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Executives

Lawrence Higby – Chief Executive Officer

Chris Karkenny – Chief Financial Officer and Executive Vice President

Analysts

Darren Lehrich - Deutsche Bank

William Bonello - Wachovia

Brian Tanquilut - Jefferies & Company

Sally Yanchus - Tradewinds

Eric Gommel - Stifel Nicolaus

Kevin Fischbeck - Lehman Brothers

Donald Hooker - UBS

Gary Lieberman - Stanford Group

David MacDonald – SunTrust

Apria Healthcare Group Inc. (AHG) Q4 2007 Earnings Call February 6, 2008 11:15 AM ET

Operator

Welcome to the Apria Healthcare fourth quarter earnings conference call. (Operator Instructions) I would like to turn the call over to Mr. Larry Higby, Chief Executive Officer. Mr. Higby.

Lawrence M. Higby

Thank you, Julie, and good morning, everyone. Welcome to Apria Healthcare’s fourth quarter and year end 2007 earnings conference call. With me this morning is Chris Karkenny, our Chief Financial Officer.

I will lead off by first reviewing our 2007 strategies, the primary accomplishments tied to those strategies, and give you an overview of the current climate in Washington surrounding healthcare.

Chris Karkenny, our Chief Financial Officer will then take you through the detailed fourth quarter and full year 2007 financial performance, and discuss guidance for 2008. As with every other call we’ve had, we start off with this disclaimer.

This conference call may include statements regarding anticipated and future developments that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Results may differ materially as a result of the risk factors included in the company’s filings with the Securities and Exchange Commission and other factors over which the company has no control. We advise listeners to review the risk factors discussed in our press release this morning and other periodic filings we make with the SEC.

For the fourth quarter and full year, we are pleased to report solid results in almost every aspect of our financial performance, from revenue growth to customer satisfaction scores; to revenue management and operating income. The fourth quarter contributed significantly to another solid year of performance.

In the fourth quarter net revenue was $452.7 million, an increase of $61.4 million or 15.7% from the fourth quarter of 2006. Full year revenues increased 7.6% to over $1.6 billion in 2007, compared to $1.5 billion in 2006.

Both of these numbers include Coram, which as you know we acquired on December 3, 2007. Coram results are reflected in our numbers only from the date of the acquisition. Chris will provide you additional color on this in his comments.

Adjusted for Medicare cuts and Coram, the fourth quarter net revenue actually grew 16.4%, and the full year growth would have been 8.5% had Medicare cuts not taken place. In 2007, Medicare cuts were primarily attributable to the change in the maximum rental period for durable medical equipment, and a policy change for respiratory assist devices.

Net income for the fourth quarter of 2007 was $25 million or $0.57 per share diluted, compared to $21.4 million or $0.50 per share for the same period of 2006. Net income for 2007 was $86 million or $1.95 per share, versus $74.3 million or $1.73 per share in 2006. Again, these numbers include Coram.

The year was also one in which we made a major strategic move by announcing and completing our acquisition of Coram in the fourth quarter. Coram is one of the nation’s largest providers of specialty infusion services and widely considered to be the market leader. We believe this transaction transforms Apria Healthcare by diversifying both our therapy and our payor mix, and lessening our reliance on respiratory therapy and government payors.

The Coram acquisition also gives us scale, in that we are expecting to generate more than $2.1 billion in sales this year, and provides us access to new markets and therapies. The transaction moved our combined infusion businesses into the number one position of being the largest provider of home infusion and specialty infusion services capable of serving patients in all 50 States.

As I stated in the start of 2007, our plan consisted of two core strategies. One, improve our organic sales growth; and two, continue to leverage our cost structure. I would like to highlight a few of our specific accomplishments that helped us meet those goals for the year.

First, revenue growth accelerated as the year progressed with especially strong performance in the second half of the year as we had projected. This was primarily due to segregating our sales force targeting infusion and respiratory therapy separately; expanding it by 150 sales people, and increasing our investment in sales training, development, and retention programs.

Today, Apria has over 625 respiratory sales people, and 217 infusion sales people, including Coram.

Second, we continued to improve our productivity in virtually all areas of operations including clinical functions logistics and revenue management. We reduced overtime and increased patients served per day; improved the utilization of our assets in the field; decreased our provision for doubtful accounts as a percentage of revenue, and achieved a company record day sales outstanding or DSOs of 44 for the period ending December 31, 2007, excluding Coram, compared to 49 days for the same period in 2006.

Third, even with increased transaction and sales, we continued to leverage our field infrastructure by applying technology enhancements to our information systems and innovative patient care models.

Fourth, in terms of quality patient care two notable events occurred in 2007. Early in the year we completed our Joint Commission Accreditation triennial survey with over 125 unannounced brand surveys in 70 day period.

As you may recall, accreditation is a mandatory requirement of Medicare competitive bidding by 2009, and the entire Medicare program by 2010.

I am pleased to report that Apria completed its survey in 2007 with outstanding results that translated into a 98% score, making this our 18th full year of an independently accredited homecare provider.

Coram is also a long-term accredited provider. In addition, in 2007 just as in 2006 our patient satisfaction scores, which are measured by an independent third party, continue to increase in both the respiratory and infusion service lines. We support the efforts of the government in making these standards continue to be tight and continuing to raise them.

Let’s turn for a moment to Washington. Our efforts there continue to focus on educating policy makers and legislators about the short and long-term value of homecare, whether the subject was home oxygen therapy, competitive bidding, or the tremendous cost savings potential associated with the much needed modernization of Medicare’s policies for the treatment of obstructive sleep apnea, and coverage policies relating to home infusion therapies.

We built on our efforts of the prior year to create a more open dialogue between the industry and government, using data from respected Washington healthcare policy firms to illustrate the value of the industry’s services.

We submitted written comments on proposed and final rules relating to a number of issues impacted the industry in 2007 and beyond; such as competitive bidding, quality standards, the Deficit Reduction Act, and the payment levels for various oxygen modalities.

