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CHEMED Corporation (NYSE:CHE)

Q1 2008 Earnings Call

April 25, 2008 10:00 am ET

Executives

Kevin J. McNamara- Chief Executive Officer, President

Spencer S. Lee- Executive Vice President, Chairman of Roto-Rooter Inc. and Chief Executive Officer of Roto-Rooter, Inc.

David P. Williams- Chief Financial Officer and Executive Vice President

Timothy O’Toole- Executive Vice President, Director, and Chief Executive Officer of Vistas

Arthur V. Tucker, Jr. - Principal Accounting Officer, VP and Controller

Analysts

Kemp Dolliver- Cowen and Company

Eric Gommel- Stifel Nicolaus & Company, Inc.

Darren Lehrich- Deutsch Bank Securities

Jim Barrett- C.L. King & Associates, Inc.

Dawn Brock- J.P. Morgan

Paul Kleinschmidt- Argus Research Co.

Frank Morgan- Jefferies & Co.

Michael Wiederhorn- Oppenheimer & Co.

Operator

Good morning ladies and gentlemen, and welcome to the CHEMED Corporation first quarter 2008 conference call. My name is Jeheyda and I will be the coordinator for today’s call. Please note that today’s call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer period. I will not like to turn the call over to Ms. Sherry Warner with CHEMED Investors Relations. Please proceed.

Sherry Warner

Good morning. Our conference call this morning will review the financial results for the first quarter of 2008, ending March 31st 2008. Before we begin let me remind you that the Safe Harbor Provisions of the Private Securities Reform Act of 1995 apply to this conference call. During the course of this call the company will make various remarks concerning the companies’ expectation, predictions, plans, and prospects that constitute forward-looking statements. Actual results may differ materially from those projected by those forward-looking statements as a result of a variety of factors including those identified in the company’s news release of April 24th and in various other filings with the SEC. You are cautioned that any forward-looking statements reflect managements current view only and that the company undertakes no obligation to revise or update such statements in the future. In addition, management may also discuss non-GAAP operating performance results during today’s call including earnings before interest, taxes, depreciation, and amortization or EBIDTA, and adjusted EBIDTA. A reconciliation of these non-GAAP results is provided in the company’s press release dated April 24, which is available on the company’s website at www.CHEMED.com. I would now like to introduce our speakers for today. Kevin McNamara, President and CEO of CHEMED Corporation; Dave Williams Executive Vice President and CFO of CHEMED; and Tim O’ Toole CEO of CHEMED’s Vitas Healthcare Corporation subsidiary. I will not turn the call over to Kevin McNamara.

Kevin McNamara

Thank you Sherry. Good morning everyone. Welcome to CHEMED Corporations First Quarter 2008 Conference call. I will begin with an overview of the quarter. I will then turn over the call to David Williams, CHEMED’s CFO. This will be followed by Tim O’Toole, CEO of our Vitas subsidiary for a discussion on some of our hospice metrics. I will then open this call up for questions. CHEMED consolidated revenue in the quarter totaled $285 Million and net income was $16.8 Million. This equate to diluted earnings per share from continuing operations of $.69. If you adjust for non cash items, or items that are not indicative on on-going operation, earnings per diluted share were $.73 in the quarter, which equals our prior year’s earnings. I’m disappointed with Vitas net income for the quarter. Specifically our field-based margins. As our ADC growth has moderated leaving just three additional staff per hospice team is putting pressure on our margins. Clearly we need to improve our ability to flex direct patient care labor on a daily basis to minimize inefficiencies. This tighter control of labor must be accomplished in an environment that ensures a high level of patient care. The logistics involved in tightly controlling labor on a real-time basis is complex. We currently admit over 15,200 patients and discharge at approximately 15,000 patients in a quarter. Our median length of stay is 13 days, which means half of our admits will require implementation of an extensive plan of care and will require significantly more visits per day than our average patient. In our hospice teams if we are over-staffed by as few as 2-3 FPE’s on any given day our margins will be negatively impacted by nearly 200 basis points. With that said it is imperative that we improve our consistency in managing labor and minimizing any over-staffing. This will involve improving our existing labor reports, as well as evolving the culture within the field to provide quality patient care with an efficient cost management. On a positive note, we had excellent admissions in the quarter, growing 7.8% to over 15,200 Admits and revenue growth of 7.9%. VITAS had revenue of $199 Million and generated income of $13.3 Million. Adjusted EBIDTA for Vitas totaled $23.6 Million in the quarter ,equating to an 11.9% margin. Gross Margin in the first quarter of 2008 was 20%. This is 257 basis points below the adjusted margins for the first quarter of 2007. This margin decline is a combination of increased expenses related to our strong admissions as well as increased costs for direct patient care labor. Vitas has expanded its investment in the admissions process, increasing spending $2.1 Million in the quarter. At the end of the first quarter of 2008, Vitas had 252 sales representatives, an increase of 17%, and a total of 432 Admissions Coordinators and nurses, an increase of 19% over the prior year period. Overall staffing and admissions process also increased 4.3% when compared to the fourth quarter of 2007. This increase in our admissions infrastructure caused a decline of 106 basis points in gross margin in the first quarter. The payback of this increased staffing generated over the next several quarters as the additional patient census remained in hospice for the subsequent quarters. The remaining margin decline is due to an increase in direct patient care labor. This additional labor expense is a combination of salary rate increases for existing employees as well as excess staffing relative to the current patient census.

In the first quarter of 2008 field salary increases averaged 4.2% over the prior year period which is largely commensurate with the local market salary requirements. This is above the 3.0% inflation per diem increase we received from CMS in October of 2007. Over the past several years the CMS calculated inflation factor has been below the actual cost inflation on direct patient care costs, primarily wages. Historically we have been able to offset this inflation adjustment shortfall to scale and in management systems and infrastructure.

