LHC Group Inc (LHCG) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the LHC Group Second Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Eric Elliott from Investor Relations.

Thank you, Javon, and welcome, everyone, to LHC Group's Earnings Conference Call for the second quarter of 2010. Hopefully, everyone has received a copy of our earnings release. If not, you may obtain a copy of this, along with other key information about LHC Group and the industry on our website at www.LHCgroup.com.

In a moment, we will hear from Keith Myers, President and Chief Executive Officer; Don Stelly, Chief Operating Officer; and Pete Roman, Chief Financial Officer of LHC Group.

Before that, I would like to remind everyone that statements included in this conference call and in our press release may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These statements include are not limited to comments regarding our financial for 2009 and beyond. Actual results could differ materially from those projected in forward-looking statements, because of a number of risk factors and uncertainties which are discussed in our annual and quarterly SEC filings. LHC Group shall have no obligation to update the information provided on this call to reflect subsequent events. Now I am pleased to introduce the CEO of LHC Group, Keith Myers.

Thanks, Eric, and good morning, everyone. Let me start by saying we could not be more pleased with our operating results in the first half of 2010. I'd like to thank our entire team for their unwavering commitment to excellence in the areas of quality, ethics, and patient satisfaction.

We know that these things are the foundation for building long-term value and matter most to those we serve in communities across the country.

Despite many external challenges we faced in the first six months of this year, we have continued to see solid growth in our business. Our revenues increased 16.6% in the first six months of 2010 as compared to the same period in 2009, and our total new home health admissions increased 17.1% compared to the first six months of 2009.

We have also exceeded our internal earnings and revenue projections for this quarter, which are in line with the annual guidance we have provided and reaffirmed in our earnings release. As we did last quarter, we are going to limit our prepared remarks today so we can leave more time for Q&A.

To touch on our CMS proposal, as you all know, on July 16th, CMS issued the home health BPS proposed rule for 2011. It goes without saying that we were disappointed to see the higher-than-expected case mix creep adjustment in 2011 and the additional case mix creep adjustment in 2012.

We are working with the National Association for Home Care and other members of the industry to address these proposed cuts. While we certainly hope these efforts will result in a reduction of the proposed cuts, at LHC we have made investments on our infrastructure and people over the past few years that will prepare us for these cuts and will allow us to take advantage of the consolidation opportunities that will result.

Turning to the Senate Finance Committee and the SEC, we have responded in full to the committee's request and will fully cooperate with any further requests should they come.

With regard to the SEC, we have received an official subpoena and are responding to their request. The information requested by the SEC is very similar to the information requested by Senate Finance, so much of the work has already been completed. At this time, we can't speculate on the outcome of either of these matters, but we will continue to cooperate fully and are confident in our data and the historical results of our longstanding, decentralized operating model that focuses on the needs of each individual patient we serve.

This clinically driven operating philosophy combined with our strong compliance program is the cornerstone of our reputation and the relationship of trust we've developed with patients, payors, referral sources, and our employees over the years.

Turning to growth, since our last earnings call, we filed for approval or have received approval for de novo branches in Eufaula, Alabama; Coleman, Alabama; Louisville, Mississippi; Quitman, Mississippi; and Bay Minette, Alabama.

We have acquired 100% of the assets of Idaho Home Health and Hospice and 100% of St. Francis Specialty Hospital, a long-term acute-care hospital located in Monroe, Louisiana.

We have also entered into home health joint ventures with the health care authority for Baptist Health, and affiliate of UAB Health Systems, and Baptist Medical Center South, located in Montgomery, Alabama; and Craig General Hospital located in Vinita, Oklahoma.

I would like to welcome all of our new team members that have recently joined the LHC Group family through these acquisitions and joint ventures.

At the end of last quarter, we had $72 million in trailing 12-month revenues in our active pipeline. Since that time, we have closed transactions representing $26 million in trailing 12-month revenue and today have $54 million in trailing 12-month revenue in our active pipeline. The current active pipeline consists of 25 locations in 12 states with 13 of these being hospital joint ventures, and 12 being 100% acquisition.

As always, we will continue to pursue acquisitions and joint venture opportunities that are appropriately priced and provide the best opportunity for upside potential.

And now I'll turn it over to Pete for a review of our financial results. Pete?

Thanks, Keith, and good morning, everyone. Comparing the results of the second quarter in 2010 to the same quarter last year, consolidated net service revenue increased 16% to $154.2 million. Net income attributable to LHC Group increased 20.8% to $12.4 million and diluted earnings per share increased 19.3% to $0.68.

Diluted earnings per share includes some unanticipated charges recorded in the quarter of approximately $1.1 million, or $0.04 per diluted share.