These efforts, combined with others in the industry, we believe resulted in a deeper understanding about the benefits of homecare among certain policy makers. Unfortunately the arcane budget scoring process used by the Congressional Budget Office and the Office of Management and Budget, gives staffers and legislators a false sense of the savings that would be achieved were additional cuts to be implemented.

For example, it has come into question whether or not the most recent forward-looking scores associated with the Hill’s December 2007 proposals concerning potential rate cuts to home oxygen therapy, appear not to include the savings that Medicare will realize from either competitive bidding or the Deficit Reduction Act from 2008 forward.

We continue to seek information concerning this from CBO, OMB and the Hill. This inaccurate data potentially gives legislators a false basis for making decisions about life sustaining therapies like oxygen, which is frustrating for those of us who are advocates of ongoing access to this low cost therapy for America’s seniors.

With the announcement of the Medicare competitive bidding winners expected in March and the implementation of competitive bidding just five short months away, not to mention the fact that January 2009 is the go-live date for the associated cap associated with DRA or the Deficit Reduction Act, we believe that it is not responsible for Congress to contemplate additional payment cuts when the effects on patient care from the most profound changes ever to impact the oxygen benefit have not yet been studied or measured.

The savings from any incremental cut would essentially be double counted. Our views by the way of supported by a recent survey of U.S. adults conducted by Harris Interactive on behalf of the American Association for Homecare, which clearly illustrates older American preferences for in-homecare.

The survey concluded that three out of four, almost 75% of Americans, agree with this statement. Homecare is part of the solution to the problem of rapidly increasing Medicare spending for America’s seniors. Americans aged 55 plus, which is demographic group that is expected to turn out in record numbers this year in the vote, are even more likely to agree at 81%.

Finally, on the subject of Medicare policy by now you’ve probably seen the President’s Budget proposal, which was released this past Monday. As in past years the Budget includes the same line item that would reduce the 36 month cap rental period for oxygen mandated by the Deficit Reduction Act to a maximum of 13 months. This has been included for the last three annual Budgets and it’s not likely to be removed.

However, I would like to point out a few things regarding the President’s proposal. As I mentioned earlier we believe the budget savings score does not accurately portray the forthcoming cuts to oxygen that will be associated with competitive bidding and the Deficit Reduction Act.

The 13 month limit was chosen arbitrarily by our recommendation despite the Administration’s knowledge that oxygen differs greatly from DME or durable medical equipment.

With competitive bidding set to begin in 2008, and the oxygen cap in 2009, we believe the Administration and Congress would be unwise to implement another major change at this late date, giving its strong belief that the competitive market forces will reduce oxygen prices to levels that providers can support.

Finally, with the average length of stay for a Medicare oxygen patient approximately 20 months, capping oxygen at any length of time or transferring of oxygen equipment ownership is simply bad healthcare policy and may impact patient care.

As we have said before, we believe this service will continue to be the number one differentiation point in our industry. Our investments in service improvements in technology in 2007 did translate into enhanced growth in customer satisfaction.

We believe we are well positioned for meeting our 2008 performance targets as we continue to fine tune our sales force deployment plans; enhance the overall customer experience; integrate Coram into our organization; and drive additional cost savings initiatives via technology and process improvements.

On that note I’ll turn the call over to Chris Karkenny, our Chief Financial Officer. Chris will review the financial highlights for the quarter and the year, and provide our earnings guidance as well.

Chris A. Karkenny

Thank you, Larry, and good morning. I’d like to begin by discussing the income statement, and then move on to the balance sheet and cash flow statement.

As I go through our results I’ll comment on the consolidated numbers, and will also provide our results excluding Coram. I would like to remind everyone that the acquisition closed on December 3, 2007, and our financials reflect Coram’s results from the date of acquisition except where noted.

Please keep in mind that Coram’s operating and cost structure are slightly different from that of Apria’s overall business and will impact a few of our reporting metrics going forward on a consolidated basis. I will touch upon these further in a moment.

Turing to sales, sales for the fourth quarter 2007 were $453 million, up 15.7% over the fourth quarter 2006. Sequentially, fourth quarter 2007 sales grew 14.2% over the third quarter of 2007.

For the 12 months of 2007, revenues were $1.63 billion, an increase of 7.6% compared to our prior year results. Excluding our recent acquisition of Coram, fourth quarter revenues were $411 million, a 4.9% increase over the fourth quarter of 2006 and 3.6% over the third quarter of 2007.

In addition, full year sales excluding the Coram acquisition were $1.59 billion, a 4.8% increase compared to prior year results. In addition to that, excluding Medicare cuts of $7.3 million and the Coram acquisition, overall revenue grew at 5.3%.

Including Coram, fourth quarter infusion therapy revenues grew 66.9% over the fourth quarter 2006, and 21.6% for the full year. Excluding Coram, infusion therapy revenues grew 8.2% over the fourth quarter of 2006, and 6.3% compared to the full year.

Respiratory therapy revenues grew 5.1% in the fourth quarter 2007, and 5.3% for the full year. Excluding the impact of Medicare cuts, respiratory therapy revenues grew 5.8% for both the fourth quarter and 12 months ending December 31, 2007.

Lastly, in the fourth quarter of 2007, HME and other revenues grew 1.5% sequentially and increased 0.6% for the full year. Excluding the impact of Medicare cuts, HME and other revenues grew 2.2% sequentially in the fourth quarter, and 1.7% for the 12 months ended December 31, 2007.

Now we’re going to turn to gross margins. Gross margin was 64.2% for the fourth quarter of 2007 compared to 65.6% for the fourth quarter of 2006, and 66.2% for the third quarter of 2007. Excluding Coram, gross margin was 66.2% during the fourth quarter of 2007.

For the full year 2007, gross margin was 65.4% compared to 65.6% for the full year 2006. Now excluding Coram, our gross margin was 65.9%. The improvement in Apria’s standalone gross margin for 2007 is due to better asset utilization, increased purchasing efficiencies, and improved formulary management.

