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LHC Group, Inc. (NASDAQ:LHCG)

Q1 2008 Earnings Call Transcript

May 1, 2008 11:00 am ET

Executives

Eric Elliott – VP of IR

Keith Myers – Chairman and CEO

Pete Roman – SVP, CFO and Treasurer

John Indest – President and COO

Analysts

Brian Tanquilut – Jefferies & Co.

David MacDonald – SunTrust Robinson Humphrey

Whit Mayo – Stephens, Inc.

Newton Juhng – BB&T Capital Markets

Sudeep Singh – Deutsche Bank

Sheryl Skolnick – CRT Capital Group

Stephen Anderson – Wachovia Securities

Greg Williams – Sidoti & Co.

Eric Gommel – Stifel Nicolaus

Ralph Giacobbe – Credit Suisse

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2008 LHC Group Earnings Call. My name is Tanya and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Eric Elliott, Vice President of Investor Relations. Please proceed.

Eric Elliott

Thank you, operator, and welcome everyone to LHC Group's first quarter 2008 financial results conference call. In a moment we'll hear from Keith Myers, Chief Executive Officer of LHC Group, John Indest, President and Chief Operating Officer, and Pete Roman, Chief Financial Officer.

Before that, I'd like to remind everyone that statements included in this conference call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These statements include, but are not limited to, comments regarding our financial results for 2008 and beyond. Such statements are subject to a number of risks and uncertainties such as changes in reimbursement, changes in government regulations, changes in the company's relationships with referral sources, increased competition for its services, increased competition for joint venture and acquisition candidates, and changes in the interpretation of government regulations. Therefore, actual results may differ materially from any financial outlook presented herein.

Further information or potential factors that could affect the company's financial results can be found in the company's Form 10-K for the year ended December 31, 2007. LHC Group shall have no obligation to update the information provided on this call to reflect subsequent events.

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

Keith Myers

Thanks, Eric, and welcome, everyone. The first quarter of 2008 was a repeat performance of Q4 2000 for the LHC Group team where we successfully negotiated a significant change in reimbursement once again. Our performance is a tribute to the hard working, dedicated employees of LHC Group who faced the adversity of a new reimbursement environment head on. The depth and experience of our management team has once again proven to be the competitive edge that enables us to transform challenges into opportunities. Our continued success acknowledges the long-term commitment to excellence that is ingrained in our culture, and in every member of the LHC Group family. Our commitment to the patients, families, and communities we serve is at the heart of everything we do.

Now, I'll touch on some of the highlights of the quarter and then turn it over to Pete Roman, our CFO, to review financial results, and John Indest, our President and Chief Operating Officer, who will provide an update on operations. Starting with acquisitions in Q1, we have added seven acquired locations in four states. On January 1, we acquired 100% of the assets of Access Home Health Agency in Springfield, Missouri. The service area of this acquisition spans 20 counties in southwest Missouri. The primary service area has an estimated total population of 857,000, with almost 15% over the age of 65. Total annual Medicare revenue for this agency is approximately $2.9 million.

The purchase of Access Home Health Agency represents LHC Group's initial entry into the state of Missouri. Also on January 1, we entered into a partnership agreement with Marshall Medical Center to provide home health services in Guntersville, Alabama, and the surrounding areas. Marshall Medical Center consists of two hospitals, Marshall Medical Center North, a 90-bed hospital located in Guntersville, and Marshall Medical Center South, a 150-bed hospital located in Boaz. The service area of this acquisition spans eight counties in northeast Alabama, two of which were not covered by LHC Group agencies. This brings LHC Group's total service area in Alabama to 41 counties. The primary service area has an estimated total population of 864,000 with almost 14% over the age of 65. Total annual Medicare revenue for this agency is approximately $1 million.

Then on April 1, we acquired 100% of the assets of Home Care Connections and Rivercrest Home Health. The acquisition consists of four locations in Amarillo, Odessa, Uvalde, and San Antonio, Texas. The service area of this acquisition spans 64 counties in Texas, which brings LHC Group's total service area to Texas to 102 counties. The primary service area of this acquisition has an estimated total population of 4.8 million, with almost 11% over the age of 65, and total annual Medicare revenue of approximately $8 million.

And today, May 1, we acquired River West Home Care located in Plaquemine, Louisiana. The primary service area of this acquisition has an estimated total population of 1.3 million, with almost 11% over the age of 65, and total annual Medicare revenue at approximately $500,000, currently.

Moving on to de novo locations, de novos continue to contribute significantly to our organic growth. In the first quarter, we opened six new de novo locations in four states, and have 18 additional de novo locations in six states scheduled throughout the remaining three quarters of 2008.

With regard to our acquisition pipeline, we continue our disciplined process of identifying targets that are fairly priced and have significant upside potential through internal growth and geographic expansion through new de novo locations. Because of our stringent criteria, only a small percentage of the opportunities presented to us are approved by senior management for consideration. In the first quarter, we realized an increase in the volume of opportunities presented to us, which has resulted in increased pipeline activity.

At this time, we are in active negotiations with 23 acquisition candidates that have been approved for consideration at the senior management level. These 23 opportunities include 46 locations in 12 states, and approximately $60 million in current annual revenue. In response to the increased pipeline activity, it is our intention to increase our line of credit with Capital One from $50 million to $75 million during Q2.

With regard to current activity in Washington, we continue our efforts, along with patients, families, and other members of the home health provider community, advocating for reauthorization of the 5% add-on payment for Medicare beneficiaries residing in rural areas. Legislation currently being considered would provide a rural add-on for one year. We are very encouraged by the support of this legislation across the industry and with lawmakers in Washington. It's an access-to-care issue for patients in rural areas, and a precedent exists, two important factors to keep in mind. Historically, Congress has recognized the add-on as an important tool in mitigating the unique financial pressures rural providers face.

