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LHC Group, Inc. (NASDAQ:LHCG)

Q4 2008 Earnings Call

March 11, 2009 10:00 am ET

Executives

Keith G. Myers - Chief Executive Officer

John L. Indest - President and Chief Operating Officer

Donald D. Stelly – Senior Vice President of Operations

Peter J. Roman – Senior Vice President and Chief Financial Officer

Eric Elliott - Vice President of Investor Relations

Analysts

Arthur Henderson - Jefferies & Co.

Kevin Ellich - RBC Capital Markets

Ralph Giacobbe - Credit Suisse

Darren Lehrich - Deutsche Bank Securities

Eric Gommel – Stifel Nicolaus

Newton Juhng – BB&T Capital Markets

Sheryl Skolnick – CRT Capital Group

Tony Perkins – First Analysis

Greg Williams – Sidoti

David MacDonald – SunTrust

Operator

Good day and welcome to the LHC Group year end 2008 earnings conference call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Mr. Eric Elliott, Vice President of Investor Relations.

Eric Elliott

Welcome everyone to LHC Group’s 2008 fourth quarter and year end earnings call. In a moment, we’ll hear from Keith Myers, Chief Executive Officer of LHC Group; John Indest, President and Chief Operating Officer; Don Stelly, Senior Vice President of Operations; and Pete Roman, Senior Vice President and Chief Financial Officer.

Before that I’d like to remind everyone that statements included in this conference call may constitute forward-looking statement within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, comments regarding our financial results for 2009 and beyond. Actual results could differ materially from those projected in forward-looking statements because of a number of risk factors and uncertainties which are discussed in our annual and quarterly SEC filings. LHC Group shall have no obligation to update information provided on this call to reflect subsequent events.

Before I turn it over to Keith, I want to point out that in this call we have elected not review all the financial and operational statistics which we have included in a table in our earnings release.

Now I’m pleased to introduce the CEO of LHC Group, Keith Myers.

Keith G. Myers

Good morning, everyone. We are very happy this morning to present another very strong performance from the LHC Group family. Without question, 2008 was a great year for the company. Our management team and caregivers continue to prove that they are truly best of class. During 2008, we added 63 locations in 13 states through acquisitions with combined annual revenue of approximately $73 million. We also opened 20 de novo locations in 8 states during 2008. We ended 2008 with 250 locations in 17 states as compared to 172 locations in 11 states at the end of 2007. Also at the end of 2008 we had 206 home nursing agencies across 17 states serving 656 counties with a population of 45.3 million in which about 14% is over age 65. At the end of 2007 we had 144 home nursing agencies across 11 states.

We have also grown our hospice division; from 9 locations in 2007 to 19 locations at the end of 2008. Our continued ability to deliver a strong return on assets, return on capital, and return on equity was recognized in 2008 when we were named #8 on Forbes 2008 List of Best Small Companies in America, the second year in a row that LHC Group made to top 10.

We saw great improvement in our DSOs in 2008. DSOs improved 22 days in 2008 as compared to 2007. This improvement is a credit to our hardworking staff and the continuing relationship with our consulting partner, Simione Consultants.

During 2008, we made great progress in preparing LHC Group for the future. We made significant investments in quality through our Joint Commission Accreditation strategy and enhancements to our performance improvement team. We also made a significant investment in our revenue cycle department which accounts for our improvements in DSOs.

Throughout the organization we also strengthened the quality and depth of our management team. However, despite our strong 2008 results, at LHC Group we’re always focused on our long-term goals and objectives. Therefore, in 2009 we intend to continue making significant investments in people and technology to become even more efficient and deliver even higher-quality outcomes to every patient we serve. We believe these investments in our future will allow us to provide the highest quality of care to our patients, adapt to the changing reimbursement environment, and continue providing the return on assets, capital, and equity that our shareholders have come to expect.

One of the tools we intend to leverage more in the future is point of care technology. We currently have 23 locations on point of care; in Maryland, Tennessee, and Virginia. These locations are generating financial results comparable to our other non point of care locations and are serving as good beta testing sites for our point of care valuation.

Compared to 5 years ago, when 30% to 40% of home health agencies and only about 5% of hospices utilized point of care technology, today 65% of home health agencies and 30% of hospices utilize point of care. Five years ago, point of care tools did not have predictive to disease management capabilities built in; today, they do. Today, 55% of all Americans already have broadband access at home, up 47% in 2007 according to the July Pew Internet and American Life Project report. The study also found that 38% of rural Americans have broadband at home, an increase of 23% from the previous year.

$7.2 billion of the $787 billion federal stimulus package is set aside to expand the reach of broadband to rural areas. This supports the increasing ability for real-time transfer of information from the field to the office and presents a more compelling quality and efficiency ROI.

I know that many of our shareholders are focused on the proposed budget outline that President Obama unveiled on February 26th. We know that in 2009 we will receive a 2.9% market basket adjustment which will be offset by a 2.75% case creep adjustment to the base rate; the result being that Medicare reimbursement rates in 2009 will be effectively over 2008. In 2010, we know the overall proposed cut in home health is $550 million. At this time the manner in which the $550 million savings will be achieved has not been fully explained by the administration. However, based on the information we know today, we believe we’re well prepared to adapt to the potential 2010 reimbursement changes.

In 2011 and beyond, the proposed cuts in home health reimbursement are more significant. Again, we do not have full details on how those cuts were calculated, but if the proposed budget follows the MedPAC recommendations, it would involve a rebasing of rates by CMS to reflect the average cost for providing care. According to the National Association for Home Care, if the proposal is adopted as is, over 60% of home health agencies in the country would have negative margins in 2011. I think we should all remember that this is just a budget proposal and if history tells us anything we expect there to be many changes in this budget proposal between now and 2011.

It is also worth reiterating that much of the proposed budget appears to be a recitation of this year’s MedPAC recommendations that have not been adopted or endorsed by Congress. Historically, we have seen positive modifications between the MedPAC proposal and what is ultimately adopted. MedPAC remains an advisory body in nature and its recommendations do not carry the force of law. Further, we believe that the home health industry has strong data to counter MedPAC’s inaccurate average margin calculation.

Something else to consider; it’s not clear in the broad outlines of the plan that we’re seeing how Medicaid would be affected. We do know that Medicaid today represents the largest single item in each state’s budget. On average, it accounts for $1 out of every $5 of state budget increasing to 25% or more in some states. Long-term care under Medicare constitutes one of our healthcare system’s greatest challenges. Despite the fact that all states in 2004 or earlier began a program to rebalance Medicaid moving patients from institution of care to community-based care, the burden is now untenable for states who rely on property tax revenues.

Were this proposal to pass in its current form, we believe that it would dramatically shift billions of dollars to state Medicaid programs and what would become an unfunded mandate, it would shift onto the backs of the state the crushing burden of 3.5 million of the sickest Americans suffering from a myriad of chronic diseases. It would be undermining the infrastructure to governance and members of Congress know we need more of rather than less of.

With all that said, as you are aware, this is not the first time that our industry has faced proposed reimbursement changes, and our company has a proven track record with regard to our ability to adapt to changes and reimbursement. First, we will continue to focus our efforts on operations, quality patient care, and internal growth during 2009 and 2010. Second, we will continue implementing and focusing on operational strategies that will build our foundation for the future and allow us to adapt to whatever changes are ultimately adopted.