I would like to point out that Coram’s lines of business have historically had lower gross margins than Apria’s overall combined gross margin. This is consistent across the infusion industry. Going forward, we expect to see the overall gross margin for the company to decline slightly due to the increase in the infusion revenue from the Coram acquisition.

Now turning to net income and EPS or earnings per share. In the fourth quarter and throughout 2007, we continue to realize ongoing benefits from a number of initiatives designed to drive costs out of the system and improve our bottom line.

Net income for the fourth quarter was $25 million or $0.57 per share on a diluted basis. This is improvement of $0.07 per share over the fourth quarter of 2006. Excluding Coram our net income for the fourth quarter was $24.3 million or $0.55 per share on a fully diluted basis.

Fourth quarter 2007, net income per share on a fully diluted basis included a one-time positive impact of $0.03 resulting from the reduction in tax reserves due to the expiration of certain State statute of limitations. They also included a $0.02 positive impact related to the contribution from the Coram acquisition during the quarter.

It is important to note here that the majority of the integration related costs associated with Coram will be incurred during 2008 and beyond, and as a result Coram’s contribution during the fourth quarter 2007 should not be used as a measure for the full year of 2008.

Excluding the positive impact of certain one-time tax items, net income per share on a fully diluted basis was $0.54 for the fourth quarter of 2007, and $0.48 for the fourth quarter of 2006.

Net income for 2007 was $86 million up from our prior year result of $74.3 million. This is an increase of 15.9%. Full year 2007 earnings per share were $1.95 on a fully diluted basis, and we’re up $0.22 over 2006 full year earnings per share of $1.73.

Excluding Coram, net income was $85.3 million resulting in earnings per share of $1.93. This represents a 14.9% increase over 2006 net income, and a $0.20 increase in earnings per share.

Now turning to earnings before interest taxes depreciation and amortization, EBITDA for the fourth quarter of 2007 was $80.1 million, compared to $74.2 million for the fourth quarter 2006, an increase of 8%. Sequentially, fourth quarter EBITDA increased 13.2% over the third quarter 2007.

Full year 2007, EBITDA was $293 million compared to 2006 EBITDA of $286 million. Excluding the results of Coram, EBITDA was $77.7 million in the fourth quarter of 2007. This is an increase of 4.7% over fourth quarter 2006, and 9.8% higher than the third quarter of 2007.

Now turning to selling, distribution, and administrative expenses. For the fourth quarter 2007, SD&A expenses were 51.9% of revenue compared to 52.5% for the fourth quarter of 2006. Excluding Coram, fourth quarter SD&A expenses as a percent of revenue were 53%.

As expected, labor costs are up slightly due primarily to the additions in our sales force. As Coram becomes a larger percentage of Apria’s overall business, you should expect to see the SD&A ratio trend lower. This is primarily the result of lower cost associated with the distribution system for the infusion business.

Now turning to bad debt expense. Bad debt expense for the fourth quarter was 2.1% of revenues compared to 2.5% for the fourth quarter of 2006. For both the full year 2007 and 2006, bad debt expense was 2.6% of revenue. Now excluding Coram, bad debt expense as a percent of revenues was 2.3% for the fourth quarter 2007, and 2.7% for the full year 2007.

Our continued focus on patient-pay receivables, and increased credit card utilization has resulted a day sales outstanding of 48 days for the year-end versus 49 days a year-ago. Excluding Coram, day sales outstanding were 44 days for the fourth quarter of 2007.

Historically, days sales outstanding for the infusion industry have been higher than Apria’s which of course reflect a blend of infusion, respiratory, and HME days sales outstanding. The addition of Coram from the December 3 date of purchase contributed to the sequential up tick in this metric.

The reason for a slightly higher DSO in the infusion industry is the significantly higher revenue per patient and the fact that prescription medications are usually processed under a major medical or prescription drug benefit, as opposed to a durable medical benefit where the per patient average revenue is much lower, and therefore not subject to as much review by Managed Care payors. The review process simply slows the payment process down more than in RT/HME segment.

Now turning to balance sheet and cash flow. For the year our free cash flow was $165.2 million, which is a 6.4% improvement over 2006. Excluding Coram, free cash flow was $161.3 million compared to $155.3 million for the 12 months ended 2006.

Net purchases of patient service equipment were 5.5% of net revenues this year compared to 6.6% last year. This reduction is a direct result of our success in implementing and monitoring the initiatives designed to improve the management of inventory and capital expenditures.

We also continued to make investments in home transfill oxygen systems and in organization-wide information technology infrastructure that is designed to enable improvements in service, productivity, and access to information.

As it relates to infusion, capital expenditures have historically been lower than those found in the respiratory business. Typical CapEx spend in the infusion industry is associated with leasehold improvements and IT spend.

During the first 11 months of 2007, we paid down $170 million on our revolver. Our debt outstanding as of December 31, 2007 was primarily comprised of $424 million on our revolver and $250 million on our three and three-eighths convertible notes.

At present the outstanding balance on our revolver is $419 million. In addition, you will notice the balance sheet reclassification on our outstanding $250 million three and three-eighths convertible notes.

Due to certain provisions in the indenture, these notes may be put back to us in September 2008, and as a result we have reclassified them as a current liability on our December 31, 2007 balance sheet.

It is our intention to go out for the markets later in the year to refinance a portion of our existing debt. We have a variety of financing options available to us, and we continue to explore the various alternatives.

Turning to Coram. As mentioned previously we completed our acquisition of Coram on December 3 of last year and the integration efforts are well underway. A sampling of progress to-date includes the consolidation of 7 of the 21 overlapping branches; efficiencies gained from purchasing and contracting; and some preliminary systems rationalization.

The total purchase price for the acquisition was $350 million, which we financed using our revolving line of credit.

Now turning to guidance. Based upon recent performance and a strong start to the integration process, management now expects the acquisition of Coram to be neutral to 2008 earnings.

Including the impact of anticipated Medicare reimbursement reductions, and the impact of Coram from the day of acquisition, management estimates that 2008 revenue growth will be in the range of 33% to 35%.