And since the move to PPS reimbursement in 2001, and continuing without interruption through 2006, Congress employed the rural add-on to ensure rural beneficiary access to home health services with only a one-year interruption in 2007. This year, the entire home health community, as represented in Washington by the National Association for Home Care and Hospice and The Visiting Nurse Association of America, the two leading national trade associations for home care, and other consultants, are aggressively working for reauthorization of add-on in Medicare legislation anticipated before the end of June.

And now, I will turn it over to Pete for a more detailed review of our financial results. Pete?

Pete Roman

Thank you, Keith. Our net service revenue for the quarter ended March 31, 2008, increased 21.5% to $83.5 million, compared with $68.7 million in 2007. For the three months ended March 31, 2008 and 2007, 82.4% and 81.9%, respectively, of net service revenue was derived from Medicare. For the first quarter, home-based services accounted for 81.9% of revenue compared with 80.1% for the comparable prior-year quarter. Income from continuing operations for the first quarter of 2008 totaled $5.5 million, or $0.31 per diluted share, compared to $6.1 million, or $0.34 per diluted share for the first quarter of 2007. The effective tax rate for the quarter ended March 31, 2008 and 2007 was 38.1% and 38.5%, respectively. We expect the effective tax rate for the remainder of the year to be 38.5%.

Net income for the first quarter of 2008 totaled $5.3 million, or $0.30 per diluted share, compared to $5.8 million, or $0.33 per diluted share for the first quarter of 2007. Net income for the first quarter of 2008 includes a $131,000 after-tax loss from discontinued operations, which resulted in a $0.01 decrease in earnings per share. Net service revenue for the home-based services for the three months ended March 31, 2008, increased 24.1% to $68.4 million, compared with $55.1 million for the three months ended March 31, 2007. Organic growth in net service revenue and in Medicare net service revenue for the home-based services for the three months ended March 31, 2008, is 6.9% and 8.6%, respectively, as compared to the same period in 2007. Organic growth in average weekly census and in Medicare average weekly census for the home-based services for the three months ended March 31, 2008, is 6.9% and 12.1%, respectively, as compared to the same period in 2007. We calculate organic growth by dividing organic revenue growth generated in a period by total revenue generated in the same period of the prior year.

Revenue contributed by acquired agencies contributes to organic growth beginning in the 13th month after acquisition. However, we generally are able in the first 12 months after an acquisition to grow the acquired agency's revenue, and we look for this opportunity when evaluating a potential acquisition. We call this internal acquisition growth. Internal acquisition growth in net service revenue and in Medicare net service revenue for the three months ended March 31, 2008 was 2.7% and 3.2%, respectively. Internal acquisition growth in average weekly patient census and in average weekly Medicare patient census in the three months ended March 31, 2008, was 3.7% and 4.4%, respectively.

When developing our forecast and 2008 guidance, we combined internal acquisition growth together with organic growth to estimate 2008 revenue growth over 2007. We consider this measurement meaningful and will continue to disclose it in future quarters. Combined organic growth and internal acquisition growth in net service revenue and in Medicare revenue for the home-based services in the three months ended March 31, 2008, was 9.5% and 11.7% respectively. Net service revenue for our LTACs for the three months ended March 31, 2008 increased 10.6% to $15.1 million, compared to $13.7 million for the same period in 2007. The increase relates primarily to higher occupancy and patient days in the quarter, both of which were higher than any quarter in 2007. For most of January, CMS payments were approximately 10% of what they had been running previously. In February and March, payments increased but have not yet caught up to the amounts missed in January.

Days sales outstanding, or DSO, for the three months ended March 31, 2008 was 74 days as compared with 79 days for the same period in 2007. Included in accounts receivable is $16.4 million generated by acquired agencies, and which remain unbilled at March 31, 2008, awaiting approval of the change of ownership from the fiscal intermediaries. After adjusting for these unbilled accounts receivables, adjusted DSO is 56 days compared to 68 days for the comparable period in 2007, and compared to 63 days at December 31, 2007. Since March 31, 2008, and through the end of April, the company has received the change of ownership approvals on about $7.8 million of the $16.4 million in unbilled receivables and has begun billing these claims.

Non-operating income for the quarter ended March 31, 2008 included a $315,000 gain on the sale of our previous aircraft. In the March quarter of 2007, non-operating income included about $278,000 in interest income on invested cash. For the current quarter, interest income was about $55,000, and we expect quarterly interest income to remain at that level in 2008. Cash provided by operations was $16.5 million for the quarter ended March 31, 2008. CapEx for the quarter ended March 31, 2008 was $5.5 million, and related primarily to the purchase of a new aircraft at the beginning of the year.

During the March 2008 quarter, we acquired three locations for $5.7 million in cash, including acquisition costs. At March 31, 2007, we funded two acquisitions which were effective on April 1 for $8.3 million. This payment is recorded in prepaid acquisitions costs on the balance sheet. We can drill down into these results further during Q&A if anyone desires.

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

John Indest

Thank you, Pete, and good morning. First, I'd like to touch on the operational data from the first quarter of 2008. Total admissions to home nursing climbed 24.2% to 13,180 in the three months ended March 31, '08, from 10,615 in the three months ended March 31, '07. Medicare admissions rose 34% to 9,828 in the three months ended March 31, '08, from 7,333 in the three months ended March 31, '07. For the first quarter of 2008, our average weekly patient census was 18,958, an increase of 20.7%, as compared to 15,712 patients for the first quarter of '07.

Average weekly Medicare patient census rose 27.8% to 14,876 in the three months ended March 31, 2008, from 11,642 in the three months ended March 31, '07. We had 25,415 completed Medicare episodes in the first quarter of 2008. Total growth in Medicare episodes was 46.4% for the three months ended March 31, '08, as compared to the same period in '07. Our average case mix for completed Medicare episodes in the first quarter of 2008 was 1.3, with an average reimbursement of $2,402 per episode. Touching briefly on our seven LTAC locations, patient days increased 3.1% to 12,034 in the three months ended March 31, '08, from 11,674 in the three months ended March 31, '07. These seven locations in Louisiana continue to be stable, consistent contributors to earnings, sharing operational synergies with our home health agencies in the markets they serve.