Johnny and Don will discuss our 2009 operational strategies in a few minutes.

Finally, we will work with the President, Congress, other members of our industry, and the National Association for Home Health and Hospice to develop reimbursement changes that reflect the value and importance of home care, but at the same time reflect the need for this country to improve the quality and efficiency of our national health care system.

2007 data shows that the Medicare program paid $5765 per day for hospital stays, $544 per day for skilled nursing facility stays contrasted with an average cost of approximately $57 per day for home health services based on 2008 data. As over 78 million baby bloomers age, it’s critical that we find ways to lower the cost of accessing health care.

Before leaving this topic of the proposed budget, I wanted to read a quote to you from Senator Blanche Lincoln of Arkansas. This quote was made yesterday during a Senate Finance Committee hearing in which Peter Orszag, the Director of the Office of Management and Budget was answering questions about the proposed home health budget. Senator Lincoln said, “I’ve been a longtime supporter of home health care as an option for seniors. I think it’s cost effective and it’s patient preferred, and it’s been my understanding and certainly witnessing that because of home care more patients are getting rehabilitation services, they’re gaining independence, and they’re staying out of more costly institutional care. How has OMB assessed the impact of these cuts on access to home care especially in rural areas; states like mine that are predominantly rural? We’re getting estimates that 56% of home health agencies in my state will have a negative margin by 2010 and 73% have a negative margin by 2011 if the President’s proposed budget cuts go through. I understand the need to be physically responsible here and tightening our belts; we all have to do that, but is there someway we can ensure that these changes wouldn’t adversely affect patient access or that the policy won’t have the opposite of intended effects with higher cost to Medicare due to beneficiaries that are going to be moving to something more costly.”

I thought this quote was important for everyone to understand that our representatives in Washington understand the value of home care particularly in rural communities and understand that home care is part of the solution.

I received many questions during the past week about our acquisition strategy in light of the proposed reimbursement changes. We do not intend to in anyway discontinue our strategy of growth through appropriately priced acquisitions that yield a strong rate of return. In fact, if history repeats itself we expect for the proposed budget cuts to result in greater acquisition opportunities at lower prices. Obviously, our pricing of acquisitions must take into consideration the proposed 2010 cuts and the unpredictable reimbursement environment beyond 2011.

At this time, we’re in active negotiations with 10 acquisition candidates that have been approved at the senior management level. These 10 current opportunities include 13 existing locations in 7 states and approximately $36 million in annual revenue. With our $75 million unused line of credit, we’re well positioned to finance our acquisition strategy. In this environment, we believe our strong balance sheet is a huge asset for our company and we intend to maintain our strong balance sheet position during 2009 and beyond.

I’ll now turn it over to Pete for a more details review of our financial results.

Peter J. Roman

Our consolidated net service revenue for the December 2008 quarter was $111.5 million, an increase of $30.3 million or 37.3% from the fourth quarter of 2007, and was $383.3 million for the year ended December 31, 2008, an increase of $85.3 million or 28.6% compared with 2007. Net income for the December 2008 quarter was $10.5 million or $0.58 per diluted share. For the year, net income was $30.2 million or $1.69 per diluted share. Revenue for the home-based segment was $96.7 million for the December 2008 quarter, an increase of $28.9 million or 42.6% compared to the same quarter in 2007. For the year, revenue for the home-based segment was $326 million, an increase of $81.9 million or 33.6% as compared with 2007.

Revenue for the home-based segment for the December 2008 quarter consists of $81.1 million in organic revenue and $15.6 million in acquired revenue. For the year, revenue for the home-based segment consists of $289.2 million organic revenue and $36.8 million in acquired revenue.

Revenue for the facilities-based segment for the December 2008 quarter was $14.8 million, an increase of $1.4 million or 10.3% over the same quarter in 2007. For the year, revenue for the facility-based segment was $53.9 million, an increase of $3.3 million or 6.2% compared with 2007. The increase over the prior year in both the December quarter and for the full year is primarily due to an increase in patient days and higher acuity patients being treated in 2008.

Medicare revenue was 83.8% of consolidated net service revenue in the December 2008 quarter and 83.1% for the entire year.

During 2008 we reemphasized cost controls, efficiencies in our mature agencies, and closed monitoring of acquired companies and de novo locations. To do this, we increased the amount of time taken to review the operating results of every business we operate and reviewed them in a more comprehensive manner. The effect of these procedures is evidenced in the financial results. Consolidated gross margin increased 3.2% as a percent of net revenue in the December 2008 quarter over the same quarter 2007. For the year ended December 31, 2008, consolidated gross margin increased 1.9% compared to 2007.

Gross margin for the home-based segment increased 2.2% as a percent of net revenue in the December 2008 quarter over 2007 and increased 0.6% in all of 2008 as compared to all of 2007. The increase in the gross margins for both the quarter and the year is due primarily to a reduction in salaries and its applied expense and extensive revenue. In part, this is caused by the operation reviews I referred to above and in part to improved margins on revenue from acquisitions and de novo locations in 2008 compared to 2007.

For example, the gross margin in the December 2008 quarter was 4.1% higher than 2008 de novo locations and 4.9% higher for 2008 acquisitions than the gross margin contributions to the December 2007 quarter that was made by the 2007 de novo and 2007 acquisition locations.

Beginning in late 2007 and throughout 2008 we invested in our billing and collections process. The investment included additional people, training, and engaging Simione Consultants to manage the billing and collections operations, to assist in collecting older claims, and to help design a department to support a billion dollar company with 500 locations.

Throughout 2008, we added resources to the acquisition department including a senior vice president and increased our transition teams and care management teams as we continued to grow through acquisitions. Including this internal investment consolidated G&A expense decreased as a percent of net revenue for the December 2008 quarter as compared to December 2007 and only increased 20 basis points for the entire year of 2008 compared to 2007.

As a result of the investments in billing and collections and the development of that department, our day sales outstanding or DSO at December 31, 2008, was 51 days. This is down from 73 days at December 31, 2007, and down from 52 days at the end of the third quarter. DSO adjusted for about $600,000 in claims that cannot be billed until approval of the change in ownership is obtained is 50 days at December 31, 2008, compared to 63 days at December 31, 2007, and 49 days at the end of the third quarter.

Our continued strong collection on receivables has also resulted in lower bad debt expense. Consolidated bad dept expense is 1.2% of net revenue in the December 2008 quarter and was 3.1% for the year ended December 31, 2008. Both percentages are lower than the same period in 2007 and have been coming down each quarter during 2008. We expect bad debt expense to be between 2% and 3% of consolidated net revenue in 2009.

Our effective tax rate for the December 2008 quarter was 36.4% as compared to 34.8% in 2007, and 37.9% for the year ended December 31, 2008, as compared to 36.4% in 2007. The increase over last year’s rate relates primarily to the absence of the WOTC employment credits in the current year and increased state income taxes as a result of our growth and expansion into new states. The WOTC tax credits were extended in the fourth quarter of 2008 for businesses in the core Katrina zone, and we expect the tax rate to be 39% throughout 2009.