On a pro forma basis reflecting Coram’s full year 2007 results, management estimates that the company’s combined revenue should grow 4.5% to 5.5% in 2008 compared to 2007.

Net income per diluted share for 2008 is estimated to be between $2.04 and $2.14, and free cash flow is anticipated to be in the $95 million to $105 million range. The decrease in projected free cash flow compared to 2007 results is related to the planned investments in home transfill oxygen systems and in IT.

In addition, free cash flow will be impacted by expenditures related to the integration of Coram, as well as the potential cash tax payment related to an anticipated modification of our capital structure.

The guidance for 2008 earnings also reflects costs associated with the investments I just mentioned. While uncertainties surrounding government reimbursements makes it difficult to provide guidance for 2009, the company expects that the combined impacts of the Coram acquisition, organic revenue growth, and cost saving initiatives will mitigate a portion of the anticipated affect of expanded competitive bidding and the implementation of the Deficit Reduction Act.

And with that, I will turn the call back over to Larry.

Lawrence M. Higby

Thank you, Chris, well done. We will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Darren Lehrich - Deutsche Bank.

Darren Lehrich - Deutsche Bank

Good morning. I do have a couple of questions here. The first relates to your guidance for 2008 and what you are saying with regard to Coram. Obviously you are a little bit upbeat about how you started off with the integration, so that’s great.

I am just trying to understand, the swing in terms of your original guidance that it would be dilutive to it being neutral, how much of that is operational related, and how much should we attribute to a lower interest rate environment; just trying to get a sense for how much the reduction in LIBOR has played into this as well? Thanks.

Chris Karkenny

That’s a great question there, Darren. On the first front, on the acquisition, the real change in that, is twofold; one, is the synergies and the integration, we’ve been able to spend a little bit more time validating some of the synergies and finalizing those; that’s the one piece; and then certainly the purchase price allocation which we were able to finalize as well, between those two points, and that enables us to bring it to a neutral for 2008.

Darren Lehrich - Deutsche Bank

Okay. And then, if I could just ask about the capital structure and your debt, can you just update us some on where you are with regard to how much of the credit facility has been swapped and at what LIBOR rate? Just trying to get a feel for your floating rate exposure, obviously with the current rate environment that helps you.

Chris Karkenny

On the credit facility, we have a credit facility which is LIBOR plus 100 for the outstanding revolvers is at that rate; in addition we have $25 million of that swapped.

Darren Lehrich - Deutsche Bank

Okay, that’s great. And then just two housekeeping items: one, your CapEx outlook for 2008 I hear what you have to say about spending moving a little higher just wanted to get a range for that, and then the Medicare part is from backing those rates, it was $3 million in the fourth quarter can you just confirm that please?

Chris Karkenny

The first part on the CapEx, CapEx will tick up a little bit for us as a company. If you look at the CapEx for the full year 2007 we came in at approximately 8%. I think what you will see is that tick up probably closer to 9% on a CapEx basis for the entire company.

And then the second piece on the overall cuts it was $7.3 million for last year and it was $2.8 million for the fourth quarter.

Darren Lehrich - Deutsche Bank

Okay. Thanks very much.

Operator

Your next question comes from the line of William Bonello - Wachovia.

William Bonello - Wachovia

I just want to follow-up a little bit where Darren started on the guidance and thank you for all the color you’ve given. So the change from dilution to no dilution in Coram you said is synergies and purchase price allocation; can you break that out for us? How much of that is that you feel better of the synergies and how much of the $0.08 to $0.10 is simply different assumptions about amortization expense?

Chris Karkenny

Most of that’s related to the synergies and we don’t breakout the specific pieces but most of it’s related to the synergies.

William Bonello - Wachovia

Okay. And is that timing of synergies or is that total synergies that you think?

Chris Karkenny

It’s primarily related to total synergies.

William Bonello - Wachovia

Okay. So, you got in there and just saw more opportunity than you realized?

Chris Karkenny

Yes.

William Bonello - Wachovia

Okay. That part is helpful. And then I just want to sure I understood, you said in your guidance, what does it assume in terms of your having to refinance your debt? You said you will have to go to the market, are you assuming that that is a dilutive transaction; is that incorporated into your guidance or how are your thinking about that?

Chris Karkenny

Yes, it’s included in our guidance. We assume going out later this year for a refinancing. We have a variety of different options available to us Bill.

William Bonello - Wachovia

Okay. But in general, should we assume that those will at least be to some degree dilutive or is that not necessarily the case?

Chris Karkenny

No, it’s included in the guidance, but we are doing refinancing.

William Bonello - Wachovia

I know, I am just trying to separate from the guidance the operating growth versus the impact of refinancing. In other words, if I take Q4 and I just annualize that you’re at $2.08; guidance is $2.04 to $2.14, which is basically not much growth at all in the core business and I am trying to figure out how much of that is operations not growing and how much of that is just an impact of refinancing?

Chris Karkenny

It’s not from the impact of the refinancing. The financing is obviously with the credit markets the way they are. It’s probably more expensive today than it was six months ago but we think its prudent later this year, we will go out to the markets and we have got some assumptions in there that the financing is a little bit more expensive. So, in the mid-year period I would expect us to go out.

William Bonello - Wachovia

Okay. And then just the final question on that line and then just thinking about that growth, is it essentially that the Medicare drug cuts and the continued roll in of the DME cap or are offsetting most of the growth in the respiratory and DME business or is there anything else that’s impacting growth, if we think of Coram as being neutral on a year-over-year basis?

Chris Karkenny

The other piece that you have in there is the RT meds.

William Bonello - Wachovia

Right, the drug cuts and the DME then. Okay, so that’s basically what eats up the growth?

Chris Karkenny

Yes, that eats up a good portion of it there. You have RT meds cuts on a revenue basis, that’s what you’re talking about I would assume?

William Bonello - Wachovia

I mean if you annualize Q4 you would be at $2.08 and you might think the target would be higher than what it was so, I am just trying to figure out what…

Chris Karkenny

What you’re getting out there is really the RT meds cuts. The RT meds are going to be about $10 million to $12 million in revenue that would be cut out that’s included in our guidance, just want to make that very clear. And then there’s some assumptions we have for competitive bidding but as you know we don’t have the final rates back on the 10 MSAs.