These adjustments, where, first, we increased the reserves on Workers' Compensation by $500,000. The increase resulted from two specific claims, which occurred in the quarter. We also completed a local parish sales and use tax audit of our pharmacy operations and recorded the assessment of approximately $473,000. This audit covered the years 2005 through 2009.

Finally, we incurred approximately $200,000 in legal fees and other third-party supporting costs associated with our response to the Senate Finance Committee inquiry.

Looking back to revenue -- for the home-based segment, which made up 88.5% of consolidated revenue in the second quarter, revenue was $136.6 million, an increase of 15.4% compared to the same quarter in 2009. It consists of $126.6 million in organic revenue and $10 million in revenue from acquisitions. Total organic home-based revenue growth was 6.6% and organic Medicare revenue growth was 6.1%.

For the facility-based segment, revenue for the second quarter of 2010 was $17.7 million, an increase of 21% compared to the same quarter of 2009 and consists of $16.3 million in organic revenue and $1.4 million in revenue from acquisitions.

Our consolidated gross margin was 48.5% in the second quarter compared to 48.8% in the first quarter and 49.6% in the second quarter of last year. The decrease in gross margin compared to the first quarter was 0.3% and was caused by the sales tax adjustment I spoke of earlier, which increased supplies costs.

The decrease to gross margin compared to the second quarter last year was 1.1% and is due to the sales tax adjustment and, in addition, a lower gross margin in certain agencies acquired throughout the last nine months compared to the gross margins in same-store agencies.

These agencies had combined revenue of $8.1 million in the quarter and a combined gross margin of 36%. We expect the agencies to move toward normalized gross margins for the next couple of quarters.

Throughout the remainder of 2010 we expect consolidated gross margin to be between 48% and 49% of consolidated net revenue, and this considers the effect of the Joint Commission surveys to complete accreditation of all of our agencies over the second half of 2010. Don will touch a little bit more on this later.

G&A expense in the second quarter of 2010 was 32.1% compared to 31.3% of revenue in the first quarter and 32.8% in the second quarter of last year. The increase from the first quarter was 0.8% and was due primarily to the workers' comp reserve adjustment and the increase in legal and other expenses associated with the Senate Finance Committee inquiry, both of which I spoke of earlier.

Throughout the remainder of 2010, we expect the consolidated G&A expense to be between 31% and 32% of consolidated net revenue. This estimate does not include any future legal or other expenses associated with future responding to the SEC or Senate Finance inquiries.

Day sales outstanding, or DSO, at June 30, 2010, was 45 days. Bad debt expense in the quarter was $1.5 million, or 1% of revenue. We expect bad debt expense to remain around 1.5% of consolidated net revenue for the remainder of 2010.

Cash provided by operations was approximately $41.4 million for the first six months of 2010 and during the first six months we acquired four home health agencies, one hospice entity, and one long-term acute-care hospital. The total purchase price of the acquisitions was $20.2 million, which was paid primarily in cash and includes an advance payment on an acquisition with a July 1st effective date. Currently, we have nothing drawn on our line of credit.

CapEx for the quarter was $4.1 million, $3 million of which was IT-related hardware and software purchases including our new payroll system software and the related hardware. We expect CapEx to be between $1.5 million and $2 million per quarter for the remainder of 2010.

Depreciation expense is $1.8 million in the quarter, and we expect it to remain between $1.8 million and $2 million for the rest of the year -- $1.8 million and $2 million per quarter for the rest of year.

We can drill down to these results further during Q&A, if anyone desires. Now I am pleased to turn the call over to Don Stelly. Don?

Thank you, Pete. Before discussing the operations of our Company, I, too, want to acknowledge and thank our entire LHC (inaudible) team from the home office up to the agency level. Your commitment to our mission and to the execution of our initiatives is unwavering.

Those of you who have recently joined our LHC Group family -- welcome and thank you for choosing to be part of our Company. We recognize that you have a choice and are certainly pleased that you made the one that you did.

Moving on, I'll touch first on quality. As Pete alluded, we have 93 of our home health and 19 of our hospice agencies in final preparations for their visit by the Joint Commission. These surveys will begin on or about September 1st of this year and will finish around October 31st. Once accomplished, these will join the present 131 locations already accredited in our Company. The combined group totaling 243 agencies will make history together as they become the only national family of home care and hospice agencies with the Joint Commission accreditation.

Next, and still within the realm of quality, I want to update you on our chronic care initiatives. Since our last call in late April, we have finalized these programs, which are aimed at improving outcomes for patients with congestive heart failure, COPD, diabetes, hypertension, stroke, as well as a few other chronic conditions.

Registered nurses, who are called "care transition coordinators," will have the responsibility to work with physicians, hospitals, and other clinicians to ensure that coordinated and accountable care is being rendered to the patients who live with these chronic conditions.

Our decentralized clinical delivery model is a glove fit for the rollout of these programs. We can offer best-practice interventions with an individualistic patient-centered approach, all driven by physician orders and in accordance with clinicians in local markets.

