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Executives

Steve Paige – SVP, General Counsel and Secretary

Ron Malone – Chairman and CEO

Tony Strange – President and COO

John Potapchuk – EVP, CFO and Treasurer

Analysts

Arthur Henderson – Jefferies & Co.

Whit Mayo – Robert Baird

Ralph Giacobbe – Credit Suisse

Darren Lehrich – Deutsche Bank

Newton Juhng – BB&T Capital Markets

Sheryl Skolnick – CRT Capital Group

John Ransom – Raymond James

Gentiva Health Services, Inc. (GTIV) Q3 2008 Earnings Call Transcript October 30, 2008 10:00 AM ET

Operator

Good morning. My name is Brandy and I will be your conference operator today. At this time, I would like to welcome everyone to the Gentiva Health Services third quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator instructions) Thank you.

It is now my pleasure to turn the floor over to your host, Steve Paige, General Counsel. Sir, you may begin your conference.

Steve Paige

Good morning, everyone. I’m Steve Paige, General Counsel of Gentiva Health Services, and this is Gentiva’s third quarter 2008 earnings call. Speaking on the call today are Ron Malone, Gentiva’s Chairman and Chief Executive Officer; Tony Strange, President and Chief Operating Officer; and John Potapchuk, our Chief Financial Officer. We hope that each of you had a chance to review the company’s earnings report, which we released earlier this morning.

All statements made during this call relating to future results and events are forward-looking statements that are based on our current expectations. 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 and in the cautionary statements contained in our press release and on our web site.

Our call today will be consistent with the SEC’s Regulation FD. We encourage participants to ask their questions during the call, since we have certain limitations on comments that can be made in individual inquiries. Today’s call also conforms to Regulation G, regarding the reconciliation of GAAP and non-GAAP disclosure. As a result, we will not discuss non-GAAP financial measures on this call, except for those set forth in our press release.

You may access a replay of this call on our web site for the next seven days. A transcript of the call will be posted to our site within the next 36 hours and will be available for the next 12 months.

Following today’s prepared remarks, we’ll open the call to questions. Please limit your initial comments to one question and one follow-up, so that we can accommodate as many callers as possible in the allotted time. Let me now turn the call over to Gentiva’s Chief Executive Officer, Ron Malone, for comments on our third quarter and year-to-date 2008 activities.

Ron Malone

Good morning. Thank you, Steve, and thanks to everyone for joining us. The third quarter was a productive one for Gentiva, both financially and strategically. We delivered solid financial results, led by 26% growth in operating contribution in our Home Health segment on a 17% increase in revenues. And during the quarter, we completed the sale of a majority stake in CareCentrix in a deal valued at $147 million. The transaction sets Gentiva on a clear path to invest in and grow our home health business, including our industry-leading specialty programs.

In many ways, our performance this quarter validates our strategy of focusing on the delivery of services to the aging population, which will continue to grow rapidly over the next several years. Company-wide, Medicare revenues rose more than 20% in the quarter, to over $165 million and that figure presented a 14% same-store increase. The Medicare revenue increase was driven by the expansion and performance of our specialty program, including the opening of 20 new locations in the third quarter, as well as our treatment of higher-acuity patients. With the third quarter expansion, we now have more than 270 programs, with nearly three dozen new rollouts planned for the fourth quarter. At the same time, we added 220 net new, full-time caregivers, well beyond the already-strong recruitment levels of the last several quarters. These achievements drove greater than 12% revenue growth for the company overall to $348 million in the third quarter. Please note that the overall results include nearly a full quarter of CareCentrix results prior to the divestiture.

EBITDA was over $30 million, which was up 19%, excluding the significant gain we booked on the CareCentrix transaction and various special charges. Diluted earnings per share reached $0.42, compared with $0.30 in the prior year period, again excluding the gain on the sale. As we move forward, we are employing a pretty simple and proven formula; by investing in our patients and our caregivers, we will position Gentiva for continued growth, leadership and value creation. We’re working hard to set the standard for high-quality, innovative and efficient care in home health. We’re focused on building the industry’s most capable and most productive team of caregivers.

As a result, we will not only grow Gentiva but also improve the profile of homecare overall as a preferred platform in a revitalized national healthcare system. So you can continue to see us invest in the business, both organically and through acquisition. We’re doing it organically by adding capacity, by adding to our roster of specialty care programs and expanding our network of locations, and by creating the automated tools that make our caregivers more productive. We will also continue to play a lead role in consolidating what remains a very fragmented industry, using our strong balance sheet to capitalize on opportunities as they present themselves.

Scale brings not only economic benefit, but I believe it will help the entire industry rate by raising the overall standard and uniformity of care for patients nationwide, given the resources and focus we bring to bear. We are driving that evolution in home health and we will continue to set the example for others to follow.

In sum, we remain very optimistic about Gentiva’s future. We’re moving forward with a sharpened focus on home health and we have good momentum. Our goal is to keep that going by continuing to invest in our patients and our people.

Thanks again for joining us this morning and I will now turn the call over to Tony.