Lawrence Higby

I’ll just add in there, that’s our best shot on the RT cuts. You never know exactly what ASP is going to be and we have been surprised before so we took a conservative posture there.

William Bonello - Wachovia

Sure. Okay. I will hop back into the queue. Thanks a million.

Operator

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

David MacDonald – SunTrust

One question on Coram you mentioned system rationalization is one of the synergies. I was wondering if you could tell us, is the legacy Apria business moving to the Coram system or you moving the Coram business to the legacy Apria system?

Lawrence Higby

We are still working through that piece. Both options are workable but we are not sure which option we are going to take yet and we probably won’t know for at least a month.

David MacDonald – SunTrust

Okay. And then Chris just a couple of questions. When we think about 2008, is flattish bad debt as a percentage of revenue good way to think about it with the higher bad debt on the infusion side being offset by what looks like continuingly lower DSOs?

Chris Karkenny

I think when you look at our year-to-date performance of 2.6% the full year 2007. That’s probably a good number. We hope to improve upon that slightly. So 2.5%, 2.6% certainly getting in that range would be a good range for us as we go through this.

David MacDonald – SunTrust

Okay. And then just the only other housekeeping question I had on 20’08, any reason to think the tax rate would be materially different. Is there anything about the acquisition or anything going on at the state level that would change that?

And it also if I’m doing the math right, looks like D&A was down sequentially? Can you give us a sense, a ballpark, what type of D&A we should be expecting for 2008?

Chris Karkenny

Sure so on the first question on tax that’s a great questions, I am glad you brought that up. Our tax rate will start out higher at the beginning of the year we have an estimate of about 39.5% for the full year.

But understand that we do have some State statute expirations at the end of the year so we’ll see a typical trend toward the end of the year that the tax rate will decline slightly. So keep that in mind when building the models.

Then the second piece on the D&A expense, I am sorry, what was that question again?

David MacDonald – SunTrust

Just if I am doing the math right looks like D&A was down sequentially from the third quarter. Two questions: one, if you could just walk me through why that is and then two, if you can give me a sense is that a good run-rate level and what’s a decent full year number to think about for 2008?

Chris Karkenny

On the D&A piece I have a combined number I am looking at from just the SD&A altogether and when you look at that combined number for the full year it was 52.8% I think what we would see next year is that dropping slightly.

In addition, on the depreciation and amortization, the amortization that’s some of the follow-up from prior amortization from acquisitions previously done many years ago. So, that’s why you see that tick down but you will see some changes in the D&A going forward as I had mentioned for the full year SD&A combined you will see that slightly decline.

In the fourth quarter of 2007 it was 51.9%; for the full year as I mentioned it was 52.8% and I think what you will see is that decline down into the 51%, 51.5%, 51.7% range. So under 51.9% for the full year.

David MacDonald – SunTrust

Okay. Thank you.

Operator

Your next question comes from the line of Gary Lieberman - Stanford Group.

Gary Lieberman - Stanford Group

Thanks, good morning. I was hoping you go into little more detail in terms of the decision to increase the spending on transfill and just how you think about it in terms of the higher price for the transfill versus the higher reimbursement rate you get for it?

Lawrence Higby

We think it makes good economic sense particularly in major metropolitan areas where the windshield time is so high for a number of our drivers because the traffic congestion and the cost associated with any kind of delivery activity in those areas. We think that this transfill will provide us a significant offset to that.

In addition to that as you know you get higher reimbursement from Medicare on the transfill product. They are clearly trying to move the industry in that direction and we are taking what we think is a prudent step moving into that product during the year.

It really doesn’t have much of an affect on the P&L during the first year but the second year it should start to have some significant impact if it’s managed right. And I emphasize it has got to be managed appropriately so that you are actually moving in a way that cuts down the time your drivers are spending on the road.

Gary Lieberman - Stanford Group

So, do you have some target in mind in terms of the percentage of your concentrators that you are going to transfill devices by the end of the year?

Lawrence Higby

Not at this point in time but it will be significant.

Gary Lieberman - Stanford Group

Okay. And then just in terms of 2009, I realize it’s difficult given all the uncertainties with the reimbursement changes but versus the 2008 guidance that you gave is your expectation that EPS should be higher in 20’09, the same or will it be down?

Lawrence Higby

I think we are going to stand on that what we said in our press release and what Chris said, I don’t think we are prepared to take any additional comment at this time. We have got a lot of work here to do in 2008.

Gary Lieberman - Stanford Group

Okay, right. Thanks a lot.

Operator

Your next question comes from the line of Donald Hooker - UBS.

Donald Hooker - UBS

Great, good morning everyone. I was wondering if you all could comment on some of the potential changes in sleep apnea reimbursement and how you might think about addressing those changes, particularly referring to the proposal back in December?

Lawrence Higby

The big change that’s going to take place we believe in sleep apnea is the fact that you will be able to do home testing.

Donald Hooker - UBS

Yes.

Lawrence Higby

And Apria already does a sizeable amount of home testing up in the northwest with one of our major payors up there now. So, we understand how to do it; we understand the equipment needs; we understand how to work with the physician on it.

There is, at this point in time a number of people waiting in line even to get into sleep labs, and the evidence was pretty conclusive based on the studies done by CMS that home testing would certainly be an adequate substitute or adequate complementary, maybe would be a better way to say it, testing modality in addition to the sleep lab.

So we would expect that to come out sometime this year and that we will move aggressively in that assuming that the overall reimbursement makes sense.

Donald Hooker - UBS

Okay. Can you give us some color as to where you are now in terms of sleep apnea revenues; how big of a business that is for you?

Lawrence Higby

It’s a business that’s approaching around $300 million, a little bit less. It’s growing quite well in the 7% to 8% range on a real dollar basis and we continue to be the industry leader in that particular segment, probably having somewhere around 20%, 25% market share.

