================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly Report Under Section 13 or 15 (d) of the Securities
---------- Exchange Act of 1934
For the Quarterly Period Ended September 30, 2006
Transition Report Pursuant to Section 13 or 15(d) of the
----------- Securities Exchange Act of 1934
Commission File Number: 1-8351
CHEMED CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 31-0791746
(State or other jurisdiction of incorporation or (IRS Employer Identification
organization) No.)
2600 Chemed Center, 255 E. Fifth Street, Cincinnati, Ohio 45202
(Address of principal executive offices) (Zip code)
(513) 762-6900
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
------- -----
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2
of the Exchange Act).
Large accelerated filer X Accelerated filer Non-accelerated filer
--- ---- ------
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
------- -----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Amount Date
Capital Stock 26,270,441 Shares September 30, 2006
$1 Par Value
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1
CHEMED CORPORATION AND
SUBSIDIARY COMPANIES
Index
Page No.
--------
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Unaudited Consolidated Balance Sheet -
September 30, 2006 and December 31, 2005 3
Unaudited Consolidated Statement of Income -
Three and nine months ended September 30, 2006 and 2005 4
Unaudited Consolidated Statement of Cash Flows -
Nine months ended September 30, 2006 and 2005 5
Notes to Unaudited Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
Item 4. Controls and Procedures 28
PART II. OTHER INFORMATION
Item 2.(e). Purchases of Equity Securities by the Issuer and Affiliated Purchasers 28
Item 6. Exhibits 29
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CHEMED CORPORATION, INC. AND SUBSIDIARY COMPANIES
UNAUDITED CONSOLIDATED BALANCE SHEET
(in thousands except share and per share data)
September 30, December 31,
2006 2005
------------------ -----------------
ASSETS
Current assets
Cash and cash equivalents $ 5,414 $ 57,133
Accounts receivable less allowances of $10,016
(2005 - $8,413) 104,240 95,063
Inventories 6,381 6,499
Current deferred income taxes 25,461 26,691
Prepaid income taxes 5,642 9,096
Prepaid expenses and other current assets 5,844 9,768
------------------ -----------------
Total current assets 152,982 204,250
Investments of deferred compensation plans held in trust 24,278 21,105
Other investments - 1,445
Note receivable 12,500 12,500
Properties and equipment, at cost, less accumulated
depreciation of $75,271 (2005 - $66,655) 68,616 65,449
Identifiable intangible assets less accumulated
amortization of $12,222 (2005 - $9,612) 69,880 75,358
Goodwill 434,066 433,756
Other assets 19,459 21,222
------------------ -----------------
Total Assets $ 781,781 $ 835,085
================== =================
LIABILITIES
Current liabilities
Accounts payable $ 45,745 $ 43,626
Current portion of long-term debt 207 1,045
Income taxes 4,903 3,916
Accrued insurance 41,368 38,894
Accrued compensation 32,429 33,156
Other current liabilities 27,460 48,258
------------------ -----------------
Total current liabilities 152,112 168,895
Deferred income taxes 20,570 22,304
Long-term debt 165,796 234,058
Deferred compensation liabilities 23,932 21,275
Other liabilities 3,929 4,378
------------------ -----------------
Total liabilities 366,339 450,910
------------------ -----------------
STOCKHOLDERS' EQUITY
Capital stock - authorized 80,000,000 shares $1 par; issued
28,809,618 shares (2005 - 28,373,872 shares) 28,810 28,374
Paid-in capital 250,373 234,910
Retained earnings 199,467 171,188
Treasury stock - 2,672,077 shares (2005 - 2,394,272 shares), at cost (65,555) (52,127)
Deferred compensation payable in Company stock 2,402 2,379
Notes receivable for shares sold (55) (549)
------------------ -----------------
Total Stockholders' Equity 415,442 384,175
------------------ -----------------
Total Liabilities and Stockholders' Equity $ 781,781 $ 835,085
================== =================
See accompanying notes to unaudited financial statements.
3
CHEMED CORPORATION AND SUBSIDIARY COMPANIES
UNAUDITED CONSOLIDATED STATEMENT OF INCOME
(in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2006 2005 2006 2005
-------------- ------------- ------------- --------------
Continuing Operations
Service revenues and sales $ 253,202 $ 233,328 $ 749,223 $ 678,274
-------------- ------------- ------------- --------------
Cost of services provided and goods sold
(excluding depreciation) 187,190 165,229 546,012 479,301
Selling, general and administrative expenses 39,160 38,423 116,279 114,981
Depreciation 4,200 4,086 12,465 11,934
Amortization 1,421 1,248 4,234 3,671
Other expenses--net 2,692 (130) 2,692 (801)
-------------- ------------- ------------- --------------
Total costs and expenses 234,663 208,856 681,682 609,086
-------------- ------------- ------------- --------------
Income from operations 18,539 24,472 67,541 69,188
Interest expense (4,081) (5,147) (13,726) (16,021)
Loss from impairment of investment (1,445) - (1,445) -
Loss on extinguishment of debt - - (430) (3,971)
Other income--net 715 1,317 2,734 2,644
-------------- ------------- ------------- --------------
Income before income taxes 13,728 20,642 54,674 51,840
Income taxes (3,541) (6,010) (19,430) (18,192)
-------------- ------------- ------------- --------------
Income from continuing operations 10,187 14,632 35,244 33,648
Discontinued operations, net of income taxes (2,226) - (2,226) (2,015)
-------------- ------------- ------------- --------------
Net income $ 7,961 $ 14,632 $ 33,018 $ 31,633
============== ============= ============= ==============
Earnings Per Share
Income from continuing operations $ 0.39 $ 0.57 $ 1.35 $ 1.32
============== ============= ============= ==============
Net income $ 0.30 $ 0.57 $ 1.26 $ 1.24
============== ============= ============= ==============
Average number of share outstanding 26,190 25,719 26,147 25,453
============== ============= ============= ==============
Diluted Earnings Per Share
Income from continuing operations $ 0.38 $ 0.55 $ 1.32 $ 1.28
============== ============= ============= ==============
Net income $ 0.30 $ 0.55 $ 1.23 $ 1.21
============== ============= ============= ==============
Average number of share outstanding 26,633 26,401 26,750 26,202
============== ============= ============= ==============
Cash Dividends Per Share $ 0.06 $ 0.06 $ 0.18 $ 0.18
============== ============= ============= ==============
See accompanying notes to unaudited financial statements.