We continue to refine the processes of scheduling direct labor to allow for more daily flexibility with the goal of insuring proper levels of staffing, notwithstanding length of stay and census fluctuations. This involves more efficient utilization of field-based labor management tools designed to meet and respond to hospice team staffing requirements. We have begun using some of these tools and expect more efficient labor management during the second quarter of 2008, with margins returning to more historical levels in the second half of 2008. We did not have any billing restriction related to Medicare Cap for the first quarter of 2008 operating activity. As of March 31st 2008, we have not accrued any Medicare billing restrictions for the 2008 or 2007 cap years. Of Vitas’ thirty five unique Medicare provider numbers, thirty provider numbers, or 86% have a cap cushion greater than 20% for the2008 cap year. Four provider numbers are between 10% and 20% and one provider number has a cap cushion of approximately 4%.

Roto-Rooter is being marginally impacted by the slow- down in the economy. Fortunately our business model is recession-resistant through a combination of emergency work that customers find difficult to defer as well as a cost structure that is extremely variable to the utilization of plumbing and drain cleaning technicians that are paid exclusively by commission. In the first quarter of 2008, Roto-Rooter had an 11% decline in aggregate call volume tracked in Roto-Rooters two centralized call centers. We were able to increase our call conversion rate to pay jobs which mitigated a portion of this call volume decline resulting in aggregate jobs declining 7%. There is also greater disparity in demand within the United States. The Southeast region has experienced a 14.1% decline in commercial jobs, while the Northeast had a modest 1.8% decline in commercial volume. Residential demand is also following a similar pattern in the Southeast with job count declining 10.1% while the remaining regions had experienced a job count decline ranging from 4.3% and 6.7%. We have adjusted our guidance for the remainder of 2008, taking into consideration current April 2008 run rate and factoring in a slight decline in demand.

Both Vitas and Roto-Rooter continue to operate fundamentally sound business models that we believe are well positioned to weather the current economy, although there are risk factors impacting both business segments we believe these risks are manageable. In addition, given our strong balance sheet and capital structure, a difficult economy may provide opportunities relative to our competition. With that I would like to turn this teleconference over to David Williams, our Chief Financial Officer.

David Williams

Thanks Kevin. Net revenue for Vitas was $199 Million in the first quarter of 2008, which is an increase of 7.9% over the prior year period. This revenue growth was the result of increased ADC of 3.4%, a Medicare price increase of approximately 3%, and a favorable shift in revenue mix from routine homecare to high acuity care. Average revenue per patient per day in the quarter was $186.67, which is 3.5% above the prior year period. Routine homecare reimbursement and high acuity care average $145.42 and $633.10 respectively, per patient per day in the first quarter of 2008.

During the quarter, high -acuity days of care was 8.5% of total days of care. Quarterly high- acuity days of care have averaged between 8.0% and 8.4% in 2007. Any shift in revenue mix will have a noticeable impact on overall revenue given the significant disparity in reimbursement per diems. However, given the relatively low profitability margin on high- acuity care, this favorable mixed shift had minimum impact on gross profit and net income in the quarter.

Selling, general and administrative expense for Vitas was $16.1 Million in the first quarter of 2008 which is an increase in 1.5% over the prior year. Adjusted EBIDTA totaled $23.6 Million, a decline of 9.3% over the prior year, and equates to an adjusted EBIDTA margin of 11.9%. During the first quarter of 2008, Vitas’ direct patient care margin for routine home care was 49.5%. This compares to 50.8% in the prior year quarter. Direct in-patient margins in the quarter were 19.3% which compares to 20.1% in the prior year. Occupancy over in-patient units averaged 80.7% and compares to 80.8% occupancy in the first quarter of 2007. In-patient margins have ranted between 15.9% and 20.1% over the past six quarters. Continuous care, the least predictable of all levels of care, had a direct gross margin of 16.5% in the quarter, which compares to 20% in the prior year. Continuous care margins have ranged between 16.5% and 20% over the past six quarters.

Now let’s turn to the Roto-Rooter segment. Roto-Rooter generated $87 Million in the first quarter of 2008, 3/10% higher than the $86 Million reported in the prior year quarter. Net income for the quarter was $9.1 Million. The first quarter net income includes $0.4 Million after-tax charge for settlement of litigation related to a 2003 fire that for unique reasons was not covered by Roto-Rooters secondary insurance carrier. Excluding this settlement, net income for the first quarter of 2008 declined approximately 6/10 of 1% over the first quarter of 2007. Adjusted EBIDTA in the first quarter of 2008 totaled $15.9 Million, a decrease of 2.7% over the first quarter of 2007, and equated to an adjusted EBIDTA margin of 18.4%. Job count in the first quarter of 2008 declined 7% when compared to the prior year period. Total residential jobs decline 6.4% and consisted of residential plumbing jobs decreasing 4.9%, and residential drain cleaning jobs declining 7.1% when compared to the first quarter of 2007. Residential jobs represent approximately 70% of total job count. Total commercial jobs declined 8.4% with commercial plumbing declining 4.9% and commercial drain cleaning decreasing 9.9% over the prior year quarter. Consolidated cash flow remains strong with CHEMED generating $40 Million of net cash provided from operating activities in the first quarter of 2008. Capital expenditures aggregated slightly less than $4 Million, resulting in free cash flow of $35.6 Million in the quarter.

Our 2008 Earnings guidance is as follows. Vitas is now estimated to generate four-year revenue growth from continuing operations, prior to Medicare cap, of 8-10%. Admission are estimated to increase 5-8%, and full-year adjusted EBIDTA margins, prior to any Medicare cap, is estimated to be 13-14% . EBIDTA margins are anticipated to improve sequentially throughout 2008, with an adjusted EBIDTA margin averaging 13.5-14% in the second half of the year. This guidance assumes that hospice industry receives a full Medicare basket increase of 3% in the fourth quarter of 2008. Full calendar year 2008 Medicare contractual billing limitations are estimated at $3.75 Million.

Roto-Rooter is estimated to generate revenue totaling $343 Million to $349 Million, basically flat with the prior year. This guidance assumes a second quarter sequential revenue decline of 3% resulting in forecasted revenue of approximately $83-85 Million in the second quarters of 2008, and assumes revenue of approximately $90-92 Million in the fourth quarter of the year. Adjusted EBIDTA margins for 2008 is estimated to range of 18.5-19.5%. Our effective tax rate is being increased to 39% in 2008, about 50 basis points higher than the prior year. This consolidated tax rate is being impacted by volatility in the stock market and its related impact on tax accounting for certain retirement plans.