As previously stated, our clinical and sales teams will begin using these programs beginning in September.

So as a Company, we are committed to deploy the resources necessary to ensure that we are the leader in terms of quality and compliance. And while these differentiators may add cost in the short term, we contend that they will provide long-term value to our patients, employees, referral sources, and shareholders.

Speaking of long-term value proposition, I will now touch on our progress as point of care. We presently have about 16% of our home health agencies and about 19% of our hospice locations utilizing point of care. Since our last call, we have tied our conversion methodology to our overall timeline for company-wide deployment and still expect our total portfolio to be utilized in point of care by the end of 2012.

As I previously committed, I'll keep you updated along the way, but this is the just of where we are at this time.

Lastly, I'll direct my comments toward our internal growth. Total new admissions growth for our second quarter of 2010 was 14% as compared to the second quarter of 2009, while organic growth for total new admissions in this quarter, 2010, was 3%. New Medicare admission growth was 11.2% in Q2 of 2010 as compared to the second quarter of 2009, while organic growth for new Medicare admissions was 2.3%.

We know that you'll have questions about our organic growth rate, and I'll be glad to address those in Q&A in a second. But I do want to stress that while the SEC and Senate Finance inquiries played a role in our activities in Lafayette, they did not attribute to any bearings in our volume. In order to improve our organic rate for new admissions, we have intensified our focus on growth in markets within our license service area that we're currently not serving.

We are licensed to serve 753 counties in 19 states today. Of these, 477 were in CON states or those with a moratorium on new providers. The total licensed service area represents 53 million people, 6.7 million whom are 65 years of age or older. Today we are only at locations in about 30% of that, or 225 of those 753.

We know this new territory provides significant opportunity for organic growth. A good example is in the state of Oklahoma, where we are licensed for 47 counties today and service six of them. The remaining 41 have an approximate population of 65 and over of 300,000. Another good example is inside the state of Maryland where we have CON for 19 of the 24 counties. Within those 19 counties, we are currently not servicing markets that represent 30% of the over-65 age population, which is approximately 170,000 people.

Our market development team clearly has opportunity in front of them. Now led by Stuart Archer, our Senior Vice President of Market Development, there is also a clear expectation to capture it. In that light, we are presently seeing an upward admission trend in this third quarter and are presently on track to yield higher organic growth numbers that I have just reported to you this second quarter.

In closing, I would again like to thank each of you for joining in this morning, and we'll be glad to answer questions that you may have shortly. In the meantime, I will now turn the call back over to Keith.

Okay, thanks, Don. As you saw in our earnings release, we are reaffirming our previously issued full-year 2010 guidance for net service revenue of $615 million to $625 million and fully diluted earnings per share of $2.75 to $2.85. This guidance does not take into account the impact of any future acquisitions, if made, or de novo locations, if opened.

This guidance also does not include any future legal or other expenses associated with responding to the Securities and Exchange Commission or Senate Finance Committee inquiries.

In closing, to our shareholders we want to say thank you once again for your investment, confidence, and support. And with that, Operator, we are ready to take questions at this time.

Thank you. (Operator Instructions) Art Henderson, Jefferies & Company.

Just real quick, could you describe where the charges, the one-time charges were in the income statement? I've seen the Worker's Comp charge was in SG&A, and the sales tax settlement was possibly still in there also. How should we think about that, Pete?

The Workers' Comp and the legal expenses are in G&A, and the sales tax audit results are in cost of sales.

Cost of sales, okay. And then just real quick, that $1.1 million was not included in your previous guidance range. So we should back that out to get to the full six-month run rate towards where your guidance is at the moment?

Yes. Those are the kinds of things that are relatively unpredictable. With respect to the Senate Finance, we knew we were going to spend something on it. I actually thought we were pretty efficient at the way we responded to it with the $200,000. The other two, you have Workers' Comp adjustments that go up and down all the time, but in this particular case, we had two pretty significant claims, both of which were adjusted in the quarter. So I thought that was an unusual adjustment to come through the quarter. And then, finally, for the sales tax audit, it went back to 2005. So from my perspective, even though all three of those things could be considered general business type items, to me they were unusual to all hit in the same quarter, so I thought they warranted a little bit different look. And I agree with you, they ought to be backed out to look at a run rate.

Okay, all right, that's helpful. And, Don, just a quick question for you -- I think this is what you said in your prepared remarks. You're not seeing any sort of impact in the field at the site level from the investigation-related issues?

No, we're not, Art. As a matter of fact, I'd be less than honest if I said that. It's just not the case. But, you know, Art, since you bring this up, I mean, everybody on this call, I would assume, have questions about our growth rate. So let me just take a moment to dive into a couple of pieces and possibly give clarity right out of the box and ward off future questions, but I'll also maybe provide some data for subsequent -- through the rest of the call.