Cash provided by operations for 2008 was $84.6 million with $25.2 million provided in the December quarter. CapEx which is primarily expenditures on information technology for the year was $8.5 million and was $1.2 million in the December quarter.

During 2008, we acquired existing operations of 11 entities operating a total of 43 agencies and a majority ownership in 13 entities operating a total of 20 agencies. The total purchase price for these acquisitions was $62.6 million including $2 million of acquisition related costs. These investments were funded through operating cash flow and at December 31, 2008, we have nothing drawn on the $75 million line of credit.

Just as we have in 2008, in 2009, we intend to continue making additional internal investments in people and technology. We believe these investments are necessary and will help build a strong foundation for the long-term future of our company. The cost of these investments is reflected in our updated 2009 guidance. We can drill down on these results further during Q&A if anyone desires.

Now I’m very pleased to have Johnny Indest, our Chief Operating Officer, take over to review the details of operations.

John L. Indest

First, I would like to speak about the acquisitions and de novos that were added to our family in 2008. As with any growing company, in many instances our best feature has been the experience that we have gained from the past. This was certainly true as we continue to expand our company. More and more we are fine tuning the integration of new agencies into our model. I would like to complement our business development team, our legal team, transition team, all departments within our home office, our start-up teams, and our operations team. All of these personnel have formed a superior work group and processes that enable us to integrate our new agencies into our company quicker and more efficiently.

Also as is customary in my updates, I would like to update you on our continuing quality initiatives. And this is why I compare from prior reporting periods, July 2007 through June 2008, and we have shown improvement in 10 of 12 outcomes over the last reporting period. This includes improvement in our acute care hospitalization rate, unplanned emergent care rate, and percentage of patients staying home after an episode of care. We are currently meeting or exceeding 5 of 12 national reported outcomes. Without acquisitions, same stores as this time last year, we have shown improvement in 10 of 12 outcomes over the last reporting period and have stayed unchanged in one. It is important to note that we have shown continuous improvement in these home care compare scores over the last 7 reporting periods.

As discussed in our last call, we have been working with Outcome Concept Systems, Inc., the nation’s leading post acute healthcare information company, for independent benchmarking and analysis. The standard outcome index or SOI is an index score developed by OCS that focuses on patient improvement in completed cases of care. It is designed to reflect the overall quality of care through one number. Several clinical and functional measures are included in this calculation including pain, dyspnea, urinary and bowel incontinence, pressure ulcers, surgical wounds, infusion, dressing, bathing, toileting, transferring, and ambulation. Each measure is weighted and the calculation takes into consideration the amount of improvement to augment the more straightforward perspective of improved, stabilized, or decline.

At December 31, 2008, our SOI as calculated by OCS was 1.839 while the national norm was 1.67. Our scores are significantly higher than the industry averages, but more importantly, we’re continuing to improve each quarter and continue to widen the gap between our overall quality scores and the industry mean.

In 2008, our LHC Group interdisciplinary quality council continues its active involvement in all areas of operations. With oversight from this council, we are well into our rollout plan to have all of our home care and hospice locations Joint Commission accredited by the end of 2010. In addition, the council continues to develop our corporate-wide education programs and maintains oversight of our external and internal auditing functions.

2008 also saw the formation of the LHC Group Incorporated Clinical Quality Committee. The committee’s purpose will be to provide oversight to the measuring, disseminating, and improving of clinical practices with the goals of sustaining leadership in and setting best practices for the home care industry. This committee is comprised of both board and non-director members. We could be more pleased with the results of our quality initiatives and we will continue to strive for excellence in this area as we do all things.

I would also like to take time to publicly acknowledge and thank our sales and marketing team. At no time in the history of our company have these areas been as focused as they are now. The leadership of these efforts has made 2008 a banner year for LHC Group. Our divisional sales leaders took the initiative this past year to travel throughout our company conducting small group sales training meetings. I am pleased that I was able to attend a majority of these sessions. I was particularly pleased with the tone and direction of the meetings, which educating referral sources on those Medicare patients that comprised the very backbone of the home care benefit, specifically those in need of teaching and training and observation and assessment.

These patients significantly benefit from our services. These are the patients that are most often forgotten when discharged from an acute care facility or when they leave the physician office. In many cases, these patients are not a highly reimbursed HHRG, but they form the basis for the patient population that we serve. In 2009, I intend to continue working closely with our sales and marketing team to continue growing the top line of our business.

As Keith mentioned in his opening remarks, our operations are well prepared to address the Medicare reimbursement environment in 2009, 2010, and beyond. As we do every year, we will continue to focus on key operational strategies to be certain that we’re providing high-quality care as efficiently as possible and that we are ready to adapt to any future reimbursement changes. As operators we understand that reimbursement will continue to change, and time and again, our management team and clinicians have proven their ability to overcome and prosper during these times of change.

I want to now turn the call over to Don Stelly, Senior Vice President for Operations, to discuss our key operational objectives for 2009. During 2008, Don was instrumental in developing an implementing the strategies that allowed us to successfully adapt to the changes in reimbursement. As I mentioned earlier, Don has done an outstanding job in creating an environment of operational consistency and accountability throughout the organization that will allow us to continue producing strong operational results as we continue our ramping growth.

Donald D. Stelly

Before discussing our 2009 operational objectives, I also want to thank the entire LHC team for their hard work and dedication during the past year. It was the collaborative effort of our home office, sales, and operations team members that truly allowed us to achieve the 2008 successes. This entire team also understands that we must continue to improve as we implement our aggressive growth strategy and adapt to change in political and reimbursement environment. With that in mind, we developed these key operational objectives for 2009 and we intend to focus our efforts on these and other areas in order to achieve our short and long-term objectives.

For this year, we grouped our objectives into broad categories and I’ll briefly touch on a few high points. A primary objective under the category of efficiencies is to leverage our home office overhead; a short statement, but an important objective. Also falling into this category is our use of technology. This relates to both field operations and decision support for management. Our existing relationship with OCS and Simione continues to add tremendous value as we move forward with this strategy.

A third objective classified under the category of efficiency is that of shortening our timeline for what we call operationalizing our acquisitions and de novos. Other objectives fall under our organic growth category. Certainly de novo mapping, market development, and sales initiatives are all grouped here, but we’re also focused on process changes that will support our organic growth efforts. Examples of what I’m talking about include customer service initiatives as well as our intake procedures.

Our final category that I’ll mention is portfolio management. We’re executing strategies geared to improve operations in existing service lines such as hospice, private duty, and labor business, while at the same time we’re keeping the momentum that has yielded consistent predictable operating results from our long-term acute care hospitals.

Throughout 2009 we’ll continue to keep you updated on these and other efforts in regards to these operational objectives, and again, I would like to thank our clinicians and leaders throughout this company because you truly are best of class.

I’ll now turn the call back over to Keith.

Keith G. Myers

Before we open the call up for questions, I want to take this opportunity to reiterate the increase in our guidance which was outlined in our earnings release yesterday afternoon. We’re increasing our guidance for full year 2009 which was initially announced on December 2, 2008. Full year net service revenue is expected to be in the range of $480 million to $500 million as compared to the initial guidance of $450 million to $470 million. Fully diluted earnings per share are expected to be in the range of $2.00 and $2.10 as compared to the initial guidance of $1.90 to $2.00. The increase is primarily due to the acquisitions that we acquired toward the end of the fourth quarter after giving the initial guidance. The guidance does not take into account any future acquisitions or de novo locations, but does take into account the investments in our future that Pete Roman and I have discussed.