Based upon these factors, and an average diluted share count of 24.2 Million shares, our estimate is that full year 2008 earnings per diluted share from continuing operations, excluding non-cash expense for stock options, and charges or credits not indicative of ongoing operations will be in the range of $3.05 to $3.20 per share. I am going to turn this call over to Tim O’Toole, our Chief Executive Officer of Vitas.

Tim O’Toole

Thank you David. Vitas generated 15,212 admissions in the first quarter of 2008. This was a 7.8% increase over the first quarter of 2007. April , 2008 continued to run strong, and are currently showing an increase of nearly 6% over April of 2007. Our discharge rate has begun to moderate in the first quarter of 2008, growing at a rate of 6.7%, 110 basis points below our admissions growth rate in the quarter. Over the past year we have significantly increased our resources dedicated to admissions. In an incremental basis this increased our field based cost $2.1 Million when compared to the prior year period. To a certain extent, a material uptake in our admissions rate puts some downward pressure on our current quarters’ margins. This is a result of our low median length of stay which is currently 13 days. What this means is that half of our admissions are discharged ,primarily through death, in less than two weeks. These patients are extremely ill and require significant resources to admit, establish a plan of care, and deliver such things as durable medical equipment, supplies, and meds on the first day of admission. In other words, an uptake in our admissions growth rate does put some pressure on margins. With that said, I am disappointed with our process of flexing patient labor to more closely match our daily change in patient census. Our need to manage labor effectively is critical to sustaining appropriate operating margins. Hospice teams that are over-staffed by as few as one or two employees can materially impact our margins. I am focused on improving the scheduling of direct labor to allow for daily flexibility with the goal of insuring proper levels of staffing, notwithstanding length of stay and census fluctuations. This involves more efficient utilization of field-based labor management tools designed to meet and respond to patient care staffing requirements. Vitas’ average length of stay in the quarter was 71.5 days which compares to 76.9 in the prior year quarter and 75.7 in the fourth quarter of 2007. This decline is related to our expansion in our admissions and has resulted in our median length of stay dropping one day to 13. Our days of care totaled 1,063,859 in the quarter. Routine home-care days increased 4.4%. In-patient days of care increased 7.7% and continuous care days increased 3.6%. We currently have three programs classified as start-ups. Three are licensed, two of which are Medicare certified. These start-up programs have an ADC of 37 patients with revenues of $311,000 and pre-tax operating losses of $485,000. These same programs had effectively 0 ADC and revenue with operating losses of $296,000 in the prior year quarter. With that I would like to turn the call back over to Kevin.

Kevin McNamara

Now is time for us to consider questions from the assembled multitude.

Question-and-Answer Session

Operator

Your first question comes from the line of Darrin Lehrich with Deutsche Bank. Please proceed.

Darrin Lehrich- Deutsche Bank

Thanks. Good morning everyone. A few questions on Roto-Rooter and a few questions on Vitas. As far as Roto-Rooter goes, I guess I need to know if you could comment a little further on call volume in April and what you are seeing at the present time. Just to give us a feel for the outlook there, and how closely you are gauging call volume.

Tim O’Toole

We don’t expect call volume to change appreciably. The current run-rate of April is actually above what our guidance has it so sales are running stronger than our guidance. But given the volatility we have seen, and the impact I would say the recession is having, we are conservative. So basically April is running a little stronger than our guidance and we are anticipating a 3% drop in the second quarter of 2008 for Roto-Rooters revenue over the first quarter. But without a doubt if the recession runs extremely severe or it spreads well beyond the West and the South it could impact Roto-Rooters numbers b but we are not seeing that in April

Darrin Lehrich- Deutsche Bank

Ok, and just as far as your geographic dispersion, I know you have commented on the West and California and Florida having this exposure, can you give us a sense for your footprint and your revenue concentration in maybe broad geographic swaths just to help us have a feel for that?

Tim O’Toole

Let me just say this. We don’t have much of a presence in California. That’s a tough market, it just turns out that several of our multi-location franchisees exist in California. Basically, most of the major metropolitan areas east of the Mississippi is where we are, and then west of the Mississippi, we have a presence but it is a little more scattered. Clearly the concentration is Northeast, Southeast, and Midwest.

David Williams

And Darrin if you go to our website and Chemed.com and look under industrial presentations, we keep our presentation that is updated and you will actually see a map that has the footprint of company-owned territories in the United States. Some of those are owned and operated, some of those are independent contractors, but you will see where the concentration is. And you will see a significant concentration in the state of Florida.

Darrin Lehrich- Deutsche Bank

Sure. And then, Tim I want to get your perspective on the down-turn. Is it your sense that people are deferring things, is it more do-it-yourself? Can you just give us a little bit of a feel of what you think is going on out in the field with Roto-Rooter?

Tim O’Toole

I will tell you that my sense of it is that it is deferral, and something that definitely happens on the commercial side. To the extent that you have new construction starts at a stand-still, you have a big influx of plumbers on the commercial side. They can’t really make a dent on the residential side, you see those on the commercial side. They are just putting in bids, feet on the street. There is no question in markets we have where there has been a lot of new construction we see a lot of increased competition on the commercial side. They can’t go out and get a bigger yellow page ad, so it’s not as big effect on the residential side as we have indicated there is a residential decline when things get tough. We call that internally the Home Depot effect. And that is people that if money is more of an issue they look for cheaper alternatives, and one of the cheaper alternative is to go to a Home Depot and get involved in what they call an “assisted repair”. Then you can rent a drain-cleaning machine, you can do minor plumbing work with some assist from the salesperson at Home Depot, and a call to one of their help lines. We think that’s what is going on in the residential side. But again, given the nature of the repairs, we don’t think it is a “stacking up”. There is some deferral when it comes to major plumbing activity but with regard to the decline in drain care work, obviously that’s gone. We are comfortable with the Roto-Rooter business in that the decline of 11% in call volume and jobs only down 7% I would say it shows some good work by the Roto-Rooter people. It’s anecdotal but I will tell you what the reports from many of our 500 franchisees , they are telling us that jobs are down between 10-15%. So, it’s pretty broad and we hammering away at the commercial side of the business and for the current time all that effort is allowing us to somewhat hold our own there, but we think we will be better positioned when the economy turns.