Let me start by adding this, and talk to you a little bit about that. As you all know, there are really two components to our organic calc. One of them is what I call pure same-store run rate. How are our mature agencies growing the business? Most of them want quarter-over-quarter, et cetera.

And then there's another component that I want to talk to you about, and that's what I call the acquisition roll-in. For example, in the last five quarters that we've reported, we've had an average of 10 home-health agencies attribute to that calc. Ten agencies becoming mature inside of its 13 month and, therefore, driving a piece of that number. In that last five, we've had an average of those 10, and our organic admission growth rate was 8.9%. In this quarter, we've had four agencies do that. And, again, at that 3% rate.

So if you just look at it proportionately and just really simply do an algebraic equation, it shows you that that would be predictable on that piece.

So, certainly, and as I said in my prepared comments, there are opportunities -- we call it an opportunity gap for us to go grab in admissions, and I'll address that in just a second. So I guess what I'm trying to tell you is is that there are two components, one of them is as steady as a rock. It's the piece that the acquisition roll-in, which is indicative of our activity last year, didn't fall into that calculation at the same rate it had been historically.

So now let me turn my attention towards census and then, if you'll just give me a second, I'll wrap all these components together into a picture that I think will provide clarity.

Census essentially has four components -- I teach our operators that two of them what I call primary and two secondary. The two components of census are the type of patient that you have and the admits, the secondary are the re-cert rate and the discharges within the period.

Because of the type of patients, and you've heard me say this for the last two quarters -- our mix has changed and started dramatically in 2008 when we were so acquisitive. Our patient mix is changing. This quarter we actually, inside of the quarter saw a re-cert rate a little bit less than prior period, same period prior year, 1.61 on a 12-month rolling period versus 1.62 same period prior year. And we saw more discharges than normal. So you had two of those components attributing to the census.

Now, when you overlay these on top of an admit that is just solid, that's where we saw the dip in our unit census. So let me kind of bring all of these pieces together.

On the admit side, we had the component on the acquisitions that we didn't do last year, not rolling in. On the census, we had to do what was right with patients. And, therefore, so we saw a slightly lower re-cert rate and slightly higher discharge rate. And when you overlay all of that onto our, what I would call "missed opportunity" driving secondary market share, those numbers were what we saw.

But I do want to say this as well -- when you look at a pure same-store growth number, if you take the US Census Bureau data, you will note that the 2010 growth rate of the 65-plus population is actually estimated to the spectrum of this year to be 2.4% higher than 2009.

So it's not like we're sitting still and not growing our pure same-store business. The analogy I use is that, you know, we may not be running a 12-minute mile, but we're not sitting back watching the race, either.

So I think those things, in combination together, attributed that in the last piece that I want to say -- is while those may be looking at the glass half empty, you will also note that our case mix increase, because of the type of patients that we're shifting to, and therefore our net revenue per episode trailed up, and those are two good trends.

That's very helpful, okay, good. Let me just toss one more question out for Keith, and then I'll let some others ask. First, on the deal front, you're still out there doing deals. A lot of your competitors aren't. What's your thinking there with respect to moving ahead with those acquisitions? And then, secondarily, any sort of thought on a hospice strategy from here? I know that there has been some activity in the space. I want to get your thoughts on what your view of hospice is at the moment, thanks.

Thanks, Art. Let's talk about pipeline activity first. We continue to move transactions through the pipeline. We haven't seen any slowdown. In fact, I think we've seen an increase in the volume.

One thing that I think people don't understand about LHC Group, and it's a distinction, is the number of deals that we look at here. It's a much higher volume, and we haven't given this before, but I thought this might help. I pulled this before the call.

On December 31st of 2009, we had 40 CAs outstanding. Meaning that we were analyzing data from 40 opportunities on December 31st. So since that time, since January 1st, we have issued an additional 99 CAs, and or have either gone through that data or going through it now to close a number of transactions you've seen us close.

So we've being very, very selective, but our capacity to process a larger number of opportunities is what's allowing us to continue close transactions. We are still turning down far more opportunities than we are closing. So I hope that helps to maybe explain how it is that we're continuing to close acquisitions, and that we're not chasing them by price.

With regard to hospice, we are extremely bullish on hospice. For the past several years, we've focused on refining the model, really fine-tuning the model, and we are at a point now where the operators are extremely confident, and I'll let Don touch on this a little bit. But we can say now that the goal, the vision, of LHC Group is to develop hospice in every market that we have home health locations. And, Don, do you want to take it from there?

Well, I think, Keith, that's absolutely correct. I mean, it's not only of great benefit for our patient population when they have six months or less to live, it's also something that our operators have done such a great job on, and that's actually modeling it up.

