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Executives

R. Dirk Allison - Senior Vice President and Chief Financial Officer

Robert A. Lefton - Chief Executive Officer and President

Analysts

Albert Rice - Soleil - Pomeroy Research

Frank Morgan - RBC Capital Markets

Darren Lehrich - Deutsche Bank

Brendan Strong – Barclays Capital

Newton Juhng - BB&T Capital Markets

Jeff Englander - Standard & Poor’s

Odyssey HealthCare, Inc., (ODSY) Q4 2008 Earnings Call February 19, 2009 9:00 AM ET

Operator

Welcome to the fourth quarter 2008 Odyssey HealthCare earnings conference call. My name is Dan and I will be your coordinator for today. (Operator Instructions). I would now like to turn the call over to your host for today’s call, Mr. Dirk Allison, Senior Vice President and Chief Financial Officer.

R. Dirk Allison

Let me welcome everyone to our conference call to discuss Odyssey’s fourth quarter 2008 financial results. Bob Lefton, our CEO, will lead off, and I will follow with more details concerning our financial results. We will then open the call for your questions.

Before I turn the call over to Bob, I want to take care of a couple of items. The first, as it relates to forward-looking statements. Certain statements in this presentation are forward-looking statements within the meaning of the Federal Securities laws. Such forward-looking statements are based on management’s current expectations and are subject to known and unknown risks, uncertainties, and assumptions, which may cause the forward-looking events and circumstances discussed in this presentation to differ materially from those anticipated or implied by the forward-looking statements.

Such risks, uncertainties, and assumptions include, but are not limited to those risks, uncertainties, and assumptions identified in our press release dated February 18, 2009, and the disclosures contained under the headings Government Regulations and Payment Structure in Item 1 Business and Item 1A Risk Factors of Odyssey’s annual report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2008, and in Odyssey’s other filings with the Securities and Exchange Commission.

Many of these factors are beyond the ability of the company to control or predict. Given these uncertainties, listeners are cautioned not to place undue reliance on such forward-looking statements, which reflect management’s views only as of today’s date. The company undertakes no obligation to revise or update any of the forward-looking statements or publicly announce any updates or revisions to any of the forward-looking statements to reflect any change in the company’s expectations or any change in events, conditions, circumstances, or assumptions underlying such statements.

Second, this call is being recorded on behalf of Odyssey and will be available in approximately two hours following the conclusion of this call until March 5, 2009, and will be accessible through our website at www.odsyhealth.com or by calling (888) 286-8010 or (617) 801-6888 and using the pass code 80166391. With that, I will turn the call over to Bob.

Robert A. Lefton

Good morning everyone and thank you for joining us today. This morning, I will begin with some comments about our accomplishments in 2008. I will then discuss our areas of focus for 2009. Finally, I will give you an overview of our fourth quarter results, comment on the portions of stimulus package affecting hospice, and then turn the call over to Dirk to give you more details about the quarter.

2008 was a very important year for Odyssey. It was a year in which there were numerous accomplishments. Obviously, one of the most important accomplishments was our successful acquisition of VistaCare. This acquisition enhanced our leadership position, increased our scale, and solidified our local positions in many markets. Most importantly, it leveraged the investments we have been making in our infrastructure allowing us to achieve significant synergies as VistaCare’s corporate office functions were integrated into our support center in Dallas. I am pleased to report that the integration of the support center functions was completed in the fourth quarter. The integration was completed on time and on budget.

There were also other important accomplishments in 2008. These were especially significant as they were achieved while the integration of VistaCare was occurring and answered any questions concerning the timing of the acquisition and whether or not the company was ready to undertake a transaction of this size while we were facing challenges of our own. There were significant accomplishments in dealing with the Medicare cap. Although the cap is something that we will need to continue to deal with on an ongoing basis as it can be very volatile, significant progress was made as we combine programs, exited some markets, and did a better job of attracting a more balanced patient mix.

2008 was also a year in which we started to recognize the benefits of our enhanced approach to sales and marketing with strong same-store growth and admissions in the latter half of the year. And finally, our ability to better manage our costs was also a major accomplishment. The implementation of more sophisticated tools and management processes allowed us to better manage our labor expense. Our increased size also gave us greater leverage to obtain better pricing and savings on non-labor items. All of these accomplishments put us in an exciting position as we enter 2009 and I would like to discuss some of our initiatives for the New Year.