Tony Strange

Thank you, Ron, and good morning, everyone. Our Home Health business continued to generate strong revenues, driven by 24% growth in total episodic revenues. Episodic revenues now represent 75% of the company’s Home Health revenues in total. We continue to invest in the business and advance our strategy of serving higher acuity patients by expanding our specialty programs, becoming the employer of choice for clinicians, and concentrating on tools to improve patient outcomes. We have expanded our base of full-time clinicians by adding a net total of 220 in the third quarter, a significant increase from the 140 to 150 added in each of the last several quarters. These net additions, plus those added through acquisitions, give us a net of more than 700 new full-time clinicians added year-to-date. I want to take a minute to welcome these new employees to Gentiva, and also to thank our entire caregiver staff for the outstanding work they’re doing for our patients and for Gentiva.

It’s also worth noting that, in addition to the many new folks that have joined us, our employee turnover rates declined again for the seventh straight quarter. So we continue to improve on our ability to retain our people as well. We take pride in these accomplishments because we know that a stable work force will help us drive both our growth and consistency of our results. As we grow this clinician base, we’re also optimizing productivity. We continue to migrate a growing percentage through a pay-per-visit model as opposed to a salaried status. Since the beginning of 2008, we’ve moved this number up from about 50% in Q1 to 53% in Q2, and to 56% in Q3. At this time a year ago, that number was about 39%. So we’re making very good progress in shifting to a more variable clinician cost structure, which gives us more control over productivity and margins.

Gentiva also continues to set the pace in specialty programs in terms of both innovation and expansion. At the end of the third quarter, we had fully implemented these programs in 270 locations versus the 250 at the end of the second quarter. We have approximately 35 new location launches in the pipeline for the fourth quarter, which would put us over the 300 milestone for the year. These programs are a key part of Gentiva’s growth, but it’s also important to understand the significant positive impact they’re having on our industry and on the Medicare system since their inception more than five years ago. To date, more than 200,000 patients have been treated in our specialty programs. During the third quarter, our three largest programs – Gentiva Orthopedics, Gentiva Safe Strides and Gentiva Cardiopulmonary – all reinforced their success with a posting of new national surveys on patient outcomes. The complete data is all on our corporate website.

In our Cardiopulmonary program alone, we’re keeping patients with chronic heart and lung problems out of the hospital for up to a year after discharge at the time when the average cost to Medicare for a day in the hospital is more than $1,500. Results like this demonstrate our belief that Gentiva’s programs will play an important role in the national healthcare reform that is sure to come. Continuing to innovate in the specialties arena is good for our patients and good for our business.

We also saw solid improvement in performance from our Other Related Services segment during the third quarter. This segment posted 11% revenue growth as well as an operating contribution increase of nearly 6%. Hospice, which represents more than half of the Other Related Services revenues, grew its revenues sequentially by about 16% in the third quarter. On our last call, we noted that we’re seeing positive impact from the sales force investments that we made in the beginning of the year, as well as the recent strategic clinical hires, and we continue to believe in the opportunities offered by hospice. And while we’re seeing traction in the revenue growth, we’ll need to continue to focus on improving profitability. On another note, I’d like to congratulate our employees in our HME/respiratory division on another good quarter.

To wrap it up, it was an impressive quarter on many fronts, but most impressive to me is the progress that we are making in both attracting and retaining great caregivers and in continuing to set the standard for home health, in particular, with the growth of our specialty programs. To close, I’d like to thank the Gentiva employees throughout the organization for their contributions to our results this quarter, and for the great work they’re doing for our patient community. Now I will turn the call over to John for the financial discussion.

John Potapchuk

Thanks, Tony, and good morning, everyone. Gentiva’s 2008 third quarter was highlighted by the announcement and subsequent closing of the CareCentrix transaction and a strong overall financial performance from our remaining businesses. Let me take a few minutes to comment on these issues, results and trends. I’ll then update our 2008 financial outlook and provide a preliminary view of 2009.

First, as was noted in the press release, we completed the sale of the 69% interest in CareCentrix on September 25. Consideration included 84 million in cash proceeds, a $25 million seller note bearing interest at a 10% fixed rate, and a 31% ownership interest in both the preferred and common stock of CareCentrix. We recorded a pre-tax gain, net of transaction costs, of nearly $108 million relating to the sale of the CareCentrix business. This is reflected as a separate line item in our third quarter and nine month income statement for 2008. Due to Gentiva’s relatively high tax basis in CareCentrix, there was no tax expense recorded in connection with the transaction. As a result, the CareCentrix transaction had a positive impact of $3.67 per diluted share on 2008 third quarter results. Our numbers for the third quarter included 87 days of CareCentrix operating results, while we recorded our minority ownership interest for four days of the quarter.

Going forward, Gentiva’s statement of income will reflect our remaining 31% interest in the earnings and dividends of CareCentrix on the equity and affiliated net earnings line, interest income on the seller note of over $600,000 per quarter, and lower corporate expenses of about $2 million per quarter in connection with our transition services and management agreements with CareCentrix. We don’t anticipate commenting significantly on CareCentrix’ results in the future, other than to note any material factors impacting its quarterly equity contribution to our results.