You know, sometimes I think our hospice team members felt they were taking a back seat to their home care partners, and I think what we've done in the last six months is move them up equal. And Keith is right, we're going to look at organically doing it first. But if there is a situation where there is a barrier to stepping alongside of our home care in the market, we're going to go look for the cheapest provider, flip it, and start operating it.

We have finalized what we call our bridge program, where we identify the appropriate patients for the appropriate setting, and it's working beautifully. It has done so for the last three months in two of our locations and given us the confidence to push forward in this strategy.

So I think this is not a fast approach at any means, but I think that over the long haul what Keith said is absolutely our final destination.

Kevin Ellich, Royal Bank of Canada.

Just wanting to go back to the organic growth metrics, Don. You mentioned that there's a few components that go into the census. I missed the second one. You said (inaudible) then there was something else before the re-cert and the discharges.

Just the admit type. I mean, in the type of patient you're getting. So you've got admits and the type of patients. So what I'm saying there, Kevin, is that historically, we've seen the launch of our business be clinically driven into congestive heart failure, COPD type patients. Well, when you look at -- just I'll pick two, and I'm kind of diving in the weeds, so just forgive me. If you look at B54 and B57 code patients, that's an orthopedic patient.

So, right off the bat, if you take that one admit, statistically and throughout the country, it will never have the attributation to census through the spectrum of a year or a quarter that a clinical patient will. You're going to get them in, get them well, and discharge them faster so that the components are, of this growth, admits, patient type, research, and discharges.

Okay. But episodes per admit, on a sequential basis -- that actually went up, didn't it?

Not in the same period prior year. Quarter-to-quarter it did, but same period prior year, it was 1.62, and it's 1.61 this quarter. And when you're looking at the multitude of episodes, every .01 in that parameter is pretty big for us.

Okay. And then with the patient acuity, I mean, how does that impact the discharges? Because I think you guys said that acuity went up this quarter.

Yes, let me be real clear -- the acuity of the patient doesn't. It's when they meet their goals. And, statistically an orthopedic, which is a more mobile patient, less chronically ill, will meet their goals faster, and that's what actually drives the discharges. It just so happens that those orthopedic patients come with many times more a higher acuity in those clinical -- I mean -- in those functional scorings.

Okay. And then would you say that the discharges are still kind of trending in a similar fashion as what you guys saw in Q2?

Well, that's difficult to say. The answer is, to date, no. We saw it slow down, but, again, because it's so patient-driven, I may sit here in another couple of quarters and tell you that our growth rate is actually high on what is attributed to less discharges. It's a factor, really, of the kind of patients you have on service. If you think about having a 90 or 91-day span if more patients in the last five weeks of a quarter just so happen to meet their goals, it's just that kind of functionality.

What I would tell you is that I don't see any drastic change. The change that we see is an upswing, as I said, in admissions. And so right now, as I said, I mean, granted, we're not even halfway through the third quarter, all factors equal, we're on pace to do better than the numbers that we turned into Q2 on organic census and admits.

And then going back to one of Art's questions or your commentary about the pure same-store run rate, would you say that's high single digits, or where do you think that's going to shake out?

Well, I think we've always said in between 5% and 10% combined. And I don't see us moving from that position.

Combined with acquisitions?

Combined with the organic calc, which, what I would call combined with the agencies falling into the same-store category combined with the pure organic growth rate of the same store. Those two, you can factor in 5% to 10% as we said historically.

Okay, thank you. That's helpful. And then just a couple of questions for Pete. The guidance that you gave us for the G&A and the consolidated gross margin -- is that just for the remainder of the year or for the full year, that's where you expect them to shake out?

You can apply that quarterly for the remainder of the year.

Then how much -- the Joint Commission Survey -- was there cost embedded in Q2, where that hit Q2? And I missed that. As you said, if it did happen?

Not much, not much. Most of that -- maybe some preparatory costs, but not real significant numbers in the second quarter.

And then did you guys provide how much the 3% add-on benefited you this quarter?

(inaudible) you the actual number, honestly, and I thought about going and getting that for this call, but I just didn't do it. I think we forecasted a $1.5 million a quarter? Was that -- we estimated $1.5 million a quarter when we adjusted our guidance at the end of the first quarter. I can go back in and try and pull that number for you and give it to you, but I'll have to do that offline.

Darren Lehrich, Deutsche Bank.

I just wanted to go back to the organic growth question, just so I'm clear. Basically, Pete, what you're saying is the 5% to 10% outlook on organic volume growth would be mature base plus the acquisitions that roll in each quarter. Is that how that 5% to 10% builds up?

Darren, this is Don. That's exactly how it builds up, and let me be just as crystal clear as I can. I nothing else ever rolled in, the existing portfolio, for an extent of time, would certainly be at the lower end of that range. And that's why I told you the whole population isn't growing but 2.4% year-over-year. So to get that 5% floor, you know you've got to go and take patients away from either other providers or fill in that opportunity gap.