An important part of the integration of VistaCare that was completed in the fourth quarter occurred at the program level where we substantially completed the implementation of our management systems and processes at the VistaCare locations allowing us to more effectively manage the operations of these programs. As a result, a major focus for 2009 will be to use these processes to enhance the performance at the VistaCare locations and to implement initiatives that have proved to be successful at the Odyssey locations.

In addition, the fact that all programs are now operating on a common platform with the same management processes allows us to develop and implement standardized operating policies and practices across all of our programs that incorporate the best practices of both the VistaCare and Odyssey programs. We believe that this will lead to improved efficiencies and improved operating results for our combined operations.

We will continue to focus on same store growth in 2009. We will do this by continuing to enhance and expand our service offerings, rolling out the Odyssey programs to the VistaCare sites, and using our new IT infrastructure to strengthen our sales management skills through new tools available to the sales force.

With the successful completion of the VistaCare acquisition, I believe we are now prepared and ready for additional integrations. As a result, during 2009, we will work to increase our acquisition and development efforts through strategic complementary acquisitions while maintaining our disciplined pricing philosophies.

And finally, we will continue to work on improving our cost structure. In addition to the continuation of our efforts to improve labor management, we will be exploring new ways to use our size and leverage to more fundamentally change our cost structure. Among other areas, our cost structure initiatives will focus on our billing and collection expense, our DME costs, and improving our overall productivity through better scheduling and on-call systems.

I will now turn to some comments about the fourth quarter results. I am very pleased with our admission growth. On a sequential basis, admissions for the fourth quarter grew by approximately 1.6% over the third quarter 2008. On a year-over-year same-store basis, excluding the VistaCare and consolidated sites, admissions grew by 9.8%. However, consistent with recent historical seasonal trends we also experienced an increase in the number of discharges, particularly towards the latter part of the fourth quarter. The net effect of the increase in both admissions and discharges resulted in average daily census from continuing operations, increasing slightly on a sequential basis to 12,357 for the fourth quarter of 2008 compared to 12,329 for the third quarter of 2008.

On a year-over-year basis, ADC increased by 50.5%. Same-store year-over-year growth in ADC, which excludes the VistaCare and consolidated sites, was 9.7%. I would like to point out that the spike in discharges at the end of the fourth quarter resulted in a lower beginning patient census as of the 1st of the year. While admissions for January remained strong, the increase in discharges also continued throughout January. The combination of a lower starting point at the beginning of the year and the increase in discharges resulted in average daily census from continuing operations decreasing to 12,196 in January.

As I mentioned in our last call, we expected that our Medicare cap would increase over the third quarter number for two reasons. First, the third quarter cap was positively impacted to benefits recognized as a result of slight consolidations and reductions in prior year periods as actual cap assessments were received.

Second, the fourth quarter is typically a more volatile quarter since it starts a new Medicare cap year. Our Medicare cap contractual was 1.8% of gross patient service revenue for the fourth quarter of 2008 as compared to 1.6% for the fourth quarter of 2007 and 0.7% for the third quarter of 2008.

We are continuing to take steps to address the Medicare cap in those markets where we are experiencing significant Medicare cap contractual adjustments. For example, we recently entered into a lease agreement for the development of an inpatient unit in one of our largest cap markets. We expect to open this inpatient unit in the fourth quarter of 2009. This should allow us to treat higher acuity, shorter length of stay patients in that market.

As you are aware, effective strategies to address the Medicare cap take time to implement and time to realize the benefits of those strategies. For the near term, we continue to expect our Medicare cap contractual to run approximately 1.5% of gross revenue on a go-forward basis.

We also continue to demonstrate the results of our operating initiatives to improve our labor productivity and overall expense management. Total salaries per patient day decreased 6.5% from $75.48 for the fourth quarter of 2007 to $70.59 for the fourth quarter of 2008. Total adjusted operating expense per patient day decreased from $139.93 for the fourth quarter of 2007 to $134.17 for the fourth quarter of 2008, a decrease of 4.1%. Both of these statistics include ramp-up expenses related to the integration of VistaCare but exclude ramp-down expenses. In addition, adjusted total operating expenses exclude depreciation and amortization.

Adjusted total operating expenses did, however, increase on a sequential basis primarily due to an increase in our workers’ comp expense of approximately $2 million pre-tax. Dirk will have more information on that increase later.

Operating expenses also included the write-off of certain development costs related to an IPU that we decided not to pursue and the charge related to the abandonment of office leases in connection with some program consolidations.