At this time operator, we’re ready to open the call up for questions.

Question-And-Answer Session

Operator

(Operator Instructions). We’ll go first to Arthur Henderson - Jefferies & Co.

Arthur Henderson - Jefferies & Co.

A couple of question; first, back on the point of care technology that you talked about in the early part of your script there Keith, you mentioned that 23 locations currently are being used as beta testing sites. It sounds like this year you might start ramping that up a bit more, and if so, how should we think about the CapEx?

Keith G. Myers

I think the ramp up for us in this fiscal year, the effective deployment of additional units, will come in the second half of the year after we complete the testing in these existing locations. If that is successful we’ll have a larger deployment in 2010; those are my early thoughts on it.

Peter J. Roman

As far as CapEx, we’re evaluating this, and so where we are right now is we’ve gotten some preliminary numbers on licensing and equipment. We’re trying to determine how we would deploy that equipment, but nothing is really finalized so we would even look at that for at least another quarter, and I think what has to happen first is we have to be comfortable with these sites that we have on hand right now and then just continue to develop how we’re going to roll this out. I think where we are right now is right there.

Arthur Henderson - Jefferies & Co.

So Pete, in the interim, what shall we use in terms of CapEx; what should our expectations be at the moment?

Peter J. Roman

I don’t think our current run rate is going to be any different in the first quarter.

Arthur Henderson - Jefferies & Co.

That’s fair. Keith, I know you mentioned that statistic about the number of rural Americans that have access to broadband; does that impede your ability to roll out some of this technology in some of your markets?

Keith G. Myers

Rural is a broad term. We actually operate in bedroom communities really outside of metropolitan areas that have a rural designation and there are no access limitations there, but I’m not going to call anyone out here or name any really small towns, but there are some out there where it may be a while before they get point of care technology. So, it’s really market specifics, but we are encouraged by the commitments made by the administration and the dollars that are going to be spent in those areas. So, we do see as the future, and we do believe that every market will be there at some point in the future.

Arthur Henderson - Jefferies & Co.

Last question and I’ll get back in the queue. Obviously the budget is on everyone’s mind. Have we been able to ascertain why it was singled out in the manner that it was; it strikes me that Congress, the quotes that you gave, seems pretty positive on this space and yet certain areas of the administration either can’t see the opportunity or are overlooking something? I’m just curious what you’ve been able to find out in terms of why this particular area was targeted, and then more importantly, at least from my perspective it seems like the National Association of Homecare has failed in many ways in highlighting the value that this space brings to or provides more solutions than it does problems, and I’d love to just get your thoughts on that.

Keith G. Myers

I think I’ll try and answer that and structure that in two parts. First of all, I think it’s important to understand that the efficacy of the home health benefit is not what’s under attack. What it questions is what should the margins be, and the debate is over MedPAC’s margins; are they accurate or not? We believe they’re not accurate because of the way they calculate it. They do not consider all costs. They only consider Medicare cost, and it’s based on cost report data, but there’s an ongoing debate about what are the margins and what should the margins be. So, to sum that up, and you can read the transcript from the hearing we were citing yesterday and the stars actually point to some of that; I won’t read that off here, but they believe that we should be able to tighten our belts as an industry and we should have lower margins that we have today, and that’s where the debate is, and we don’t want to push those margins down so much that it would create an access issue in the industry and push people into more costly settings.

So, I think there’s some truth to both of it, and in our statements we see 2010 as something that would not have a huge impact on us. We believe that we can tighten our belts, and we have some efficiencies that are the low-hanging fruit, if you will. So, that’s what I think about the battle. I think it’s important; some people think it’s an attack on home health.

Now, let’s talk about how this budget got there; my opinion. I think the administration did nothing more than take the MedPAC recommendations, absent any real time to dig into this issue themselves; remember we had no HHS Secretary, there’s really no staff to lead this. In that vacuum, I think they just took MedPAC recommendations and loaded that in. To your comment about the national association maybe falling short; we’d like to see things different too, but I understand the landscape there and I understand their budget, and they stay in defensive posture 100% of the time. They don’t have the opportunity to apply resources proactively. So, one of the things that I’ve been pretty excited about in the last year has been the formation of an alliance of some of the larger home care providers that also includes though the National Association for Homecare and VNAA, all working in concert and the purpose of the alliance is to fund research and proactive initiatives to shape the future of homecare and not concentrate their efforts on reimbursement and short-term defensive posturing.

So, I hear you and I agree that there should have been more done earlier; there’s not much to do about that right now, but we are doing something about the future, and I can already see a difference in the landscape in Washington.

Arthur Henderson - Jefferies & Co.

I appreciate it. That’s very good color.

Operator

We’ll go next to Kevin Ellich - RBC Capital Markets.

Kevin Ellich - RBC Capital Markets

Following up on those comments Keith, you guys know or the industry have a sense as to what cost information the government is using; is it updated information or is it stale data?

Keith G. Myers

My understanding is that it’s 2006 cost report data that MedPAC is using, which is a good point.

Kevin Ellich - RBC Capital Markets

Again, that’s only Medicare; do you think if indeed they do go through and realign the cost in 2011, we could see a new cost survey come out; have you guys picked up any chatter about that?

Keith G. Myers

I have not.

Kevin Ellich - RBC Capital Markets

Hypothetically speaking, if the cuts go unchanged in 2011, I know the last was about a 10% cut; have you guys gone through and calculated how that will impact the business and thought through strategically what you would do to counteract those effects?

Keith G. Myers

No, we haven’t taken that down to a budgeting process for 2011. For one, I think there’s a very low probability that that 2011 budget arrives as it’s presented now; that’s almost never happened in history. So, really our view is that we may be getting to the same end, but we’re constantly focusing on efficiencies here because it’s just the right thing to do regardless of what’s going on in Washington; to be as lean and mean as we can, if you will. The one thing that I do know and I’m quite certain of is when we look at our company five years from now; I think we’re going to be serving a much larger patient population. I see the homecare industry as being much more involved in chronic disease management, and I think there’ll be opportunities for us to serve a larger patient population, but I also think we’re going to see lower margins. I think we’ll make it up in our absolute earnings, but our operating margins I think will come down from where they are today. I think that’s a reasonable expectation.

Kevin Ellich - RBC Capital Markets

I know it’s tough to go on a limb and answer this, but any idea as to what the optimal or where do you think margins over what timeframe?

Keith G. Myers

No, I wouldn’t go there. I think we would all just look at other healthcare providers and look at where their margins settle in over time. I think the good news for us is that at the size and scale we operate at today, there are certain advantages that we have through leverage that will be hard for others to attain, and I think the same holds true in all industries, but what the overall industry margins would settle in, I don’t think I’d want to speculate on that.

Kevin Ellich - RBC Capital Markets

Given the pressures coming from Washington, have you picked up any chatter again or what do you think of the likelihood of getting the 5% rural add-on this year?