So what you're saying is correct. If you take that base of business, adding in the agencies that we have historically purchased and now will roll into the same-store definition, those two combined, going forward, would be a baked-in 5% to 10% number.

Does that help you?

That's exactly how we've been thinking about it. I just wanted to make sure I was totally clear on the range that you're providing.

I guess, just, you know, on the re-cert, you're providing episodes per beneficiary. Is there a way for you to just characterize your actual re-cert rate for us and how that may have changed? And I guess the corollary to that question would just be somewhat consistent with what we're hearing from others and I'm sure you've had some time to go back and look at it. If I'm hearing you right, Don, some of this relates to mix and the types of patients that you're admitting are just not going to statistically go on to a second episode. But did you see anything else in the period that stands out to you?

I'll answer the last one first. The answer is no. And the way we've always reported that is the way we want to stick with it, Darren, because any little blip ought to give you an indication that our mix is changing. And so we don't even look at it any other way except for what we've been reporting, for the most part. And I really didn't see that.

What we do see is that you'll have a give and take. Like, for example, some of the acquisitions of past, when we go into that market, they are already servicing a different profile of patients than we are. But at the end of the day, when you put all of that into our large melting pot of patients, it doesn't move the bar that much.

On the flip side of that, ever so slightly, just a little bit, without backfilling admissions to outpace that re-cert decrease, shows you where we get to that 3% number. But, no, I haven't seen any dramatic changes, and I don't think, because of our generalist nature, that you're going to see that.

And, Keith, if I could just ask you a question about the proposed rule that we just got. Given your geographic footprint, I guess one of the things that crossed my mind in just reading the rules, this requirement for face-to-face visits with physicians. And I guess I'd like to just get your thoughts on that, that may be a little bit of a burden for your patient population. So how are you responding to that in common, and do you think that's a correct characterization relative to just your markets?

Good question. First of all, we are very much ahead of it operationally. And I think I'll let Don give you the details on that. But even that being the case, we don't -- we think LHC Group can be ready well in time for it. We still think it's bad policy, and it's one of the two priority items on the legislative agenda that we'll be attacking for the rest of this year in Washington, D.C. The first, of course, being the case mix creep. I think there's really not a first and second. There are two. There's case mix creep and the physician face-to-face issue.

And so all of the consultants that we'll use in the industry, similar to what we did last year, will be focused on those two issues as their two primary targets. So we're going to continue to -- we're going to push back on it and try to reshape it, because we just think it's bad policy. But we are preparing for the worst. Operationally, Don, why don't you take it from here?

Darren, it's a great question, and let me probably interject from a clinical perspective and tag on to what Keith said. We do believe it's bad policy. Just think of that, in the dead of winter, a frail, elderly, 80-year-old person having to go see a physician continue to care. It is what it is.

But from an operational standpoint, we've brought together internal and external people to look at our policies, recommend changes, and get ready to operationalize this by January 1st of this year.

We've got a lot of work to do on it, but from a Company standpoint, we'll be ready, and we'll do it. It's a burden for the patient. It's also a burden for our providers.

On one of your competitors' calls, it was just mentioned that there's some discussion with CMS about maybe considering a start for this in 2012. I'm sure you're going to lobby separately on this in Congress. But can you just maybe clarify that particular comment, or if there is any discussion around this being effective, the face-to-face piece, in 2012?

Nothing that I would hang my hat on and tell Don to relax and back off about. I think it's viewed as ridiculous policy by a number of people who are well versed. I mean, some of the research people who are doing work for us tell me that in looking at all of the post-acute settings, the verification process or requirements that had placed for home health, what we are doing now in home health is beyond what other post-acute providers do. But we don't think CMS and our med pac, for that matter, has a clear understanding of that. So I understand what their intent is. But when you talk to a member of Congress, and you explain to them that, as Don said, an 85-year-old elderly homebound person, by the way, is required to go to a physician's office in order to have a nurse come out and provide care for them in the most efficient setting available, you pretty quickly get to the policy being considered ridiculous.

So I think that's where that's coming from. A lot of people think that we will be able to reshape this. Again, we're not taking that for granted.

And, Darren, while we hope -- this is Don -- while we hope that is our timeline, that's not our strategy. We are planning for January 1 here.

My last thing, just so I'm clear on this pharmacy sales tax adjustment. I guess I'd like to just understand the genesis of that, and if you could just repeat the number, Pete. I think you said in your prepared remarks, but I didn't catch it.

It's a local parish sales tax, and it has to do with the difference between the local parish and the state requirements. There's an exception for prescription drugs and supplies in the state regulations that is not honored in the parish and local regulations. And I want to say it's, like, 4% on supplies and 2% on prescription drugs. So it's that. It's the interpretation of those regulations or, I guess, the (inaudible) of those regulations.