As you are aware, CMS issued a final rule phasing out the application and the budget neutrality factor that is included in the computation of the annual hospice wage index. In the final rule, CMS also announced that the annual market basket increase to base hospice rate was 3.6%. As a result of the final rule, we received an increase on October 1, 2008, of approximately 2.5% consisting of a 3.6% market basket increase, decreased by approximately 1.1% due to the first year phase-out of the budget neutrality factor.

As you may also know, the recently enacted stimulus package includes a provision that postpones the implementation of the final rule until October 1, 2009. This was an important step in the industry’s effort to maintain funding for hospice services at a level which assures access to quality hospice services. At this time, we are not sure of the exact details on how this retroactive provision will be implemented nor are we sure on its timing; however, we believe that it will result in our re-capture of the 1.1% reduction in our rates to the fourth quarter of 2008 and the restoration of our full market basket increase of 3.6% through September 30, 2009. We estimate this will increase 2009 revenue by approximately $6 million to $8 million and increase our 2009 earnings per share by approximately $0.12 to $0.16 including the benefit attributable to the fourth quarter of 2008.

The impact on the fourth quarter of 2009 due to the delaying in the implementation of the elimination of the BNAF is unclear at this time and will not be known until CMS provides some guidance.

During the fourth quarter, we consolidated or made substantial progress in consolidating three markets in which Odyssey and VistaCare both had programs. While we remain convinced that the strategy to maintain and operate both the Odyssey and VistaCare brand is the right strategy, there were compelling opportunities in those markets that led to the consolidations. The primary reason we consolidated programs is to help address the Medicare cap issues. These consolidations should allow us to serve a more diversified mix of patients in these consolidated markets.

Going forward, we will continue to evaluate whether there are additional consolidation opportunities in our overlap markets. As we previously announced, on January 1, 2009, we acquired the hospice operations of Avalon Hospice, a community-based non-profit hospice provider in Flint, Michigan, with an average daily census of about 80 patients. The acquisition of this program complements our existing program in Detroit, Michigan, and allows us to increase the geographic area that we serve and more effectively serve the communities in the overlapping service areas of the two programs.

Now, I would like to turn the call over to Dirk to provide more detail on our financial results.

R. Dirk Allison

As mentioned in our press release, our consolidated net patient service revenue from continuing operations for the fourth quarter of 2008 was $167.3 million as compared to $102.2 million for the fourth quarter of 2007. For 2008, our net patient service revenue from continuing operations was $616 million as compared to $398.2 million for 2007.

Our income from continuing operations for the fourth quarter of 2008 was $5.7 million as compared to $2.3 million for the same period in 2007. Our income from continuing operations for 2008 was $19.7 million as compared to $16 million for 2007. Our income per diluted share from continuing operations for the fourth quarter of 2008 was $0.17 as compared to $0.07 for the fourth quarter of 2007. For 2008, our income per diluted share from continuing operations was $0.59 as compared to $0.48 for 2007, an increase of 23%.

Our consolidated average daily census from continuing operations for the fourth quarter of 2008 was 12,357 as compared to an ADC of 7647 for the fourth quarter 2007. Our consolidated admissions were 12,037 for the fourth quarter of 2008 as compared to 8100 for the fourth quarter of 2007. Our discharges for the fourth quarter of 2008 were 12,210 as compared to 8294 for the fourth quarter of 2007. Our consolidated discharge average length of stay for the fourth quarter of 2008 was 82.5 days compared to 84.5 days in the fourth quarter of 2007 and 86.4 days in the third quarter of 2008. Our consolidated billable days for continuing operations for the fourth quarter of 2008 were 1,136,826 as compared to 703,539 days for the fourth quarter of 2007. Our net patient service revenue per day from continuing operations in the fourth quarter of 2008 was $147.15 as compared to $145.22 for the fourth quarter of 2007.

The mix in our levels of care for our billable days for the fourth quarter of 2008 was 97.6% for routine care, 1.7% for inpatient care, 0.5% for continuous care, and 0.2% for respite care. Our level of care mix for the fourth quarter of 2007 was 97.3% routine care, 1.7% inpatient care, 0.8% continuous care, and 0.2% respite care.

In the fourth quarter, our same store average daily census exclusive of combined size was 7090 as compared to 6465 for the fourth quarter of 2007, an increase of 9.7%. Same store admissions exclusive of the combined size were 7742 as compared to 7054, an increase of 9.8%. In the fourth quarter, our same store net patient service revenue exclusive of the combined size increased 13.8% from the fourth quarter of 2008.

