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Executives

Eric C. Elliott - Vice President of Investor Relations

Keith G. Myers - Co-Founder, Chairman and Chief Executive Officer

Peter J. Roman - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Donald D. Stelly - President and Chief Operating Officer

Analysts

Jonathan Chan

Darren P. Lehrich - Deutsche Bank AG, Research Division

LHC Group (LHCG) Q3 2013 Earnings Call November 7, 2013 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the LHC Group Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Mr. Eric Elliott, Senior Vice President, Investor Relations. Please go ahead.

Eric C. Elliott

Thank you, Jonathan, and welcome, everyone, to LHC Group's earnings conference call for the third quarter ended September 30, 2013. Hopefully, everyone has received a copy of our earnings release. If not, you may obtain a copy along with other key information about LHC Group and the industry on our website at lhcgroup.com. In a moment, we'll hear from Keith Myers, Chief Executive Officer; Don Stelly, President and Chief Operating Officer; and Pete Roman, Chief Financial Officer of LHC Group.

Before that, I would like to remind everyone that statements included in this conference call and in our press release may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include but are not limited to, comments regarding our financial results for 2013 and beyond. Actual results could differ materially from those projected in forward-looking statements because of a number of risk factors and uncertainties, which are discussed in our annual and quarterly SEC filings. LHC Group shall have no obligation to update the information provided on this call to reflect subsequent events.

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

Keith G. Myers

Thank you, Eric, and good morning, everyone. Let me begin by thanking our team of dedicated health care professionals for a job well done. Our ability to consistently deliver high-quality care for the growing number of patients, families and communities we serve is a testament to the collective talent, work ethic and experience of the growing number of health.care professionals who make up our LHC Group family. Thank you for all that you do.

I'd like to begin by providing an update on growth related initiatives beginning with external growth. The number of acquisition opportunities coming to market continues to increase quarter after quarter. After a sluggish 2011 and first half of 2012, the current pipeline trend began in the second half of last year. Clearly, there are significant and growing number of providers who are evaluating our alternatives. Our greatest challenge, as it relates to our ability to close on acquisition opportunities, has been the lack of clarity around future Medicare reimbursement for home health and other post-acute services.

We expect CMS to release its final rule on or before November 27. This year's rule should provide a 4-year window of relative reimbursement clarity. We believe that this will serve to bring buyer and seller expectations more in line and significantly accelerate consolidation in the industry. We worked hard over the past several years to prepare for what we believe will be an unprecedented period of consolidation in the post-acute sector. As a result, we expect the next several years to be strong growth years for our LHC Group family.

Turning now to internal growth, in addition to our constant focus on organic growth within our existing post-acute verticals, we have been paying close attention over the past 18 months to the changing needs and emerging opportunities in communities we serve and in particular, within our growing network of hospital partners and affiliates. While we are best known for being one of the highest quality national home health providers in the country, our collective experience in hospice, community-based services, SNF, IRF and LTAC dates back to the 90s, long before our initial public offering in 2005. Our main focus is clearly on home health and that will always be the cornerstone of our service model in every market we serve. But we have a successful track record of adding additional service offerings into existing markets especially in markets where we have a strong hospital partner.

For example, in 2008 we began a roll out a strategy to grow our hospice volume by offering hospice services in markets where we had a strong home health presence. Since then, we have grown from 9 hospice locations at the end of 2007 with 8 million in annual revenue to 34 hospice locations at approximately $60 million in annual revenue today. The plan is to continue to grow hospice services in certain markets where we have a home health presence. More recently, in response to changing needs and emerging opportunities, we made the decision to move into community-based services. Following a similar path as hospice, this is a service line we've historically provided in a few select markets. Our growth strategy is much the same as hospice. We will grow this business by bringing this additional service offering into existing markets, and anticipate that this, too, eventually will become a service we offer in certain markets where we have other home -- have a home health presence.

In addition to our more global strategy around home health hospice and community-based services, we are working with some of our hospital partners to evaluate a comprehensive post-acute model that would potentially include home health, hospice, community-based services, LTAC, SNF and IRF. Our strategy is to develop the model in a few select markets then determine which other existing markets should be good candidates for such a comprehensive post-acute model or some derivative of such model.