Earlier, Keith referred to our acquisitions of Access Home Health, Home Care Connections, Rivercrest Home Health Care, and River West Home Care. In addition, Keith referred to our joint venture with Marshall Medical Centers Home Health. I could not be more pleased with these additions to the LHC Group family of homecare locations. I fully understand the concern in the minds of each employee as they move from their former owners to a new company of which they have relatively little knowledge. I first want to thank each and every employee in these agencies for their dedication to those patients entrusted to their care, and for the trust that they have placed in our company. Also, I want to thank our LHC Group team members who worked so hard to make these deals come to fruition, and who are on the front line transitioning these agencies into the LHC culture and model of providing care. It is this team that continues to impress me with their ability to assimilate into the LHC Group the large number of agencies that we have added in the past, and therefore gives me confidence to continue our controlled yet aggressive expansion into the future.

Along with the active acquisition pipeline, we have also been busy establishing de novo locations. In the first quarter of 2008, we established six de novo locations. These locations were in Moss Bluff, Louisiana, Branson, Missouri, Clarksville, Maryville, and Dyersburg, Tennessee, and Cartersville, Georgia. As we have been doing in the past, we continue to focus on adding de novos in strategic markets surrounding our provider locations.

Quality care has always been the focus of our company. Our commitment has never waned, but our method of providing the highest quality care in all of the communities that we serve continues to evolve. I could not be more pleased with our newly established quality council. As part of our commitment to deliver superior patient care, we have formed this multi-disciplinary group. Responsibility of the council is to oversee all quality-related activities, prioritize performance improvement initiatives, and make recommendations that positively impact patient outcomes. One area of focus for the quality council is our homecare compare outcome measures. As of March 30 homecare compare update, which covers data from October of '06 through September of '07, we have shown consistent improvement in 10 of the 12 outcomes over the last reporting period. This includes improvement in our acute care hospitalization rates. We currently meet or exceed 5 of the 12 national outcome marks.

Without acquisitions, same stores at this same time last year, we have shown improvement in 11 of the 12 outcomes over our last reporting period. It is very important to note that we have shown continuous improvement in these scores over the last four reporting periods. I'd like to conclude by offering special thanks to our operations team. In the spring and summer of 2000, our team worked diligently and prepared us well for the new homecare prospective payment system. We are blessed to have many members of this same team working with us today. Led by our Senior VP of Operations, Don Stelly, his team worked many hours to ready our company for the challenges presented with the January 1 reimbursement changes enacted by CMS. The results of their efforts have been clearly demonstrated and continue to evolve into an effective operating model.

I also say, "job well done" to all of our leaders and staff in the field. While continuing to provide the highest level of patient care, they participated in the many education sessions that were presented to them. They obviously learned their lessons well. Like Pete, I'll gladly take any questions you may have concerning operations in a moment.

Keith Myers

Thanks, Johnny. I want to say thank you to all of our shareholders for your investment in LHC Group and for your support. We are excited about the future, and with your help we will continue to grow and achieve new milestones as we continue to provide the highest quality care possible to the many patients, families, and communities we are so fortunate to serve, and doing so in the most cost-effective, least-restrictive environment possible, creating a win-win value proposition for both patients and payors. We cannot be better positioned for the future. As policy makers struggle to mitigate increasing healthcare costs, the role of home healthcare will continue to expand, especially in the area of disease management and chronic long-term care for the age 65-plus population in the U.S., which will more than double over the next 30 years.

83% of those aged 65 plus have at least one chronic condition, and 23% have five or more chronic conditions, and account for 68% of all Medicare spending. A comparison done by the Social Security Administration of hospital and nursing home charges show that in 2006, a one-day hospital stay was $5,036, and one day in a nursing home was $535. The home health services we provide cost less than $50 a day on average. It's no secret that using home healthcare to manage beneficiaries with chronic conditions reduces costs and improves patient satisfaction. Providing the care that lets people live at home is less expensive than providing care in a nursing home or a hospital, and, obviously, people are happier living at home. Finally, in closing, we reaffirm our guidance for this year at $325 million to $350 million in revenue, and $1.25 to $1.35 in EPS.

Operator, we are ready to take questions at this time.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Brian Tanquilut with Jefferies and Company. Please proceed.

Brian Tanquilut – Jefferies & Co.

Hi, good morning, guys. Congratulations on the good quarter. Keith, just the first question. Thank you for providing us an update on the acquisition pipeline and what you guys are doing there, but can you give us some color on what you are seeing in the field in terms of the reaction of the sellers? Are we seeing increased distress from smaller providers, or it's just an increased willingness to sell? And if you can give us – if you can characterize what these agencies are, whether they are rural or hospital-owned, or just a little more color in that.

Keith Myers

Okay. First of all, I think from a pricing standpoint, we are seeing price expectations on the seller's side being more realistic or more in line with where we think valuations are, so we are coming to the terms more quickly than we did in the past, perhaps. I think, quite frankly, some of the smaller providers that we target are tired [ph]. This new reimbursement methodology is complex for a small provider if they don't have the systems to manage through it. I think that contributes to the increased opportunities we are seeing.

With regard to the make up, I don't think our distribution has changed any. I mean, we have a mix of hospital-based agencies. I'd say probably 50% of the locations being considered, roughly, are hospital locations, and about 50% are freestanding locations, and a consistent distribution between rural and urban. Nothing in our strategy has changed as far as our focus. We continue to look – we are more interested in the upside potential, as we have always been. We are looking for opportunities where there is significant upside potential for internal growth within existing markets and then geographic expansion in licensed areas that aren't being served.

Brian Tanquilut – Jefferies & Co.