That shouldn’t be surprising to you because if you think about it sleep apnea is a disease that presents itself much earlier in the lifecycle. People who are involved with sleep apnea tend to be Managed Care patients or covered by Managed Care programs, and therefore the disease is really one that we will see moving forward. It really won’t be affected as much by Medicare.

Donald Hooker - UBS

In terms of the supply, is there any kind of constraint to the growth of that market, if home diagnosis is ultimately allowed in terms of simply the supply of devices out there or is there any other bottlenecks that might delay any positive impact from that?

Lawrence Higby

I think the bottleneck will probably be getting the go-ahead from Medicare because I would guess when you get the go ahead from Medicare, you will see a number of other payors in the Managed Care area move into this fairly rapidly.

Donald Hooker - UBS

Okay. And let me ask one quick question, in terms of the CapEx increase in 2008 you mentioned transfill and some one time expenses around Coram; can you break that out between transfill and Coram? Is it mainly transfill?

Chris Karkenny

Predominantly on transfill capital expenditures, yes.

Donald Hooker - UBS

Okay. Thanks, for the questions.

Operator

Your next question comes from the line of Kevin Fischbeck - Lehman Brothers.

Kevin Fischbeck - Lehman Brothers

Thank you. I just wanted to follow-up on some of the first questions about the guidance for 2008; the implications for 2009. Originally you had thought that the Coram acquisition would be $0.08 to $0.12 dilutive and now you are saying neutral, it sounds like you are saying mostly because you have increased your assumptions about the synergies? Does that mean that your guidance for 2009, accretion from Coram of $0.11 to $0.14, also moves up by about $0.10 in 2009?

Chris Karkenny

No, we are not prepared to go into 2009 right now. Right now, we have got the detailed plans for 2008 that we have worked on, and it’s a combination as we mentioned of the increased synergies and also some of the purchase price allocation and the amortizations on that piece.

Kevin Fischbeck - Lehman Brothers

Okay. But, so you are not able to quantify but is it safe to say that it’s above $0.11 to $0.14 if you now found more synergies?

Chris Karkenny

We have no comment on 2009 at this time in regard to that as I mentioned.

Kevin Fischbeck - Lehman Brothers

Okay. And then it sounds like you are really starting to spend some more money on these IT system initiatives that you’ve hinted at in the past regarding collections and revenue management. Does that mean that you better solidified your thoughts about the amount of cost saves and timing of cost saves around these things?

Lawrence Higby

Yes, we think that the cost savings opportunities become more evident. We also think that the requirements of this industry over the next ten or so years are going to mandate that you have electronic capability across the board and have electronic capability in terms of not only billing but also collections, adjudication and this sort of thing. So this is going to be an industry that requires, we think, far more capability in that area.

You’re going to have to be big; you are going to deal with a lot of payors and all that leads us to the feeling that we need to have the kinds of IT systems that will allow us to be successful in that and more importantly be cost effective.

Chris Karkenny

And just a follow-up on that, there’s an earlier question that dovetails into that depreciation and amortization line item. For the full year 2007 it was approximately $134.7 million and we would see that increase in the 2008 period probably in the 150 to 155 range and that’s primarily due to two pieces: one, the increase in the patient service equipment depreciation for growth, and then some of the CapEx that we will be spending in the IT piece in the amortization of that.

Kevin Fischbeck - Lehman Brothers

Okay, and then the last question. You talked about potentially higher cash tax payments due to the change of capital structure; can you provide a little bit more color about that?

Chris Karkenny

Sure, absolutely that’s a great question there too. With our convert, as the way it’s structured we get to take some accelerated depreciation for tax purposes so if we were to either restructure the convert or if they were to put it back to us we would have to pay a cash tax payment for taxes approximately $30 million. All included in our guidance that we have placed out there for the free cash flow.

Kevin Fischbeck - Lehman Brothers

Okay. Thanks.

Operator

(Operator Instructions) The next question comes from Eric Gommel - Stifel Nicolaus.

Eric Gommel - Stifel Nicolaus

Good morning. Just a couple of questions. Your transfill investment, I am curious did you look at any of competitors’ products relative to the Invacare Home Fill product and I am curious as your thoughts as it relates to competitors.

Lawrence Higby

The answer to that question is yes and we continue to look at a wide range of products and we’ll probably use more than one product before we complete our equipment needs of that particular product category. So, we are looking at all of them and we will continue to and we have already tested more than one product and find them to be very satisfactory. But with products the issue is how fast people can supply them.

Eric Gommel - Stifel Nicolaus

Okay. And then just on the infusion business I think you touched on this in your prepared remarks, but Larry can you just talk a little bit about reimbursement stability as it relates to infusion and just review that a little bit?

Lawrence Higby

As you know now Medicare basically does not reimburse for infusion particularly for many of the common infusion drugs. And I would guess that Medicare is going to figure out sooner rather than later that they should be investing in home infusion and reimbursing for home infusion which will double the size of that market.

Right now if you want to be infused you have two choices: quite often you are kept in the hospital for extra series of days primarily to be infused, which is ridiculously expensive and costing Medicare a large amount of money or you must go back into the hospital quite often to be infused on a number of products because it’s the only place you can go.

We think that Medicare is going to do what managed care has been doing for a large number of years here sometime in the near future and begin to understand the cost savings available through home infusion and probably authorize that. We’ve talked to them for a number of times.

Once again this is one of those arcane scoring systems where they can’t score the savings. They can only score the cost. So if you look at it the way any businessman would look at it, it’s a tremendous savings for Medicare and CMS. But if you look at it on the way Washington looks at it at least right now, you don’t get to count the savings versus the cost and the cost of course is simply switching to another venue to have the service provided.

Eric Gommel - Stifel Nicolaus

Okay, great. Thanks.

Operator

Your next question comes from the line of Sally Yanchus - Tradewinds.

Sally Yanchus - Tradewinds

Question on the provision for bad debt: what’s the realistic target for this to settle out at? I mean if you have a target or what do you think a normalized level is and are you seeing any significant changes in the trend for this one way or the other?