Let us turn now to our operating results. Please note that for comparison purposes, I’ll be discussing the results after excluding the net gain on the CareCentrix sale and various special charges. During the 2008 third quarter, companywide net revenues grew to nearly $348 million, or an increase of more than 12% versus the same period last year, driven by strong growth in our Home Health segment. Our EBITDA results were quite good as well. Adjusted EBITDA increased 19% to $30.2 million and EBITDA as a percentage of net revenue increased from 8.2% in the third quarter of 2007 to 8.7% in this year’s third quarter. If we factor out CareCentrix’s performance in the quarter, EBITDA would have been 9.9% of net revenues, giving us an early look at the improved profit margin we expect to see as we move forward as a home health-focused company. Growth in EBITDA margins also demonstrates the leverage we can generate from a better mix of Medicare revenue.

Gentiva’s adjusted net income rose 48% for the quarter to $12.6 million and 30% year-to-date to $32.7 million. That translated into $0.42 per diluted share in the third quarter and $1.12 per diluted share through the first nine months of 2008. Ron mentioned already that strong growth in our Home Health segment, including 26% improvement in operating contributions on 17% revenue growth year-over-year.

Our growth continues to be driven primarily by two factors. First, we have made it a priority to focus on increasing the percentage of revenue we receive from Medicare and higher-rate commercial programs. Total episodic revenue for the quarter grew by 24% to over $179 million, with over $165 million of that coming from Medicare PPS. Our Home Health Medicare revenues increased over 20% over the third quarter of 2007. Excluding the acquisitions we’ve made, our same-store Medicare growth approximated 14% versus the third quarter of 2007. For the nine months, episodic revenue and Medicare Home Health revenue were up about 19% and 15%, respectively. During the quarter, 75% of our total Home Health revenue was paid on an episodic basis and all but six percentage points of that figure was Medicare revenue.

Second, is our sustained leadership in specialty programs. Ron and Tony talked about the great progress we’re making in both the quality and the rollout of these programs. During the quarter, our specialty programs comprised 32% of our total Medicare Home Health revenue compared to 26% in the third quarter of last year. As we continue to focus on these two areas post-CareCentrix, we should see Home Health margins continue to expand. Operating contribution margin, which represents EBITDA before corporate expense allocation, was 16.2% in the third quarter of 2008, up from 15.1% in the year-ago period.

I’ll now review some of the underlying operational statistics that are supporting our Home Health segment growth. During the third quarter, there were about 40,000 Medicare admissions, an increase of 12% from the same period last year. For the year-to-date, we have had 120,500 Medicare admissions, an increase of 10% over the first nine months of 2007. With regard to episodic admissions, we experienced 43,400 admissions in the third quarter and 131,300 admissions year-to-date. This represents a quarterly increase of 14% and a nine-month increase of about 13%.

Total episodes in the third quarter approximated 61,700, up 14% over the 2007 third quarter. Revenue per episode was about $2,900, up 7% from the prior year. For the nine months, total episodes approximated 183,200, growing 14% from the same period last year. Revenue per episode year-to-date was just under $2,800, an increase of about 4% over the same period in 2007.

Turning briefly now to CareCentrix, revenue for the 87-day period prior to closing was roughly flat with the full quarter of the prior year at $75.5 million. For the year-to-date period, revenue increased by 8.5%. The majority of the revenue growth came from fee-for-service business and membership increases within CIGNA. CareCentrix’ operating contribution of $5.2 million, or 6.9% of net revenues, was down by approximately $1.7 million, or 25%, from the year ago quarter, and declined $3.8 million in the first nine months of 2008 versus the same period one year ago.

Other Related Services showed some improvement in the quarter, with an 11% increase in segment revenue and a 6% increase in operating contributions. Hospice revenues, which contributed more than half of the segment total, were $18.7 million in the 2008 third quarter, an increase of about 13% over the prior-year quarter of 2007. Hospice census grew to 1,440 patients at the end of the third quarter. However, the bottom-line performance of this business has not yet met our expectations. Aggregate net revenues and contributions of the other businesses in this segment, which includes respiratory services and HME, infusion therapies and consulting, showed improvement compared to the third quarter of 2007.

Shifting now to cash flow and balance sheet highlights for the company, operating cash flow was over $51 million for the first nine months of 2008, compared to $42.4 million for the same prior-year period. For the full year 2008, we expect operating cash flow to exceed $60 million and capital expenditures to approximate $24 million. Days sales outstanding or DSOs were 61 days at the end of the third quarter, unchanged compared to the DSOs at June 2008. As we indicated during our last call, we continue to expect DSOs to go below 60 days before the end of 2008.

Cash and cash equivalents were $61.5 million at the end of the third quarter, an increase of over $39 million compared with the prior quarter end. Long-term debt at September 28, 2008, stood at $261 million, a reduction of $70 million since the end of the second quarter. We applied $58 million of the $84 million in cash proceeds from the CareCentrix transaction to reduce our term loan debt. And we applied another $12 million of operating cash flows to reduce our revolving credit borrowings. Early in the fourth quarter, we repaid the remaining $10 million of outstanding revolving credit borrowings. As of today, our outstanding long-term debt consists solely of the $251 million in term loan debt.