It is clear that health care is transforming in the United States. As most of you know, bundled payments have been proposed in the health care reform debate as a strategy for reducing health care cost. It is our belief that some form of a bundled payment will occur in the future and that hospitals, being the cornerstone of health care in their respective commodities, will likely control or play a significant role in a bundled payment environment. It's long been our belief that community hospitals are the center of health care in communities we serve and we will continue to fill that role -- and will continue to serve that role for the foreseeable future. For this reason, we believe the hospital alignment strategy that has been a key growth driver for our organization over the past 15 years, remains a sound strategy going forward. Our experience in all areas of post-acute services, coupled with our management team experience in the acute care hospital space, positions us well to be a valuable partner to current and future hospital partners and affiliates.

Now, I would like to touch briefly on managed care contracting. At this time, each year, we evaluate and renegotiate contracts with payors. Of the many challenges we face in our business, one of the most frustrating has been the lack of value that some commercial and managed care payors have historically place on home health and other post-acute services. Despite our proven ability to lower overall cost by keeping patients out of more costly inpatient settings, it has been difficult to convince even some of the larger more sophisticated payors to focus on the value proposition we bring to the table. Instead, they've historically tended to purchase home health as a commodity at one low fee-for-service rate for all providers regardless of quality. That being said, I'm very encouraged by the conversations we are having with payors at this time. Rather than the customary back and forth negotiations over fee-for-service rates, we are finally seeing the opportunity to introduce a risk-based performance component. As you would expect, when we're able to do that, we take ourselves out of the commodity position and have the opportunity to bring something unique to the table. Our approach is simple and self-funded for the payor. We provide additional value to payors by lowering their overall cost primarily by keeping patients out of more costly settings. And then when we do, we share in those savings. If we fail to deliver added value then we get the low commodity rate and nothing more.

I'll now turn the call over to Don and Pete, but before doing so, I want to once again commend and thank our dedicated hard-working employees for their commitment to those who have privilege to serve in communities around the country. Pete?

Peter J. Roman

Thanks, Keith and good morning, everyone. For the third quarter of 2013, our consolidated net service revenue was $164.7 million, and net income attributable to LHC Group was $5.3 million or $0.31 per diluted share. Sequestration reduced revenue by approximately $4.1 million in the quarter. For the 9 months ended September 30, 2013, our consolidated net service revenue was $493 million, and net income attributable to LHC Group was $17.4 million or $1.02 per diluted share. Sequestration reduced revenue by approximately $8.5 million over the 9-month period.

Home-based segment revenue in the quarter was $146.9 million an increase of 4.7% as compared to the same period last year. For the 9 months, home-based segment revenue was $435.4 million, an increase of 3.7%. Facility-based segment revenue in the quarter was $17.8 million and $57.6 million for the 9 months, compared to $18.7 million and $55.9 million for the same periods last year respectively.

Our consolidated gross margin was 40.5% of revenue in the September quarter, down from 41.7% last quarter. The reduction is mainly due to an increase in education cost related to the conversion of a few of our largest home health providers to point-of-care. This reduction was expected and was mentioned in our last earnings call. The gross margin reduction, as compared to Q2, was also due to the second quarter gross margin benefit from a cost report settlement in the LTACs of about $600,000.

Our G&A expense as a percent of revenue was 32.2%, down from 32.6% last quarter. Over 2013, we continue to expect gross margins in the range of 41% to 42% and G&A in the range of 32% to 33%. Bad debt expense was 1.6% of revenue in the quarter and 2% year-to-date. The lower bad debt expense in Q3 was due to the reduction of a reserve for some commercial receivables that we now expect to collect but which have been previously fully reserved to some collectible. We expect bad debt to remain around 2% for 2013.

Our tax rate in the third quarter was 41.7%. This higher tax rate is due to the new states that we are now conducting business in that are driving up the effective over all tax rate. Because of the higher tax rates, we now expect our effective tax rate to be in the range of 41% to 42% for all of 2013.