Darrin Lehrich- Deutsche Bank.

All right. And them, switching to Vitas, obviously the labor issues cropped up here. Several times over the last two years, seems to be somewhat of a systemic issue within Vitas. One question I have is philosophically do you view labor management in Cincinnati different than they do in Miami, is there a disconnect between how you think that organization should be performing?

David Williams

I’ll start to answer it then turn it over to Tim. Let me start by saying, I will give you our thought process. Obviously it is an issue, it is an 800 pound gorilla when you are talking about where all the expenses are in Vitas. It is a service business, it is a labor expense. Historically, they have had a few blips, but they have responded pretty quickly when the labor number has gotten out of line. I will give you a good example. October of last year we saw labor numbers that were very similar to what we saw in the first three months of this year. There was a strong reaction both in Cincinnati and Tim and his people. The margins and labor expense in November and December were very good which really closed out the year for Vitas. They were over budget, had all things said and done a very good year last year.

The January number came out, it was a bad labor number, there are some issues in the first year with unemployment taxes that made January not necessarily a harbinger for the future, but it was still worrisome. February came out and it was just as bad, and I can tell you that at that point there has been an about-face totally with regard…there’s not disconnect between Cincinnati and Vitas but I think that everyone is pulling on the same side of the oar to do number one as we made reference to in our presentation a change in the culture at Vitas, an insistence on using some of the labor managing tools that already exist with development of a few others.

And if you ask me if I want to summarize everything that we have been doing, I would say this- that we are now managing labor and really profit and loss on a team basis rather than a branch basis. And I can tell you that there has been improvement already in our labor expense per week, and we’re not all the way there, but I’ll just say that we have been able to show improvement. We think it’s going to be sustained improvement. It is going to be harder- the cotter pins are more securely on the wheel as it were. We have also identified a lot of opportunities for improvement that remains to be seen if we can execute on plans to bring those to fruition but I am very encouraged by what I see.

There is no question that the major elements of the Vitas business were good in the first quarter. We shot ourselves in the foot. Good management is avoiding the disastrous quarter, every once in awhile say ho hum that is not indicative I am going to operations. That’s not good management. Good management is making sure the valleys aren’t nearly as deep. With that said, I am going to say there is no disconnect. I think there is a lot more clarity of purpose and if you ask me what really has to be translated they need to make sure that everyone of the field management personnel who are clinical people, rather than business side, fully embrace everything that we have to do. I think that’s the cultural issue we are still going through.

There is no disconnect between Cincinnati management and Tim O’Toole and his team at Vitas. With that said, Tim any comments that you have?

Tim O’Toole

Absolutely. Obviously I could. There is no disconnect. We work very closely together. We are all in the same direction of getting this in better shape. I think there have been issues over the last several years from quarter to quarter with some situations where labor has gotten higher than it should have been. We’ve been able to correct it. Usually they are different issues, and each time it is something different. We think we fix something and then a new issue comes up. Clearly we need long-term to have better systems that filter through our employees that are available to get the best match for the lowest cost possible to do the service that is required.

We also obviously have to equate that under the framework which we all agree that we provide the highest quality care and one of those issues is continuity of a nurse or home health aide to that patient and not always having a different person in t here every day, so this is something every hospice company has to deal with. We just have to do a better job of matching the best possible person to the job and make sure we are not over-staffing and providing more visits than is appropriate. We have a lot of fail-safe systems to make sure that we always provide the appropriate number and sometimes we may get a little too high on the number of visits and we need to correct that, but this situation that has come up recently, as we have highlighted to you, we did have a big increase in the selling cost about 100 basis points of the margin strength is from increase in our selling costs which we all recognized in the last year or year and a half that the biggest risk factor to the business performing well is managing the Medicare cap.

There is only one way to do it and that is to have high admissions. And the only way to have high admissions is to have a high selling effort and a qualified selling effort. So we put more people out there and more money and having better trained people so we can educate the referral sources better and work with the families to get the admissions. We have done a great job with that at some cost. I think we can adjust some of that cost structure to get more out of it, but now that we have enhanced it a lot. And now some of those costs will be coming down modestly. But we still have to press the sales so we press the admissions.

One thing that we did see in this quarter ,as we talked about, we saw a little more of our patients that are in the category of being with us for a shorter period of time. That’s a whole other issue to manage as opposed to just managing labor where you have to manage a fluctuation in your daily census that is more rapid, from day to day, which is a challenge that we are up to and we are working on systems to be able to do that. So that’s a little bit of a new issue, and as that stabilizes as we work through that it becomes the status quo instead of the new we’ll do a better job with that. We also talked to you about in the past we’ve always been able to do a heroic job at keeping our year-to-year labor from resisting employees running at a rate of maybe 3-3.5% which was fairly consistent with our reimbursement increase. This year we have seen this tick up a little bit for the first time where we are seeing about 4.5% year-over-year increases from our existing staff. There is labor pressure in the work force especially in certain segments. We have to do a better job of searching the work force to find people who can do the job at a lower cost than maybe someone on board today. But that is a little bit of a new issue so it has eaten into our margin a little bit. I think it’s not a long-term issue, you see it from time to time.

We held the labor very well for several years and we had a little slip as we moved into the last six months. Everybody sees inflation in the labor markets today like you do in all of the cost structure. We have seen some of the fixed cost structures that the costs have gone up pretty high this quarter compared to the prior year. Everybody knows the cost of gasoline- we have a lot of people who get reimbursed for mileage that drive a lot, and that cost is up statically about 12% year-over-year. So we’re up about 15-16% year-over-year with our volume growth as well. Things like our insurance- everybody knows your health insurance goes up maybe 6-7% a year and we’re working with a 3% price increase. So some of these issues are very manageable . The units that we have seen have problems usually are units that the census is flat, maybe modestly declining and the labor hasn’t been adjusted. Kevin mentioned we have made many adjustments already in the last thirty days where we know that we’ll be having a better handle on the labor costs in the next quarter. And some of these longer term issues we are working feverishly and the CHEMED people and the people in Miami are all on the same page and we’re going to get that solved as well.

Darrin Lehrich- Deutsche Bank Securities

Ok. I’ll jump back in the queue. Thanks guys.