As many of you know, we have been committed to and have made good progress in reducing our leverage ratio for some time. For example, as of the end of the third quarter in the past few years, our consolidated leverage ratio has changed from 4.2 times in 2006 to 3.0 times in 2007 to 2.4 times at September 28, 2008. At the same time, our overall liquidity position remains pretty healthy with continued strength in operating cash flows, significant cash on our balance sheet and our outstanding credit facility. There is nominally about $55 million available on that facility today, after considering outstanding letters of credit. While just under $10 million of the unused credit facility was backed by Lehman Brothers and could not be made available to us, we are nonetheless very comfortable with our current position and our ability to work through the financial industry conditions and access needed financing to conduct any external initiatives that might develop over the near-term.

Now, let me speak about our 2008 outlook. We’re adjusting our guidance to account for both the CareCentrix transaction and the better-than-expected performance of our Home Health business. Balancing the upside with the removal of CareCentrix for the fourth quarter gets us to a full-year revenue range of approximately $1.28 billion to $1.30 billion. This range is only $40 million to $50 million less than our prior guidance, even though the absence of CareCentrix revenues following the transaction date is estimated to have an impact of about $80 million on our consolidated net revenues for this year. By virtue of this stronger profitability of Home Health and our positive outlook for Q4, and in spite of the diluted effect of the CareCentrix divestiture on fourth quarter results, we are raising our 2008 outlook for diluted earnings per share to a range between $1.47 and $1.51, as compared to a range of $1.36 to $1.43, which we discussed on our last earnings call. These numbers exclude special charges and, of course, the non-recurring net gain recorded in the third quarter related to the CareCentrix transaction.

We’re also announcing an operating preview for 2009 with full-year net revenues expected to be in a range of $1.12 billion to $1.17 billion, and diluted earnings per share in a range between $1.62 and $1.72. In considering our 2009 outlook, it’s important to understand a couple of things. In comparing our revenue outlook for 2009 to 2008, CareCentrix revenues are obviously excluded from the 2009 range, while the current 2008 outlook includes about $233 million of CareCentrix revenues, which were recorded through the transaction date late in the third quarter. The 2009 outlook for diluted earnings per share represents an increase of between 20% and 25% compared to the 2008 outlook after adjusting for the impact of the CareCentrix divestiture on operating earnings. The outlook reflects strong growth in episodic revenues, driven primarily by continuing expansion of our specialty programs into new and existing markets, while reducing revenues from low-margin Medicaid and commercial Home Health businesses. The 2009 outlook excludes the impact of any future acquisitions and any special items.

And finally, Gentiva’s fiscal year ends on the Sunday nearest to December 31. As a result of this policy, fiscal 2009 will include 53 weeks of activity. Overall, Gentiva is performing very well and our outlook is optimistic. With a sharpened focus on our higher-growth Home Health business, we are in position to drive the benefits of a continued shift in payer mix toward Medicare, as well as the investments we’re making in our specialty programs and our clinicians. We’ll continue to invest prudently in the business, both organically and through targeted M&A, while also managing to an appropriate amount of balance sheet leverage.

That sums up my comments for the third quarter and the first nine months of 2008. Now we will be happy to open the call up for any questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Art Henderson with Jefferies & Company.

Arthur Henderson – Jefferies & Co.

Hi, good morning. Thanks for taking the question. Very nice quarter. John, first question for you. I know previously you had talked about an EBITDA – a fiscal ‘08 EBITDA level of about $112 million to $117 million and a tax rate of roughly around 41.5%. Has that changed in any way, or we are still using those numbers?

John Potapchuk

Yeah, I would still use those numbers, Art, in the range of EBITDA, but on the tax rate, I think I may have indicated that we would see some decline in the rate in the second half of the year. And now I think we’re in a range more like 40.5%. Let us say between 40% and 41% for the full year.

Arthur Henderson – Jefferies & Co.

Okay. That’s helpful. And then a follow-up question, kind of a two-part question here. You guys have hired a lot more full-time equivalent caregivers this quarter. I was wondering if you could comment on the acceleration that we’re seeing there. And then, Ron, if you could give us your thoughts on the economy as it relates to the commercial payer portion of your business and what’s your – if you are seeing any unusual weaknesses or things that we should be thinking about with respect to that portion of your business. Thanks very much.

Tony Strange

Well, Art let me comment first of all on the –

Arthur Henderson – Jefferies & Co.

Hi, Tony.

Tony Strange

Good morning. On the recruitment efforts and the hires – and then I’ll let Ron answer the question you asked him directly. We are continuing to invest in our recruitment strategy. I think Ron has said on previous calls that at the end of the day, he who has the caregivers is going to win, because the demand is going to outstrip the supply. So we continue to put a lot of emphasis on building that caregiver pool, if you will. But at the same time, I mentioned in the call that we’re trying to hire these people on really more of a pay-per-visit structure as opposed to a salary, to still give us the flexibility to control our margins. So from that, I can’t say that 220 is going to be our new net number on a quarterly basis, but I was pleased this quarter that we not only hired the 220, but we were able to get them into orientation without totally harming our margins. So with that, Ron, do you want to answer?

Ron Malone

Yes. Arthur, good morning.

Arthur Henderson – Jefferies & Co.

Hi, Ron.

Ron Malone

Thanks for being with us. While certainly disruptions in the economy and particularly the jobs market can lower demand in the managed-care area, I don’t believe we have any significant exposure there. While we have remained open-minded, and as mentioned over the last three years about the role that managed care plays, particularly as it relates to the older population, yes, really that older adult population is where we’ve placed our focus, and that we’ve been very selective about the managed-care business that we’ve done in the past few years. And when I look – Tony, you may want to comment – when I look at the demand we have on the Medicare side and how that compares to the managed-care side, I just don’t believe that managed care will put much pressure on us right now, even if the managed-care demand dropped a little bit.