We are reaffirming our full year 2013 guidance issued on August 7th with a net service revenue of $660 million to $670 million, and fully diluted earnings per share in the range of $1.25 to $1.35. This guidance includes the impact of sequestration, as well as the impact on the fourth quarter of 2013 from the proposed rule for Medicare, Home Health Prospective Payment System for 2014. Guidance also includes the announced acquisitions of home health service lines of Addus HomeCare Corp. and AseraCare Home Health. This guidance, however, does not take into account the impact of other future reimbursement changes, if any; future acquisitions or share repurchases, if made; de novo locations, if opened; or future legal expenses, if necessary. We can drill down into these results further in Q&A.

Now, I'm pleased to turn the call over to Don Stelly. Don?

Donald D. Stelly

Thank you, Pete. As Keith mention in his prepared remarks, we have several key initiatives to well position the company for the landscape ahead. Land and operational foundations to carry forth these initiatives requires constant attention to details of today more so than ever. Simply stated, we're staying focused on the task at hand while preparing for what lies ahead. For our team, we have a multitude of those present day tasks so we group them inside of 6 key themes. Themes that were in place during the 3rd quarter or in place today and shall continue into 2014. They are simple and as follows: going to capture efficiencies, leverage G&A cost, daily improve of quality compliance and service, daily increase in penetration in primary and secondary markets, seamless integration of point-of-care, and lastly, investment in our team. And as we host future calls, I will center my updates operationally on these so to earmark both the successes and opportunities inside of each of these. In that light, I'll touch on just a few today.

First, on volumes. In the third quarter, total new home health admissions grew by 10.7% compared to the same period prior year while total organic home health admissions grew by 1%. Growth in new Medicare home health admissions was 14.5% compared to the same period prior year, and organic growth for Medicare home health admissions was 3.7%.

For the 9 months ended September 30, total new home health admissions grew by 13.2% compared to the same period prior year, while total organic home health admissions grew by 3%. Growth in new Medicare home health admissions was 14.5% compared to the same period prior year, and organic growth for Medicare home health admissions was 3.7%. So even though third quarter volumes are usually softer than our yearly run rate, we were pleased with our Medicare organic growth. With regard to the effective commercial admissions on our overall organic growth, there are a couple of factors that I would like to just mention.

First, in select markets, we have stopped admitting patients through the LOA process even if upfront rates appear acceptable, the back office cost to collect on letters of authorization alone can decay our profitability. And when we experienced this with these payors, it's a pretty easy decision to stop admitting from them.

Also, Keith stated earlier that we are continually renegotiating rates with Managed Care. If the payor proposes rates during these negotiations is too low that our other business then must subsidize its lost profitability, we stop that as well. So our strategy is to remain contracted with non-Medicare payors, be part of their net worth but not to do so at our losses.

Moving on to point-of-care. Since our last call, 39 home health and 3 hospice agencies have gone live with point-of-care bringing the total now to just under 200. Specifically, 198 agencies are now up and running. As Pete mentioned a few minutes ago, and as I had alluded to during the last call, we did convert several of our larger agencies in Q3 and as expected, experienced a reduction to their operating margin. What wasn't expected were a few of them to hold that trough margin period for a little longer than we have been experiencing. With that, and with lessons learned, we now see them arriving back to their historical run rate on margin and expect that to improve as we go into Q4 and into 2014. If you have specific questions, I'll be glad to answer them during the Q&A.

And lastly for today, I'll update you briefly on quality. This week we learned that over 60%, our 160 of our LHC Group agencies, are honored as Homecare Elite in 2013, an increase from 134 agencies last year. As we've said before, HomeCare Elite recognizes the top 25% of home health agencies in the country based on quality, quality improvement, admission experience, process measuring implementation and financial performance.

Next, 108 agencies successfully went through joint commission surveys in the third quarter. Achieving accreditation is no easy feat and to do so over a hundred times in just a 3-month period isn't either. To accomplish this clearly demonstrates our ongoing commitment to safeguard patients and also demonstrates the way our team can multitask along the way.

So in closing, we really are proud with what our team accomplished this quarter. Even with so much going on, you, ladies and gentlemen, did a fantastic job, and I thank you.

Before we go to Q&A, I would actually like to turn the call back over to Pete Roman.