4
CHEMED CORPORATION AND SUBSIDIARY COMPANIES
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
Nine Months Ended
September 30,
------------------------------------
2006 2005
---------------- ----------------
Cash Flows from Operating Activities
Net income $ 33,018 $ 31,633
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 16,699 15,605
Provision for uncollectible accounts receivable 6,003 5,352
Losses on asset impairments 3,864 -
Discontinued operations 2,226 2,015
Amortization of debt issuance costs 1,325 1,395
Provision for deferred income taxes (1,233) (1,176)
Write off unamortized debt issuance costs 430 2,871
Noncash long-term incentive compensation - 2,574
Changes in operating assets and liabilities, excluding
amounts acquired in business combinations:
Increase in accounts receivable (17,545) (25,264)
Decrease/(increase) in inventories 118 (233)
Decrease in prepaid expenses and other
current assets 2,673 2,656
Decrease in accounts payable and other current liabilities (16,147) (3,584)
Increase in income taxes 10,636 11,827
Increase in other assets (248) (2,876)
Increase in other liabilities 2,403 1,464
Excess tax benefit on share-based compensation (4,943) -
Noncash expense of internally financed ESOP - 858
Other sources 1,374 479
---------------- ----------------
Net cash provided by continuing operations 40,653 45,596
Net cash used by discontinued operations - (1,559)
---------------- ----------------
Net cash provided by operating activities 40,653 44,037
---------------- ----------------
Cash Flows from Investing Activities
Capital expenditures (16,207) (18,874)
Net uses from disposals of discontinued operations (3,360) (7,145)
Business combinations, net of cash acquired (1,489) (5,680)
Proceeds from sales of property and equipment 287 125
Other uses (553) (232)
---------------- ----------------
Net cash used by investing activities (21,322) (31,806)
---------------- ----------------
Cash Flows from Financing Activities
Repayment of long-term debt (84,500) (141,245)
Net increase in revolving line of credit 15,400 -
Purchases of treasury stock (8,253) (4,390)
Excess tax benefit on share-based compensation 4,943 -
Dividends paid (4,739) (4,611)
Issuance of capital stock, net of issuance costs 3,854 10,009
Increase in cash overdraft payable 2,145 10,684
Debt issuance costs (154) (1,755)
Proceeds from issuance of long-term debt - 85,000
Other sources 254 204
---------------- ----------------
Net cash used by financing activities (71,050) (46,104)
---------------- ----------------
Decrease in Cash and Cash Equivalents (51,719) (33,873)
Cash and cash equivalents at beginning of year 57,133 71,448
---------------- ----------------
Cash and cash equivalents at end of period $ 5,414 $ 37,575
================ ================
See accompanying note to unaudited financial statements.
5
CHEMED CORPORATION AND SUBSIDIARY COMPANIES
Notes to Unaudited Financial Statements
1. Basis of Presentation
As used herein, the terms "We," "Company" and "Chemed" refer to Chemed
Corporation or Chemed Corporation and its consolidated subsidiaries.
We have prepared the accompanying unaudited consolidated financial
statements of Chemed in accordance with Rule 10-01 of SEC Regulation S-X.
Consequently, we have omitted certain disclosures required under generally
accepted accounting principles in the United States for complete financial
statements. However, in our opinion, the financial statements presented herein
contain all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly our financial position, results of operations and
cash flows. These financial statements are prepared on the same basis as and
should be read in conjunction with the Consolidated Financial Statements and
related notes included in our Annual Report on Form 10-K for the year ended
December 31, 2005. Certain 2005 amounts have been reclassified to conform with
current period presentation in the balance sheet and statements of income and
cash flows primarily related to the adoption of SFAS 123(R).
2. Stock-Based Compensation
Effective January 1, 2006, we adopted the provisions of Statement of
Financial Accounting Standards No. 123, revised ("SFAS 123(R)") which
establishes accounting for stock-based compensation for employees. Under SFAS
123(R), stock-based compensation cost is measured at the grant date, based on
the fair value of the award and recognized as expense over the employee's
requisite service period. We previously applied Accounting Principles Board
Opinion No. 25 and provided the pro-forma disclosures required by Statement of
Financial Accounting Standards No. 123. We elected to adopt the modified
prospective transition method as provided by SFAS 123(R). Accordingly, we have
not restated previously reported financial statement amounts. Other than the
reclassifications noted above, there was no material impact on our financial
position, results of operations or cash flows as a result of the adoption of
SFAS 123(R).
We provide employees the opportunity to acquire our stock through a number
of plans, as follows:
o We have nine stock incentive plans under which 10,700,000
shares can be issued to key employees through a grant of stock
awards and/or options to purchase shares. The
Compensation/Incentive Committee ("CIC") of the Board of
Directors administers these plans. All options granted under
these plans provide for a purchase price equal to the market
value of the stock at the date of grant. The latest plan,
covering a total of 3,000,000 shares, was adopted in May 2006.
The plans are not qualified, restricted or incentive plans
under the U.S. Internal Revenue Code. The terms of each plan
differ slightly, however, stock options issued under the plans
generally have a maximum term of 10 years. Under one plan,
adopted in 1999, up to 500,000 shares may be issued to
employees who are not our officers or directors.
o In May 2002, our shareholders approved the adoption of the
Executive Long-Term Incentive Plan ("LTIP") covering our
officers and key employees. The LTIP is administered by the
CIC. During June 2004, the CIC approved guidelines covering
the establishment of a pool of 250,000 shares ("2004 LTIP
Pool") to be distributed to eligible members of management
upon attainment of the following hurdles during the period
January 1, 2004 through December 31, 2007:
o 88,000 shares if our cumulative pro forma adjusted
EBITDA (including the results of VITAS beginning
January 1, 2004) reaches $365 million within the
four-year period.
o 88,000 shares if our stock price reaches the
following hurdles during any 30 trading days out of
any 60-trading-day period during the four-year
period:
Stock Price Shares to be
Hurdle Issued
------------------ -------------------
$ 35.00 22,000
$ 38.75 33,000
$ 42.50 33,000
-------------------
88,000
===================
6
o 44,000 shares represent a retention element, subject
to a four-year, time-based vesting.
o 30,000 shares may be awarded at the discretion of the
CIC. Through September 30, 2006, 18,000 shares have
been issued from the discretionary pool.
The 88,000 shares tied to stock price hurdles were issued
during the year ended December 31, 2005. On May 15,
2006, the CIC approved additional price hurdles and
associated shares to be issued under the LTIP
pursuant to the 2006 Stock Incentive Plan, as
follows:
Stock Price Shares to be
Hurdle Issued
------------------ -------------------
$ 62.00 20,000
$ 68.00 30,000
$ 75.00 30,000
-------------------
80,000
===================
The stock price hurdles must be achieved during 30
trading days out of any 60 trading day period during
the three years ending May 15, 2009. See Note 11
below for disclosure related to awards granted under
the LTIP.
o We maintain an Employee Stock Purchase Plan ("ESPP"). The ESPP
allows eligible participants to purchase our shares through
payroll deductions at current market value. We pay
administrative and broker fees associated with the ESPP.
Shares purchased for the ESPP are purchased on the open market
and credited directly to participants' accounts. In accordance
with the provisions of SFAS 123(R), the ESPP is
non-compensatory.
