- on the commercial market. They really can't make a dent on the residential side. You see them on the commercial side, them just putting in bids, feet on the street,. It's just that -- there's no question in markets we have, where there had been a lot of new construction, we see a lot of increased competition on the commercial side. They really -- they can't go out and get a bigger yellow page add, so it's not a big effect on the residential side.

As we've indicated, there's a residential decline. When things get tough, we call that internally the Home Depot effect. That is people -- if money is more of an issue, they look for a cheaper alternative. One of the cheaper alternatives is go to a Home Depot and get involved in what they call an assisted repair. You can rent a drain cleaning machine. You can do minor plumbing work with again, some assist from initially the salesperson at Home Depot, and a call to one of their help lines.

We think that's what's going on on the residential side. But, again, given the nature of the repairs, we don't think this is stacking up when we face deferrals or --- there's some deferral with regard to major plumbing activity. But with regard to the drain --- the decline in drain care work and on that, obviously, that's gone. But again, we are comfortable with our Roto-Rooter business, in that -- with the decline of 11% in call volumes and jobs down only 7%, I would say that just shows some good work by the Roto-Rooter people. It's anecdotal but I will tell you among --- what the reports from not all, but many of our 500 franchisees, the reports are that they are telling us jobs are down -- their jobs are down between 10 and 15%. It is pretty broad and again, we're hammering away at the commercial side of the business. For the current time, all that effort is maybe just allowing us to somewhat hold our own there. But again, we think we will be better positioned when the economy turns.

Okay. All right. Then, switching to VITAS. Obviously, the labor issues cropped up here several times over the last two years. It seems to be somewhat of a systemic issue within VITAS. I guess just sort of a -- one question I have is just philosophically, do you view labor management in Cincinnati different than they do in Miami? Is there a disconnect between how you think that organization should be performing? And I will start there.

Let me start right there. And Tim O'Toole is sitting next to me here, and I will start to answer it and then turn it over to Tim. Let me start by saying that I -- I will give our thought process. Obviously, it's an issue. It's an 800-pound gorilla when you are talking about where all the expenses are in VITAS. It is a service business. It is a labor expense.

Historically, they've had a few blips, but it's -- they have been -- the organization has responded pretty quickly when the labor number has gotten out of line. I will give you a good example. October of last year, we saw labor numbers that were very similar to what we saw in the first three months of this year. There was a strong reaction, both in Cincinnati and Tim and his people. The margins and the labor expense in November and December were very good. I mean, which really closed out the year for VITAS. They were over budget.

They had, all things said and done, a very good year last year. The January number came out, it was bad labor number. There's some issues with labor in the first year, with unemployment taxes that make January not necessarily a harbinger for the future, but it was still worrisome. February came out and it was just as bad. I can tell you that at that point, there has been a -- an about face totally with regard to -- it's not -- there's no disconnect between Cincinnati and VITAS. But I think that everyone is pulling on the same side of the oar to do --- . Number one, as we made reference to in our presentation, a change in the culture of VITAS, insistent on using some of the labor management tools that already exist with development of a few others. And if you ask me if I wanted to summarize everything that we have been doing, I would say this, and that is, that we are now managing labor, and really profit and loss, on a team basis rather than a branch basis.

I can tell you that there has been improvement already in our labor expense per week, and we are not all the way there. But I will just say that, we've already been able to show improvement. We think it's going to be sustained improvement. It's going to be harder --- codder pins are more securely on the wheel, as it were. I think we've also identified a lot of opportunities for improvement. It remains to be seen if we can execute on the plans to bring those to fruition. But I'm very encouraged by what I see.

There's no question that major elements of the VITAS business were good in the first quarter. We shot ourselves in the foot. Good management is avoiding a disastrous quarter every once in a while. And just say, oh, how that's not indicative, ongoing operations. Well, that's not good management. Good management is making sure those things, the valleys aren't nearly as deep. But with that said, I'm going to answer your question and say, there's no disconnect. I think there's a lot more clarity of purpose. If you ask me what really has to be translated, is making sure that every one of the field management personnel who almost by definition are clinical people, people who come up on the clinical side, rather than the business side, fully embrace everything that we have to do. I think that's the cultural issue we are still going through. But there's no disconnect between Cincinnati's management and Tim O'Toole and his team in VITAS. With that said, Tim, any couple comments you'd add

Absolutely. Obviously, there's no disconnect. We work very closely together and we are all in --- on the same direction of getting this in better shape. I think there have been issues over the last several years from quarter to quarter. We've had some situations where labor has gotten higher than it should have been. We have been able to correct it. Usually there are different issues and each time it's something different. We think we fix something and then a new issue comes up.