Peter J. Roman

Thank you, Don. In January of 2013, we announced that Jeff Kreger had joined our team as Senior Vice President of Finance. Prior to coming to LHC Group, Jeff served as Senior Vice President and Corporate Controller for Sun Healthcare Group, a publicly traded post-acute care company based in Irvine, California. Before that, he held financial leadership positions with Consolidated Graphics, Philip Services and American Habilitation, Incorporated, all of Houston, as well as Sava Senior Care of Atlanta, Georgia. Jeff spent the first 8 years of his career with the Houston office of Ernst & Young. Immediately upon joining our team, Jeff began managing and overseeing all of finance and accounting, financial reporting and forecast and projection functions. He's been responsible for all treasury and cash cycle functions, including managing the relationship with our bank group. Jeff has done a great job and I've enjoyed working with him over our short-time together. Pete, Don and I, along with our Board of Directors, are very pleased to announce that effective January 1, 2014, Jeff will be taking over the position of Chief Financial Officer for the company. I will be retiring. I want to thank our Board of Directors, at who's pleasure I've served as CFO, for their faith and support of my work. I also want to recognize Keith and Don who have been extraordinary partners. I believe we have been a pretty good team. I want to thank the other members of management, my staff and fellow employees, all of whom have provided assistance, support and guidance to me over all these years. Your commitment, dedication and hard work have always been my inspiration, and I have very well-recognized that every success is built on that foundation. Thank you, all. Thanks also to the investment community, the analysts and investors who challenged and questioned our decisions and strategies and helped me develop as a businessman, a financial manager and a communicator.

Jonathan, we're now ready for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Ralph Giacobbe from Credit Suisse.

Jonathan Chan

It's actually Jonathan Chan on for Ralph. I just want to go back to the comments about the, I guess, more diversified and comprehensive post-acute strategy. I guess, clearly, we're seeing more like acquisitions in the space both vertically and horizontally. I just want to get a sense of this, is this strategy a response to the referral sources, to mandate a more diversified offering? And is there a -- and it's a greater move toward capitation, I know you referred to some capitation on the managed care side but is there, I guess, a broader move towards this type of payment?

Keith G. Myers

It's really -- this is Keith. It's -- primarily, I would say in response to the needs being expressed by our hospital partners and affiliates. I mean, that's really 80% of it, let's just say that. I would say the other 20%, just to pick a number, is the response to request from payors in certain markets especially markets where capitation is taking hold.

Jonathan Chan

Got you. And I guess, just a follow-up question on your comments about the risk-based performance opportunities with managed care, I guess, how would these arrangements work? Is it kind of a bundle with other post-acute or acute services? And you mentioned the downside would be just the commodity rate, so is it only upside from here if you were able to implement that type of strategy?

Keith G. Myers

Yes. It's only -- I mean, so, let me take that in 2 parts. So in the immediate contracts that we're negotiating now, to be clear, they're only within the home health space, and there's only upside, no downside. The downside, if you will, would be that we accept a low commodity rate that is at or only slightly above our cost to provide these services. So our opportunity to make double-digit margins on that business comes only if we can outperform the market on key indicators, primarily 30-day ACH rates at this time. In the future, however, we were having discussions about incentives tied around a comprehensive post-acute model and post-acute sub-caps and markets where we have hospital partners participating in capitation. That's something that I believe is probably something we're preparing for now, but contracting wouldn't take place on that until fiscal 2015 at the earliest.

Jonathan Chan

Understood. Okay. And, I guess, just one final question for me, just related to, I guess, some of these initiatives, how does the capital intensity of these new initiatives compare to the more home-based models, which are obviously kind of on the lower end of the spectrum?

Keith G. Myers

Yes. I might let Pete help a little bit with that. But, really, it's not much. We're not -- so, we're not buying any real estate. It's really similar to LTAC space because when we go with SNF and IRF, in most cases, they will just be in leased space within 1 of our hospital partners' facilities, it's much -- it's similar to the way we operate LTAC. Pete, do you want to...