For the three and nine months ended September 30, 2006, we recorded
$355,000 and $960,000, respectively, in amortization expense in the accompanying
statement of income for stock-based compensation expense related to the
amortization of restricted stock awards previously granted. For the three and
nine months ended September 30, 2006, we recorded $597,000 and $615,000,
respectively, in selling, general and administrative expenses for stock-based
compensation expense related to stock options granted. There were no capitalized
stock-based compensation costs as of September 30, 2006. The pro-forma
disclosure as required by SFAS No. 123 for the three and nine months ended
September 30, 2005 is as follows (in thousands):
Three Nine
Months Months
-------------- --------------
Net income, as reported $ 14,632 $ 31,633
Add: stock-based compensation expense included in
net income as reported, net of income taxes 182 2,670
Deduct: total stock-based compensation determined
under a fair value method, net of income taxes (234) (6,548)
-------------- --------------
Pro-forma net income $ 14,580 $ 27,755
============== ==============
Earnings per share:
As reported $ 0.57 $ 1.24
============== ==============
Pro-forma $ 0.57 $ 1.09
============== ==============
Diluted earnings per share:
As reported $ 0.55 $ 1.21
============== ==============
Pro-forma $ 0.55 $ 1.06
============== ==============
As of September 30, 2006, approximately $2.9 million of total unrecognized
compensation costs related to non-vested stock awards are expected to be
recognized over a weighted average period of 2.8 years. As of September 30,
2006, approximately $6.0 million of total unrecognized compensation costs
related to non-vested stock options are expected to be recognized over a
weighted average period of 2.75 years.
7
The following table summarizes stock option and award activity during the
first nine months of 2006:
Stock Options Stock Awards
---------------------- -----------------------
Weighted Weighted
Number Average Number Average
of Exercise of Grant-Date
Shares Price Shares Price
----------- ---------- ------------ ----------
Stock-based compensation shares:
Outstanding at January 1, 2006 1,741,833 $23.57 142,445 $27.10
Granted 370,450 51.76 29,600 53.17
Exercised/Vested (408,861) 20.99 (33,855) 36.53
Forfeited (300) 51.76 (2,715) 30.32
----------- ------------
Outstanding at September 30, 2006 1,703,122 $30.32 135,475 $30.37
=========== ========== ============ ==========
Vested at September 30, 2006 1,332,972 $24.36
=========== ==========
The weighted average contractual life of outstanding and exercisable
options was 6.75 years at September 30, 2006.
The options outstanding at September 30, 2006, were in the following
exercise price ranges:
Weighted
Average Aggregate
Number of Exercise Intrinsic
Exercise Price Range Options Price Value
- ------------------------------------------------------------- ---------- --------- ------------
$16.10 to $30.32 1,023,572 $20.21 $12,723,000
$30.33 to $51.76 679,550 $45.54 $ -
The total intrinsic value of stock options exercised during the nine month
periods ended September 30, 2006 and 2005 was $14.1 million and $18.8 million,
respectively. The total intrinsic value of stock options that are vested as of
September 30, 2006 and 2005 was $12.7 million and $41.8 million, respectively.
The total intrinsic value of stock awards vested during the nine month periods
ended September 30, 2006 and 2005 was $1.7 million and $3.4 million,
respectively. The total cash received from employees as a result of employee
stock option exercises for the nine month periods ended September 30, 2006 and
2005 was $3.8 million and $10.0 million, respectively. In connection with these
exercises, the tax benefits realized for the nine months ended September 30,
2006 and 2005 were $4.9 million and $6.6 million, respectively. We settle
employee stock options with newly issued shares.
In connection with the adoption of SFAS 123(R) on January 1, 2006, we
reassessed our valuation technique and related assumptions. We estimate the fair
value of stock options using the Black-Scholes valuation model, consistent with
the provisions of SFAS 123(R), the Securities and Exchange Commission (SEC)
Staff Accounting Bulletin No. 107 and our prior period pro forma disclosure of
net income including stock-based compensation expense. We granted 370,450 stock
options on June 28, 2006 pursuant to the 2006 Stock Incentive Plan. For purposes
of determining the key assumptions and the related fair value of the options
granted, we analyzed the participants of the LTIP separately from the other
stock option recipients.
8
Key input assumptions used to estimate the fair value of stock options
granted on June 28, 2006 are as follows:
LTIP
Participants All Others
------------- ----------
Stock price on date of issuance $51.76 $51.76
Grant date fair value per share $18.95 $16.47
Number of options granted 262,750 107,700
Expected term (years) 6.0 4.5
Risk free rate of return 5.21 % 5.19 %
Volatility 28.0 % 28.9 %
Dividend yield 0.5 % 0.5 %
Forfeiture rate - % 10.0 %
Volatility was determined using our historical stock price tracked over a
period equal to the expected term of the option. We believe using the
Black-Scholes model and the related assumptions are appropriate in estimating
the fair value of our stock options granted. Estimates of fair value are not
intended to predict actual future events or the value ultimately realized by the
option recipient. The ultimate value received by an employee for options granted
is not necessarily indicative of the reasonableness of the estimate made by us
in accordance with SFAS 123(R).
3. Capital Stock
In July 2006, we announced a $50 million on-going stock repurchase program.
Our previous stock repurchase program approved in February 2000 had remaining
authorization of $8 million. For the three and nine months ended September 30,
2006, we repurchased 111,380 shares at a weighted average cost per share of
$37.30 under the February 2000 program.
On May 15, 2006, our shareholders approved an amendment to our Certificate
of Incorporation increasing the number of authorized shares of capital stock
from 40 million shares to 80 million shares.
On March 11, 2005, our Board of Directors approved a 2-for-1 stock split in
the form of a 100% stock dividend to shareholders of record at the close of
business on April 22, 2005. This stock split was paid May 11, 2005. Under
Delaware law, the par value of the capital stock remains $1 per share.
4. Revenue Recognition
Both the VITAS segment and Roto-Rooter segment recognize service revenues
and sales when the earnings process has been completed. Generally, this occurs
when services are provided or products are delivered. VITAS recognizes revenue
at the estimated realizable amount due from third-party payers. Medicare
billings are subject to certain caps, as described further below.
We actively monitor each of our hospice programs, by provider number, as to
their specific admission, discharge rate and median length of stay data in an
attempt to determine whether revenues are likely to exceed the annual
per-beneficiary Medicare cap ("Medicare Cap"). Should we determine that revenues
for a program are likely to exceed the Medicare Cap based on projected trends,
we attempt to institute corrective action to influence the patient mix or to
increase patient admissions. However, should we project our corrective action
will not prevent that program from exceeding its Medicare Cap, we estimate the
amount of revenue recognized during the period that will require repayment to
the US Federal government under the Medicare Cap and record the amount as a
reduction to patient revenue.
9
During the three and nine month periods ended September 30, 2006, we
recorded a pretax charge of $5.5 million and $7.8 million, respectively for
Medicare Cap. The components of the pretax charge for the nine months ended
September 30, 2006 are as follows (in thousands):
All
Phoenix Other Total
--------- --------- ---------
2006 Measurement Period $3,961 $2,249 $6,210
2005 Measurement Period 671 961 1,632
--------- --------- ---------
Total $4,632 $3,210 $7,842
========= ========= =========
The Phoenix program is discussed in further detail in Note 5 below. Charges
for the 2005 measurement period relate to prior year billing limitations
resulting from the fiscal intermediary reallocating admissions for deceased
Medicaid patients who received hospice care from multiple providers. As of
September 30, 2006 and December 31, 2005, respectively, we had $9.7 million and
$2.4 million accrued in current liabilities in the accompanying balance sheet
for the Medicare Cap.