We have a pharmacy operation here in Lafayette, and so it falls under the jurisdiction of the Lafayette Parish, and it's just that simple. They came in and did an audit back in 2005, looked at all the invoices, did the calculation, applied it, and we paid. And the number -- I could give you the number in just a -- it's $473,000 for the entire period.

Eugene Goldenberg, Branch Bank & Trust Capital Markets.

I just have a few follow-ups. One of the things I wanted to take a little bit of a deeper dive in is the surge in LTAC acuity this quarter. If I'm looking at this correctly, we're seeing an almost 8% sequential increase. So I'm just trying to reconcile what can cause such a massive spike in acuity in just one quarter?

Yes, Eugene, this is Don. It's our care facility that we jointed ventured with Ochsner. It's in the heart of New Orleans, and the acuity and the [panel] bank of patients is just that. It's that simple.

Eugene, I would say that the -- we don't expect that to continue on. That was really a second quarter event. I think it will normalize back down in the third quarter and thereafter.

Yes, I should have said that, too. I mean, it was unbelievable, the patient type we had in there but I think, Pete, you're right.

Actually, there's one item on the non-operating income line. There was a pop of about 600K. Was that reflective of an asset sale in the quarter or -- ?

No, about $350,000 of that was related to the pay for performance, the program that -- companies participated in.

That's for the first year?

Yes.

It was for the demonstration product. That's non-recurring, as well, right now.

Okay, that makes sense. And I want to touch base on the last two items, and that's the de novo strategy that you guys currently have in place. I know, initially, you were targeting around 25 to 30 de novos, but considering you only have five in place, so far, through the first six months. How do you feel about that target? Do you think it's a little bit aggressive or is your pipeline that much -- I guess, you expect to get it in your pipeline going in the back half of the year to get there.

It was absolutely designed that way, Eugene. We're still on track for it. But I want to say you'll hear us and me speak much moreso about greenfield opportunities, too. Going back to all of those counties -- just think about it. If we can go grab that same patient population and not have additional resources for a branch manager, an office manager, and can do that through out point of care strategy, we think we can be very successful in decreasing that fixed cost threshold and still accomplish our organic touch.

The last question I have is the Joint Commission certification process that (inaudible). Has there been any impact on volumes from that process?

During the survey, I can't tell you that it's substantial, but there are a few agencies that saw a hiccup in volume during the time that the Joint Commission surveys were actually there. But the offset by the other agencies in the marketplace picking them up (inaudible) it through. So I don't think you should bake in because we're going through September and October. Any volume decreases are, quite candidly, any cost of service increases on that.

Let me finalize that. In Pete's prepared comment, he has said that our forecast take that into account. So I wouldn't bake in any incremental other than what Pete has already alluded to. Pete, would you agree?

Yes, that's right.

Jerry Doctrow, Stifel Nicolaus.

[Rick Stractis] in for Jerry. I have just a few questions for you. First question for Don. Could you talk a little bit more about your early intervention programs and how they are progressing? I believe you said last quarter that you were discharging patients earlier because of these programs, and just to what extent did this impact the discharges in second quarter?

I think you make a good point. I think that's exactly part of it. And you take that in combination with the other side of the spectrum of increased orthopedic admissions and some of those higher acuity patients, it still blended that case mix to just a slight increase.

I will say this -- that early intervention campaign did what it was aligned to do, and that's to shift overall referral source patterns, get us into the competitive profile offices. And we're going to shift that toward a more chronic disease management into what I was talking about earlier.

So it did what it did. I do believe it had an attribute to discharge because they come with a shorter length of stay. But I think it's going to normalize the rest of this year, especially going into the high acuity season and seasonality piece.

Is that primarily medication education or -- what are you doing there exactly?

Yes, that was a large portion of it.

Second question for you -- just wondering -- you said you don't expect the LTAC business to retain the same momentum you saw in second quarter. Where do you see it trending for the rest of the year?

Well, just to be clear, I think what we said we didn't expect the [Kenner] acuity to substantially keep that aggregate case mix up. The momentum of volume and occupancy and contribution margin, I think you can probably take that second quarter run rate and bake that into the next two quarters.

And then just another question -- could you give us some comments on Pecos and whether or not you see that as a risk for the industry going into the next year? I believe CMS has delayed implementation. We're hearing a lot of docs haven't sign up yet.

Boy, that was a curve ball thrown at us through the quarter. Is it a risk if it goes in as originally written and would be effective imminently? Yes. Are we sitting back on our heels? No. Just, again, being out of transparency here, we had over 4,000 physicians that we needed to make sure that we looked at and made sure that they were in that data bank. And while I would say is while there is uncertainty, and there is a potential of risk out there, we feel very good of where we are right now in what I call our 90-10. Ten percent is left out there. We believe we could get it if we had to. But those are the ones that we call tier 3 positions, and there are other providers in the market space trying to get them signed up.