Clearly, we need long-term to have better systems that filter through our employees that are available to get the best match for the lowest cost possible to do the service that's required. But we also obviously, have to equate that under the framework, which we all agree that we provide the highest quality care. One of those issues is continuity of a nurse or home health aid to that patient, and not always having a different person in there everyday. This is something every hospice company has to deal with. We just have to do a better job of matching the best possible person to the job and to make sure we're not overstaffing and providing more visits than is appropriate. We have a lot of fail-safe systems that make sure we don't --- we always provide the appropriate number. Sometimes, we may get a little too high on the number of visits and we need to correct that.

This situation that has come up recently, as we've highlighted to you, we did have a big increase in the selling cost, about 100 basis points of the margin shrink is from increase in our selling cost. We all recognized over the last year or year and a half, that the biggest risk factor to the business performing well is managing the Medicare cap. There's own one way to do it and that is to have high admissions. And the only way to have high admissions is to have a selling effort and a qualified selling effort. We put more people out there, more money, and having better trained people, so we can educate the referral sources better and work with the families to get the admissions. We've done a great job with that at some cost. I think we can adjust some of that cost structure to get more out of it, now that we have enhanced it a lot. And so those costs will be coming down modestly, but we still have to press the sale, so we press the admissions.

One thing that we did see in this quarter was, as we've talked about, we saw a little more of our patients that were in the category of being with us for a shorter period of time. That's a whole other issue to manage, as opposed to just managing labor. You have to manage a fluctuation in your daily census that's more rapid from day to day. Which is a challenge that we're up to and we're working on systems to be able to do that. That's a little bit of a new issue. I think as that stabilizes, as we work through that, that just becomes the status quo instead of the new. We will do a better job with that.

We also talked to you about --- in the past, we have always been able to do I think an heroic job of keeping our year-to-year labor for existing employees running at a rate of maybe 3 to 3.5% which was fairly consistent with our reimbursement increase. This year, we've seen that tick up a little bit for the first time, where we are seeing, as we mentioned, about 4.5% year-over-year increases from our existing staff. There is labor pressure in the workforce, especially in certain segments. We have to do a better job of searching the work place to find people that can do the job at a lower cost than maybe we have someone on board today. That's a little bit of a new issue so it's eaten into our margin a little bit. I think it's not a long-term issue. You see it from time to time.

We held the labor very well for several years and we have a little slip as we moved into the last six months. Everybody sees inflation in the labor markets today, like you do in all of the cost structure. We have seen some of the fixed-cost structure that are pretty fixed, that the costs have gone up pretty high this quarter, compared to the prior year. Everybody knows the cost of gasoline. We have a lot of people that get reimbursed for mileage that drive a lot, and that cost is up just statically, about 12% year-over-year. We are up 15, 16% year-over-year with our volume growth as well. Just things like our insurance. Everybody knows that your health insurance goes up maybe 6 or 7% a year. We are working with a 3% price increase.

Some of these issues are very manageable. The units that we see that have had problems, usually are units that the census is flat, maybe modestly declining and the labor has not been adjusted. Kevin mentioned, we've made many, many adjustments already in the last 30 days where we know that we'll be having better handle on the labor cost in the next quarter. Some of these longer term issues, we are working feverishly. The Chemed people and the people in Miami are all on the same page. We are going to get that solved as well.

Okay. I will jump back in the queue. Thanks, guys.

Your next question comes from the line of Dawn Brock with JP Morgan. Please proceed.

Good morning. Very quickly, just following up on your comment, Tim, on the fluctuation of the shorter-stay patient mix. This is opposite of the trend that we saw in 2007. So I think my question is, what is driving the shift back? How does this impact the patient mix expectation and the average length of stay expectation for 2008?