Operator

You’re next question comes from the line of Dawn Brock of J.P. Morgan. Please proceed.

Dawn Brock- J.P. Morgan

Good morning. Very quickly just kind of following up on your comments Tim on the fluctuation on the shorter stay patient mix. This is kind of opposite of the trend we saw in 2007. So I think my question is, what is driving this shift back, and how does this impact the patient mix expectation and the average length of stay expectation for 2008?

Tim O’Toole

We’ve seen a little bit of an increase in stay over the last four years, increasing every year. And again it is a function of managing your Medicare cap. So when you go in the market, most of the markets are very competitive, there is market growth out there and long-term there is huge growth in the demographics, but when you go after trying to take market share, and trying to find every referral source, and as we have tried to find new referral sources some of the way the business works is sometimes you get some of the patients that maybe should have been on hospice for two months but because they are not fresh with you, they are new referral sources, maybe they are referring it a little late in the process. There is no doubt in my mind that when you see patients that are on hospice service for two weeks probably 9 out of 10 of them should have been on hospice for a couple of months. It’s a little bit of our aggressive strategy of finding a strong selling effort, penetrating all markets and all referrals, and that mix will work its way through and I think longer term we are not going to see this increase. It’s stable and longer term we will see our average length of stay increase from this level of 71 days. It may not in the next quarter. But longer term it should be longer.

Kevin McNamara

And Dawn with regard to that, I think you have to say what is going on in the medical reviews, and virtually every long-stay patient is reviewed, bounced at least once, subject to appeal, and we win those, but it has an effect on referral sources and the organization and to the extent that we went through a period where we had a significant increase in discharge of long length of stay patients. We are through that. We are now in a very comparable comparisons. When you have discharges of a very unusual number of long length of stay patients that in a sense artificially drives your average length of stay up because the average length of stay is calculated on discharge patients. To get to your question, do we think what is the outturn of a day, based on your estimate as far as our average length of stay? It was 71 this quarter, what do you see the trend in that?

David Williams

And we will basically assume no change in length of stay, but Kevin’s is right in that. From the third quarter 2006 to the fourth quarter we saw a spike in our length of stay, calculated from discharge patients, and that spike is attributed to the FMR’s and the fact that we did have an increase in our log discharge for extended prognosis. So I would argue that artificially inflated the length of stay for really four or five quarters. Now in the first quarter of 2008 we see the exact opposite. We are seeing a drop in our live discharge for extended prognosis but because we had a really ,really nice uptake in our admissions, both sequentially and over the prior year this is a greater percentage of our discharge patients with 13 days or less has artificially deflated that length of stay. So really over the last four quarters it was artificially deflated and this quarter it was lower than it should be. So we think it will moderate somewhere around a 73 day period once we continue with this higher admissions trend, and we start lapping it, and we’ll see a stabilization in the length of stay.

Tim O’Toole

And the bottom line is we were fairly happy, all things considered, with our average daily census and our increase in revenue for the quarter. That was the least of our problems.

Dawn Brock- J.P. Morgan

Understood. Quickly , from the competitive landscape, what are you seeing? Is one of the drivers behind the increasing admissions staff competition from charitable organizations? A lot of the non-profits in certain regions? What are you seeing right now as far as the Mom and Pops and the pressure on them from Cap?

David Williams

Well, I’ll turn it over to Tim. I will say this, that the best indication that you can have is on the political side. We are hearing from our lobbyists that senators and representative are being deluged with commentary from the not-for-profits and the smaller hospices that things are very tight and the budge neutrality factor must be fought at the battlements, that they cannot stand for a reduction in the increase in October. So we from that perspective we are hearing that they are doing a lot of complaining on the political side. I think that what we are doing is that we want to increase our admissions, so it is not that we are doing it purely defensively, but we are taking the offensive. We want to increase it. But it’s always tough. As these organizations start struggling, they start calling all the referral sources and start crying poor, and saying you have to help us out, but with why we are spending more on the admissions front is we want to take market share. It’s not purely defensive, as we have eluded to in the presentation, the payoff when you get more patients, 9 out of 10 of them live less than six months. They are fairly low margin, and a lot activity involved in treating those patients. It is not until you get the statistical outliers adding up that you get the payback for those. But Tim, do you have any comments?

Tim O’Toole

As far as the competition, there are no big changes out there. We don’t see a reduction in the number of players. We look at each market that we serve in a global situation, and one of the bigger trends in the industry is the hospital based palliative care program. They are maybe keeping certain people in the hospital a little longer through that effort, but our strategy is that we are working with many of them and they become a referral source to us at the appropriate time. One thing you have to remember in this business is that obviously your competition is curative care. And people are aggressively seeking curative care with some of the new treatments in cancer. It hasn’t changed the landscape at all. But that is always an issue that is out there. We think over time that hospice gets more ingrained into peoples minds as it is always, they compare that with more of an educational outlook as compared to an emotional one and we do very well long term. No big change in the marketplace. We have competition in each market and it’s really a local market situation rather than an overall in the country,

Dawn Brock- J.P. Morgan.

Ok, and one last thing. This is going to be further depth into a question that was asked initially about the potential disconnect on the labor side, and I am curious, and maybe I’m just missing it, you talk about one of the reasons for the increased expenses is excess staffing, but volumes are up and admissions are up, so it would seem as though the additional staff would actually be utilized. You would have a higher utilization of the staffing. I’m not quite understanding what I would consider maybe a disconnect there, or maybe I’m just not getting it.

Tim O’Toole

The answer to your question is about 106 basis points of margin is associated with increased admission coordinators and nurses. So that is the number $2.1 Million in additional spending in the quarter. That is there. We meant to do that. We hope that the pay back for that would be shorter, and we gave guidance, but it hasn’t been – we’ve been swamped a bit by the shorter stay patients. By increased utilization, by people having things to do, being needed, however, when you compare, on a team-by-team basis, and too many of the teams, when you compare them to 12 months ago, 6 months ago, the cost per patient for these teams to care for this patient is up by double digits in too many instances. In other words we have identified inefficiencies, and I’ll just say Dawn that with regard to the type of changes we have made, that is pushing out inefficiencies, over the last couple of weeks we have reduced labor expense on a weekly basis in excess of $200,000 a week. I’m focused on the inefficiency side. We’ve identified a number of other areas where it looks like we should be able to make similar progress. It’s very clear in our mind that a significant element of the labor problem is inefficiency. We’ve already begun to address it and we hope to be able to say we are addressing it not with a band-aid but with permanent changes in the way labor is managed and assigned on a team-by-team basis. We’ve already seen the progress. How much progress are we looking for? I would say we are half way there coming up with efficiencies that we think have to be achieved. Our presentation says we will be achieving those this quarter. We are off to a fast start, we think we are going to be there the second half of the year. This is a quarter where we are expecting to make great headway.