Got you. All right. And then second question, just if you can give us an update on the commercial relationships. I know last quarter you guys talked about moving away from the commercial or the private payors. If you can just give us an update on that one.

Keith Myers

Okay, sure. Well, as you saw, we are doing a really good job, our team is, of turning that around. I just can't say enough about the job they are doing. But to be clear, what we said last quarter was that we wanted to stay away from or try to avoid payors that did not reimburse us adequately. We don't – we welcome commercial business or managed care business that pays us fairly. So what we were doing is shifting away from those that pay us 20%, 25%, 30% below cost, and trying to increase those that pay fairly such as the commercial PPS plans. And the result is a 19% decrease in admissions in that category, but a 17% increase in revenue.

Brian Tanquilut – Jefferies & Co.

So are you seeing some of those payors that you basically told that you are moving away from them, I mean are you seeing them come back to the table yet?

Keith Myers

We are. We are.

Brian Tanquilut – Jefferies & Co.

Okay.

Keith Myers

And we are really happy about that. And I have to tell you that it's – I don't see a conspiracy on the part of commercial or managed care companies to pay too little for home care. It's really an education process. When we meet with those decision makers at higher levels, they really have no idea what they were paying for home health because it's just been an, "oh, by the way." And then when they look at the economics, for $50 a day, they would prefer to have someone at home as opposed to having them in a hospital, so it doesn't take us long to renegotiate.

Brian Tanquilut – Jefferies & Co.

Got you. And then last question for Pete. If you can just give us sort of some color on the aging of your receivables and where you think the DSOs can come down to over time?

Pete Roman

We'll have an aging table in the Q when we file it, and I can tell you that just overall I think the aging has improved on a dollar basis. On a percentage basis, the percent of total receivables over 240 has remained kind of consistent with the percent at December 31. But because the dollar amounts came down, you will see the dollars come down in that category. We don't think that we are where we are going to be yet. And the 55-day DSO that the adjusted DSO that we disclosed in this particular conference call, although it's very good and it's a good improvement, we still believe that we have some room in there to improve it. I really have to say that that department collecting receivables has been at it consistently for the entire six months that I've been around here, and the addition of Simione has been very positive. The processes are improving.

We are improving our Group, and we are now applying electronic filtering methods that will allow us to collect receivables quicker. I think all those things are going to continue to drop the DSOs on an adjusted basis. The unadjusted basis, where you talk about the receivables that are kind of hung up waiting for the chow [ph] approval, we are really locked up with the fiscal intermediaries. The numbers that I've seen is that it's taken over 270 days for them to get the approval to come through. So consequently what I think is you can't look at that number because as our acquisitions grow, that adjustment is going to grow, so I think you have to get back to the adjusted DSO, and I think that's kind of where we are headed.

Brian Tanquilut – Jefferies & Co.

Got you. All right. Thanks, guys.

Keith Myers

Thank you.

Operator

Our next question comes from the line of David MacDonald with SunTrust. Please proceed.

David MacDonald – SunTrust Robinson Humphrey

Good morning, guys. Hey, Keith, can you give a little detail on the new managed care contracts? As you circle back and re-sign these, what type of payment terms are you putting in these new managed care contracts in terms of DSOs?

Keith Myers

In terms of DSO?

David MacDonald – SunTrust Robinson Humphrey

Well, I mean just I'd assume you are putting some type of payment terms in there in terms of we've got to be paid in 60 days, 90 days, whatever the number is. What are those terms looking like on the new contracts that you are signing? Just because I know receivables on the old managed care business was a bit of an issue.

Keith Myers

Yes. Our standard is 30 days from a clean claim date.

David MacDonald – SunTrust Robinson Humphrey

Okay. And then were those terms not in the previous contracts, or were these folks just not paying attention to it?

Keith Myers

Some of both. I mean, some of them had longer terms, but for the most part they weren't paying attention to it. We weren't negotiating at a high enough level to get someone's attention you would make them pay attention to it. Now after terminating contracts, when you re-sign, we are monitoring it more closely. So if denial percentages get above the threshold that's acceptable, then we deal with it upfront.

David MacDonald – SunTrust Robinson Humphrey

Okay. And then two other questions. Can you talk a little bit about the LTAC business? Do you guys think that kind of 1Q trends are sustainable, or should be expect that to kind of back off a little bit throughout the course of the year? And then can you also give us some sense in terms of what you expect cash from operations to be for 2008?

John Indest

This is Johnny. I'll handle the question on the LTACs. As I've said in my statement, I'm very proud of our LTACs. They have done a lot of things to meet the challenges that's been presented by reimbursement changes. As far as what you can expect, I think you can expect similar performance in Q1 throughout the year.

David MacDonald – SunTrust Robinson Humphrey

Okay. And then just the cash flow?

Pete Roman

Yes. I think I can take that. And I don't know that I can exactly predict what cash flow from operations is going to be over the entire year. I think last year we had some pretty wide variances quarter-over-quarter. If you look back, we had one quarter that we had $12 million, and then we had another quarter where we had a negative $1.9 million. I think that the primary driver in cash from operations for us, there really are two. One is our ability to manage payables, and I think we do a very good job with that. And then the second one is our ability to collect the receivables, and I think that's starting to happen. One way I'd say to look at this is right now our net income was about $5.3 million, and we generated $16.5 million in operating cash flow. I don't expect us to maintain a 3-to-1 ratio between operating cash flow and income, but I–

David MacDonald – SunTrust Robinson Humphrey

No. But is it fair to say that EBIDTA is probably a pretty good proxy for cash flow? Because I'd assume your working capital would be at least a push, maybe even a little bit of a benefit with what's going on in the collections side. Is that fair?

Pete Roman

I think it is fair.

David MacDonald – SunTrust Robinson Humphrey

Okay. Thank you.

Operator

Our next question comes from the line of Whit Mayo with Stephens, Incorporated. Please proceed.

Whit Mayo – Stephens, Inc.