Tony Strange

And, Art, I agree with that. When you think about – we tend to use the term Medicare to describe a demographic as opposed to a payer and that’s probably a little bit unfair. When we talk about really focusing on our business with Medicare, we’re really talking about a geriatric population more so than a payer. And when you think about the definition of this geriatric population, these folks are generally retired and are not seeing the impact of what’s going on in the workplace. So by moving the company further away from these commercial lives that are more than likely still working or still out wage-earning, I don’t still think it has as big an impact on our business.

Arthur Henderson – Jefferies & Co.

Good. Thanks, Tony.

Ron Malone

Thank you.

Tony Strange

Thank you, Art.

Operator

Your next question comes from the line of Whit Mayo with Robert Baird.

Whit Mayo – Robert Baird

Hey, good morning, guys. Just a question, it may be helpful just given the sale of CareCentrix, to sort of give us an idea of frame up, sort of how we should think about that the growth next year and the margins reaching the segments – not to hold you to any numbers – but maybe if you could just kind of give us some directional sense there.

John Potapchuk

Yeah, and not hold me to any numbers, though, right? When I look at the revenue numbers, what the preliminary outlook reflects is growth in revenue of – kind of $70 million to $100 million range. It’s kind of in that 7% to 10% range overall. And when you take out the – obviously you’ve taken out the CareCentrix piece of it – but I clearly would expect Home Health Medicare revenue to continue to grow in the double-digit range. And we expect to see some growth in Other Related Services on the top line. And then I’ll say the non-Medicare Home Health episodic – I’m sorry – the non-episodic revenue in Home Health will be flat to down as we continue the process that we’ve been working through the past few years of really moving away from some of the lower-margin Medicaid and commercial business. So that’s kind of a build-up, if you will, of the top line. And in my comments, I mentioned that if you take this quarter and you extract out CareCentrix, you’re looking at an overall EBITDA margin of 9.9%. We certainly would see that continuing to grow next year and above the 10% range and, again, if you think back and look at – over past history of what has happened as we move our mix to higher-margin businesses, our gross profits and our EBITDA margins have grown accordingly and we expect that to continue in 2009.

Whit Mayo – Robert Baird

Okay. That’s really helpful. I appreciate that. And just, your comment that you made about walking away or seeing a little less of the kind of non-episodic business – I know you’re exiting some business here in Tennessee with homecare given some cuts, but are you guys planning on accelerating any of those initiatives in other states?

Tony Strange

And, Whit, we still have some non-traditional home health business, like private-duty related services, and we’re just selectively looking at those businesses and based on its contribution margin, making the determinations to get out of those businesses. So I wouldn’t want to try to indicate there’s going to be some mass exodus – or there’s some big number, but strategically, as we go through state by state and we look at pockets of business that become small enough that they become really distractive to the rest of the business, then that’s where we may make the decision to let’s go ahead and get out of the business today.

Whit Mayo – Robert Baird

And that makes sense. And maybe just one more question. Just, if we could get an update on your point of care rollout. How many agencies you converted that to – I know it’s in the early stages, but just any general thoughts as to how that progress has developed?

Ron Malone

We don’t – I really don’t have a remarkable update since the last call. We’re still ironing out the defects; we still have it running in four markets right now and would anticipate finishing the application such that it’s ready to roll out in a much larger way during the first quarter of next year. The IT team is working hard. I think they have a good grip on what they need to do to resolve the defects, but right now, I’m a little disappointed as to where we are. I thought we we’d be farther ahead, but we do anticipate having it finished in the first quarter.

Whit Mayo – Robert Baird

Great. Thanks, Ron.

Ron Malone

You bet.

Operator

Your next question comes from the line of Ralph Giacobbe with Credit Suisse.

Ralph Giacobbe – Credit Suisse

Great. Thank you. Just – I guess over time, is there anything structural or are there any reasons why you want to be able to sort of drive margins closer to levels of some of your peers, say in that kind of mid-teens level again over time?

Tony Strange

Well, Ralph, if you look at the business – and I’ve given you enough of the metrics to kind of back into that. If you look at our business today, we talked about 75% of revenues came from episodic reimbursement. And I think John mentioned that 6% of that was from Medicare Advantage. So 69% of our revenues came from Medicare. When you try to compare those margins to other peer groups, that’s the first place you have to go look. So as that mix changes, I would expect those margins to change as well.

Ralph Giacobbe – Credit Suisse

Okay. And then I guess you mentioned sort of same-store Medicare revenue and the Home Health business up 14%, can you just sort of work that out between sort of price and volume?

John Potapchuk

Yes, Ralph. I do have that. On those totals, I’ve got – for the quarter, we’re at about 9% on the revenue and we’re up some 5% to 6% on the volume.

Ralph Giacobbe – Credit Suisse

Okay. And – I am sorry, go ahead.