David Williams

This question has come up a number of times, and to put it in perspective, there has been an fundamental evolution and shift over the last four years at Vitas. Our footprint has gotten significantly bigger, we have expanded a lot more programs, and particularly in the small and medium sized programs we have probably close to doubled the number of hospice teams. Average daily census forecasts slowed. We’ve always had stranded labor at any given time in a hospice team. But now we have a lot more hospice teams, that are growing a lot slower, a much bigger footprint with small and medium programs, and again a small and medium program has less opportunity to shift labor between hospice teams when they are only running three hospice teams versus nine in a large program. So as Vitas has grown and changed its footprint, the potential for more stranded costs in a hospice team in any given day over staffing has increased. That’s why to a great extent it was harder to get things back in the bottle every time labor flared up, which led up to an epiphany that we need to fundamentally change the way we schedule labor because of what I call this flare-up of over staffing. So it’s an acknowledgement of managing labor differently, recognizing average daily census is slowing, and there’s more pockets of stranded labor because we are dealing with almost 200 hospice teams, versus four years ago we had less than 100 hospice teams. That’s the acknowledgement of the changing of the environment.

Dawn Brock- J.P. Morgan

Ok, that’s helpful. Thank you.

Operator

Your next question comes from the line of Eric Gommel with Stifel Nicolaus & Company. Please proceed.

Eric Gommel- Stifel Nicolaus & Company

Good morning. I think Dave you just touched on the thing that I was going to ask about and that is they ADC growth. You would say that part of the issue maybe with the labor may also be related to slowing ADC growth overall? Is that one way to characterize it?

David Williams

Yes, certainly if you go back from four years and three years ago to today, that is right. The slowing ADC growth and a lot more hospice programs and a lot more provider numbers, the potential for a flare-up is greater, and again a flare- up in a small program in Detroit, you can’t manage that against two other hospice teams if you don’t have two other hospice teams.

Tim O’Toole

Let me give you another example. A Texas program that has a relatively significant decline in census. The first thing is the client census, the full time equivalents have to be reduced. That type of action presents us with something that Vitas has never dealt with before, and that is the danger of a mixed shift between home health care workers and nurses. One of the things being covered in that branch is their FTE’s were reduced appropriately but it was the mix shifted and there were more home health care aides released than there were nurses, with a view that the census will come back and the nurses are harder to get, we’ll cut, we just won’t cut as severely with the nursing staff. That has a dramatic effect on the labor cost in that branch, or to the team where the cuts were being made. That mix shift is something Vitas never had to deal with previously, and that pops up when overall your census is growing a few percents as opposed to 12%. That is the type of thing they are dealing with the first time. But a team can’t go seven days now without getting a lot of attention if that type of situation is developing. We’re handling it on a slot basis, each team that seems to be out of whack. I think we’re going to get a lot of benefits from it.

Eric Gommel- Stifel Nicolaus & Company

It’s my experience that hospice nurses are rather unique with their skills set in what they do. How concerned are you that if you try to more actively manage this labor force that this could potentially drive some of these nurses, which I am assuming is highly competitive in the sense that there are other providers looking for them, maybe I’m wrong there, but how do you balance that aspect of the?

Tim O’Toole

That’s a tough one. Let me give you the classic example. Previously we had a reasonable sizeable home health care business. You have to look at each salary range, to the extent that you have too many workers at the top of the salary range, and if it’s good, everything is stable, everyone has been with you for a few years so everyone is at the top of the salary range, if you are being paid by the government that is a problem. The government numbers are premised on the full spectrum. And so basically you have to say that if some of your good people say that “I can make 10% more working somewhere else” then you have to say, “ Hate to lose you but you’ve graduated”. I don’t know. It’s a tough one, and you used the right word, balance. You have to be willing to do that. You have to be willing to be sure that if you’re being paid by the government that you have to have that broad spectrum of workforce through the entire salary range. And it’s not easily done, and one of the reasons that we saw our salary increases were almost 4.5% over the last four months. It’s not because everyone said things are good, let’s give everyone big increases- these were caused by competitive situations. And one of the things that we’re definitely going to be trying is to be tougher, and modify this so basically one of the top two people in the Vitas Corporation has to personally approve any staff salary increase over 3.0%. You’ve got to pick and choose those. It’s a balance, a risk of the business, to the extent that there is somebody who is, it has to be a subjective determination but we don’t want to cut into the bone to the extent that somebody who is the glue that is holding together the team or a branch, the call goes in their favor. It’s going to be a high hurdle, because long term, if the government figures are right, our increase is premised on changes in the labor market so theoretically we have a shot at managing it, and we’re gonna believe the numbers, and hold our increases to that number. Whatever the number ends up being.

Eric Gommel- Stifel Nicolaus & Company

And my last question, is Dave can you update us on what’ s going on with CMS and the budget neutrality factor? Do you have any insight into what the potential impact from a change might be, or what’s happening at this point?

David Williams

Again, it’s hard to get your arms around it because some of it is rumor. Some of it is said behind the scenes. By all indications CMS it appears that CMS is following directive from the White House in terms of trying to hold back on all entitlement programs, both Medicaid and Medicare. They are making a statement and they are taking a wide range of trying to hold reimbursement. One of which of course is the budget neutrality factor, by all indications they intend to put out at some point in the Federal register a phase-out of a portion of our historical inflation index of the budget neutrality factor that would work out to be in theory 4.5% reduction phased in over three years of our basket increase. Or about 140-150 basis points a year for three years.