Thanks, guys. Good morning. Just looking at the margin trends between the two segments, just I mean the – the LTAC margins were substantially higher than I think many of us were looking for and – was there any reclassification of any expenses between the two segments in the quarter?

Pete Roman

No. The primary thing that drives the LTACs really is revenue, and their cost base is not something that you can flex up and down with very successfully. So when they are able to get increased patient days and increased occupancy that really falls almost straight to the bottom line. I think that if you are talking about the relative G&A percentages between the two segments, then I think you have to consider the application of G&A or the additional G&A that we picked up that really does relate to the home health side. And that would be some of the consulting fees that we've brought in to help us collect the receivables. None of that is facility based. That's all home based side.

John Indest

Pete, I think the only thing I'd add to that is we've also been pretty successful in consistently increasing our case mix in the LTAC division, which goes exactly into what you are saying about increasing the revenue.

Pete Roman

Yes.

Whit Mayo – Stephens, Inc.

Okay. But sort of a 16% operating margin you feel like is fairly sustainable for the rest of the year?

Pete Roman

Well, the March quarter every year is the highest quarter for the LTAC, so I think you have to consider the seasonality.

Whit Mayo – Stephens, Inc.

Sure.

Pete Roman

But yes, I do think that we are doing a pretty good job managing the revenue side, and obviously we are doing a good job on the cost side.

John Indest

It's the best performance we've had in a quarter on the LTAC. I think that is certainly the top range that we are going to probably be looking at and – but I am confident of us being able to have comfortable margins in our LTAC, that we can continue our good performance.

Whit Mayo – Stephens, Inc.

Okay. That's great. And, Pete, just – I hate to be a knucklehead about this, but looking at the allowance on the balance sheet, it was down about 2% from quarter-to-quarter. And that may just be due to lower AR from less managed care, but can you just help me understand what's going on there?

Pete Roman

Yes. And I think that you have to consider two things when you are looking at the allowance. You can't really just look at the allowance on a static basis.

Whit Mayo – Stephens, Inc.

Sure.

Pete Roman

The movement in the allowance is both the additional bad debt expense in a period and the amounts that were written off. And the primary reduction in the reserve had to do with some write-offs of claims that we had on the balance sheet that were fully reserved at 12/31 related to discontinued operations. And that was the acute care hospital that we sold, I think it was in June of 2007. So relatively speaking, if you pull that piece out, the reserve as a percentage of the remaining receivables actually is a couple percent higher.

Whit Mayo – Stephens, Inc.

Okay. And just going back to the payor contracts just for a second and the re-contracting there, the ones that you have been able to renegotiate with and have come back to the table, how close are they to Medicare-like rates now? Are they still below cost, at cost, just where is sort of the dialog? Where have you guys sort of agreed upon right now?

Keith Myers

There are many different contracts, and most of them have a requirement that we not disclose the details of individual contracts. So let me just say this. We don't – we are not negotiating anything that's below cost. And our goal is to bring them up to – at least up to Medicare rates because there is more cost associated with doing business with commercially managed care payors on the administrative side. You have the case management aspect, for lack of – in plain words, the permission giving that goes on and then all of the additional paperwork that has to be filed. So when we go into it, we have several combinations. Some can't pay an episodic rate. Some of them need to stay with a per-visit rate that pays different for nursing and therapy and different things. So we have a model that offers them per-visit rates, but at the end of the day they equate back to Medicare reimbursement when all is said and done. So if we contract with someone, we have gotten them up to Medicare rates, or maybe only slightly below if it's a very large provider in a market that we really want.

Whit Mayo – Stephens, Inc.

Okay. Now, that's helpful. And just one last question. Just looking at your clinicians right now in sort of salary structure, how many are on a pay-per-visit type of structure right now?

John Indest

It's right at about half and half.

Whit Mayo – Stephens, Inc.

Is that an ongoing initiative to try to grow that more?

John Indest

We run on a productivity model, Whit, so I mean paying per visit helps us. Certainly it tends to simplify things, but we are basically looking at a productivity model that is budgeted to our agencies, so we pretty much do what the market demands.

Whit Mayo – Stephens, Inc.

Okay. Understand. Thanks guys. Good job.

Keith Myers

Thanks.

Operator

Our next question comes from the line of Newton Juhng of BB&T Capital Markets. Please proceed.

Newton Juhng – BB&T Capital Markets

Thank you. Gentlemen, I was wondering about the rising fuel costs. We were actually just on another call talking about that, and just how it affects you guys considering the rural exposure that you have, and kind of how we should look at the effect on your margins as we move through 2008?

Keith Myers

Yes. That's an excellent point. No question that fuel cost is a significant issue, and that's one of our supporting arguments for the rural add-on, and it comes up in every conversation about it. But I think that how you should look at it for–your question was how you should look at it for '08? Yes. I'm trying to give you a precise answer. We would have to – our guidance, the guidance that we have issued in our – in reaffirming guidance we've taken into consideration the increasing – the fuel cost of where it is today. But we had already budgeted high fuel costs. I mean, this – it's more an issue of recruiting employees, to be honest with you, because that's where we are having the greatest hit with it. Not so much from a budget standpoint internals.

Newton Juhng – BB&T Capital Markets

And, Keith, how often do you true up I guess the rate of reimbursement that you are giving to your employees? And is it like on a monthly basis or just as the rates go up and you just feel like you need to do it to give some relief?

Keith Myers

No, it's quarterly. It runs out of our HR department. There is a formula we use that's based on U.S. fueleconomy.gov and it plugs in every quarter and updates the rate. And it does it by state because there are different prices in different states, so–

Newton Juhng – BB&T Capital Markets

Got you. Switching gears more to the top line, just can you help me out here on the – how much of the strength in the home health revenue can be related to kind of increased case mix versus how much is related to being able to get some more better codings and more certifications or re-certifications and so on?

Keith Myers

I mean, I'll let Pete and Johnny jump in here, but our case mix is actually down–

Newton Juhng – BB&T Capital Markets

Correct.