5. VITAS' Phoenix Program
On September 28, 2006, we announced our intention to exit the hospice
market in Phoenix, Arizona. We have been successful in growing admissions of
terminally ill patients who reside primarily in assisted living settings.
Patients residing in these types of facilities tend to exit curative care and
enter into hospice care relatively early in their terminal diagnosis. The
current Medicare Cap limits payment for hospice care when a significant portion
of the patient census enters into hospice early in their terminal diagnosis.
Although we have, on average, relatively short average and median lengths of
stay in the majority of our programs, all programs are measured separately and
cannot be considered in the aggregate of programs under common control. Due to
these billing limitations, the Phoenix program has had an operating loss through
the first nine months of 2006. The operating results (unaudited) of the Phoenix
program are as follows (in thousands):
Three months ended Nine months ended
September 30, September 30,
------------------- ------------------
2006 2005 2006 2005
----------- ------- --------- --------
Net revenue before Medicare cap $ 2,398 $2,436 $ 7,171 $8,043
Medicare cap (2,891) - (4,632) -
----------- ------- --------- --------
Net revenue (493) 2,436 2,539 8,043
Cost of services provided (1,791) (1,812) (5,475) (5,423)
Selling, general and administrative expenses (22) (23) (65) (75)
Depreciation (28) (9) (80) (15)
Amortization (67) - (267) -
----------- ------- --------- --------
Income (loss) before income taxes (2,401) 592 (3,348) 2,530
Income tax benefit (provision) 1,068 (256) 1,484 (1,110)
----------- ------- --------- --------
Income (loss) from continuing operations $(1,333) $ 336 $(1,864) $1,420
=========== ======= ========= ========
Impairment charge $(2,419) $ - $(2,419) $ -
Income tax benefit 1,064 - 1,064 -
----------- ------- --------- --------
Impairment charge, net of tax benefit $(1,355) $ - $(1,355) $ -
=========== ======= ========= ========
The operating results, balance sheet accounts and cash flows of the Phoenix
program have been included in continuing operations for the three and nine
months ended September 30, 2006 and 2005. We intend to either close or sell the
Phoenix program by December 31, 2006. As a result of our announcement, we
performed interim impairment tests of our long-lived assets of the Phoenix
operation as of September 30, 2006 in accordance with Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." An impairment charge of $2.4 million was recorded for the
referral network intangible asset and fixed assets during the third quarter of
2006. The impairment charge is included in income from operations in the
accompanying statement of income.
10
6. Segments
Service revenues and sales and aftertax earnings by business segment are as
follows (in thousands):
Three months ended Nine months ended
September 30, September 30,
------------------------ --------------------------
2006 2005 2006 2005
----------- ----------- ------------ ------------
Service Revenues and Sales
- ----------------------------
VITAS $174,795 $160,408 $515,411 $460,146
Roto-Rooter 78,407 72,920 233,812 218,128
----------- ----------- ------------ ------------
Total $253,202 $233,328 $749,223 $678,274
=========== =========== ============ ============
Aftertax Earnings
- -----------------
VITAS $ 7,798 $ 11,663 $ 30,054 $ 31,876
Roto-Rooter 8,509 7,080 22,713 20,265
----------- ----------- ------------ ------------
Total 16,307 18,743 52,767 52,141
Corporate (6,120) (4,111) (17,523) (18,493)
Discontinued operations (2,226) - (2,226) (2,015)
----------- ----------- ------------ ------------
Net income $ 7,961 $ 14,632 $ 33,018 $ 31,633
=========== =========== ============ ============
Historically, we have allocated stock-based compensation expense to the
segment that employs its recipient. In connection with our adoption of SFAS
123(R), we re-assessed the classification within our business segments of
stock-based compensation expense and determined that our chief decision maker
analyzes stock-based compensation as a corporate expense. Accordingly, all
stock-based compensation expense for 2006 and 2005 has been included as a
corporate expense in the chart above.
7. Earnings per Share
Earnings per share are computed using the weighted average number of shares
of capital stock outstanding. Earnings and diluted earnings per share for 2006
and 2005 are computed as follows (in thousands, except per share data):
Income from Continuing
Operations Net Income
------------------------ ------------------------
Earnings Earnings
For the Three Months Ended per per
September 30, Income Shares Share Income Shares Share
------------- ------ ------ ----- ------ ------ -----
2006
Earnings $10,187 26,190 $0.39 $7,961 26,190 $0.30
======= =======
Dilutive stock options - 393 - 393
Nonvested stock awards - 50 - 50
------- ------ ------- ------
Diluted earnings $10,187 26,633 $0.38 $7,961 26,633 $0.30
======= ====== ======= ======= ====== =======
2005
Earnings $14,632 25,719 $0.57 $14,632 25,719 $0.57
======= =======
Dilutive stock options - 617 - 617
Nonvested stock awards - 65 - 65
------- ------ ------- ------
Diluted earnings $14,632 26,401 $0.55 $14,632 26,401 $0.55
======= ====== ======= ======= ====== =======
11
Income from Continuing
Operations Net Income
------------------------- -------------------------
Earnings Earnings
per per
For the Nine Months Ended September 30, Income Shares Share Income Shares Share
- --------------------------------------------- -------- ------- -------- -------- ------- --------
2006
Earnings $35,244 26,147 $1.35 $33,018 26,147 $1.26
======== ========
Dilutive stock options - 546 - 546
Nonvested stock awards - 57 - 57
-------- ------- -------- -------
Diluted earnings $35,244 26,750 $1.32 $33,018 26,750 $1.23
======== ======= ======== ======== ======= ========
2005
Earnings $33,648 25,453 $1.32 $31,633 25,453 $1.24
======== ========
Dilutive stock options - 676 - 676
Impact of LTIP shares issued - 12 - 12
Nonvested stock awards - 61 - 61
-------- ------- -------- -------
Diluted earnings $33,648 26,202 $1.28 $31,633 26,202 $1.21
======== ======= ======== ======== ======= ========
The EPS impact of discontinued operations was $0.09 for the three and nine
months ended September 30, 2006, respectively. The EPS impact of discontinued
operations was zero and $0.08 for the three and nine months ended September 30,
2005, respectively. The diluted EPS impact of discontinued operations was $0.08
and $0.09 for the three and nine months ended September 30, 2006, respectively.
The diluted EPS impact of discontinued operations was zero and $0.07 for the
three and nine months ended September 30, 2005, respectively.
Excluded from diluted earnings per share were 372,150 and 128,807 stock
options outstanding that were determined to be anti-dilutive for the three and
nine months ended September 30, 2006, respectively. There were no anti-dilutive
stock options outstanding for the comparable periods of 2005.