Well, it is a little bit of a -- we have seen an increasing length of stay over the last four years, increasing every year. And, again, it's a function of managing your Medicare cap. When you go into the market, and I think most of the markets are very competitive. There's market growth out there and long-term, there's huge growth in the demographics. But when you go after trying to take market share, and trying to find every referral source, as we've tried to find new referral sources. Some of the way the business works is obviously, sometimes you get some of the patients that maybe should have been on hospice for two months, but because they are not fresh with you, and understanding it as much, their new referral sources, maybe they are referring a little too late in the process. There's no doubt in my mind that when you see patients that are on hospice services for two weeks, probably nine out of ten of them should have been on hospice for a couple of months. It is a little bit of our aggressive strategy of finding a strong selling effort, penetrating all markets and all referrals. That mix will work its way through. I think longer term, we are not going to see this increase. It's stable and I think law-of-return, we will see our average length-of-stay increase from this level of 71 days. It may not in the next quarter, but longer term it should be longer.

And Dawn, with regard to that, I think you can't --- really, the average length-of-stay, you have to say, what's going on in the focused medical reviews. And that is, virtually every long-stay patient is reviewed, bounced at least once, subject to appeal. And, again, we win those. But it has an effect on referral sources, and the organization, and to the extent that, we went through a period where we had significantly -- a significant increase in discharge of long length-of-stay patients. Again, we're through that. We are now in the very comparable comparisons. When you had discharges of more -- of an unusual number of long length-of-stay patients, that in a sense, artificially drives somewhat your average length-of-stay up. Because the average length-of-stay is calculated on discharge patients. So really to get to your question, do we think that, what is an optimal day. Based on your estimate, as far as our average length-of-stay, it was 71 this quarter. What do we see in a trend in that.

We basically assume no change in length-of-stay, But Kevin is precisely right in that. From the third quarter of 2006 to the fourth quarter, we saw a spike in our length-of-stay, calculated from discharged patients. That spike, a big piece of that is attributed to the FMRs and the fact that we did have an increase in our live discharge for extended prognosis. That would artificially inflated the length-of-stay for really four or five quarters. Now in the first quarter of 2008, we see the exact opposite. We are seeing a drop in our live discharge for extended prognosis. But because we had a really, really nice uptick of our admissions, both sequentially and over the prior year, it is a greater percentage of our discharged patients, the 13 days or less patients, has artificially deflated that length-of-stay. Really over the last four quarters, it was artificially deflated. This quarter, it's slightly lower than it should be. It's a long way of saying as we think it will moderate, probably around a 73-day period. Once we hopefully continue with this higher admissions trend, and we start lapping it, then you will see a stabilization of the length-of-stay.

The bottom line is, we were fairly happy, all things considered, with our average daily census and our increase in revenue for the quarter. That was the least of our problems.

Understood. Just quickly, following the competitive landscape, what are you seeing? Is one of the drivers behind the increasing -- behind increasing the admissions staff competition from charitable organizations? A lot of it not-for-profits in certain regions? What are you seeing right now as far as the mom-and-pops and the pressures on them from cap?

Well, I will turn it over to Tim. I will say this, that the best indication that you can have is on the political side. We are seeing --- we are hearing from our lobbyists and what not, that senators and representatives are, relatively speaking, are being deluged with commentary from the not-for-profits and the smaller hospices, that things are very tight. That the budget neutrality factor must be fought at the battlements that they just can't -- they just could not stand for a reduction in the increase in October. We are -- from that perspective, we are hearing that they are doing a lot of complaining to their -- on the political side. With regard -- I will turn it over to Tim. But let me just say, that I think what we are doing is we want to increase our admissions. It's not that they are doing it purely defensively, but we are taking the offensive.

We want to increase it. But it's always tough. Again, as I just said, as these organizations start struggling, they start calling all the referral sources and crying poor, and saying, you got to help us out. We do see that. With regard to why we are spending more on the admissions fund is we want to take market share. It's not purely defensive. But it's -- as we alluded to in the presentation, the payoff --- initially , when you get more patients than you expect, again nine out of ten of them live less than six months. You have a fairly low margin --- lot of activity involved in treating those patients. It's not until you get the statistical outliers adding up, that you get really the payback for those. Tim, any

As far as the competition in the market place, there's no big changes out there. We certainly do not see a reduction in the number of players or the number of competition. We look at it in each market that we serve, more than a global situation. One of the bigger trends in the industry is the hospital-based palliative care programs. They're maybe keeping certain people in the hospitals a little longer through that effort. But our strategy is that we are working with many of them and they have become a referral source to us at the appropriate time.