Our Medicare cap as a percentage of gross patient service revenue for the fourth quarter of 2008 was 1.8% as compared to 1.6% for the fourth quarter of 2007. As of December 31, 2008, we had 13 programs in cap. Remember, due to the way we calculate cap, our fourth quarter will show certain programs in cap that may not be there by the end of the Medicare cap year.

In regards to the individual program cap stratification that we have been giving you, approximately 6.4% of our programs were in category 1, 41.5% in category 2, 39.4% in category 3, 6.3% in category 4, and 6.4% in category 5. As a reminder, category 1 are those programs whose gross revenue per admission is less than 50% of the Medicare cap amount; category 2 are programs at 50% to 80% of the Medicare cap amount; category 3 programs between 80% and 105%; category 4 programs between 105% and 115%; and category 5 programs greater than 115%.

Recalculating our program's gross revenue per admission using a methodology where we divide actual revenue generated by patients discharged in the current Medicare year by the number of discharges in the current Medicare year yields the following results: 43.6% of our programs are in category 1, 40.4% are in category 2, 14.9% are in category 3, 0% are in category 4, and 1.1% are in category 5. We believe this method provides a more accurate picture of our program's gross revenue per admission and should be a better indicator of a program’s longer term status as it relates to the Medicare cap limitation.

As it relates to the 2009 Medicare cap year at the end of the fourth quarter, adjusted Medicare admissions for sites that exceeded the cap limitation represented 93.1% of total site admissions. For the fourth quarter of 2008, our admissions by diagnosis were 31.2% for cancer admissions; 17.4% for heart disease; 13.3% for Alzheimer’s and dementia; and 8.6% for COPD. For the fourth quarter of 2007, our admissions by diagnosis were cancer 31.8%; heart disease 17.8%; Alzheimer's and dementia 15.9%; and COPD 7.5%.

Our gross margin from continuing operations was 41.1% in the fourth quarter of 2008 as compared to 41.2% in the fourth quarter of 2007. Sequentially, our gross margins decreased slightly from 41.2% in the third quarter of 2008.

During the fourth quarter of 2008, we changed our estimate as it relates to our workman’s compensation expense. This change resulted in an increase in this expense of approximately $2 million pre-tax for the fourth quarter.

As you know, going forward, our experience rating will determine whether or not our workman’s compensation expense stays at this higher level. During the fourth quarter, we wrote-off $187,000 related to costs previously capitalized on a potential IPU that we decided not to pursue. We also expensed $241,000 of accelerated lease expense during the fourth quarter. This accelerated write-off was due to the site consolidations we completed during the quarter.

After accounting for the consolidation of programs which occurred in the fourth quarter, we had 94 Medicare certified programs on December 31, 2008. We had 7 programs with an average daily census of less than 50, having an average negative operating margin of 16.2%, 28 programs with ADC between 51 and 100 with an average margin of 7.6%, 41 programs with census of 101 to 200 with an average margin of 21.2% and 18 programs with ADC over 200 with an average operating margin of 20.9%.

In the last year, we had 2 programs that had lower margins due to either the cost of consolidation or change in management. If we eliminate these two programs from our margin calculation, then the remaining 16 programs with an ADC over 200 had an average operating margin of 24.1%.

We currently have four programs having less than 12 months of operations and one program that was certified by Medicare during the 2008 year. These programs recorded pre-tax operating losses of approximately $400,000 during the fourth quarter of 2008 as compared to pre-tax operating losses of approximately $600,000 for the same period in 2007. Our pre-tax losses related to the opening of our inpatient units was approximately $300,000 for the fourth quarter of 2008 compared to pre-tax losses of approximately $700,000 for the fourth quarter of 2007.

Our bad debt expense for the fourth quarter of 2008 was $3.1 million or 1.9% of net revenue as compared to $2.3 million or 2.3% of net revenue for the fourth quarter of 2007 and 1.6% for the third quarter of 2008. Our effective tax rate for the fourth quarter of 2008 was approximately 36.5%.

As of December 31, 2008, our total cash and short-term investments was $56 million while our accounts receivable balance was $127.9 million. Our day sales outstanding was 60.3 days for the fourth quarter of 2008 as compared to 63.6 days for the third quarter of 2008. This decrease is largely due to a decrease in accounts receivable at the VistaCare sites that were converted to our billing system. It is our goal during 2009 to see our day sales outstanding to return to the mid 50-day level.