Keith G. Myers

I feel like I’ve said I feel good about it about a hundred times, but we can’t find anyone who’s ever opposed to it. It’s always a question of what vehicle does it get in. It was interesting and encouraging for us to hear that mention in Senator Lincoln’s comments yesterday. I’d now just say this; everything I hear continues to be very positive, and Senator Breaux, who’s on our board, who I think you all know is very close to that issues tells me he feels strongly that if a Medicare bill passes that we’re at the table and have a very good chance of getting it in.

Kevin Ellich - RBC Capital Markets

Just had a quick question for Pete; obviously cash flow was strong, you talked about that a little bit, but can you talk about the changes in working capital and what we should expect in 2009?

Peter J. Roman

We’ve been going back and forth on that. I really think that the operating cash flow, it makes a lot of sense to stay at EBITDA. I think what we’ll see in the current year, at year end, are a couple of things. We’ve got a little bit of an increase in payables and accrued expenses. Part of that has to do with just timing of payroll, we had a couple more days accrued at December ’08 versus ’07, so that’s part of it in the growth of the company, but we also had what the Katrina Legislation that was signed in October; they just spent all of the payments on taxes through to January. So, we had about $9 million of accrued income taxes payable also in that number. So, to normalize it I’d take that out at least. The other items in working capital actually are moving pretty nicely. I think the collections and receivables ought to stay right around where it is right now; I still expect it to go down a little bit, and then we manage the accrued liabilities. So, my recommendation would be just stay with EBITDA for the operating cash flow.

Operator

We’ll take our next question from Ralph Giacobbe - Credit Suisse.

Ralph Giacobbe - Credit Suisse

Just given the reimbursement concerns and potential pressure on the home health side, any thoughts of expanding and maybe continuing to diversify whether that be bigger in hospice or LTAC or even some other service line?

Keith G. Myers

I think we were already going there. We talked about the expansion on hospice. One of the things that is very encouraging for us is that we’ve developed a very predictable model in hospice over the past year that’s real comparable to what we’ve had in home health for a long time that raised our confidence level. So, I think we will expand our hospice locations, but not as a result of the legislation. It’s just something that we were going to do. Also, with regard to LTAC; because of the credit crunch we do see some smaller LTAC operators that are facing challenges, specially small one or two shop places that are located in areas where we have significant home health presence, and if those come to market we’d be interested in those. All of the things that we would do are regardless; or what I am saying is there is nothing in us that causes us to want to back away from home health. We believe that scored us and that’s always going to be our biggest presence. What it does is that it causes us to take a harder look right now at pricing and to be much more particular about acquisition.

Ralph Giacobbe - Credit Suisse

Just on the hospice side; I think you went from 9 to 19, any idea of how fast the growth in that area is going to be in 2009?

Keith G. Myers

No, nothing that we have plotted out, and part of the reason is that when we go back and we backfill hospices in areas where we’re already basic in home health and there’s an opportunity in the market, and then when we acquire locations, we try to acquire the hospice with the home health agency if there’s one; a little bit on there, but I don’t think we have specifics on that.

Ralph Giacobbe - Credit Suisse

In the fourth quarter just looking at the margins; a pretty nice spike and I think you’ve talked about better and faster margin capture from the acquisitions you’ve made; is there anything else in the fourth quarter we should consider that caused that little bit of spike and why shouldn’t we assume that you’ll be able to put up similar margins in 2009?

Keith G. Myers

I think you should assume that. What’s happened is throughout 2008 the improvement in margin of acquisitions and de novos had a greater celerity than it had in 2007. I think that trend is going to continue. We made some significant acquisitions right at December, about $40 million in revenue, and in all of the announcements, in all the press releases that we had, we really don’t see them contributing a significant bottom line amount in 2009. I think that may be what you’re trying to reconcile back to. I think our historical operations are going to continue to operate right where we are for 2009.

Ralph Giacobbe - Credit Suisse

The only reason I ask obviously; in 3Q and 4Q I see from the EBITDA margin line, 17.5% margin, 19.5% margin in 4Q; everything below the EBITDA line should be fairly steady and your guidance range is $2.00 to $2.10 on the EPS line; and I struggle to keep the margin just up slightly in 2009 to get to the mid $2 numbers, I wasn’t sure if I was missing something. So you’re saying that you expect continued strength in that EBITDA margin for 2009 similar to what we saw in the third and fourth quarter as opposed to what we saw in the first half of the year.

Keith G. Myers

Yes, that’s exactly what I’m saying, and then you have to factor in that additional $40 million; the acquisition, and then you have to damp it a little bit more for these investments that we’re talking about. We are investing internally and those are really P&L investments; they’re not assets that we’re talking about. They’re infrastructure and development of costs here at home office, and so I think that if you consider all of that it’s pretty easy to get back to the numbers that we’re looking at in our guidance.

Ralph Giacobbe - Credit Suisse

Some of your peers put a focus on specialty programs; can you remind us if you have anything similar. You don’t talk about it much if you do, and if you don’t, do you expect to roll out anything like that in the near term?

John L. Indest

We have disease management programs. As a matter of fact we have 50 plus disease management programs that we have available for care of our patients. To say that we focus on any specialty specific programs; you’re absolutely right. We all are working very hard on establishing a base of patients who fit right into the core of what home health is all about, and those are the patients that have the chronic diseases of congestive heart failure, diabetes, COPD, hypertension; those most prominent diseases that we take care of every day that these patients benefit from the teaching and training, the observation and assessment, etc. Now, is that to say that we don’t have specific programs for rehabilitation services or for Coumadin therapy and other conditions, the answer is no, but I can’t say that we’re going to roll out any great specific program we’re going to focus on totally because I think it basically takes our eyes off of the things that we want to focus on and that’s the care of any geriatric patient who is Medicare reimbursed or semi-Medicare reimbursed and take care of their general needs.

Operator

We’ll go next to Darren Lehrich - Deutsche Bank Securities.

Darren Lehrich - Deutsche Bank Securities

Pete, I just have one specific question about bad debts; for the fourth quarter we saw some improvement on that line. Is there anything, any number, or amount that you’d attribute specifically to the collection of age pay or that is outside the period; just to try to isolate the impact of that on the bad debt number?

Peter J. Roman

Once the 10-K comes out you’re going to see that the balances that are over 240 dropped in half compared to 2007; clearly we had a great emphasis on those older claims on those older claims and getting them in. That definitely had an impact on it. As a third quarter, I thought that bad debt expense is going to be between 1.5% and 2% and it came in at around 1.3% or something like that. So, we were expecting it to come down a little bit. It was actually a little bit better, and in the December quarter, there were weeks in there that we collected 150% of revenue on a monthly run rate; you can’t keep that kind of thing up, but those are the kinds of weeks that drive the calculation of bad debt reserves way down. So, what I think you’re seeing is that as our ageing improves, the ultimate reserve that we calculate and put on the books, the change from the prior period to the current period, results in a lot lower number, a lot lower expense number.

Darren Lehrich - Deutsche Bank Securities

Did I hear you correctly that you’re going to have the revenue cycle infrastructure now for a billion of revenue; is that where you are at this point?