One thing you have to remember about in this business, obviously your competition is curative care. People are aggressively seeking curative care with some of the new treatments in cancer. It hasn't changed the landscape at all, but that's always an issue that's out there. We think over time that hospice gets more engrained in the people's minds as it is always, they compare that with more of an educational outlook instead of an emotional one, and we do very well long-term. No big change in the market place. We have competition in each market. It's really a local market situation more than an overall in the country.

One last thing, and this is going to be further in depth into a question that was asked initially about the potential disconnect on the labor side. I think that, I'm just curious and I'm --- maybe I'm just missing it. You talk about one of the reasons for the increase expenses being excess staffing, but volumes are up, admissions are up. It would seem as though the additional staff would actually be utilized. You would have a higher utilization of the staffing. I think that --- I'm not quite understanding the --- what I would consider maybe a disconnect there or maybe I'm just not getting it.

Well, the answer to your question is, as we said about 106 basis points of margin climb is associated with increased admission coordinators and nurses[sw1], so that --- it's the number --- I can't remember, $2.1 million additional spending in the quarter. That is down. And that is --- we meant to do that. We hope that the payback for that would be shorter. We gave guidance, but it hasn't been the -- we've been swamped a bit by the shorter-stay patients. By just what you said, by increased utilization, people having things to do, being needed. However, when you compare -- again, we are looking at it on a team-by-team basis.

Too many of the teams that when you compare them to 12 months ago, six months ago, that the cost per patient by --- for these teams to care for these patients is up by double-digits in too many instances. In other words there's a -- we have identified inefficiencies. I will just say, Dawn that with regard to the type of changes that we have made, not with regard to the former type of charges which is the latter, just pushing out inefficiencies. Just order of magnitude over last couple of weeks, we reduced labor expense on a weekly basis in excess of $200,000 a week, just so you want to talk --- down that --- on the inefficiency side. We have identified a number of other areas where it looks like we should be able to make similar progress. So with regard to -- it's very clear in our mind that it's a significant element of the labor problem is inefficiency.

We already begun to address it, which we hope to say that we are addressing it not with a Band-Aid, but with permanent changes in the way labor is managed and assigned on a team-by-team basis. We have already seen the progress. Is a question, if you ask me, are we --- well, how much progress are we looking for? I would say, we are a little more than halfway. We are halfway there as far as coming up with what we think is the efficiencies that have to be achieved. And, again, our presentation says that we will be achieving those this quarter. We are already --- we are off with that start. We think we're going to be there the second half of the second half of the year, but this is a quarter where we're expecting to make great headway.

And, Dawn, this is David Williams. This question has come up a number of times and to put it in perspective, there's been a fundamental evolution in shift over the last four at VITAS. Our footprint has gotten significantly bigger. We've expanded a lot more programs, and particularly in the small and medium-sized programs. We have probably close to doubled the number of hospice teams. The average daily census forecasts slow. We've always had stranded labor at any given time in a hospice team, but now we have a lot more hospice teams that are growing a lot slower. A much bigger footprint with small and medium programs.

Again, a small and medium program has less opportunity to shift labor between hospice teams, when they are only running three hospice teams versus nine in a large program. As VITAS has grown and changed its footprint, the potential for more stranded costs in a hospice team on any given day, over staffing has increased. That's why to great extent, it was harder to get things back in the bottle every time labor flared up which led us to an epiphany, probably too late, that we need to fundamentally change the way we schedule labor because of what I call this flare-up of overstaffing. Really, it is an acknowledgement of managing labor differently, recognizing average daily census is slowing. There's more pockets of stranded labor, because we are dealing with almost 200 hospice teams. Versus four years ago, I think we had, what David, less than 100 hospice teams. That's really kind of the acknowledgement of the changing of the environment.

Okay. That's helpful. Thank you.

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

Good morning. I think Dave, you just touched on the thing that I was going to ask about and that's ADC growth. You would say that part of the issue maybe with the labor is also related to slowing ADC growth overall. Is that one way to characterize it?