John Potapchuk

Yes, it’s – in fact, let me try – on the year-to-date, we said that revenue growth – Medicare revenue growth was 15%. One way of looking at that, I think, and again, this may help you as look at 2009 also, is – again, I’m rounding here – but it’s roughly an even spread among the volume growth, the increase in revenue per episode, and the impact on acquisition. So if you take, say, five-ish on each side. And when we talk in 2009 about Medicare revenue going up double-digits, again, we’re not reflecting any acquisitions in that. We saw a little bit of impact in 2009, a full-year impact on acquisitions we made in 2008. So that would contribute maybe a percent or two and then the rest will be same-store Medicare growth at this stage.

Ron Malone

And Ralph, there is something you might want to consider when you think about rate versus volume. It’s a not as simple – it’s not a simple equation as here’s a patient and the rate is going to change for that patient.

Ralph Giacobbe – Credit Suisse

Absolutely.

Ron Malone

As we implement the specialty programs throughout the country, the patient we’re giving is of higher acuity related to these specialty programs, and that’s really what’s changing the rate. So it’s really a volume. It’s a volume change, maybe, not – it’s a change in the type of patient that’s driving the change in rate.

Ralph Giacobbe – Credit Suisse

Sure. It’s (inaudible). That’s fair. And then just my last question

maybe can you talk a little bit about Medicare Advantage and maybe what the growing population base in those plans means to you and, I guess, how you negotiate these rates versus your commercial business?

Tony Strange

Well, it’s really driven by capacity and we have a firm belief and a very disciplined thought process that there is limited capacity and that we are going to preserve the capacity for those people who’re willing to pay us fair rates. And so we’ve taken a very disciplined approach to negotiation with the Medicare Advantage plans and we are really pushing them toward an episodic reimbursement just like – and if they don’t want to do that, then we’ll preserve that volume for somebody else. And that’s going to continue to be our approach. Now as it relates to the election and the outcome and what’s going to happen with Medicare Advantage, I mean, your call on that is good as mine.

Ralph Giacobbe – Credit Suisse

Okay. So it sounds like you’re going in looking for the Medicare pipe rates for Medicare Advantage?

Tony Strange

Well, we – .

Ralph Giacobbe – Credit Suisse

Is that fair?

Ron Malone

It’s the same patients.

Tony Strange

That’s right; it’s the same patients for us. We provide the same service and we expend the same expense, so why wouldn’t we be paid the same?

Ralph Giacobbe – Credit Suisse

Okay. Fair enough. Thank you.

Operator

Your next question comes from the line of Darren Lehrich with Deutsche Bank.

Darren Lehrich – Deutsche Bank

Thanks. Good morning, everyone. Nice job. I have a couple of questions here about margins and I just wanted to get your comments on what the gross margins were in the Home Health business and where you think that can go as you continue to, I guess, move to a more variable cost structure. And then, Tony, it sounds like you’re a tad disappointed with the margin progress in the other segment, particularly hospice. So I just wanted to hear from you what you thought you needed to do to improve that and what that looks like going forward and then I’ll have a follow-up.

Tony Strange

From a qualitative perspective, Darren, I’ll talk about the margins in the Home Health business. We’re going to continue to get margin pressure related to increase in salaries and fuel expense and just the escalation or inflation in other costs. But we’re hopeful, and I believe that we’ve demonstrated that we’re going to be able to hold margins consistent through better management or productivity, the implementation of the pay-per-visit model, those types of initiatives. So while I don’t think – if you look at our – if you look at the outlook, we’re not indicating that we’re going to have a tremendous increase in gross margins, but we’re working very diligently to protect those margins on a go-forward basis. So does that answer your question about Home Health, or do you want me to go into more specifics?

Darren Lehrich – Deutsche Bank

I think, John, maybe you can provide the gross margin?

John Potapchuk

Yeah, sure, Darren. Our gross margin in home healthcare for the quarter was 51.9%, and I think it’s important to note as we go forward without CareCentrix, I think there will be a little bit more clarity for everyone, because while we reported a gross margin in the third quarter, if you go through the math of 43.4%, if you exclude CareCentrix, you’d be at 50.5%. And I’ll also say there’s a little bit of depreciation of DME reflected in the reported margins, so if you took that out, it gives you kind of an EBITDA kind of component, you’d be at 51.2%. So you see that, going forward, that the margin we’ll report will be very much in proximity to the Home Health margins.

Tony Strange

So kind of going back to my qualitative comment, when you look at us calling a 52% gross margin, we’re not projecting that number’s going to continue to climb and go to 55% or 56% or 59%, but we’re also not expecting to experience a significant decline from that related to wage pressures and fuel cost and those kinds of things. We have enough going in both directions. Our hope is to hold that steady.

Darren Lehrich – Deutsche Bank

Okay. And then my follow-up here relates just to the guidance, and I just wanted to ask another couple of things about the components there. The extra week or so of activity in the quarter, I guess, is that about a four-cent impact? And could you also please comment on just how you see the year progressing, maybe, with all the hiring that you’re doing in the back half we’ll see some additional training costs early in the year, if you could just give us some flavor on that? And then I do want to confirm here, do you contemplate any adjustments to corporate overhead in 2009 embedded in this guidance? Thanks.