Peter J. Roman

No, I think what you heard me say was that that’s how we evaluate ourselves right now. When we’re putting any kind of system in place, we’re not looking at the current state. We’re really looking at what kind of processes and people and networks do we need to be at a billion dollar revenue run rate.

Darren Lehrich - Deutsche Bank Securities

DSOs; is there any updated target there, if we think about the next year or two?

Peter J. Roman

I like where we’re at and if it turns out that it comes down a little bit, which I fully expect it will come down a little bit, that would be great, but I’ve got no problems staying right in the low 50s; that’s a fine number for us.

Darren Lehrich - Deutsche Bank Securities

Revenue for episodes; I was just hoping to get some commentary from Johnny or Keith on that, we did see a case mix, I believe, declining year over year; I’m just trying to reconcile data; I’m assuming maybe you’ve got some urban mix in there, I’m not sure if you benefit from non-repeat supplies or something like that, but if you could just help me reconcile the growth in revenue for episode again for case mix.

Keith G. Myers

Are you comparing the case mixes from last year to the current year; is that what you’re talking about, because the case mix itself has been growing on a quarterly basis, and it is going up, it’s not going up a great deal, but it is going up, and our revenue per episode is also going up slightly, but if you compare the last year prior to the final rule, that’s not a very good comparison, and clearly our case mix has dropped, I think it was like 1.35 last year and it has dropped down into the 1.28, something like that, and that was all expected, that was what the final rule was meant to do. To try to answer your question, we manage that process as best as we can, but the fact of the matter is that’s generated by the patients that you get and the treatment that you provide those patients. So, what you’re looking at is really a result of the marketing efforts that Johnny talked about, of the patients that we have on hand right now; ultimately the effect of the final rule.

Darren Lehrich - Deutsche Bank Securities

My last question here as it relates to the regulatory side as opposed to the legislative that we’ve spent a lot of time on the call. Just in terms of the OIG work plan, one of your competitors made a comment that their internal audit process is focused a little bit more on physician relationships. I’m just wondering if you can give us some commentary about whether you are seeing the DFIs, additional review processes around that, or whether you think that’s an area of regulatory concern that we ought to be thinking about, and then from an operational standpoint, can you give us a sense for how much of your admissions are coming directly from physician referrals as opposed to hospital-based discharges.

Keith G. Myers

As far as physician referrals and the relationships with physicians being a compliant issue, that’s really old news in homecare. That’s always been the case, and as part of our compliance program, we monitor everything about conversations and relationships with physicians in great detail, and we’ve always have. I think that’s an important part of any homecare provider’s corporate compliance plan, but generally speaking about compliance, I think we can read the tea leaves and know that there will be more emphasis on compliance in the future, and so when we talk about investments in infrastructures, one of the areas that we will be also investing in is our compliance metrics to the point of bring in some of the best compliance experts in the country to review what we believe are solid processes in all, but to take another look and to see what we can do to add to that, always with the goal of being absolute best of class in compliance just as we are in everything else. So I think we hear the chatter, and we know and believe that there will be a greater focus on compliance. I wouldn’t say that I agree with that position, but it’s not our company anyway because it’s always been very much a top of mind issue for us.

Operator

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

Eric Gommel – Stifel Nicolaus

Before the budget proposal came out, there was some talk about concerns about a JAO report, I think, due out of Grassley’s office. Do we have an update as to the timing of that and any idea what might be in that report?

Keith Myers

I don’t have any knowledge of that other than what’s out there that everyone knows. They know that is something that is supposed to be coming out. I don’t think anybody expects it to be a favorable report. I haven’t heard of anyone in the homecare industry that’s excited about the report coming out that’s going to be very complementary.

Eric Gommel – Stifel Nicolaus

This may not be that important given the budget stuff that’s out there. I just wanted to change gears and maybe talk a little bit more about the LTAC business. It seems the acuity on the LTAC is growing, but maybe it’s a little less than one of the public companies out there. I’m interested in whether or not now given that you are potentially going to invest more dollars or maybe invest more time into that business to drive higher acuity or is it really just a matter of continuing to operate this business segment as you have in the past, just promote the profitability of the existing operations, just run it, blocking and tackling? It sounds like this might be area that you are going increase more effort on, and I would like to get some color on that.

Don Stelly

You are absolutely right that our case mix inside of the LTAC has been consistent, extremely consistent throughout 2008, and it is the blocking and the tackling and keeping the momentum and the margins there, and I don’t think we are going to see any severe change in the seven that we have. Remember that only two of those hospitals right now are in other than rural markets, so our ventilator patients and some of the higher acuity room patients truly reside there, and I think if you look at our percent occupancy, quite candidly, we don’t have a lot of room to change that dynamic. Turning the attention toward any future, number one, it would be anticipatory to say where they would be if they do come, but secondarily, you can assume that in those bigger markets you would have a bigger draw and a different patient population to draw from, so theoretically those could possibly have a higher case mix, but again that’s just something we don’t know right now, and if you look at the margins that we’ve sustained in the last 18 months, we are very proud of where these things are, and to truly keep them where they are is a win for us going forward in the next couple of years.

Eric Gommel – Stifel Nicolaus

So, you are not really investing additional funds or making big CapEx changes or anything with these units. You’re just running the existing shifts as you have been over the past few years.

Keith Myers

That’s absolutely fair to say in the existing same store LTAC. Now if we do come upon one, certainly there may be CapEx needs, but we don’t know that.

Operator

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

Newton Juhng – BB&T Capital Markets

I did have a followup on just on the LTAC side. Do you have generally what the occupancy rate is in those facilities at this point and where it’s been trending as of late?

Don Stelly

It’s around 85% and has been almost 2 years.

Newton Juhng – BB&T Capital Markets

So running at a very high efficiency level there. In the past I have talked to you guys about potential for selling that business. You said that you didn’t really want to do it, that corporate overhead is shared amongst these two businesses and so on, but considering the fat that your margins are getting looked at very closely by powers that be and so on, is there any chance that you might be willing to sell that piece off in order to try and rebase where your margin profile is coming from these days?

Don Stelly

No. Our position hadn’t changed at all Newton. Again, it’s so much more than that. In the communities where we operate these LTACs, there are communities where we’re very basic in home health and hospice, and they are woven into the fabric of who LHC Group is in those communities. It’s the same patients, same referral sources.

Newton Juhng – BB&T Capital Markets

The case mix on the home health side was brought up earlier, and I was just curious as to how we should look at that. Obviously the last couple of quarters or three quarters have been trending northward trying to get back to the level that you’d seen prior to the reimbursement changes. I’m just kind of curious as we move into 2009 and beyond that, should we continue to see that trending upward as a function of just the patient acuity?

Keith Myers

I’ll let John and Don get in on that in a minute, but the one thing that you said, you said that we had a goal of getting back to where we were pre-cut, and that’s not a goal because the effect of the final rule, the intention was to bring those down, so if you had the same patients, there is really nothing we can do differently to move that number northward, so we don’t have that goal. I wanted to be clear on that. Now, whether or not it will continue to go up, Don?

Don Stelly

I think Pete alluded to it at one point to aid case mix, and we can expect that to continue. That is extremely reflective of the diverse patient population we have, and our strategy as Johnny mentioned didn’t change to target any different base any differently, so I think you are accurate in saying that we can expect exactly what you see today.