Chris Karkenny

Yes, as we mentioned earlier the bad debt for the year was 2.6% and we hope to trend that a little bit lower; we mentioned about 2.5%, 2.6% for the year 2008.

Sally Yanchus - Tradewinds

Do you think that longer term that most likely where it will settle out?

Chris Karkenny

No, we continue to focus on that area and as we have always done quarter-to-quarter we will keep you updated on it. It’s certainly very near and dear to our hearts with regards to bad debt because it’s cash that we can bring in. So it is one of our key focus areas.

Lawrence Higby

Yes, I think that’s the most important point, Sally, is the fact that we continue to make significant efforts against this, significant improvements in terms of our collection techniques and use of credit card. Some of our IS systems are doing a much better job now qualifying patients.

All those things go into keeping that number down and keeping the pressure against it and if you look at our track record over the last two or three years its been pretty good and we are not going to let up on that in any way shape or form.

Sally Yanchus - Tradewinds

Okay and I just one other quarter question. Beyond the Coram acquisition, what other areas of related businesses or home health care could you envision diversifying into or getting involved in in some way? Where do you see the opportunities in this field to continue to reduce reliance on Medicare payments?

Lawrence Higby

We think there are lot of opportunities out there, Sally, that are intriguing in terms of being able to move into the home care setting. But for the immediate future we are going to focus on Coram; that is such a large opportunity.

Particularly when you look at the specialty growth area there that for us to take our eye of that ball would be a mistake. So that’s where we are going to focus most of our efforts here over the next year.

Sally Yanchus - Tradewinds

Okay and can you envision expanding Coram geographically as well?

Lawrence Higby

We already have a national footprint with Coram; when you add in our infusion business to theirs, we are now able to serve people in all 50 states very well and that’s a long way ahead of what any of the nearest competitors can do.

So we think we have got the geographical expansion now; it’s really getting the two companies integrated together. If there is a need, however, because when one of our clients wants some additional service in some area, obviously that’s easy for us to provide.

Sally Yanchus - Tradewinds

Okay, thank you.

Operator

Your next question comes from the line of Brian Tanquilut - Jefferies & Company.

Brian Tanquilut - Jefferies & Company

Thanks. Good morning. Larry you just mentioned the competitive environment or the competition in the infusion space. I’m just wondering if you can give us some color on what you’re seeing now in the competitive landscape for infusion, particularly given that Walgreens bought Option Care; Medco just bought an infusion business; Express Scripts is in it. I’m just wondering what your thoughts are on the competitive landscape.

Lawrence Higby

We think infusion is going to be a very big business over the next several years for several reasons. First of all you’ve got the traditional infusion, which we think will move more into the home setting, and secondly you’ve got the rapidly expanding growth of the specialty area.

Having said that, it’s going to take us a while to get this whole thing swallowed, and performing at the level with the kind of systems and processes and procedures that we really want. So we are not looking for major leaps forward here over the next 12 months. We think we’ve got a lot of internal work to do in that area.

The reason we bought Coram as I think we stated to you on a number of occasions is because it is now the largest independent infusion company. That gives us we think a couple of advantages. First of all we can serve all the PBMs and all clients equally; we are not tied to one company, we are not tied to one PBM.

And secondly with our strong relationships in managed care we think there is a real opportunity to introduce Coram to some of our existing clients. As you know we are the largest provider of managed care in the United States. So over the long haul we think this is going to a big business in a big area.

Right now it’s a matter of getting this thing swallowed and operating and integrated into our overall systems and getting the management team there integrated in the system. Remember they are taking on 20 new Apria branches right now. So there is a lot of work to be done there.

Finally, I just say that as we said in our prior statements, if you look two or three years out here, a large portion of the drugs that are in the pipeline right now, particularly in the cancer area, are going to need to be infused. So, we think there is a significant future there long term once we get this acquisition working the way we think it will.

Brian Tanquilut - Jefferies & Company

So, in other words there are the big PBMs, you are not bumping into them right now?

Lawrence Higby

We serve a lot of the big PBMs and we will continue to do so. I think it’s difficult competitively, and maybe I’m wrong, but if you are associated with one large PBM and the ownership is the same to go to some other payor or somebody else who has another PBM and get as much of a deal with them.

That’s why we thought the independence idea was an important idea here over the long haul.

Brian Tanquilut - Jefferies & Company

I understand. Chris, just a quick question on, we are hearing from the field that manufacturers have started raising prices on some equipment partially because of the China impact, cost of manufacturing in China have gone up for some of these components, that they have put on their products, are you seeing that yet?

Chris Karkenny

Simply, I could just say no; our purchasing department’s doing a great job, and as we have mentioned, I think earlier in the year, last quarter we’ve talked about our gross margin, holding that steady and that was a function of two areas.

One, the contracting group doing a good job with the sales group holding the pricing firm, but also on the second piece on the cost of goods, the purchasing group really working in partnership with our suppliers to understand how we can work together to have better pricing.

So we haven’t seen that pricing pressure, and as we work with our partners on the procurement area, we understand it’s a two way street.

Brian Tanquilut - Jefferies & Company

Got you. Thanks.

Operator

Your next question is a follow-up from William Bonello - Wachovia.

William Bonello – Wachovia

Thanks for taking another question. I just want to revisit a couple of things; on the bad debt expense in your comments around the DSO being higher for the infusion business. Are you basically saying that it takes longer to collect what you’re owed, but you don’t necessarily collect less of it as a percent than you would on the respiratory side?

Chris Karkenny

You’ve got it Bill, that’s exactly right.

William Bonello - Wachovia

Okay. So, not higher bad debt on infusion?

Chris Karkenny

That’s correct. Not higher bad debt on infusion.

William Bonello - Wachovia

Okay, that’s helpful. And then on the home fill side, it seems like part of the value proposition to a provider on the home fill side is that you don’t have to see the patient as often, and are you at all concerned that that would put you at a competitive disadvantage to some of the other providers and/or that it might reduce your value proposition to the payors, particularly the government?