8. Other Expenses - Net
Other expenses - net, included in continuing operations, comprises the
following (in thousands):
Three months ended Nine months ended
September 30, September 30,
----------------------- ---------------------
2006 2005 2006 2005
------------ --------- --------- ----------
Asset impairment related to selling or
closing VITAS' Phoenix operation $2,419 $ - $2,419 $ -
Costs related to class action litigation 273 - 273 -
Adjustments to transaction-related costs
of the VITAS acquisition - (130) - (801)
------------ --------- --------- ----------
Total other expenses $2,692 $(130) $2,692 $(801)
============ ========= ========= ==========
12
9. Other Income -- Net
Other income - net, included in continuing operations, comprises the
following (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2006 2005 2006 2005
--------- --------- ---------- --------
Interest income $426 $ 530 $1,977 $1,443
(Loss)/gain on trading investments of employee benefit trust 340 796 825 1,114
(Loss)/gain on disposal of property and equipment (50) (67) (105) (86)
Other - net (1) 58 37 173
--------- --------- ---------- --------
Total other income $715 $1,317 $2,734 $2,644
========= ========= ========== ========
10. Other Current Liabilities
Other current liabilities as of September 30, 2006 and December 31, 2005
consist of the following (in thousands):
2006 2005
-------- --------
Accrued legal settlements $ 1,946 $23,108
Accrued divestiture expenses 2,720 3,895
Accrued Medicare Cap estimate 9,728 2,410
Other 13,066 18,845
-------- --------
Total other current liabilities $27,460 $48,258
======= =======
11. 2002 Executive Long-Term Incentive Plan
No performance targets under the LTIP were reached in the three or nine
months ended September 30, 2006. As of September 30, 2006, no accrual was
recorded for awards under the earnings component or the remaining market price
component of the LTIP since no awards have been granted.
12. Long-term Debt and Extinguishment of Debt
On March 31, 2006, we repaid in full our $84.4 million term loan with
JPMorgan Chase Bank. The term loan was paid with a combination of cash on hand
and a draw on our revolving credit facility. At that time, we also amended the
$175 million revolving credit facility with JPMorgan Chase Bank to reduce the
commitment and annual fees and to reduce the floating interest rate by
approximately 50 basis points. The interest rate of the amended revolving credit
agreement is LIBOR plus 1.25%. The amended revolving credit facility also
includes an "accordion" feature that allows us the opportunity to expand the
facility by $50 million. In connection with the repayment of the term loan, we
recorded a write-off of unamortized debt issuance costs of $430,000.
The following is a schedule by year of required long-term debt payments as
of September 30, 2006 (in thousands):
September 2007 $ 207
September 2008 208
September 2009 159
September 2010 15,429
September 2011 150,000
-------
Total debt 166,003
Less: Current portion (207)
-------
Total long-term debt $165,796
=======
13
We are in compliance with all debt covenants as of September 30, 2006. We
have issued $33.3 million in standby letters of credit as of September 30, 2006
mainly for insurance purposes. Issued letters of credit reduce our available
credit under the revolving credit agreement. As of September 30, 2006, we have
approximately $126.3 million of unused lines of credit available and eligible to
be drawn down under our revolving credit facility, excluding the accordion
feature.
13. Loans Receivable from Independent Contractors
The Roto-Rooter segment sublicenses with approximately sixty independent
contractors to operate certain plumbing repair and drain cleaning businesses in
lesser-populated areas of the United States and Canada. As of September 30,
2006, we had notes receivable from independent contractors totaling $2.2 million
(December 31, 2005-$2.6 million). In most cases these loans are fully or
partially secured by equipment owned by the contractor. The interest rates on
the loans range from 5% to 8% per annum and the remaining terms of the loans
range from two months to 5.4 years at September 30, 2006. During the three
months ended September 30, 2006, we recorded revenues of $4.5 million (2005-$4.3
million) and pretax profits of $1.7 million (2005-$1.6 million) from our
independent contractors. During the nine months ended September 30, 2006, we
recorded revenues of $14.1 million (2005-$13.3 million) and pretax profits of
$5.5 million (2005-$4.6 million) from our independent contractors.
We have adopted the provisions of Financial Accounting Standards Board
("FASB") Interpretation No. 46R "Consolidation of Variable Interest Entities--an
interpretation of Accounting Research Bulletin No. 51 (revised)" ("FIN 46R")
relative to our contractual relationships with the independent contractors. FIN
46R requires the primary beneficiary of a Variable Interest Entity ("VIE") to
consolidate the accounts of the VIE. We have evaluated our relationships with
our independent contractors based upon guidance provided in FIN 46R and have
concluded that some of the contractors who have loans payable to us may be
VIE's. We believe consolidation, if required, of the accounts of any VIE's for
which we might be the primary beneficiary would not materially impact our
financial position, results of operations or cash flows.
14. Pension and Retirement Plans
All of our plans that provide retirement and similar benefits are defined
contribution plans. Expenses for our pension and profit-sharing plans, ESOP's,
excess benefit plans and other similar plans are $2.6 million and $3.4 million
for the three months ended September 30, 2006 and 2005, respectively. Expenses
for our pension and profit-sharing plans, ESOP's, excess benefit plans and other
similar plans are $7.5 million and $8.7 million for the nine months ended
September 30, 2006 and 2005, respectively.
15. Litigation
We are party to a class action lawsuit filed in the Third Judicial Circuit
Court of Madison County, Illinois in June of 2000 by Robert Harris, alleging
certain Roto-Rooter plumbing was performed by unlicensed employees. We contested
these allegations and believe them without merit. Plaintiff moved for
certification of a class of customers in 32 states who allegedly paid for
plumbing work performed by unlicensed employees. Plaintiff also moved for
partial summary judgment on grounds the licensed apprentice plumber who
installed his faucet did not work under the direct personal supervision of a
licensed master plumber. On June 19, 2002, the trial judge certified an
Illinois-only plaintiffs class and granted summary judgment for the named party
Plaintiff on the issue of liability, finding violation of the Illinois Plumbing
License Act and the Illinois Consumer Fraud Act through Roto-Rooter's
representation of the licensed apprentice as a plumber. The court did not rule
on certification of a class in the remaining 31 states. In December 2004, we
reached a resolution of this matter with the Plaintiff. The court approved this
settlement in July 2006. We accrued $3.1 million in 2004 as the anticipated cost
of settling this litigation.
Like other large California employers, our VITAS subsidiary faces
allegations of purported class-wide wage and hour violations. It was party to a
class action lawsuit filed in the Superior Court of California, Los Angeles
County, in April of 2004 by Ann Marie Costa, Ana Jimenez, Mariea Ruteaya and
Gracetta Wilson ("Costa"). This case alleged failure to pay overtime wages for
hours worked "off the clock" on administrative tasks, including voicemail
retrieval, time entry, travel to and from work, and pager response. This case
also alleged VITAS failed to provide meal and break periods to a purported class
of California nurses, home health aides and licensed clinical social workers.
The case also sought payment of penalties, interest, and Plaintiffs' attorney
fees. VITAS contested these allegations.