We’ve also seen indication out of Washington that both Democrats and Republicans are severely resisting this administrative process of taking away reimbursement of some very important healthcare benefits to Medicare beneficiaries and Medicaid beneficiaries. So without a doubt there is a struggle going on in Washington, Metpak certainly reported on average of hospices losing money in the provider based, hospital based, and not for profit, so this will take them further under water. And hospice by the latest Duke study saves the government money and politicians recognize it is poor politics to severely harm this type of health care plays. But there does seem to be a battle going on. If the budget neutrality factor is phased out over three years, that would theoretically, if we didn’t do anything to adjust our structure, cost us $.05 a quarter, $.20 a year starting in the fourth quarter of 2008. We also think there are serious questions legally whether CMS could take administratively, confiscate inflation that we’ve received, that Congress mandate we receive over the last ten years, but it appears to be a risk factor that is out there.

Eric Gommel- Stifel Nicolaus & Company

Thank you.

Operator

Your next question comes from the line of Adam Feinstein with Lehman Brothers. Please proceed.

Adam Feinstein- Lehman Brothers

Thank you. Just real quick. Two questions. Not to beat a dead horse here, but in terms of the additional staffing related to admissions, I understand the reasons behind it, but I don’t know why you wouldn’t have known about it when you established guidance previously. So just curious in terms of why that caught you off guard.

Tim O’Toole

We did we realize we are doing this. It’s a factor that given the fact that it was successful but it resulted in a higher number of short-stay patients the expenses associated with those patients caught us a little off guard, let’s put it that way. When you look at our discharges versus our admits they only differ by 200 for the whole quarter. We expected a little more bump in census from them which would then have covered those costs, but when you have a declining creek it shows a lot of stumps. We had that activity without the census to cover it. It was an additional decline in margin. We didn’t raise the admission coordinator and nurse numbers inadvertently. We did that intentionally, but there wasn’t the “rise in creek” that would have covered that. It’s not an excuse, but where did the extra expense come from?

David Williams

And that is exactly right. It was up 18% over the prior year, 4% sequentially, and we’re just reconciling the difference in margin from this year versus a year ago, not using it as an excuse, because at the end of the day our miss is due to having too much labor in the field primarily related to patient care. This is just reconciling where margins came from.

Adam Feinstein- Lehman Brothers

Very helpful. Ok, and a follow up question about CMS. One of the other overhang issues in the regulatory front has been more scrutiny over hospice patients are treated in nursing homes, some recent literature out of Medpak talking about that. Just curious, your thoughts there, do you anticipate changes and your exposure to those patients?

David Williams

We do look at routine home care, we look at nursing home and non-nursing home routine care patients, and Medpak’s understanding of hospice has actually grown light years over the past twelve and eighteen months. Primarily because Vitas has provided to MedPak information on hundreds of thousands of patients and how hospice is working on visits, ,both nursing homes and non-nursing homes. MedPak has a greater appreciation for Medicaid patients in a nursing home, basically the reimbursement is now covering largely the roof, the meals, and the bed and we provide the health care. As opposed to a double dip. They recognize there are greater efficiencies to treat multiple patients at a single site but they have evolved their thinking relative to nursing home versus non-nursing home patients. I think they are always going to be taking a tough look at this issue, but I think they have a greater understanding that it’s not a “double dip”.

Adam Feinstein- Lehman Brothers

Ok. Thank you very much.

Operator

Your next question comes from the line of Jim Barrett of C.L. King

Jim Barrett- C. L. King & Associates, Inc.

Good morning. I have one question at this point. Dave, your revenue guidance for Q4, for Roto-Rooter, does that implicitly imply an improvement in the macro economic environment, or is there some specific actions being taken by Roto-Rooter to start growing the business again?

David Williams

Great question. That is exactly right, the fourth quarter of Roto-Rooter, that includes the high end of what we typically see in seasonality relative to it. It’s also related to the fact that we have relatively low numbers in Q2 and Q3. But we think that some of these deferred jobs do materialize, I am hoping it will be earlier than Q4,but still very optimistic we are going to get a nice bump relative to the “holiday activity”, but even if we are in a recession I expect a big chunk of that holiday activity will still happen. I think I am very conservative on the guidance. I have a fair amount of movement downward within the range we have given. That is probably the only area of aggressiveness I have, potentially maybe 1 to 2 points sequential growth Q3 to Q4. I think there is a solid basis for anticipating it.

Jim Barrett- C.L. King & Associates

Thank you very much.

Operator

Your next question comes from the line of David Larsen with Cohen. Please proceed

David Larsen- Cohen

Hi, how is the April call volume trending for Roto-Rooter? I think it was down 11% in Q1. How is April doing?

Tim O’Toole

I think we said earlier, we don’t have that number sitting here at the desk. But I will say that the report was running that it was similar to March. So, not worse, not better. Based on our estimates our sales are a little bit better than we had built into our guidance. So the Roto-Rooter would suggest one of two things- that calls have improved slightly, or that our conversion rate has improved slightly from our normal predictive mechanism.

David Larsen- Cohen

That’s helpful. And then, of the $2.1 Million in admission expense, do you have a rough percentage breakdown of how much of that was for sales reps, versus admissions coordinators and nurses?

Tim O’Toole

It’s pretty similar between sales and admissions. Admission nurse category is up a little higher than the salesman category.

David Williams

But you would almost expect them to be within the same mix ratio. They get paid about the same.

David Larsen- Cowen and Company

You had made a comment that labor expense was down $200,000 a week from recent initiatives? That sounds very impressive to me. If I think about that on a quarterly basis that is around $2.4 Million a quarter, right? Should we expect labor costs to come down $2.4 Million in Q2?

Tim O’Toole

That’s the run rate and that would be very similar to our goals, yes.

David Williams

And in our anticipation to get things down to normal we need about twice that. We need more like $400,000 over a 13 week quarter.

David Larsen- Cowen and Company

You would need twice that?

Tim O’Toole

Comparing that to our goal, obviously if our revenue is higher….

David Williams

Well let’s put it this way. In the third quarter we expect the comparison to the first quarter weeks to be different by about $400,000.

David Larsen- Cowen and Company

Ok.