Newton Juhng – BB&T Capital Markets

So continuation of that level, I was just thinking that with increased use of disease management program is trying to pick up more of the chronically ill that that might actually cause it creep upward a little just as a function of dealing with sicker patients, but I guess you are saying for right now just keep it at a flat line level.

John Indest

Looking at those patients, that’s the reason why it’s going to stay flat. Just because you are targeting and it’s really not targeting, caring for a more chronic population does not increase your case mix. Increasing case mix goes more towards specialty programs and etc., and I think it would be wise to look at us as pretty flat.

Newton Juhng – BB&T Capital Markets

Johnny, obviously I appreciate the fact that you are operational data came in here this quarter and the release, that was really helpful. I do have a few more questions for Pete, but I think I’m going to take those offline.

Operator

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

Sheryl Skolnick – CRT Capital Group

I need to go back to this question of margins and what you said about the Medicare budget proposals as well as the Medicare cost report data and the MedPAC margin recommendations, and I don’t know how to ask this question any other way, so forgive me if this is not politically correct or polite, but you’re generating very high margins in your business. If I calculated the operating income from home-based services at 18.6% in this quarter, I think that would be the right number, it’s certainly a mid-teens number, so if you’re that high all costs are in, what would you be on a Medicare cost report basis, and doesn’t that make you very vulnerable?

Keith Myers

When I was talking about MedPAC margins, I was talking about industry margins, not our margins. Obviously, we’re operating at a higher margin than the smaller operators, but I was really talking about the industry margins all in.

Sheryl Skolnick – CRT Capital Group

So, then they’re going to have to argue that their margins look a lot more like your margins, or that their margins look even worse relative your margin when you put all the costs in and that’s why they’re the ones who are going to go out of business, if this proposed law is enacted.

Keith Myers

Yes, exactly. Remember that as far as LHC Group, we represent only 1% of the industry, and I think public companies altogether are about 8%, but because of our scale, we have certain efficiencies not available to them, but still the vast majority of providers are just small one or two shop operators.

Sheryl Skolnick – CRT Capital Group

I understand that. I would be feeling very vulnerable reporting numbers like this in advance of a discussion about Medicare reimbursement for home health, because be it as it may, we don’t see and I don’t think Washington actually sees in a public forum searchable on Google margins for the home health agencies that are not publicly traded companies, so it puts you and the others in an interesting almost leadership kind of position to have to justify why the rest of the industry shouldn’t be cut when your margins are so much higher. My question, if there is a question here, is how do you deal with that, one, and two, is there any data that you can use to support the contention, no, I’m going to back away from that because you’re conceded the point that your margins are going to come down, but doesn’t it put you in a somewhat difficult position here to go forward and lobby when you’re just so profitable?

Keith Myers

No. It depends on what you’re lobbying for. When I’m asked about margins and the industry margins and can we afford to tighten belts in the industry, my answer is yes. Obviously, I look at our margins, and I know that those can come down when we compare to other sectors, and I expect them to in the future. The question is how far can they come down. In 2011, if 60% of the providers in the country had negative margins, we couldn’t consolidate all of that that quickly, and you’d have an access to care issue, with the result being the institutionalization of people at higher costs, so I think when the debate is finished, the right answer is going to be somewhere in the middle.

Sheryl Skolnick – CRT Capital Group

Peter, thank you very much for clearing up those timing differences on the cash flows, so I don’t have to be a nag and ask those same questions over and over again because it does disturb me when I see 85 versus 12 and then I see roughly $30 million of the delta being pretty obviously timing differences, but fortunate ones because you were able to generate that much to buy your acquisitions, which leads me to my next question, which is you have made very significant acquisitions, and you said they are more accretive in the nature of margin improvement than you thought, but it also results in a pretty big buildup of minority interest and a pretty big buildup of goodwill on your balance sheet. I guess in this environment, isn’t that a little bit troubling? You don’t own all the cash flow, and when we think about cash flow operations, shouldn’t we be looking at EBITDA less minority interest or the cash portion thereof?

Peter J. Roman

You always come up with an awful lot of questions, and I’ll try to get those in order. I think you’re correct. I think that if you’re looking at operating cash flow from a real sense, then you have to consider the minority interest distribution. You have to do that, but when I was speaking earlier, I was actually going just right off the capital statement, and it’s below that. If you were trying to model the company’s cash flow and determine how much would be available to the company from operating profits, then yes, you’d have to distribute the minority interest component.

Sheryl Skolnick – CRT Capital Group

Right, because the rest of it is down in the financing activities.

Peter J. Roman

That’s right. So talking about goodwill and minority interest, one of the ways that we’ve developed and gotten to this point is to enter into joint ventures, and it’s been a very successful strategy for us, although when you look at the total cash flow of the operation on a 100% basis versus a minority interest basis, it looks like you’re getting something a little bit less. There is a great deal of intangible benefits associated with that. When we move into a geographic area that has a significant hospital in that area and we partner with that hospital, we have the hospital’s name and the goodwill that is associated with it. I think that’s all a benefit to us. In general, those home health are not operated very efficienty, so we can go in and we can turn them around pretty quickly. We have great relationships with our JV partners, in that they like us to come in there and partner up with them, so if you think of it in terms of a partnership as opposed to a joint venture, I think you end up a little bit closer to what the reality is with us.

On the goodwill side, I think we’re conservative about the way we go out and develop our companies. We don’t necessarily pay highest dollar. We don’t get into a lot of bidding wars. If it’s brokered deal, chances are we’re not going to be in there. I think Keith said it almost every call that I’ve been involved in, and what that does is it damps down the goodwill that goes on your balance sheet and puts it into a little bit more realistic basis. If you look at the equity or the tangible net worth that we have, we’re in excellent shape right now. We clear our debt covenants significantly every quarter when we put that together, so I mean from where I stand, I think our strategies have been successful, and I don’t think with that we’ve a high risk of the goodwill that’s sitting on our balance sheet right now because of some disciplines acquisition strategies that we’ve applied in the past.

Sheryl Skolnick – CRT Capital Group

Did you give out average episodes per admission? I’m not sure I can calculate it actually from the operating statistics because I’d be afraid that I would make a mistake there. I have completed episodes, but I don’t have total episodes.

Peter J. Roman

I think it’s going to be somewhere around 1.6.

Sheryl Skolnick – CRT Capital Group

That’s reasonable. The other thing that I wanted to try to go back and clean up is this. We’ve talked a lot about the home health piece, I assume $37 billion mentioned in the Obama budget. We’ve not talked about bundling. Is it your expectation that as part of their post-acute bundling proposal, which looks like they’ve ran their fingers down the CBO list of options and said I like that one, so if you look at that bundling one, do you expect that home health would be considered part of that 30-day bundle payment?

Keith Myers

Reading from Mr. Orszag’s comments yesterday, they’re specifically targeting the 18% of Medicare beneficiaries that are readmitted within 30 days, and so I think they’re trying to bundle all post-acute expenditures for those patients in that first 30 days. Whether or not they can get that done, that’s what I think they’re trying to do.

Sheryl Skolnick – CRT Capital Group

Have you resolved most of your issues with your managed care customers and are you now continuing to recontract with them?