Our total debt as of December 31, 2008, was $123.1 million. In addition, we have a $30 million line of credit which remains un-drawn. Our cash flows from operations for the fourth quarter of 2008 were $10.9 million as compared to cash flows of $2.9 million in the fourth quarter of 2007.

During the fourth quarter, we received 2 letters from our fiscal intermediaries related to our 2007 Medicare cap year. There was no material adjustment to our Medicare cap accrual based on these letters.

Capital expenditures were $1.6 million for the fourth quarter of 2008 as compared to $1.1 million for the fourth quarter of 2007 and $500,000 for the third quarter of 2008.

We continue to hold 3 auction rate securities with a face value of $17.1 million. We have recognized a reduction of $400,000 on these remaining auction rate securities leaving a book value of $16.7 million, which is shown on our balance sheet under long-term investments.

Let’s now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Albert Rice - Soleil - Pomeroy Research.

Albert Rice - Soleil - Pomeroy Research

A couple quick questions if I could ask; first of all, you mentioned the $2 million worker’s comp adjustment in the fourth quarter, is it right to think about that as being reflective of expenses incurred in the fourth quarter only or should that have been probably spread over the course of the previous quarters of 2008? Can you give us any incremental flavor you have for that?

R. Dirk Allison

It is a little difficult to be able to answer that entirely. As we look at our actuarial report, there is an opportunity going forward that the $2 million run rate workman’s comp in the fourth quarter could be lower, we’ll have a better view for that at the end of the first quarter.

Albert Rice - Soleil - Pomeroy Research

You mentioned obviously the purchase of Avalon Hospice in the fourth quarter. It looks you spent, if we’re looking at the full year spending for acquisitions minus the third quarter, you are about $4.5 million; was that all for that Avalon purchase or was there anything else going on in there in spending for acquisitions whether it was a payout for VistaCare or something else, an earn-out, or anything.

R. Dirk Allison

It wasn’t an earn-out, it was related to some tax issues for the VistaCare acquisition. The acquisition price for Avalon was approximately $500,000.

Albert Rice - Soleil - Pomeroy Research

Right. It seemed like a very high number for just that one acquisition.

R. Dirk Allison

Right, the remainder of that has to do with VistaCare transaction.

Albert Rice - Soleil - Pomeroy Research

Again on the cash flow numbers, you had a good cash flow quarter, but I’m looking at the CapEx for ’08 relative to ’07 for example; is the ’08 number, looking ahead this year, is that the right number to use. You stepped down a bit in CapEx this year versus last year?

R. Dirk Allison

The CapEx number, we expect to spend about 1% to 1.5% of revenue, which for us will be right around $7 million to $8 million or so an annual basis. The big issue related to our operating cash flow for the fourth quarter was the reduction in day sales by 3 days; that contributed a lot to that cash flow.

Albert Rice - Soleil - Pomeroy Research

You ended the quarter with about $56 million in cash, you’ve talked about already that auction rate securities on top of that which hopefully will get freed up eventually; maybe give us some thoughts about priorities for your cash flow in this environment, you just let that build up on the balance sheet or what are the imperatives; if it is acquisition related, what do you see available on the acquisition front?

Robert A. Lefton

Obviously, in this environment cash is very precious and I think we will be keeping that cash to take advantage of acquisition opportunities that comes up. In addition to that, there are provisions in our credit agreements that call for some scheduled as well as some additional repayments on excess cash for principal paying down the loan. So, I think between those two is primarily what we’ll be using the cash for.

Albert Rice - Soleil - Pomeroy Research

Any characterization of the acquisition environment at this point?

R. Dirk Allison

Still not a lot of the activity going on again. As I said in the prepared remarks, last year we kind of stepped back from being aggressive because of our digesting the VistaCare, but we’re back, we’ve got our development guys out there, there are a lot of conversations going on. Obviously these economic times as well as some of the right pressures that were existing in hospice have created some pressures on hospices around the country which is creating additional activity, but we want to make sure that acquisitions that we do fit well strategically as well as pricing is very important to us.

Operator

Your next question comes from the line of Frank Morgan from RBC Capital Markets.

Frank Morgan - RBC Capital Markets

One of your competitors commented earlier this week they were seeing problems with their admissions and attributed it to referral patterns, the commotion of economic dislocation, the slowdown of the economy as affecting referral sources and referral patterns. I was curious if you had any comments on that, if you got any of that kind of experience. The numbers don’t indicate that, but have you noticed that in any particular market? My second question, the whole notion behind making this not for profit acquisition, I think this may be our first not for profit acquisition, I was hoping you could give us a little bit of color on how that all developed, and do you think it’s more likely in the future as you look at add-on opportunities that you perhaps might see more from the not for profit side?