John Potapchuk

I’ll try and answer some of that, Darren. I think that with respect to the 53rd week, the impact on EPS, I believe, is much less than what you had mentioned. I was looking at more like a penny or two, and what we’ve seen the last couple of times that we had this extra week, you don’t necessarily get a full week of revenues that occurs toward the back end of that holiday season. So that incremental revenue would be in the, maybe in the $12 million to $15 million range. But then what’s also happening is you get vacation time and things like that. So I was really looking at that extra week possibly having an impact of maybe a penny or two. And then, with respect to corporate overhead, I’ll try and answer that one, also. As you know, in connection with our transition services agreement with CareCentrix, we will be reimbursed during that period of time, the equivalent of about $2 million a quarter, so you’ll see a reduction in our corporate overhead. And over time, I mean, we’re operating the business and only looking to operate in the most efficient manner possible. But I can’t sit here today and talk about any wholesale changes as a result of CareCentrix.

Darren Lehrich – Deutsche Bank

Great. Thanks a lot.

Operator

Your next question comes from the line of Newton Juhng with BB&T Capital Markets.

Newton Juhng – BB&T Capital Markets

Thank you very much. With regard to the uses of your free cash flow, obviously a lot of debt repayment recently, should we see that really slowing and more of a concentration on the M&A front like you were saying in your prepared remarks? I was just kind of curious as to what your priorities are on that front.

John Potapchuk

Yes, I think that’s fair, Newton. I mean, we were very focused on getting our leverage ratio down and we have it down below 2.5 times now, which, doing that gives us a little bit more flexibility, I will say, I think with the term loan debt we have, it’s a very favorable arrangement that we’re paying a LIBOR plus 175 basis points or prime plus 75. So, I mean, it’s pretty inexpensive debt. So I would think that, at least in the short term, you would see us accumulating cash and/or using that for other reasons than paying off term loan debt.

Newton Juhng – BB&T Capital Markets

But should you see something that’s really attractive, that’s a little bit larger, are you willing to move that leverage ratio back up?

John Potapchuk

Sure.

Tony Strange

Yes.

Ron Malone

Yes.

John Potapchuk

Yes. I – we definitely were comfortable with a higher rate.

Tony Strange

Assuming there’s somebody out there that’ll lend it.

Newton Juhng – BB&T Capital Markets

Well, you come and talk to us. Anyway, in terms of the clinician turnover, it’s nice to see that number continue to get driven down. I was just wondering if you could give us a little more idea of what you’re doing to help drive that number down, as well as kind of what level you might be looking to get to at some point? What’s a reasonable level of turnover to look at in terms of your employee turnover?

Tony Strange

Well, Newton, first of all, let me start with what we’re doing. We continue to invest in our clinicians. We’ve rolled out our benefits for ‘09; we continue to make significant investments into that. We’ve really put in place field accountability related to turnover – we’ve tied our leadership out in the field, we’ve tied their compensation to turnover. And I personally believe that’s the biggest thing that we’re doing to really impact that number. As it relates to kind of – where do we think we can get to? We’re probably already at what is considered to be industry standard in terms of our full-time benefited caregivers. As a matter of fact, in some cases we’re probably already below some of our peer groups. I don’t think that’s going to be good enough. I think I would like to see us get down into the single-digit number. If you look at a lot of our therapists that work specifically within our specialty programs, we have single-digit turnover amongst that group, and that’s related to the esprit de corps that that group has. And I think my goal is to get that throughout our company. And I’m hoping that we can get all of our turnover down into the single-digit numbers, which would put us well below anybody else in the healthcare industry.

Ron Malone

Yes. I think I would add, if you look at the combination of career opportunities and educational opportunities, I think Gentiva presents an extraordinarily attractive employment setting for these clinicians. And I happen to agree with Tony, and we acknowledge our continued investment in growth in the specialties has been a driver of that esprit de corps and probably better supervision. And not all companies are positioned to allow a clinician to focus in the area where they have the greatest experience and expertise; that has helped as well.

Tony Strange

And, Newton, just in reference of our fourth-quarter call, I didn’t say that we were going to get our turnover to single-digits. I said that was my goal.

Newton Juhng – BB&T Capital Markets

Understandable. Thank you very much.

Ron Malone

Yes. Full-time clinical turnover is in the low 20% range. I think that’s probably ahead of the industry already, but I agree with Tony, it can’t get low enough to suit us.

Newton Juhng – BB&T Capital Markets

Thank you.

Ron Malone

Thank you.

Operator

Your next question comes from the line of Sheryl Skolnick with CRT Capital Group.

Sheryl Skolnick – CRT Capital Group

Thank you, I actually have a request to clarify the corporate expense levels a little bit more specifically, John, but I also need another clarification, which is maybe more operating-related and that is – so let me start there. The revenue-per-episode growth in the third quarter, I think you said it was 7%, and that was significantly higher than the trends of 2.4% and 4% for the six and nine months of this year. So is that directly related to, presumably, the specialty programs, but also better understanding, familiarity with the revenue opportunities for appropriately billing patients under the new reimbursement system?

Tony Strange

I don’t know that I would agree with the latter half of your comment.

Sheryl Skolnick – CRT Capital Group

Okay.