David Williams

We’re already there with half of it, that is really by the last week of March in the first quarter. So, we’re going to show good improvement in the second quarter and our plan is to be there or beyond for the entire third quarter. And long term through brute force, Tim O’Toole and his team is bringing labor back now, and then in the process we are re-engineering the process to avoid it in the future. So really there are two things going on. Immediately just trying to draw down labor expense, and put better tools in the field, and have a better process to keep them from happening in the future. And that’s the late 2008-2009 long-term benefit.

David Larsen- Cowen and Company

OK, and just one last question here. Are you basically eliminating staff? Are people being laid off? Is that how you’re lowering your expenses, or are they paid per visit or something like that?

David Williams

It’s the former. They could be part time or salaried but basically we have what number of terminations in this quarter Tim? Do you have that number?

Tim O’Toole

Probably about 120 at this point. It’s a combination of terminations of your staff, and utilizing less overtime because you do a better job of scheduling the people you have, doing a better job in the decision between a salaried person and a per diem person, and doing a better job of using an appropriate mix of skilled and non-skilled to not let it drift. The mix is not bad, so it’s a multitude of issues.

David Williams

We run about 25-32% turnover depending on the category. And taking advantage of that natural turnover to reign in costs.

David Larsen- Cowen and Company

Ok, sounds like the $2.1 Million, that’s sort of an investment to increase your sales activity. You are trying to basically secure referral sources. Now with the people you are letting go, that $2.4 Million to date, that’s sort of the people in the field, the nurses doing the work?

David Williams

That’s correct- and home health care aides.

David Larsen- Cowen and Company

And home health aides, OK. So, it’s not like spend that $2.1 Million and then you let half of them go, it’s sort of the strategy is taking time to roll out.

David Williams

That’s right. If anything, we’re still continuing to be successful, there’s no reason why we wouldn’t continue to increase our sales reps and admission personnel to the extent that we felt we were getting bang for that buck.

David Larsen- Cowen and Company

Ok, and then the increase in the admissions staff was not to meet existing demand, it’s to increase that in the future?

David Williams

That’s correct.

David Larsen- Cowen and Company

Ok, I think that pretty much answers my questions. Thank you.

Operator

Your next question comes from the line of Sean Daly with THM Holdings. Please proceed.

Sean Daly- THM Holdings

Hi, good morning. Given the stocks performance, and I think you’re doing a nice job in a difficult environment, but the reality of the situation is the stock has performed quite poorly the last year- does the board from time to time review the way the company is structured with the two very, very different businesses and would shareholders be better served selling one of the businesses and re-investing in the other and paying shareholders a special dividend or something of that nature?

David Williams

Over the last four years we have gotten this question virtually any time a group of shareholders get together. The real answer is historically and even to this day, we don’t think we are putting any limitations on valuation based on the disparate nature of the two entities. We think that to the extent that there are advantages when you have a business that is almost 95% dependant on the government to pay the bill, it is reassuring to lending services to know that you have a subsidiary whose cash flow is more than sufficient to pay the debt service on any reasonable amount of debt. The real answer to your question is, if we thought that we were facing some limitation of value, or a reduction in value based on the unusual nature of….

Sean Daly- THM Holdings

You’re trading at less than 10x your current guidance, so….

David Williams

Not due to a discount due to disparate operations, that’s due obviously to excess labor in Vitas and the overhang of what will reimbursement look like at the end of this year and next year.

Tim O’Toole

We had a bad quarter. I mean the multiple of the F&P 500 at this point is probably 12. That has more to do with the capital markets that anything going on within our business.

Sean Daly- THM Holdings

I’m not trying to be argumentative, but it’s two extremely different businesses, and….

Tim O’Toole

I’ll give you a normal issue. Our basis in Roto-Rooter is less than $100 Million. There are all sorts of limitations, there’s no tax-free spin-off possibility because you have to own Vitas for five years and have you, but basically it would be a taxable transaction, even after five years it would be taxable shortly after the spin-off. But the tax bill, selling Roto-Rooter for any reasonable amount would be such that to get back to even we would have to have a use of proceeds, there would be a significant diminution in total value of the holding.

Sean Daly- THM Holdings

And that would be the same as if you separated the two entities into two different publicly traded companies?

David Williams

That is correct.

Sean Daly- THM

OK

Tim O’Toole

What you are really suggesting is a tax free spinoff of one of the two entities. Technically cannot do that, for a period of another year and a half or so, and then as I mentioned, and even if we did that, Roto-Rooter was a separate publicly owned company at one point where we owned 60% of it and it traded at a big discounted value, just because it was kind of an orphan company. From what we would have anticipated a week after we did that, someone would make an offer closer to the real value of the company, and it would be a taxable transaction at that point, for all holders.

Sean Daly- THM Holdings

And what would preclude the sale of the hospice business?

David Williams

Same thing. You could sell it, but it would be a taxable transaction, it couldn’t be a tax free spin-off for the same period of years.

Sean Daly- THM Holdings

Well thanks very much.

Operator

Your next question comes from the line of Gene Vaught with Cardinal Capital Management. Please proceed.

Gene Vaught- Cardinal Capital Management

Gentlemen, somewhat along the same lines, obviously the stock is somewhat down today. Your free cash flow was reasonably good in the quarter. I saw Dave that you did buy stock in the first quarter but relative to your stated objective of acquisitions given that you know the job in front of you does it make sense that you guys might continue to buy stock aggressively at these levels?

David Williams

Yes it does, at these levels. It’s a pretty good deal, from our prospective. We are more likely to buy stock at this level.

Gene Vaught- Cardinal Capital Management

You had indicated roughly $100 Million of free cash flow as being reasonable for 2008. Does that really change a great deal based on your new forecast?

David Williams

Well basically our cash flow and our EPS are one and the same. Nothing really sticks to our balance sheet.

Gene Vaught- Cardinal Capital Management

OK.

David Williams

What we’ll do is 305-320 in cash flow as well.

Gene Vaught- Cardinal Capital Management

CapEx for the year, Dave?

David Williams

CapEX is pretty well equal to depreciation, so that’s how it works out that way.

Gene Vaught- Cardinal Capital Management

OK. Thank you very much.

Operator

At this time we have no more questions and I will turn the call back to management for closing remarks.

David Williams

Well this has been a pretty long call already. And we’ll attempt to have better results next quarter for you. And thanks for your kind attention.

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