Robert A. Lefton

In regards to your first question, it’s hard to tell what has an impact and what doesn’t have an impact on admissions, but I’d say, speaking for ourselves we’re not really experiencing any pressures because of the economic conditions. And your second question?

Frank Morgan - RBC Capital Markets

I wanted to make sure that was your, just for the record, first not for profit acquisition, and then maybe a little bit of color on how that developed, and do you see the not for profit side being a bigger opportunity going forward or do you think you’ll more likely go down the traditional road of buying smaller for profits?

Robert A. Lefton

I believe, Frank, that there was one other non-profit acquisition in the company’s history, it was before I got here, so it has been some time ago. I do think that there will be opportunities going forward on the non-profit side. The Avalon acquisition came about as a series of discussions. I think the people up there recognized the benefits of affiliating with a larger organization that had some greater skill and resources to bring the bear on and pin the situation up there. It’s too early to tell whether or not there’ll be additional non-profit, but certainly, we’re placing a lot of attention in discussions with not only the for profit, but the non-profit players out in the industry.

Frank Morgan - RBC Capital Markets

One final question, this is more for Dirk; I know DSOs came down here, but do you have any of those remaining edits going on out there, the audit reviews on your claims for those longer length of stays; what’s the status of those?

R. Dirk Allison

Yes, we have a couple of programs. If you look throughout our company, there are a couple of programs that are still receiving a number of ADRs as we attempt to work through that. Other than that, it’s slowed down considerably.

Operator

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

Darren Lehrich - Deutsche Bank

A couple of quick questions here, on the programs in cap, can you give us a little more detail on what happened in the fourth quarter, and I definitely realize that the first quarter in Medicare year is pretty volatile, and then what’s happened so far in the year that makes you guys feel comfortable that capital will come down, because I believe you mentioned that the IPU wouldn’t come on until the fourth quarter of ’09, just a little more detail on these two programs.

Robert A. Lefton

As I said over and over again, just because of the way the cap is calculated, changes in admissions can really make it volatile quarter to quarter. The thing about our fourth quarter which is Medicare’s first quarter, the year starts over again, and the way we calculate cap, we calculate starting basically on October 1st. We go through and calculate where each program stands at cap at the end of each accounting period and we book according to that. What’s different about our fourth quarter versus the remaining three quarters throughout the year is that you don’t have the opportunity to go back and recapture cap that’s already been booked in the prior quarter. So, beginning next quarter, programs that might have incurred in cap expense in our fourth quarter can recover that if your admissions increase or length of stay decreases, or whatever causes it. You don’t have that opportunity in the fourth quarter which makes it particularly volatile, but again, we believe that we go through the year and admissions get a longer period of time that will retreat more to that 1.5%, and keep in mind too that comparing it to the third quarter there were some unusual items which kept our cap lower in the third quarter than it otherwise would have been due to some prior year adjustments as well as couple other items.

Darren Lehrich - Deutsche Bank

Okay. Looking at the first half of the first quarter, are things tracking better for these two programs so far?

Robert A. Lefton

Yes, the cap is down in the beginning part of the year, and again, I caution you that we’ve only got a month worth of results, but January, the cap was down from what it was running in the fourth quarter.

Darren Lehrich - Deutsche Bank

And then a followup here, on the two programs with census over 100 and lower margins, can you give us some detail of what margins would have been without these two programs? Have those issues been fixed yet or are those still ongoing issues in the first half of ’09?

Robert A. Lefton

Yes, it’s two programs; one had to do with consolidation and one management. Both have been addressed. Remember with the consolidation, there are expenses that run through a consolidated site while you’re consolidating to drive the margin down temporarily. So, that’s already been worked through and we will continue to work with that program to improve its margin, but it is up over the fourth quarter numbers that we talked about. As relates to the other program where there was a management change, that has been made and we’re starting to see some movement there.

Darren Lehrich - Deutsche Bank

And then the last question for you on the M&A side; in your current discussions are you seeing other buyers out there, and have prices have come down to more reasonable levels or are you guys going to wait a little bit for those prices to come down?