Plaintiff moved for class certification, and VITAS opposed this motion. We
have reached an agreement with the Plaintiff class in order to avoid the
uncertainty of litigation and the diversion of resources and personnel resulting
from the litigation. In connection with our acquisition of VITAS in February
2004, we recorded a liability of $2.3 million on VITAS' opening balance sheet
for this case. At that time, this represented our best estimate of our exposure
in the matter. As a result of the tentative resolution, we recorded a pretax
charge of $17.4 million ($10.8 million aftertax) in the fourth quarter of 2005,
representing the portion of this settlement not accounted for on Vitas' opening
balance sheet. These amounts are inclusive of Plaintiffs' class attorneys' fees
and the costs of settlement administration. On April 24, 2006, the court granted
preliminary approval of the settlement and we funded $15 million of the
settlement in May 2006. On June 26, 2006, the court granted final approval of
the settlement.
14
VITAS is party to a class action lawsuit filed in the Superior Court of
California, Los Angeles County, in September 2006 by Bernadette Santos, Keith
Knoche and Joyce White ("Santos"). This case, filed by the Costa case
plaintiffs' counsel, makes similar allegations of failure to pay overtime and
failure to provide meal and rest periods to a purported class of California
admissions nurses, chaplains and sales representatives. The case likewise seeks
payment of penalties, interest and plaintiffs' attorney fees. VITAS contests
these allegations. The lawsuit is in its early stage and we are unable to
estimate our potential liability, if any, with respect to these allegations.
Regardless of outcome, defense of litigation adversely affects us through
defense costs, diversion of our time and related publicity.
In the normal course of business, we are a party to various claims and
legal proceedings. We record a reserve for these matters when an adverse outcome
is probable and the amount of the potential liability is reasonably estimable.
16. OIG Investigation
On April 7, 2005, we announced the Office of Inspector General ("OIG") for
the Department of Health and Human Services served VITAS with civil subpoenas
relating to VITAS' alleged failure to appropriately bill Medicare and Medicaid
for hospice services. As part of this investigation, the OIG selected medical
records for 320 past and current patients from VITAS' three largest programs for
review. It also sought policies and procedures dating back to 1998 covering
admissions, certifications, recertifications and discharges. During the third
quarter of 2005 and again in May 2006, the OIG requested additional information
from us. A qui tam complaint has been filed in U.S. District Court for the
Southern District of Florida. We are conferring with the U.S. Attorney regarding
our defenses to the complaint allegations. The U.S. Attorney has not decided
whether to intervene in the qui tam action. We have incurred pretax expense
related to complying with OIG requests of $344,000 for the quarter ended
September 30, 2006 and $818,000 for the nine months ended September 30, 2006.
The government continues to investigate the complaint's allegations,
against which VITAS is presently defending. We are unable to predict the outcome
of this matter or the impact, if any, that the investigation may have on the
business, results of operations, liquidity or capital resources. Regardless of
outcome, responding to the subpoenas can adversely affect us through defense
costs, diversion of our time and related publicity.
17. Patient Care Settlement
On September 28, 2006, we announced a preliminary settlement in regard to
litigation related to the 2002 divestiture of our Patient Care business segment.
In connection with the sale of Patient Care in 2002, $5.0 million of the cash
purchase price was placed in escrow pending collection of third-party payer
receivables on Patient Care's balance sheet at the sale date. As of that date,
$4.2 million had been returned and the remainder was being withheld pending the
settlement of certain third-party payer claims. We have a long-term receivable
due in October 2007 from Patient Care of $12.5 million. We also had current
accounts receivable from Patient Care for the post-closing balance sheet
valuation and for expenses paid by us after closing on Patient Care's behalf of
$3.4 million. We were in litigation with Patient Care over the collection of
these current amounts and their allegations that our acquisition of VITAS
violated a non-compete covenant in the sales agreement. We also have a warrant
to purchase 2% of Patient Care's common stock that we recorded as a $1.4 million
investment.
We settled this case in October 2006. We agreed to forgive $1.2 million of
the current receivable related to the post-closing balance sheet valuation and
convert the remaining amount into debt secured by a promissory note with the
same terms as the $12.5 million long-term receivable. We have incurred
additional costs related to the settlement of $1.1 million for additional
insurance and legal costs related to workers' compensation claims incurred prior
to the sale. An after tax charge of $1.5 million has been recorded as
discontinued operations in the accompanying unaudited consolidated statement of
income for the three and nine months ended September 30, 2006. As a part of the
settlement, we determined that the value of the warrants has been permanently
impaired and have recorded a pretax impairment charge of $1.4 million. This
charge is included in income from continuing operations on the statement of
income.
15
18. Related Party Agreements
In October 2004, VITAS entered into a pharmacy services agreement
("Agreement") with Omnicare, Inc. ("OCR") whereby OCR will provide specified
pharmacy services for VITAS and its hospice patients in geographical areas
served by both VITAS and OCR. The Agreement has an initial term of three years
that renews automatically thereafter for one-year terms. Either party may cancel
the Agreement at the end of any term by giving written notice at least 90 days
prior to the end of said term. In June 2004, VITAS entered into a pharmacy
services agreement with excelleRx. The agreement has a one-year term and
automatically renews unless either party provides a 90-day written termination
notice. Subsequent to June 2004, OCR acquired excelleRx. Under both agreements,
VITAS made purchases of $8.0 million and $22.3 million for the three and nine
month periods ended September 30, 2006 and has accounts payable of $4.2 million
at September 30, 2006. Mr. E. L. Hutton is non-executive Chairman and a director
of the Company and OCR. Mr. Joel F. Gemunder, President and Chief Executive
Officer of OCR, Mr. Charles H. Erhart, Jr. and Ms. Sandra Laney are directors of
both OCR and the Company. Mr. Kevin J. McNamara, President, Chief Executive
Officer and director of the Company, is a director emeritus of OCR. We believe
that the terms of these agreements are no less favorable to VITAS than we could
negotiate with an unrelated party.
19. Cash Overdrafts Payable
Included in accounts payable at September 30, 2006 are cash overdrafts
payable of $10.2 million (December 31, 2005 - $8.0 million).
20. Change in Accounting Principle
Effective September 30, 2006, we changed the date of our annual goodwill
impairment analysis to October 1. Previously, we performed this annual goodwill
impairment test on December 31. We believe this change in accounting principle
is preferable because the new date coincides with the US federal government's
fiscal year end of September 30 and therefore allows for a better estimation of
the Medicare related cash flows of our VITAS business. Medicare pays in excess
of 90% of VITAS' revenue. Of the total goodwill recorded as of September 30,
2006, approximately 75% is related to VITAS. Due to the Medicare Cap discussed
above, October 1 is the date when cash flows from our hospice programs are most
predictable. The change in accounting principle will have no effect on our
consolidated financial statements.
21. Recent Accounting Statements
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in the Current Year Financial Statements" ("SAB 108").
Traditionally, there have been two widely recognized methods for quantifying the
effects of financial statement misstatements. The first, called the "roll-over"
method, focuses primarily on the income statement effect of a misstatement but
its use can lead to the accumulation of misstatements on the balance sheet. The
other method, referred to as the "iron curtain" method, focuses primarily on the
balance sheet effect of a misstatement but its use can cause out-of-period
adjustments in the income statement. We currently use the roll-over method.