Peter J. Roman

That's a strategy. Normally, when we enter into a lease arrangement, we apply a lot of flexibility so that we can stay very nimble and get in and out. So the commitment that we make is for a much shorter term than maybe a normal business would be. So it's lower risk for us.

Operator

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

Darren P. Lehrich - Deutsche Bank AG, Research Division

Just want to see if you could give us an update on the Addus and AseraCare integration, and how they impacted results in the third quarter. And of those, do you have all your tie-in notices at this point, if you're able to collect from Medicare?

Donald D. Stelly

So, this is Don, I'll take those. On the tie-in notice, we have 3 of them, and actually, part of the cash flow that you will see in the filings were due to the CHOW hang-ups there. As far as for how they're operating, AseraCare was a much smaller deal, and it's on pretty much the exact trajectory that we thought it would be profitability-wise. We've turned it around from a loss leader to be an accretive so we're pleased with that. On Addus, as I said last call, it is ahead. It was ahead of where we had our internal projections. But, candidly, we made the decision to accelerate its conversion away from McKesson so we could sunset that system to homecare -- home-based and our point-of-care model. And honestly, in my prepared comments when I said some of our larger assets held the trough, it really drove that trough down, it stayed at the bottom side of that longer. And honestly, in hindsight, I think if I would've given it another couple of months and let them recover from the actual transition itself, we'd have fared probably a little bit better. Now that's the bad news. The good news is that it's past us now. And so we think that while we did take a little bit of pain, bumped it off of where it was escalating toward, corporate margins and drug it a little bit, that it will now help us going into 2014 more than it would've if we would have in fact delayed it. So in summary, we're still waiting on CHOWs. AseraCare looks like it's doing exactly what we thought. And Addus has a little bit of room to catch up, and we see it doing so in the fourth quarter.

Darren P. Lehrich - Deutsche Bank AG, Research Division

Okay. And then, just 1 more if I could. I just want to see if, like, we can get some color on the hospice business and whether or not you're seeing census being impacted by the recent ruling by CMS to discourage debility and adult failure to thrive as a primary diagnosis starting next year?

Donald D. Stelly

I guess the good news is we didn't have a lot of that to start off with, so it's not hurting us. As a matter of fact, I'm extremely pleased that we just hit the all-time high in our census numbers for our hospice. And as Keith said, we still have a lot of opportunity with that. So it's a good stout organic growth number. The failure to thrive, really, isn't going to hurt us, and we just certainly need to probably penetrate our secondary market more than we have and get it kind of up to equivalent home health secondary market penetration. So, really, up there looks pretty good for us.

Operator

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Keith for any closing remarks.

Donald D. Stelly

Keith, if I could, before you could make closing remarks, I just want to say 2 quick things. One, I'm personally, and we as a management team, are excited about just coming on board. Jeff is experienced, he's knowledgeable and honestly, he's a good guy. But for a long time now, I've sat across from my partner in crime, Peter Roman, and I just want to say that I can't even start to say what he has done for our company, our patients, our employees and our shareholders. It would take a whole lot longer than you have to listen. But what I can say is that so many times in this business, when you hear of a retirement or someone going to pursue other opportunities, we smile with the wonder of what the story behind the story. There is no story and the smile is because him, Sissy and his family are going to enjoy the fruits of a heck of a career. So Pete, I've really enjoyed being your partner. In the long run, we've had some great times and some pretty rough ones. But I've been honored to work with you, and I wish you all the best in your retirement. Maybe if you'll hold a cigar for me, I'll go smoke it with you.

Keith G. Myers

Hear, hear. I'll just jump in on that. And Pete, congratulations, sincerely. In 2004, when you and I started this journey, I couldn't have anticipated all the things that we were going to go through but I can tell you, in all honesty, with no close second, you're the best CFO I've worked with. And the mark you've left on this company is going to be around for a really long time. We owe you a debt of gratitude, and I don't think we can ever repay. We wish you and Sissy and your family all the best, and thank you, my friend, for a job well done.

Donald D. Stelly

Thank you very much. Hear, hear.

Keith G. Myers

Okay. Thank you, everyone, for joining us this morning. And as always, if you have any questions, please feel free to reach out to us and follow up in between calls. Thank you for the supporting our LHC Group family.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

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