Yes. Certainly, if you go back from four years ago and three years ago to today, that's right. The slowing ADC growth and a lot more hospice programs and a lot more provider numbers, the potential for a flare-up is greater. And, again, a flare-up in a small program in Detroit, you can't kind of manage that against two other hospice teams if you don't have two other hospice teams in that provider number. So --

Let me give you a good example also. Let's use a --- I wont' mention it to you, but a Texas program that had a relatively significant decline in census. The first thing is, well, okay, the decline in census, the full-time equivalents have to be reduced. It also --- that presents --- that type of action presents something that VITAS has never dealt with before, that is, the danger of a mix shift between home healthcare workers and nurses. One of the things we uncovered in that particular branch is their FTEs were reduced appropriately. Maybe not completely, but appropriately.

But it was --- it --- the mix shifted in between --- there were more home healthcare aides released than there were nurses with the view that, well, the census will come back. The nurses are harder to get. We will cut. We just won't cut as severely with the nursing staff. That has a dramatic effect on the labor cost in that branch, or to the team that was -- where the cuts were being made. That mix shift is something that VITAS never had to deal with previously. You have that. That pops up when you have --- overall, your census is growing a few percent, 3, 4% as opposed to 12%. That's the type of thing that they are dealing with for first time. But, again, we are --- it --- a team can't go seven days now without getting a lot of attention. That type of situation is developing. We are handling it on a -- what we refer to on a S.W.A.T. basis. Each team seems that to be out of whack. I think we are going to get a lot of benefit from it.

It's my experience that hospice nurses are rather unique with their skill set, and just in what they do. How concerned are you that if you try to more actively manage this labor force that that could potentially drive some of those nurses, which I'm assuming are highly competitive in the sense that there's other providers looking for them. Maybe I'm wrong there, but how do you balance that aspect of the --- ?

Well, it's a tough one. It's a tough one. Let me give you the classic example, and I'll use --- because we do it --- the example we talked about internally is this. Previously, we had a fairly sizable home healthcare business. And you have to look at each salary range. I mean, to the extent that you have too many workers at the top of the salary range, and you might say well, you are -- well, it's good, everything is stable, but everyone has been with you for a few years, so everyone is at the top of the salary range.

Well, if you are being paid by the government, that's a problem. Because it's the --- the government numbers are premised on the full spectrum. Basically, you have to say, well, some of your -- if some of your good people say, I can make 10% more working somewhere else, you have to say, well hate to lose you, but that's --- you've graduated. I don't know. There's no -- it's a tough one and you used the right word, balanced, you have to be willing to do that. You have to be willing to make sure that --- if you are being paid by the government, that you --- you have to have that broad spectrum of workforces through the entire salary range. It's not easily done. One of the reasons we saw, that when we say our salary increases were almost 4.5% over the last four months, it's not because everyone said, things are good, let's live in these. Let's give everyone a big increases.

These were caused by competitive situations. One of the things that we are definitely going to be trying is be tougher. Just so you know, we modified it so basically one of the top two people in the VITAS organization has to personally approve any salary increase over 3.0% at this point. You've got to pick and choose those. It is a balance. It's a risk to the business, to the extent that there's somebody who is -- that it's going to be a subjective determination. But we don't want to cut it to the bone to the extent that somebody is just -- the glue that's holding together a team or a branch, the call goes in their favor. It's going to be a high hurdle because long-term -- keep in mind, if the government figures are right, our increase is premised on changes in the labor market, so theoretically we have a shot at managing it. We are just going to take it. We are going to believe the numbers and hold our increases to that number, whatever the number ends up being.

Then my last question and I will hop off. Dave, could you just update on --- update us on maybe what's going on with CMS and budget neutrality factor? Do you have any insight as to what the potential impacts from a change might be? Or what's happening at this point?