SAB 108 requires companies to evaluate financial statement misstatements
using both methods, referred to as the "dual approach." An issuer may either
restate all periods presented as if the dual approach had always been used or
record the cumulative effect of using the dual approach to assets and
liabilities with an offsetting adjustment to the opening balance of retained
earnings as of January 1, 2006. We believe there will be no material impact on
our financial statements as a result of adopting SAB 108.
In September 2006, the FASB issued Statement No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans" ("SFAS
158"). The new standard will require employers to fully recognize the
obligations associated with single-employer defined benefit pension, retiree
healthcare and other postretirement plans in their financial statements. Under
past accounting standards, the funded status of an employer's postretirement
benefit plan (i.e., the difference between the plan assets and obligations) was
not always completely reported in the balance sheet. Employers reported an asset
or liability that almost always differed from the plan's funded status because
previous accounting standards allowed employers to delay recognition of certain
changes in plan assets and obligations that affected the costs of providing such
benefits. The requirement to recognize the funded status of a benefit plan and
the disclosure requirements are effective as of the end of the fiscal year
ending after December 15, 2006. We believe there will be no material impact on
our financial statements as a result of adopting SFAS 158.
In September 2006, the FASB issued Statement No. 157, "Fair Value
Measurements" ("SFAS 157"), which addresses how companies should measure fair
value when they are required to use a fair value measure for recognition or
disclosure purposes under generally accepted accounting principles (GAAP). It
sets a common definition of fair value to be used throughout GAAP. The new
standard is designed to make the measurement of fair value more consistent and
comparable and improve disclosures about those measures. This statement is
effective for financial statements issued for fiscal years beginning after
November 15, 2007. We are currently evaluating the impact that SFAS 157 will
have on our financial condition and results of operations.
In September 2006, the FASB issued a staff position related to the
accounting for planned major maintenance activities. The staff position sets
forth four alternative methods of accounting for planned major maintenance
activities but disallowed the accrue-in-advance method. The accrue-in-advance
method provides for estimating the cost of major maintenance activities and
accruing that cost in advance of the maintenance being performed. The guidance
is effective for the first fiscal year beginning after December 15, 2006. We are
currently evaluating the impact that this staff position will have on accounting
related to our transportation equipment.
16
In July 2006, the FASB issued Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109",
which prescribes a comprehensive model for how a company should recognize,
measure, present and disclose in its financial statements uncertain tax
positions that it has taken or expects to take on a tax return. Upon adoption of
FIN 48, the financial statements will reflect expected future tax consequences
of such uncertain positions assuming the taxing authorities' full knowledge of
the position and all relevant facts. FIN 48 also revises disclosure requirements
and introduces an annual, tabular roll-forward of the unrecognized tax benefits.
This interpretation is effective as of the beginning of fiscal years starting
after December 15, 2006. We are currently evaluating the impact FIN 48 will have
on our financial condition and results of operations.
In February 2006, the FASB issued Statement No. 155, "Accounting for
Certain Hybrid Financial Instruments", which nullifies and amends various
accounting guidance relating to accounting for derivative instruments and
securitization transactions. In general, these changes will reduce the
operational complexity associated with bifurcating embedded derivatives, and
increase the number of beneficial interests in securitization transactions. This
statement is effective for all financial instruments acquired or issued after
the beginning of our first fiscal year that begins after September 15, 2006.
Because we do not have any material derivative instruments or securitization
transactions, we believe there will be no material impact on our financial
condition, results of operations or cash flows upon adoption.
17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Executive Summary
- -----------------
We operate through two wholly owned subsidiaries, VITAS Healthcare
Corporation and Roto-Rooter Group, Inc. VITAS focuses on hospice care that helps
make terminally ill patients' final days as comfortable as possible. Through its
team of doctors, nurses, home health aides, social workers, clergy and
volunteers, VITAS provides direct medical services to patients, as well as
spiritual and emotional counseling to both patients and their families.
Roto-Rooter's services are focused on providing plumbing and drain cleaning
services to both residential and commercial customers. Through its network of
company-owned branches, independent contractors and franchisees, Roto-Rooter
offers plumbing and drain cleaning service to over 90% of the U.S. population.
The following is a summary of the key operating results for the three and
nine months ended September 30, 2006 and 2005 (in thousands except per share
amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2006 2005 2006 2005
--------- --------- --------- ---------
Consolidated service revenues and sales $253,202 $233,328 $749,223 $678,274
Consolidated income from continuing operations $ 10,187 $ 14,632 $ 35,244 $ 33,648
Diluted EPS from continuing operations $ 0.38 $ 0.55 $ 1.32 $ 1.28
The increase in consolidated service revenues and sales for the three
months ended September 30, 2006 was driven by a 9% increase at VITAS and an 8%
increase at Roto-Rooter. The increase at VITAS was primarily the result of a 9%
increase in average daily census (ADC) from the third quarter of 2005. The
decrease in revenue caused by the charge taken for the Medicare Cap of $5.5
million offset the October 1, 2005 Medicare reimbursement rate increase of
approximately 3%. The 8% increase at Roto-Rooter was driven primarily by a
combination of job mix and price increases. Job count was essentially flat for
the quarter. Consolidated income from continuing operations and diluted EPS from
continuing operations decreased from the comparable three month period of 2005
due to the Medicare Cap charge, the impairment charge taken for VITAS' Phoenix
program, the write-off of the Patient Care warrant and decreased margins at
VITAS. As further shown in the results of operations section, consolidated
income from continuing operations and diluted EPS from continuing operations
include special items and adjustments that decreased aftertax earnings by $1.2
million and increased aftertax earnings by $1.7 million for the three months
ended September 30, 2006 and 2005, respectively.
The increase in consolidated service revenues and sales for the nine months
ended September 30, 2006 was driven by a 12% increase at VITAS and a 7% increase
at Roto-Rooter. The increase at VITAS was primarily the result of a 10% increase
in average daily census (ADC) from the first nine months of 2005 and the October
1, 2005 Medicare reimbursement rate increase of approximately 3%. The increase
at VITAS was partially offset by a $7.8 million reduction in revenue for
Medicare Cap billing limitations. The increase at Roto-Rooter was driven
primarily by a 1% increase in job count combined with an approximate 6% price
increase. Consolidated income from continuing operations and diluted EPS from
continuing operations increased as a result of the higher service revenues and
sales, offset by the impairment charge taken for the Phoenix operation, the
write-off of the Patient Care warrants and decreased margins at VITAS. As
further shown in the results of operations section, consolidated income from
continuing operations and diluted EPS from continuing operations include special
items and adjustments that decreased aftertax earnings by $1.8 million and $1.3
million for the nine months ended September 30, 2006 and 2005, respectively.