Keith Myers

We are. I took that one on last year, headed it up and everyone’s involved, but I couldn’t be happier with where we are with that right now. Not only because we’ve cleaned it up and we have acceptable rates from those who we’re contracting with, but because we were successful in educating them as to the value proposition that we deliver, so that they’re contracting with us for the right reason because we deliver value, not because of any type of outside pressure. So, we’re happy with that, and we’re continuing to make progress.

Operator

Your next question comes from the line of Tony Perkins of First Analysis.

Tony Perkins – First Analysis

Keith, can you give us your thoughts on the market basket update? Is this an either/ or market basket update or the rural add-on, or do you see there possibility for both?

Keith Myers

I think they’re mutually exclusive, but the market basket update I don’t think any reasonable person would you we should expect the market basket update, so I don’t think it’s an either/or. I just think the signs are that we’re not going to get that update, and maybe the best can hope for is flat reimbursement overall, but the rural add-on does have real traction because the numbers support it. The disparity in payments between rural patients and urban patients is much greater than that 5%, and everyone is aware of that.

Tony Perkins – First Analysis

The organic growth of Medicare completed episodes for Q4, was 28.6%; yet, the organic growth for Medicare net revenue grew only 22.5%. Can you explain that 6-point difference?

Peter J. Roman

Can we take that one offline also? Let’s do that and we can explain that.

Operator

Your next question comes from the line of Greg Williams of Sidoti.

Greg Williams – Sidoti

I wanted to continue the dialogue of the solid operating margins you had in the fourth quarter and EBITDA margins and what we’re looking at going forward. I know you said that you’ve made $40 million in revenues since December, but you also mentioned internal investments, and I think you gave an example of compliance being one. Can you give more detail as to what sort of internal investments or infrastructure that would affect your P&L and why we should be really excited about the margin going forward based on the fourth quarter run rate?

John L. Indest

I’ll give a little bit of color to it, but I think that you have to look at the way the company performed in 2008, and part of the operating results was damped by additional costs that we incurred for consulting fees and additional people and growth of start-up teams and internal investment associated with future revenue. To tell you, these are the things that we believe that we’re going to do in 2009, and this is what the costs are associated with all those things. I can give you what I said, and that is that we continue to invest in our company in our internal systems, general and administrative costs as if it was an asset, and I think you have to look at the benefits that the company has had at the end of 2008 versus the end of 2007 and see the return on that investment. I don’t think it’s something that we can go forward and say this is what’s going to happen next year, but that is how the company invests, and that’s what we think is the appropriate building of shareholder value for us.

Now, if you look at the $40 million revenue number and you adjust that back out of the guidance as having no net income effect, that’s about half of the difference between the current quarter run rate and what our guidance is. The other half is this internal investment that I’m talking about. I think Keith talked about compliance. There’s some compliance in there. I think that we’re still continuing to develop our internal systems, so I just don’t think that any additional color will get you any closer to what you’re trying to look for. It’s a philosophy that the company has of investing through P&L.

Greg Williams – Sidoti

Switching gears and talking about the acquisition pipeline, with everything going on in the last few weeks and so many unknowns and multiple contractions happening in the public and I imagine private companies as well, how does that change your pipeline? Are you slowing down until more is known, or are you seeing opportunities to take advantage of the multiple contractions? How can we look at that?

Keith Myers

The very first we thing we did was to factor in the impact that the budget would have as proposed on valuations, and as you would imagine, it had a significant impact, so as we talk to potential candidates, we test their expectations, and we let them know where we see pricing now. So early on, we determine if they are up to speed and realistic about their expectations given the uncertainty now or not, and what we’ve found I guess so far, and it’s early on, but probably 50% of those who were active in the pipeline knew about the budget, they understood that adjustment had to be made, and we’re still moving forward at a significantly reduced price where from our initial discussions began prior to the budget being released. So I think short term it will have some impact. There’s no question because I think it takes a while for sellers’ expectations to catch up with reality, but we’re under no pressure to make acquisitions that are not at the right price given where we now. We can pull the no-holds off the shelf and focus on other areas. To sum that up, I’ll just tell you, if we make acquisitions, they’re going to be made at the right pricing in today’s environment.

Greg Williams – Sidoti

Right pricing as in reflecting the latest budget cut proposals?

Keith Myers

Absolutely. To be specific, when we calculate the IRR thresholds that we have to have, we pro forma out five years, and when we pro forma out five years, we’re pro forma’ing those cuts in to play just as they’re proposed.

Operator

Your next question comes from the line of David MacDonald with SunTrust.

David MacDonald – SunTrust

Should we expect nothing on the acquisition side that’s overly material, until you get some visibility on what 2011 looks like since it looks like that’s the cut that could be much more material if they rebase? My question is how difficult is it to price when the real reimbursement ugliness could be 18 months down the road? Just a little color there, and then in the same vein, should we expect an acceleration in de novo development given some of the lack of visibility on the reimbursement side?

Keith Myers

You’re exactly on the larger acquisitions. Following this company, you know that we don’t roll the dice very much, and this is not an environment where you want to do that, so I think our sweet spot has been just smaller acquisitions that have a smaller revenue base with significant potential for upside that we can build without a lot of risk going in, and I think that’s where you’ll see our focus is. I don’t see anything material coming through the pipeline nor would I expect anything short term in there, but to the de novo strategy, you’re absolutely right there too. Through all of the acquisitions we’re done in the shelf if you will of de novo opportunities that we have, that’s the reason why we do that. When we get into times like these where the pipeline could shrink somewhat, we can keep our transition team busy and focused on accelerating our de novo development. Don, do you wan to add a little bit there?

Donald D. Stelly

David, that’s a real good question, and Keith has traditionally talked about how many de novos we’ve had on the shelf, and as you can tell, we’ve opened about 20 of them over the last couple of years each year, and I alluded to de novo mapping and this is exactly what I was talking about. We’ve already mapped out 102 locations that we could agencies in, and we’ve really done a good job of refining the criteria and associating their profitability, but with that I would caution and I wouldn’t want you to build in any tremendous acceleration in these next 6 months because as Pete alluded there are also infrastructural changes that we’re doing, process development, but I know that we’re going to accelerate that pace in the last quarter of this year.

David MacDonald – SunTrust

Are you guys seeing any delays at all in terms of getting de novos approved?

Donald D. Stelly

Yes. As a matter of fact, we’ve opened 38 from January ‘07 to ’08 and 14 is still pending approval, so yes, it ranges, with some as quick as three months and some 13 months, so it varies.

Operator

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

Whit Mayo – Robert Baird

I think 90 minutes is long enough for a conference call. I’ll follow up with Pete after the call.

Operator

With no further question, I’d like to turn the conference back over to Mr. Keith Myers for any additional or closing remarks.

Keith Myers

As always, in closing, we want to thank our shareholders and our employees. We can’t say thank you enough for the confidence and support that you have in the company. We know that we have to continue to earn that every day. On behalf of all of us here at LHC Group, thank you for taking the time to listen in and participate in our call this morning, and as always, we’re available to answer any questions that may come up between our quarterly earnings calls. Thank you for supporting and believe in the LHC Group family.

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Source: LHC Group, Inc. Q4 2008 Earnings Call Transcript
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