Yes. Again, it's hard to get your arms around it because some of it is rumor. Some of it is set behind the scenes. But by all indications, CMS --- it appears that CMS is following directives from the White House, in terms of trying to hold back on all entitlement programs, both Medicare and Medicaid. They are making a statement. They are taking a wide range of trying to hold reimbursement, one of which is, of course, the budget neutrality factor. By all indications, CMS has telegraphed. They intend to put at some point in the Federal Register a phaseout of a portion of our historical inflation index on the budget neutrality factor, that would work out to be in theory 4.5% reduction, phased in over three years of our basket increase. Or about 140, 150 basis points a year for three years. We've also seen an indication out of Washington that both democrats and the republicans are severely resisting this administrative process of taking away reimbursement for some very important healthcare benefits to Medicare beneficiaries and Medicaid beneficiaries.

Without a doubt, there's a struggle going on in Washington. MedPAC certainly reported on average hospice's losing money in the provider base, hospital-based hospices and the not-for-profit, so this will take them further under water. And hospice, by the latest new studies, saves the government money. Politicians recognize it's very poor politics to severely harm these type of healthcare plays. But there does seem to be a battle going on. If the budget neutrality factor is phased out over three years, that would theoretically -- if we didn't do anything to adjust our structure, cost us $0.05 a quarter, $0.20 a year, starting in the fourth quarter of 2008. We also think there's serious questions legally, whether CMS could take administratively confiscate inflation that we receive, that Congress mandate we receive over the last ten years. But it appears to be a risk factor that's out there.

Great thank you.

Your next question comes from the line of Adam Feinstein with Lehman Brothers. Please proceed.

Yes. Thank you. Good morning. It is late in the call here, so just real quick, just two questions. I guess, one, not to beat a dead horse here, but just in terms of the admission --- the additional staffing related to admissions. I understand the reasons behind it, but I don't know why you would not have known about it when you established guidance previously. Just curious in terms of just why that caught you offguard.

We did -- we did realize we were doing this. When we say it's a factor that given the fact that, it was successful, but it resulted in, like, a high number of short-stay patients, that the expenses associated with those patients caught us a little offguard. Let's put it that way. It didn't have this -- when you look at our discharges versus our admits, they only differed by 200 for the whole quarter. We expected a little more bump in census from them than covered those costs. But again, when you have -- I mean I don't want to explain everything by use of acronyms and what.

A declining creek shows a lot of stumps. This was just --- given the fact that we had that excess activity -- we had the excess activity without the census to cover it. It it was just an additional decline in margin. But no. We didn't raise the admission coordinator and nurse numbers inadvertently. We did that intentionally. But it -- it -- there wasn't the rising creek that would have covered that.

But --

Let me be clear, it's not an excuse. It's really --- where did the additional expense come from?

And that's exactly right. Again, it was up 18% over the prior year, 4% sequentially and we are just reconciling the difference in margins from this year versus a year ago, not using it as an excuse. Because at the end of the day, our miss is due to having too much labor in the field, primarily related to patient care. This is just reconciling where margins came from.

Very helpful. Okay. A follow-up question here, you were talking about CMS earlier. One of the other overhang issues on the regulatory front, is there more scrutiny over --- hospice patients are treated in nursing homes, a recent literature out of MedPAC talking about that. I'm just curious your thoughts there. Do you anticipate changes? And just curious in terms of what your exposure is to those patients. Thank you.

Yes. We do have you are our -- we look at routine home care, we look at nursing home and non-nursing home routine home care patients. MedPAC's understanding of hospice has actually grown light years over the past 12 and 18 months, primarily because VITAS has provided to MedPAC information on hundreds of thousand of patients, and how hospice is working on visits, both nursing home and non-nursing homes. MedPAC has a greater appreciation for Medicaid patients in a nursing home. Basically, the reimbursement is now covering largely the roof, the meals, and the bed, and we provide the healthcare as opposed to the double-dip. They recognize there's greater efficiencies to greet multiple patients at a single site, but they've evolved their thinking relative to nursing home versus non-nursing home patients. I think they are always going to be taking a tough look at this issue, but I think they have a greater understanding that it really isn't a double-dip.

Okay. Thank you very much.

Your next question comes from the line of Jim Barrett with C.L. King. Please proceed.

Good morning, everyone. I really just have one question at this point. Dave, your revenue guidance for Q4 for Roto-Rooter, does that implicitly imply an improvement in the macro economic environment? Or are there some specific actions being taken by Roto-Rooter to start growing the business again?