Keith Myers

Because of – obviously because of the 2.75% reduction, but – so I think it's all related to focusing on new diagnosis groups, improvement in coding expertise, and then increase in census.

Newton Juhng – BB&T Capital Markets

Yes.

John Indest

That's exactly – Keith's right. In our preparations for the changes January 1, and we continue to work diligently toward that, but we pay much more attention now to the coding aspect, and not from the aspect of up coding but from the aspect of accurate coding. In our past, we had our nurses who were within the offices doing the coding, and with approximately 160 home care locations, there was a lot of variance for deficiencies in knowledge, a lot of varying levels of knowledge related to coding. We have brought a number of certified coders on board, and they are looking very closely at our coding and making certain that we are doing the most accurate coding possible.

Newton Juhng – BB&T Capital Markets

And recruiting those coders, as you continue to acquire them, I'm guessing a lot of these smaller agencies don't have those type of coders, is it difficult to get them on board?

John Indest

I think what your wrong assumption is that these coders are deployed throughout our company. They are more centralized, so we are using electronic means to review the plans of care and OASIS. So we are using these people mostly in Louisiana and they are reviewing remotely the documentation.

Newton Juhng – BB&T Capital Markets

I see, Johnny. Thanks for correcting me on that. And then just one last question for Pete here. Just the rise in minority interest in Q1, should we be modeling that higher level of minority interest as we move through 2008?

Pete Roman

The biggest driver of that was really the facility side. The percentage on the home-based side was about – in the fourth quarter it was about 2.2% of revenue, and in the first quarter it was about 2.5%, so it's right in line. The facility side profitability generated the increase in minority interest. Actually, our largest minority interest partner percentage is on the LTAC side, so that's what really drove that up. I don't know that I'd change going forward on that.

Newton Juhng – BB&T Capital Markets

Great. Thanks so much, Pete.

Pete Roman

Okay.

Operator

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

Sudeep Singh – Deutsche Bank

Hi. It's actually Sudeep Singh calling in for Darren. Just a couple of quick questions here. I think in the last call you guys discussed kind of a margin hit of 4% to 4.5%, and I guess I'm just wondering with a full quarter under your belt, are you seeing any light at the end of the tunnel with respect to that number? And I guess when we have this conversation a year from now, where do you think that number could settle out at?

Pete Roman

Yes. I can answer some of that. We disclosed the Medicare growth in revenue, the organic Medicare growth in revenue versus the census growth. And the difference between those two is about 3.5%, and I'd consider that to be the effect on revenue of the reimbursement change. I don't think that it's 100% 2008 claims that we are talking about. So there were some transition claims in there that mitigated some of that. In our guidance, we kind of stuck at the margin level because it was hard to predict the difference between the revenue side and the cost side. So the 3.5% is kind of in line with what we were expecting.

In addition to that, if you consider that – if you consider the change in reimbursement to have about a $1.5 million effect on revenue and then go back in and apply that to cost of sales, the cost of sales ends up being about 47.8% actual – I mean adjusted like that compared to the 48.8% that we actually came in at. So we think that that additional percent is really the application of our mitigation techniques. So you add those two together, the 3.5% and the additional percent, and you come right in at about 4.5% margin compression, which is sort of where we thought we would end up. Going forward, for the rest of the year, it's hard right now to fully predict the rest of the year and the impact of the finer rule because we really only have one – March was really the only month that had 2008 claims coming in and out.

We are in line with where we think we were going to be right now, and we are still applying the techniques Johnny talked about a minute ago as well as cost mitigation. So I think that our year looks very similar to what we had in mind, if not maybe even a little bit better.

Sudeep Singh – Deutsche Bank

Okay. That's great. Thanks for that color. And then just going back to the LTAC business, I think if I go back to my notes, in the fourth quarter you guys were talking about more kind of a flattish outlook in terms of growth for that business. And now the sense I get is that we should be modeling in higher growth for '08, but I am just – in addition to case mix, is there anything else that happened? And I am just trying to reconcile the difference in – between one quarter and the next.

Pete Roman

Yes. I really don't think that I'd model in a lot of growth there. I think what happened in the first quarter really was that we had additional patients. I think maybe we had a few outliers more than we had had prior to this, and the occupancy and the acuity on the patients drives the profits within that segment, and I just think that that's going to go up and down seasonally and the costs cannot. So I think we had a good quarter, and I think it was better than the March quarter of last year. I don't think I'd draw any conclusions that the entire year was going to be significantly better than it was in 2007.

Sudeep Singh – Deutsche Bank

Okay. And then just one kind of final housekeeping, I missed it during the call, but can you just me the numbers for total average census and organic average census in the quarter?

Pete Roman

Yes. The total average census was 18,958. Organic average census was 16,789.

Sudeep Singh – Deutsche Bank

Great. Thanks a lot.

Pete Roman

Okay.

Operator

Our next question comes from the line of Sheryl Skolnick with CRT Capital Group. Please proceed.

Sheryl Skolnick – CRT Capital Group

Good morning, and thank you for such a clear and certainly I think thoughtful explanation of everything that's going on in your business. I have one minor detail I need to clear up, and then another more substantive question. I noticed that the bad debt expense on the cash flow statement is different from what it is on the income statement. I think it's about $400,000 higher on the cash flow statement. Is that related to the treatment of discontinued operations?

Pete Roman

Yes, that's right.

Sheryl Skolnick – CRT Capital Group

Okay.

Pete Roman

We don't – the additional expense on the cash flow statement is all down – netted down in the disc ops disclosure down below on the income statement, right.

Sheryl Skolnick – CRT Capital Group

Okay. As you started to describe that on your conference call, it occurred to me.

Pete Roman

Yes.