So I know that's kind of a long way to answer it. If the rule would go into effect right now, it could be a risk for all providers not just LHC Group. Because, just simply, the delay that CMS has in recognizing all of this, but we don't foresee that as a problem in something that we have to concentrate mitigation strategies for.

Okay, and just the last question -- I'm just wondering what you're seeing in terms of labor costs? Are there any markets where you're seeing any difficulty in retaining and recruiting therapists and nurses?

It's actually a twofold question. The cost really isn't the issue. We're seeing that flat in market-specific, higher and lower in some places. It's the availability that went up and up moreso than ever before and problematic. Again, I would be less than honest to say that we don't have some agencies that we don't have a staff and yet we have a volume sitting at our feet to go get it.

So it is a balancing act. I think it's something that we have tremendous strategies for because we brought an in-house recruiting firm and also challenged our Chief Administrative Officer to change the whole portfolio of recruiting firms that we're using.

So I can't tell you that I can't come back here in two or three months and say that it's an increasing problem. But I think when we saw it increase, half the strategy is in place to get the staff we need.

Kevin Ellich, World Bank of Canada.

Sorry, I just had a couple of questions that I forgot to ask before. Keith, going back to the M&A comments, or your pipeline -- just wondering what you're seeing on the valuation front? One of your competitors mentioned that there is still a valuation gap between some of your expectations and what you guys would like to grow -- what they would like to buy at, and wondering if you're seeing the same type of pattern?

Yes, we do. And that's why I tried to explain that our ability to continue to close transactions is really a result of the volume, the high volume that we look at. But we saw that gap closing in the first half of the year, and where there wasn't much light between what we were offering and seller expectations. But then, all of a sudden, we have this proposed rule that comes out. So while we're fighting the proposed rule, we have to bake in the assumptions that the additional case mix creep does get applied. And when you do that it, once again, creates a separation. The sellers want to believe that it won't go into effect or that it will be brought down before it goes into effect, and we, of course, can't do that. So, yes, I agree with that, especially in light of the CMS proposal.

That makes a lot of sense, actually. And then, Pete, I was wondering -- I recall you guys had a Workers' Comp adjustment a while back. Could you remind us when the last one happened?

Yes, last quarter. But the last quarter was a little different. It was an audit adjustment. You know how the Workers' Comp works. They come in, and they audit payroll and all that. There was an adjustment for that. This was a little bit different. This was a reserve adjustment related to claim activity and the reserve -- the incurred reserve estimates associated with that.

Did you have a claim adjustment somewhere to that last year sometime, too?

No, honestly, I don't recall having that kind of a disclosure. The way the process works for us is we have a certain layer of retention associated with Workers' Comp. And so you estimate the total losses for the year, and that drives a premium, like a premium per $100 of payroll that you expense. And that develops a reserve. And then during the year, at each month, actually, you get together with the insurance company, in our case, Zurich, and you look at the loss runs with the totally incurred reserve estimates, and you compare them at that point in time to what you've built up.

So, consequently, if you have a couple of significant losses in a particular period, particularly early in the year, you'll have to increase your reserve to account for those additional losses. It could very likely be that between now and the end of the year, those reverse, and that would be the claim activity vibrates back down to -- so that, for the entire year, it's something similar to what we estimated at the very beginning.

But the timing -- you can't forecast that or predict it. You just have to react to the reserves as the claims come in. So -- you got it? So we've had adjustments in the past, but I can tell you that the reason that I brought it up in this one is it was so significant, and it was $0.5 million above the normally quarterly run rate. So, to me, that's worth noting and taking out of the consideration.

That makes sense. And I just have one last one for Don. Going back to the LTAC, the patient acuity, did you guys say that it was the Ochsner transaction that had the impact on the patient acuity?

Yes, it was. It's in Kenner, Louisiana, and it's the joint venture entity with Ochsner.

Wasn't that last year when Ochsner came in?

I think the middle of the year last year. Our girls and guys have done one heck of a job outperforming what we thought it would do, and it's just amazing to see. Again, I know I throw that a lot, but it's just the patient mix. It just so happens that it had a much higher acuity in a period we're not used to seeing that.

Oh, okay, so it wasn't matter of when the acquisition closes, just a matter of (inaudible).

Oh, absolutely not. And I'll say what I told to them -- it's what's in the bed. We had a very high occupancy there, and they did a great job.

At this time, I would like to turn the call over to our speakers.

Sorry, Operator?

At this time, I would like to turn the call over to our speakers.

All right, well, thank you for joining us this morning. Thank you for taking the time to listen and participate. As always, we are available to answer any questions that may come up after the call or between earnings calls. Have a great day and thank you for supporting and believing in LHC Group.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program, you may all disconnect. Everyone have a great day.