Robert A. Lefton

Speaking, for example for the Avalon, I believe we were the only ones that they were talking to. So, it’s not a lot of competitive issues. The issue is more getting valuations that make sense for us, making sure that they fit strategically. I think that’s really important to us.

Operator

Your next question comes from the line of Brendan Strong from Barclays Capital.

Brendan Strong - Barclays Capital

I thought that the cost management side looked particularly strong this quarter. If you add back some of that Medicare revenue that you otherwise would get under the stimulus package, it looks like margins will be up around 9%. Is that a good way to think about margins going forward, maybe even higher than that if workers’ comps were to lower?

R. Dirk Allison

Yes, I think we’ve been fairly consistent over the last few months saying that our plan for margin had we not had the reduction in the price increase, we had a 3-year target being able to operate between 10% to 12%. We felt comfortable we would be in that range over that 3- to 5-year timeframe. We lowered that once we had the price decrease to a 9% to 11% range. So, we’re comfortable, obviously, for this year, the way you think about it, adding back the revenue, we would be about 9%, it would be correct.

Brendan Strong - Barclays Capital

Okay. Is there a number that you look at internally, sort of like a pro forma number, that would give us a better sense for your admissions and ADC trends; the same store numbers are very very strong, but I’m just curious if there was some sort of pro forma number that would give us some better color on the overall business.

Robert A. Lefton

You mean in terms what we would expect admissions to grow on a longer-term basis?

Brendan Strong - Barclays Capital

Either that or what results were like in a quarter if you had made adjustments for VistaCare and some of the sites that were consolidated?

Robert A. Lefton

The reason that we have to exclude those is because if you combine sites and you look at it same store view, we don’t want to include the incremental volume as a result of consolidating VistaCare and Odyssey. It gets messy as you try to include that. That’s why we’ve made a decision to exclude it. Frankly, if you had included those consolidated sites, I mean, I don’t see a material difference one way or the other, either up or down, versus the numbers that we posted.

R. Dirk Allison

And Brendan, remember, one of the good things coming right down the pike is that starting in March and obviously it’s not for the full quarter, won’t be till the second quarter, will have solid same store numbers for all of our sites that we can talk to you about.

Brendan Strong - Barclays Capital

Just the last question on the Medicare outlook; clearly a positive that the provision was included in the stimulus package, and how does this debt resolve going forward? I mean, do you need Congress to pass additional legislation? Would you need to work with CMS to try to get them to not implement the wage index cost again in 2010, how do you see that playing out?

Robert A. Lefton

Yes, yes, and yes. Basically it’s a multi-pronged approach. One would be working with the new administrations at the CMS level to try to address the issues that we think, or that the industry thinks, will be caused by continuing to plan to phase it out. So, that would be prong number one. Prong number two would be; as you are probably aware, there is some litigation that the industry has filed that is still progressing, challenging the implementation of the phase out. And three would be legislative strategy as well, should that be appropriate. So, it’s multi-pronged. I will say that I’ve been real pleased over the last year with the way the industry has really come together to work with one voice collectively to try to assure continued access to quality hospice services.

Brendan Strong - Barclays Capital

Just a followup on that again; I know you guys tried legislatively in 2008 to get something passed, and in the end it didn’t seem like you were able to gather enough support, but then you were able to get a lot of support to get that included in the stimulus package. So, is there something there that changed? Any color you can give there would be helpful.

Robert A. Lefton

We’ve always had strong support. People recognize the great value that hospice brings and the way it improves quality of life. So, we’ve always had great support. I think the challenge in 2008 was more of finding a vehicle to get it through; passing standalone legislation is not really feasible and the efforts through the stimulus package was just a different vehicle that allowed it to happen.

Operator

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

Newton Juhng - BB&T Capital Markets

I was just looking for a clarification here. You talked about the $68 million and the $0.12 to $0.16 positive effect that could happen on ’09 numbers. Is that just for the first three quarters of the year because it sounds like the fourth quarter has a lot of lack of clarity or I’m wondering what the assumption was you are making on the fourth quarter at this point?

R. Dirk Allison

It’s the first three quarters, but also the fourth quarter of 2008. That’s retroactives and that hasn’t since it has just occurred, that hasn’t been booked for the fourth quarter of 2008. So, really you are talking about four quarters of benefit; three in ’09 and one in ’08.