Sheryl Skolnick – CRT Capital Group

Okay. That makes sense. You've mentioned that your – I'm going to go back to the case mix and the changes in the case mix because I guess I'm just intrigued that of the three companies who have reported in the last 24 hours, there is only one that had a significant increase in the number of episodes per admission and the revenue per episode, although it does not appear to be the case when you just look at their reported revenue proviso [ph] for Medicare. So I'm trying to understand just how fast a case mix index or the number of revenue per– number of episodes per admission can change in your business because it seems to be one of the two drivers, and then how well you think you are doing in picking up the secondary and tertiary diagnoses. And is that going to be part of driving the improved performance in the back half of the year versus the first?

John Indest

Sheryl, this is Johnny. I am not going to comment on – I didn't listen to the other calls. I don't know what was reported. I can just tell you from our standpoint that as reported earlier, all of the educational sessions that were being held last year in preparation for this new reimbursement methodology put emphasis on ‘if you are not sophisticated in your coding, you better be able to get there.'

Sheryl Skolnick – CRT Capital Group

Right.

John Indest

We have moved and continue to move more and more in that direction. We've seen the expected decrease in our case mix. That is in line with I think the expectations of CMS. We will continue to make as certain as absolutely possible that we are accurately coding all of our patients, and that we are keeping them as long as they meet Medicare requirements and discharging them promptly when they don't.

Sheryl Skolnick – CRT Capital Group

Okay. Have you seen significant changes in the number of either visits per episode yet – I realize you really only have one pure month, but either the number of visits per episode or the number of therapy visits per episode in your customer mix?

John Indest

No, very little.

Sheryl Skolnick – CRT Capital Group

Okay. And so that would explain why the case mix index did go down. Right. Okay. That's excellent. Thank you so much for the insight.

Keith Myers

Thank you.

Operator

Our next question comes from the line of Stephen Anderson with Wachovia Securities. Please proceed.

Stephen Anderson – Wachovia Securities

Hi guys. I just want to revisit the fuel cost issue with a little more specificity. One of your competitors noted that the cost of fuel is now their second largest expense in home health behind labor, and mentioned that fuel now accounts for approximately 3% of home health revenue. Is this similar to your experience as far as rank of the cost, and can you give us a sense of what the cost of fuel is now as a percent of your home health revenue?

Pete Roman

Let me see if we have that.

Keith Myers

While they are trying to get you a specific number, I hope we didn't in any way minimize that because it is a significant cost, and again it's one of the key points we make in the arguments for the rural add-on. Just – it was high when we went into this year, and we forecasted high throughout the year. But let's get a little more into it.

Pete Roman

About 3%.

Keith Myers

Yes.

Pete Roman

I mean, our total transportation expenses, which would include, but not be limited to fuel costs, is about 3% of revenue, and that's a quarter number on March of 2008.

Keith Myers

And in our fuel, when we adjust mileage, there of course is a fuel component and then there's a vehicle expense component. We only update the fuel component based on a fuel increase, so the entire 3% is an impact. But, I mean, it is an impact. I mean, to get any more detailed than that, I think we would have to do – to tell you where our fuel cost is for this quarter and how much more our costs are as a percentage of revenue over last quarter, we have to do a little homework. We don't have that now.

Stephen Anderson – Wachovia Securities

Okay, fair enough. And sorry if you've already addressed this one, can you give me the breakout of the percent of episodes in the quarter that fell solely under the new payments system?

Pete Roman

No. We don't have that broken out. I can only tell you that we had a couple in February, and then most of March. But, I mean, obviously the 60-day episode, that's how it's going to fall out, but we don't have that broken out specifically.

Stephen Anderson – Wachovia Securities

Okay. Thanks guys.

Keith Myers

Okay. Thank you.

Operator

Our next question comes from the line of Greg Williams with Sidoti and Company. Please proceed.

Greg Williams – Sidoti & Co.

Thank you. Most of my questions have been answered, but I just had one question. I think you may have said it in the scripted comments about the acquisition pipeline and you said it was ramping up. Can you talk maybe about the multiples, are they getting more attractive, and do you think they will over the course of the summer?

Keith Myers

Yes. This is Keith. Yes, I do. They are more favorable, and I think they will continue to move. But one thing I didn't mention that I'll say is that – and we've always done this, but some of the best deals that we do here are the ones we walk away from. And we walked away from two deals in the first quarter that would have been deals that would have been in range last year, maybe on the high end of the range, but we just think they couldn't hold up in this environment. And so we walked away from those two, and I think it had an impact on several other deals that were in the pipeline when we walked away from those. So I see it still – I see prices still coming down a little bit more.

Greg Williams – Sidoti & Co.

And then the acquisition profile is still a lot of single agencies to get the licenses, or are you going for multi-region agencies? Has that sort of changed?

Keith Myers

Well, it really hasn't changed. We've always looked for the multi-site, obviously. If there is a lot of activity, you want to focus on the larger opportunities. I think what we are seeing is because of the change to the newer reimbursement system and the pressures and all that agencies maybe in the $10 million to $25 million range in revenue, there are some opportunities there that are coming into the pipeline that weren't in the pipeline in '07 and in '06. I mean, they may have had different plans to grow, and then when hit with the reimbursement challenges, they have to make a real decision as to whether or not they want to invest in the serious infrastructure it takes to deal with that on a large scale, or if they want to sell short and just take cash.

Greg Williams – Sidoti & Co.

Okay. Thank you guys.

Keith Myers

Okay, thanks.

Operator

Our next question comes from the line of Eric Gommel with Stifel Nicolaus. Please proceed.

Eric Gommel – Stifel Nicolaus

Hi, good afternoon. Just a couple of questions. Something that just occurred to me, on the guidance that you guys just reaffirmed, were the acquisitions you've made year-to-date included in that guidance?

Pete Roman

No, they weren't.

Keith Myers

No, they weren't.

Eric Gommel – Stifel Nicolaus

Okay. And so that includes no additional acquisitions, correct?

Pete Roman

That's correct.

Keith Myers

Correct.