Great question, because that's exactly right. The fourth quarter of Roto-Rooter includes the high-end of what we typically see in seasonality relative to it. It's also related to the fact that we have fairly low numbers in Q2 and Q3. But we think some of these deferred jobs will materialize. I'm hoping they will be earlier than Q4, but still very, very optimistic. We're going to get a nice bump relative to, call it the holiday activity. Even if we are in a recession, I would suspect a big chunk of that holiday activity will still happen. I think I'm very, very conservative on the guidance and a fair amount of movement downward within the range we have given. That's probably the only area of aggressiveness I have, potentially maybe one to two points sequential growth, Q3 to Q4. But I think there's a solid basis for anticipating it.

Thank you very much.

Your next question comes from the line of David Larson with [Cowen]. Please proceed.

Hi. How is the April call volume trending compared to the first quarter for Roto-Rooter? I think it was down 11% in Q1. How is April doing?

I think we said earlier. We don't have that number sitting here at the desk, but it -- it was -- I will just say that the report was running similar -- the preliminary report was similar to March. So not worse. Not better. I will say that based on our estimates, our sales are a little bit better in April than we built into our guidance. The Roto-Rooter would suggest that one of two things, that calls have improved slightly or that our conversion rate has improved slightly from our normal predictive mechanism.

Okay. That's helpful. Of the $2.1 million in admission expense, do you have a rough percentage breakdown between how much of that was for sales rep versus admissions, coordinators, and nurses?

I think we do.

It's pretty similar between sales and admission. The admission nurse category is up a little higher than the salesman category.

But you don't expect those to be all in the same mix ratio. They get paid about the same.

So about 50%/50%. Okay. And then, you had made a comment, labor expense down $200,000 a week from recent initiatives. That sounds very impressive to me. If I just think about that on a quarterly basis, that's around $2.4 million a quarter, right? I mean, should we expect labor costs to come down $2.4 million in Q2?

That's the run rate and we certainly --- that would be very similar to our goals, yes.

Our anticipation to get things back to normal, we need about twice that, what Kevin said earlier. We need more like $400,000 over a 13-week quarter.

You need twice that. Okay.

That's comparing it to our goal. Obviously our revenue is higher, I mean ---

In the third quarter, we expect a comparison to the first quarter weeks to be different by about $400,000.

Okay.

We are already -- we're already there with half of it, that is really by the last week in March of the first quarter. I think we're going to show good improvement in the second quarter. Our plan is to be there or beyond for the entire third quarter.

Okay.

And really, our long-term --- through brute force, Tim O'Toole and his team is bringing labor back down. Then in the process, we are reengineering the process to avoid it in the future. There's really two things going on. Immediately just trying to draw down labor expense and put better tools in the field, and have a better process to keep this from happening into the future. That's really -- that's the late 2008, 2009 long-term benefit.

Okay. And then, just one last question here. Are you basically eliminating staff? Are you --- are people being laid off? Is that how you are lowering your expenses or are they paid per visit or something like that? Are you basically letting people go?

It's the -- it's the former. It could be part-time or salaried people, but it's basically --- we're --- we have a number of terminations in this process. Tim, do you have the current number?

Probably 120 at this point. It's up -- it's a combination of terminations of your staff, but --- utilizing less overtime because you do a better job of scheduling the people you have. Doing a better job of a decision between a salaried person and a per diem person. And doing a better job of using an appropriate mix of skilled and non-skilled, and not let it drift. The mix is not bad. So it's a multitude of issues.

And taking advantage of -- we run 25 to 32% turnover, depending on the category, and taking advantage of that natural turnover to also rein in the costs.

It sounds like the $2.1 million, that's an investment to increase your sales activity. You're trying to basically secure new referral sources now. With the people you're letting go that $2.4 million to-date, that's the people in the field and nurses in the field doing the work. Is that correct?

That's correct. And home health care aids.

And home health aides. Okay. So it's not like you hire that -- you spend $2.1 million and then sort of let half of them go. It's more of a strategy. It is just like taking time ---

That's correct. If anything, to the extent that we're still continue to be successful, there's no reason why we wouldn't continue to increase, our sales reps and admission personnel to the extent that if we felt we were getting bang for that buck.

Okay. And then -- okay. The increase in the admissions staff was not to meet existing demand. It's to basically increase that in the future.

That's correct.