Newton Juhng - BB&T Capital Markets

Okay, and expecting to see that in ’09, but no clarity on that fourth quarter of ’09. Then, the other thing that I was just wondering about; there are obviously a lot of budgetary pressures that CMS is feeling right now. I am kind of following up on previous comments, can you just give us some understanding of where you currently see those pressures translating to you; is there a resiliency that you think you can continue to build off what you’ve gotten out of the stimulus package; looking at the 2010 regularly?

Robert A. Lefton

The 2010 is all tied up into this BNF because that would be basically year one of the phase out under the delayed implementation schedule. So, the next three years is really what we’re talking about with these multi-pronged approaches to try to get to our goal, to restore to the full market basket increase, but right now everything is in flux based on the efforts that we’re making.

Newton Juhng - BB&T Capital Markets

Understanding that; I guess I was just thinking about it more in terms of the market basket and obviously that being the offsetting effect and what your costs were, but I guess maybe it’s a little too early to tell; you’ve got a lot of work to do.

R. Dirk Allison

Right now there is a one-year delay in the phase out of that neutrality factor, but the market basket mechanism is still in place.

Operator

Your next question comes from the line of Eric Gommel from Stifel Nicolaus & Company, Inc.

Eric Gommel - Stifel Nicolaus & Company, Inc.

Just a couple of modeling questions; tax rate for ’09, would it be safe to assume the annualized tax rate for 2008 as a go-forward assumption?

R. Dirk Allison

Yes, we believe it will be around 36%.

Eric Gommel - Stifel Nicolaus & Company, Inc.

Okay. Medicare cap in the progression of cap, you talked about it already, but I think last year first quarter you really had no cap liability from a Medicare standpoint, and then prior year’s it has been flat to slightly down; when we think about the modeling going forward, is that the way to think about it? And then it progresses going back into the back half of next year; is there any color you can add there relative to that?

R. Dirk Allison

Yes, if you look at the first quarter of last year, we were at $1 million cap expense. Remember, that was before we had any of VistaCare sites. So, we had a number of months to work on the Odyssey sites and implement some of the strategies that we talked about; IPUs and various other issues. This year, you’re looking at a number that includes all the VistaCare sites that have come over and the programs that they had in cap, and again, those programs are somewhat new as we’re working through consolidation and IPU and other efforts to lower that cap. So, it’s hard to look year over year and get a good feel Eric. We will say generally the first quarter is lower than the fourth quarter, and as Bob mentioned a few minutes ago, we’re seeing, although it’s only a one-month trend so far through January, we’re seeing that in the first quarter.

Operator

Your next question comes from the line of Jeff Englander from Standard & Poor’s.

Jeff Englander - Standard & Poor’s

You guys have done a nice job on the Op expense side, and I’m wondering if you can categorize for us how much of it you think is due to the conversion of the some of the VistaCare programs to your systems, and has maybe reached it’s limit, and how much more you have going forward and other things you can do to continue to drive down cost?

Robert A. Lefton

I don’t think it’s simply a result of the VistaCare piece. Over the last year and a half or two years we’ve really increased our focus on the labor side of the equation through better management tools and focus on it, and we’ve made some big strides in that. I don’t think over the next couple of years in that particular aspect we can continue to make as much big strides that we have. I do believe though that where our opportunity is that because of the increased scale of the company we have some opportunities to really take advantage, and as I mentioned in some of the prepared remarks, we’re going to be looking at some more fundamental changes in just the way we operate. I think it’s too early to say what kind of impact that’ll have, but I do believe there are some opportunities if you look at the resources that we have, the skill that we have to take advantage of that.

Jeff Englander - Standard & Poor’s

Can you give us any sense of some specific things you are considering?

Robert A. Lefton

As I mentioned in the prepared remarks, we’re looking at the DME expense for example, the size that we have, the leverage that we have, the ability to start standardizing some procedures across the platform of how we manage that expense, pharmacy as you might know earlier, I guess it was in the fourth quarter, we negotiated and dropped the VistaCare platform onto Odyssey’s pharmacy system which I think is going to provide some opportunities going forward. The way we use our IT technology, the schedule, the staff, and I think I also mentioned our on-call systems, the way we handle that; I think all of those have the potential, but again, we’re very early in the process and these are some of the things we’ve come to know over the past few years. I do believe that we have good opportunities in those areas.

Operator

At this time there are no further questions in queue. I would now like to turn the call back over to Mr. Lefton, President and Chief Executive Officer, for closing remarks.

Robert A. Lefton

Thank you for attending and we’ll talk to you next quarter.

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Source: Odyssey HealthCare, Inc., Q4 2008 Earnings Call Transcript
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