Lawrence Higby

I don’t think that’s going to be a problem. We still will have to stop by on a periodic basis with home fill equipment in the house to either check the equipment or perform routine maintenance. So, I do not think we are going to lose touch with the patient, number one.

Number two, with a lot of our patients we’ve other pieces of equipment in there besides simply a home fill machine.

Number three, if you look at the lifecycle of a patient, they start off using very different equipment than they need as they progress through the disease and you literally can go from a night only concentrator to concentrator full-time which is where you will be using home fill because you have an ambulatory patient to the end of the disease lifecycle probably only needing a concentrator again.

So, we plan on serving our patients as needed, not just to try in and horn in home fill where it doesn’t make sense. Actually what this enables you to do, Bill, if you look at it differently it frees up some of the time we are spending, windshield time, and continue to buy a higher level of service overall.

William Bonello - Wachovia

Okay. And then also on the capital outlay. Would you say 2008 is a temporary boost or does it permanently change your capital outlay going forward?

Chris Karkenny

The highest boost is really in 20’08; we’ll have some trickle out into 2009. But 2008 is really where the spend is going to be in for the capital piece.

William Bonello - Wachovia

Okay. And then it drops back down?

Chris Karkenny

Not all the way down, but it drops down significantly.

William Bonello - Wachovia

Okay. And then I know you are not in the business right now of giving 2009 guidance, but given that you did make some comments about being able to offset the impact of competitive bidding in the DRA, it would seem like you have some estimate of what the impact of those might be, and I’m just curious if you’d venture forth with either of those?

Chris Karkenny

At this point there is a couple of moving parts, we haven’t even received the competitive bids for the first 10 MSAs, and as you know there’s another 70 coming on board in 2009. In addition, there is couple of strategic initiatives that we’re working through, and we have to see how they perform and so there’s a few moving parts right now, and it would be premature to be going into 2009 at this point.

William Bonello - Wachovia

Okay, great. Thank you.

Operator

Your next question is a follow-up from David MacDonald - SunTrust.

David MacDonald - SunTrust

I just had a quick question on the home infusion potential Medicare benefit. My understanding was part of the problem they had as they couldn’t get the cost reports out of the hospitals and couldn’t figure out how much was being allocated tied to that particular service.

Would you expect before a full blown benefit was put in place that we’d see some type of demonstration project or something along that line or just what’s the pathway to get there?

Lawrence Higby

I think there is a number of pathways. First of all there were two bills in the House last year authorizing this, and I think secondly as the savings becomes more clear, the opportunity for CMS to do something will increase. I think there is going to continue to be pressure on the overall CMS Medicare Budget and for that reason I am not sure they’d have to waste much time in a demonstration project.

There has been a demonstration project in this country for the last 20 years called managed care, and it’s proven to be quite successful, and saved managed care a lot of money. So the need to do a demonstration project I think would be probably a little bit of overkill. I think you are going to be able to make the call.

Frankly, anybody who is a doctor already knows that a number of these therapies are delivered in the home setting. And I think the medical community would clearly see that that’s a real opportunity.

The issue is going to be with, once again as it that always is, with specialized groups of people who are trying to hold on to things rather than open up the benefit and probably save money across the board. But, I think that’s going to come to a head some time here in the next couple of years just like we saw sleep testing now finally coming to a head and moving forward.

Finally, we’ve already had one study done that CMS was provided that took diagnosis codes from the Medicare files that we knew required infusions as part of the standard course of a treatment, and looked at those and said what if you were able to ship a certain percentage of those into the home setting.

And I think it was done in over a 1000 cases, and all you had to do was move 2% of the cases out of the hospital and into the home setting and you start saving money. So the evidence is very persuasive. The thing I’ve heard is that’s always been the dilemma on this is the scoring system, which means you’re not allowed the score savings.

But, sooner or later somebody who really cares about healthcare is going to wise up on that, and I think try to move it forward and certainly we’re going to help them as will the National Home Infusion Association.

David MacDonald - SunTrust

And the conversations you’re having, Larry, it sounds like the government understands that this isn’t incremental dollars, they are already paying for this under B, but it’s just moving it to a different setting?

Lawrence Higby

It would be different setting that probably would result in reduced cost.

David MacDonald - SunTrust

Sure.

Lawrence Higby

And certainly easily patients would prefer to do this in a home or an alternative setting. The other alternative setting that would save money versus the doctor’s office would be the ambulatory infusion suites that Coram has and they have over 50 of them now in the country, and with our 500 branch network we’re able to add a lot more of those very easily.

So there’s going to be a way to get this done, whether you want to do it in home or you want to do it in a more private setting then I think will result in two things: cost savings and increased patient satisfaction. And this will happen I think over the next few years and you can’t pull the exact time, but this clearly is the cost savings opportunity the government should not be ignoring.

David MacDonald - SunTrust

Okay. Thank you.

Operator

Our last question is a follow-up question from Darren Lehrich - Deutsche Bank.

Darren Lehrich - Deutsche Bank

Thanks for taking the follow-up. I was just want to go back to Coram and the revenue run rate that we’re seeing in just the month of December. I think when you announced that it was a $500 million revenue business, and it looks like its closer to $550 million at this point.

I just want to make sure I have that right, and if you could just comment on whether there is any new contracts or any new products that have caused the step up in revenue since we last heard from you on this?

Chris Karkenny

And just I’ll let you know that I wouldn’t take that December number and run that through on a trend basis. Last year their revenue in 2007 was approximately $500 million, and there is some seasonality to the infusion business, so certainly the fourth quarter is typically the highest, so I’d take that into account as well.

Darren Lehrich - Deutsche Bank

Okay, that’s helpful. Thanks a lot.

Operator

I am showing no further questions.

Lawrence M. Higby

Thank you, everybody, for joining us today. We are pleased with the year, and we are confident about the future, and we look forward to talking you again in 90 days. Have a good one.

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Source: Apria Healthcare Group Inc. Q4 2007 Earnings Call Transcript
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