Okay. All right. I think that pretty much answers my questions. Thank you.

Your next question comes from the line of Sean Daley with THM Holdings. Please proceed.

Hi. Good morning. Given the stocks performance, and I must say I think you're out here, you're doing a nice job in a difficult environment, but the reality of the situation is the stocks performed quite poorly the last year. Does the board from time to time, review the way the Company is structured with these two very, very different businesses. Would shareholders be sold --- be better served selling one of the businesses and reinvesting in the other? Paying shareholders a special dividend or something of that nature?

Well, put it this way --- the answer is --- we'e looked at everything you can imagine with two very different subsidiaries like this. We've --- over the last four years we have gotten this question, virtually any time, a group of shareholders get together. The real answer is historically, and we think even to this day, the value, we don't think we are facing any limitations in valuation based on the different nature of the two entities. We think to the extent that there's advantages. When you have a business that's almost 95% dependent on the government to pay the bill, it's reassuring certainly, to lending sources to know you have a subsidiary that whose cash flow is more than sufficient to pay the debt service on any reasonable amount of debt. But the real answer to your question is -- we look at it all the time. If we thought that we were facing some --- a limation in value or a reduction in value, based on the unusual nature ---

You are trading less than ten times your current guidance.

Due to a discount, because of the disparate operations. That's due to obviously, excess labor in VITAS and the overhang of what will reimbursement look like at the end of this year and next year.

And the multiple of the S&P 500 at this point is probably 12.

Right. Right.

We can't address in multiple, but more to do with the capital markets, that does anything going on within our business.

Okay. But, I mean ---

It is a low ---

I'm not trying to be argumentative, but it's too extremely different businesses and ---

We could sell --- selling a normal issue. Our basis in Roto-Rooter is less than $100 million. Right. There are all sorts of limitations. There's no tax-free spinoff possibility because you have to own --- we would have to own VITAS for five years and what have you. But basically, it would be a taxable transaction. Either --- even after five year, it would be I'm sure taxable shortly after the spinoff. But the tax bill on selling Roto-Rooter for any reasonable amount would be such that the --- the --- just to get back to even, to make it non-dilutive, we'd have to have a use of proceeds of --- or even if the shareholders, the tax rate on it would be such that the --- there would be significant diminution in total value of the holding.

And that would be the same if you separated the two entities and the two --- two different publicly traded companies?

That's correct.

Okay.

What you are really suggesting is let's say a tax-free spinoff of one of the two entities. Technically, cannot do that for a period of another year and a half or so. And then, I mention that with a hesitantly of saying, even when you did that --- Roto-Rooter was a separate publicly-owned company, where we owned 60% of it and then traded at a a big discount to value just because it was an orphan company. We would anticipate --- a week after we did that somebody could come in and offer closer to the real value of the Company, and then it would be a taxable transaction at this point for all the holders.

What would preclude the sale of the hospice business? Would that be --

Same thing. You would sell it. It would be a taxable transaction. You couldn't get a tax-free spinoff again, for the same period of years.

Okay. Well, thanks very much.

Okay.

Your next question comes from the line of Gene Fox with Cardinal Capital Management. Please proceed.

Sure. Gentlemen, somewhat along the same lines. Obviously, the stock is down today. Your free cash flow was reasonably good in the quarter. I saw, Dave, that you all did buy stock in the first quarter. But relative to your stated objective of acquisitions, given that the job in front of you, does it make sense that you might continue to buy stock aggressively at these levels?

Yes, it does. Yes, at these levels. It hard to --- it's a pretty good deal from our perspective. So yes, we would be more likely to buy stock as well.

You had indicated roughly $100 million of free cash flow as being reasonable for '08. Does that really change a great deal based on your new forecast?

Well basically, our cash flow and our EPS are one and the same. Our free cash flow and our EPS works one and the same, because nothing really sticks to our balance sheet.

Okay.

So we'll do 305 to 320 in cash flow as well. For sure.

CapEx for the year, Dave?

CapEx is pretty much equal to depreciation, so that's how it works out that way.

Okay. Thank you very much.

At this time, you do not have anymore questions. I would like to turn the call back to management for closing remarks.

Well, that's been a pretty long call already. We'll attempt to have better results next quarter for you. Thanks for your kind attention.

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

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