Tony Strange

Sheryl, if you go back, and I’ll take you back to the first-quarter call. When we reported revenues and we gave for the first time the revenue-per-episode statistic in the first quarter, if you will recall, we were very careful in telling people that that number was artificially low, because as patients transitioned out of the old reimbursement system and onto the new reimbursement system, for the first time, you were going to have positive therapy adjustments because CMS, even though you indicate how many therapy visits you think you’re going to do, if you do less than that, they will adjust your revenue down; if you do more than that, they will adjust your revenue up. And I think I made a comment on the call that we took a very conservative approach to how we were recognizing revenue. So as you go through the year and you get into Q2 and Q3, you begin to see some of those positive adjustments now starting to flow through as you are processing your final claim.

I think we do take a pretty conservative approach to how we’re booking our revenues, because I don’t want a negative surprise. I don’t want to be on a call and say that a large number of our claims got adjusted downward and we are having to restate our revenues. So that’s contributing to the increase in revenue per episode. But in addition to that, the first half of what you said is accurate. As we roll out more and more of these specialty patients, we are going to referral sources and really positioning these specialty patients to capture a higher level of acuity in patient referrals. So as we roll out cardiopulmonary or our new neuro-rehabilitation program, that’s a very intense program related to CBAs and stroke patients. That in itself will bring a patient that needs more services from us that’s going to have a much higher cost and therefore – rightfully so, reimbursement will be higher.

Sheryl Skolnick – CRT Capital Group

Okay. So the – how much of that acceleration to 7% is due to what we’ll call prior-period settlements from earlier this year?

John Potapchuk

For the quarter, I think, it’s not much.

Tony Strange

Quarter is – but it’s consistent. We are experiencing positive, we are experiencing positive revenue adjustments in our revenue per episode, but it’s now starting to be consistent quarter to quarter.

Sheryl Skolnick – CRT Capital Group

Okay. And are patients coming from home or hospitals more acute? Can you tell? Because I would imagine that some of your specialty programs are for patients who are already at home?

Tony Strange

Well, yes, but you have to be a little bit careful in how you describe their home. For example, a lot of our patients in our specific programs are at home, as you say, but their home may be an assisted-living facility.

Sheryl Skolnick – CRT Capital Group

Okay. I get that. Thank you. And then, let me go on to a clarification. When you said there’s this $2 million, John, in the corporate expense, I’m just a little bit confused. So what we should do as we look to adjust out CareCentrix, as we split those expenses, because we know the revenue and we know the contribution margin. So now what we want to do is split the expenses between cost of revenue and SG&A. So it sounds like, on a percentage basis, a lot more of it’s coming out of cost of revenues, less of it’s coming out of SG&A. So that you’re not going to see that big a drop in SG&A. You might see, like, an $8 million drop sequentially as CareCentrix comes out of the SG&A line, is that about right?

John Potapchuk

It is. What I tried to do on this release, Sheryl, to help people with it, I put a footnote in the supplemental information and it – it’s footnote four – and what it does, it shows that the components of CareCentrix’s operating contribution for each quarter and the year-to-date period that we report. So you would see, for instance, CareCentrix’s operating contribution was $5.2 million for the quarter. So that consists of gross profit of $13.7 million and SG&A of $8.6 million. So you’ve got those components. What I am saying, in addition to that coming out, we have a transition services agreement with CareCentrix, whereby they will reimburse us for certain back office expenses; accounting, IT that we were going to provide to them. So the way to think about that, if you looking in our segment information, you will see that corporate expenses, which are included in SG&A – this is unrelated to operating contribution, $18.2 million – you would expect that to go down, because of CareCentrix, by something close to $2 million next quarter. And because of the fact that we’re continuing to incur those costs, but we are getting separately reimbursed by CareCentrix and we will net that reimbursement against the expense.

Operator

Your next question comes from the line of John Ransom with Raymond James.

John Ransom – Raymond James

Hi, I am sorry if this was asked before. I was off the call for a minute, but did you guys talk about recertifications at all?

Tony Strange

I don’t think we’ve ever given any granularity in recertification. You can kind of – we talked about admissions and we talked about total episodes. So you can kind of back into that number.

John Ransom – Raymond James

So I mean – I’ll do that, but are you seeing an increase in recertifications under the new PPS?

Tony Strange

Not really. Certain of our specialty programs, for example, the neuro-rehabilitation programs that I talked about earlier – with that program, because it’s so intense, related to these CBA patients, that program is going to have a fairly high recertification rate, but that program is now rolled out to only a couple of locations. It’s really the patient profile that’s driving that, but we haven’t seen a significant change in research today.

John Ransom – Raymond James

Okay. And my second question, when you look at industry average stats, do you get kind of an average mix of admissions directly from the physician versus admissions directly from the hospital?

Tony Strange

I don’t know that I would classify it as just those two referral sources. If you look at physicians, hospital discharge planners, assisted living facilities, nursing homes, I would probably put it pretty spread fairly equally amongst those four groups.

Operator

There are no further questions at this time. I would like to turn the conference back to management for closing remarks.

Steve Paige

Thank you very much. I appreciate all of you joining us today. We appreciate your continued interest in Gentiva and look forward to speaking with you again as we report the Q4 results. Take care.

Operator

This concludes today’s Gentiva Health Services third quarter 2008 earnings conference call. You may now disconnect.

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Source: Gentiva Health Services, Inc. Q3 2008 Earnings Call Transcript
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