Eric Gommel – Stifel Nicolaus

And then it looks like you have a really robust pipeline of acquisitions. Can you talk a little bit about – you talked about increasing your revolver, I guess capacity on that. What about funding these acquisitions just with your internal cash flow? I mean, what's the opportunity there in that sense? Do you feel comfortable with the ability to do a fair amount of growth with just your internal cash flow?

Keith Myers

I'll take the first part. I mean, obviously yes, we are going to use all of our cash flow first before we go through the line. It's just that when we see this much increased activity, and in really good prospects that we really want, we think it makes sense to have that line sitting there because we don't have the – necessarily have the ability to time these and space them out. It's kind of making hay while the sun's shining if you will. Pete, do you want to talk a little bit more about that?

Pete Roman

Yes. I mean, the only thing I'd add to that is that with a larger acquisition, you have to contemplate some period of time that you are not going to be able to bill and collect receivables, so you have to fund that in a manner – in some manner. And so the line of credit that you are looking – that we are trying to get to is both to fund the acquisition itself and to fund operations for some period of time until we can get the – get this change of ownership approval through.

Eric Gommel – Stifel Nicolaus

And I don't want to irritate you, Keith, with this question, but on the LTAC business, I mean, that's improving. I mean, I know in the past people have asked about that business as maybe a non-core business. Is there – I mean, do you look at that as a potential to may be sell or as a potential source of cash to make a larger acquisition or is that still a business you think is important to hold on to strategically?

Keith Myers

I guess I have to work on my communication style here. It seems like I've got people nervous about the LTAC. Thanks for the question. Our position is the same on the LTACs. We just operate seven LTACs in our base here in Louisiana. And in Louisiana, those seven LTACs share tremendous synergies with the home health operations in those markets that they serve. So it's – we view it here as just part of our whole continuum. There's no question that our growth focus is on home health. That's where this company is going. But the seven existing LTACs, I think we will continue to operate them because they are important to the success of our home health agencies in those communities.

Eric Gommel – Stifel Nicolaus

Great. And then my final question, and I'll jump, is really for Pete. I mean, with Simione Consulting, I mean the long term – I am assuming the long-term strategy is to bring the collections and those operations in-house at some point. Is that still the goal, and do you have any solid time frame for that?

Pete Roman

Yes. I think when you address the consultants that we've brought in here, I know that everybody looks at that just as G&A and just as an added expense, but I don't know that we really consider that to be the case. We have expertise that we are bringing in-house that provides best practices, helps us organize in the most efficient manner. We see value to what these guys bring to the table, and to just simply look at that as cost I think is incorrect. I think we consider that to be part of our investment in our company, and that there is a future benefit that we will reap because of these relationships with the consultants. So we are not in any hurry to have these relationships end, and we don't think that there is – the halcyon days are in the future with those consultants. So what I think is the most important part of this is that what you see in the financial statements, you see the DSOs coming down.

We believe that there are some intangibles that they are bringing into our departments, and so we think that the benefit that we get from them is an honest to goodness benefit, just like you'd be buying an asset. We think that's the way to go. Now, we certainly have a timeline for some of the additional services that they are providing like where they are helping us collect our older receivables. And so it's sort of like additional resources for us that we can flex to and get those claims collected. And that part, yes, I agree that at some time in the future we won't need that, but just the general consulting and the assistance with acquisitions and the way they are able to bring best practices and procedures into our departments, I think that's going to be an ongoing relationship.

Eric Gommel – Stifel Nicolaus

Okay, great. Thank you.

Operator

Our next question comes from the line of Ralph Giacobbe with Credit Suisse. Please proceed.

Ralph Giacobbe – Credit Suisse

Thanks. I may have missed this. You may have talked about it. I had to sort of step away, but can you talk about maybe about the competition out there. Obviously, with the new payment system, I'd assume some of the smaller players out there may be struggling a little more than you all. Just in terms of market share gains to be had, and maybe from the aspect of more loyalty if you will from discharge planners.

Keith Myers

Yes. Well, I guess from the smaller competitors, I think the increase in pipeline activity speaks to that.

Ralph Giacobbe – Credit Suisse

Sure.

Keith Myers

It's pretty overwhelming. I mean, there are 918 possible combinations to look at in patients now where we had 80 before, and it's just much more complex so I think that's playing into it. And obviously as those competitors sell to either us or to someone else, it creates opportunities. In smaller markets where we have existing locations and there is a local homegrown competitor, it benefits us if that competitor sells, even if they don't sell to us, because there's always a certain group of employees that won't be satisfied with the new acquirer, and relationships shift, and relationships to a large extent determine where referrals go.

With regard to discharge planners, no, I wouldn't say that there is any impact there because discharge planners really are – I mean, they operate – I mean, they have a mind of their own. I mean, they really follow physicians' orders for the most part, and then if the physician doesn't direct a patient, the discharge planners are really looking to the services of patients. So in plain English, the way you get to a discharge planner is to provide the best patient care and patient satisfaction. When discharge planners hear from patients that they are pleased with the service they provide, that's what drives their decision-making.

Ralph Giacobbe – Credit Suisse

Great. Thank you.

Operator

Our next question comes from the line, as a follow-up, from Whit Mayo with Stephens, Incorporated. Please proceed. Mr. Mayo, your line is open and you may proceed with your question. You may want to check your mute feature on your phone.

Well, there are no further questions at this time. I'd now like to turn the call back over to management for closing remarks.

Keith Myers

Okay. Thank you, operator. In closing, on behalf of all of us here at LHC Group, thank you for taking the time to listen in and participate in our all this morning. As always, we are available to answer any questions you may have or questions that may come up between our quarterly earnings calls. Have a great day, and thank you for supporting and believing in the LHC Group family. Goodbye.

Operator

This concludes the presentation. You may now disconnect, and have a great day.

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Source: LHC Group, Inc. Q1 2008 Earnings Call Transcript
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