Effective January 1, 2006, we adopted the provisions of Statement of
Financial Accounting Standards No. 123, revised ("SFAS 123(R)") which
establishes accounting for stock-based compensation for employees. Under SFAS
123(R), stock-based compensation cost is measured at the grant date, based on
the fair value of the award and recognized as expense over the employee's
requisite service period. We previously applied Accounting Principles Board
Opinion No. 25 and provided the pro-forma disclosures required by Statement of
Financial Accounting Standards No. 123. We elected to adopt the modified
prospective transition method as provided by SFAS 123(R). Accordingly,
previously reported financial statement amounts have not been restated. We have
determined that the Black-Scholes option pricing model to calculate the fair
value of our stock options is appropriate in the circumstances. We also used the
Black-Scholes model for purposes of the pro-forma disclosures under SFAS 123.
There was no material impact on our financial position, results of operations or
cash flows as a result of the adoption of SFAS 123(R).
18
Effective September 30, 2006, we changed the date of our annual goodwill
impairment analysis to October 1. Previously, we performed this annual goodwill
impairment test on December 31. We believe this change in accounting principle
is preferable because the new date coincides with the US federal government's
fiscal year end of September 30 and therefore allows for a better estimation of
the Medicare related cash flows of our VITAS business. Medicare pays in excess
of 90% of VITAS' revenue. Of the total goodwill recorded as of September 30,
2006, approximately 75% is related to VITAS. Due to the Medicare Cap discussed
above, October 1 is the date when cash flows from our hospice programs are most
predictable. The change in accounting principle will have no effect on our
consolidated financial statements.
Financial Condition
- -------------------
Liquidity and Capital Resources
- -------------------------------
Significant changes in the balance sheet accounts from December 31, 2005 to
September 30, 2006 include the following:
o The $51.7 million decline in cash and cash equivalents from $57.1
million at December 31, 2005 to $5.4 million at September 30, 2006 is
primarily attributable to the use of $69.1 million in cash to repay
our $84.4 million term note, the use of approximately $20 million in
cash to fund the Costa case settlement, the use of approximately $8.3
million for purchases of treasury stock and the delay in the monthly
U.S. federal government payment for VITAS services. The U.S. federal
government generally pays VITAS in the same month hospice care was
provided. The payment due September 29, 2006 of $23.9 million was
delayed until early October by the U.S. federal government due to its
budgetary constraints. The cash uses were partially offset by cash
provided by operations.
o The decrease in other current liabilities of $20.8 million is
primarily attributable to our funding of the Costa settlement during
the second and third quarter of 2006. The legal accrual for the Costa
case of $19.7 million at December 31, 2005 was classified in other
current liabilities.
o The reduction in long-term debt from $234.1 million at December 31,
2005 to $165.8 million at September 30, 2006 resulted from repayment
of our $84.4 million term loan with JPMorgan Chase in March 2006,
partially offset by borrowings on our revolving line of credit to fund
a portion of the repayment.
We have issued $33.3 million in standby letters of credit as of September
30, 2006 mainly for insurance purposes. Issued letters of credit reduce our
available credit under the revolving credit agreement. As of September 30, 2006,
we have approximately $126.3 million of unused lines of credit available and
eligible to be drawn down under our revolving credit facility, excluding the
accordion feature. We believe our liquidity and sources of capital are
satisfactory for our needs in the foreseeable future.
Commitments and Contingencies
- -----------------------------
Collectively, the terms of our credit agreements provide that we are
required to meet various financial covenants, to be tested quarterly. We are in
compliance with all financial and other debt covenants as of September 30, 2006
and anticipate remaining in compliance throughout 2006.
We are party to a class action lawsuit filed in the Third Judicial Circuit
Court of Madison County, Illinois in June of 2000 by Robert Harris, alleging
certain Roto-Rooter plumbing was performed by unlicensed employees. We contested
these allegations and believe them without merit. Plaintiff moved for
certification of a class of customers in 32 states who allegedly paid for
plumbing work performed by unlicensed employees. Plaintiff also moved for
partial summary judgment on grounds the licensed apprentice plumber who
installed his faucet did not work under the direct personal supervision of a
licensed master plumber. On June 19, 2002, the trial judge certified an
Illinois-only plaintiffs class and granted summary judgment for the named party
Plaintiff on the issue of liability, finding violation of the Illinois Plumbing
License Act and the Illinois Consumer Fraud Act through Roto-Rooter's
representation of the licensed apprentice as a plumber. The court did not rule
on certification of a class in the remaining 31 states. In December 2004, we
reached a resolution of this matter with the Plaintiff. The court approved this
settlement in July 2006. We accrued $3.1 million in 2004 as the anticipated cost
of settling this litigation.
Like other large California employers, our VITAS subsidiary faces
allegations of purported class-wide wage and hour violations. It was party to a
class action lawsuit filed in the Superior Court of California, Los Angeles
County, in April of 2004 by Ann Marie Costa, Ana Jimenez, Mariea Ruteaya and
Gracetta Wilson ("Costa"). This case alleged failure to pay overtime wages for
hours worked "off the clock" on administrative tasks, including voicemail
retrieval, time entry, travel to and from work, and pager response. This case
also alleged VITAS failed to provide meal and break periods to a purported class
of California nurses, home health aides and licensed clinical social workers.
The case also sought payment of penalties, interest, and Plaintiffs' attorney
fees. VITAS contested these allegations.
19
Plaintiff moved for class certification, and VITAS opposed this motion. We
have reached an agreement with the Plaintiff class in order to avoid the
uncertainty of litigation and the diversion of resources and personnel resulting
from the litigation. In connection with our acquisition of VITAS in February
2004, we recorded a liability of $2.3 million on VITAS' opening balance sheet
for this case. At that time, this represented our best estimate of our exposure
in the matter. As a result of the tentative resolution, we recorded a pretax
charge of $17.4 million ($10.8 million aftertax) in the fourth quarter of 2005,
representing the portion of this settlement not accounted for on Vitas' opening
balance sheet. These amounts are inclusive of Plaintiffs' class attorneys' fees
and the costs of settlement administration. On April 24, 2006, the court granted
preliminary approval of the settlement and we funded $15 million of the
settlement in May 2006. On June 26, 2006, the court granted final approval of
the settlement.
VITAS is party to a class action lawsuit filed in the Superior Court of
California, Los Angeles County, in September 2006 by Bernadette Santos, Keith
Knoche and Joyce White ("Santos"). This case, filed by the Costa case
plaintiffs' counsel, makes similar allegations of failure to pay overtime and
failure to provide meal and rest periods to a purported class of California
admissions nurses, chaplains and sales representatives. The case likewise seeks
payment of penalties, interest and plaintiffs' attorney fees. VITAS contests
these allegations. The lawsuit is in its early stage and we are unable to
estimate our potential liability, if any, with respect to these allegations.
Regardless of outcome, defense of litigation adversely affects us through
defense costs, diversion of our time and related publicity.
On April 7, 2005, we announced the Office of Inspector General ("OIG") for
the Department of Health and Human Services served VITAS with civil subpoenas
relating to VITAS' alleged failure to appropriately bill Medicare and Medicaid
for hospice services. As part of this investigation, the OIG selected medical
records for 320 past and current patients from VITAS' three largest programs for
review. It also sought policies and procedures dating back to 1998 covering
admissions, certifications, recertifications and discharges. During the third
quarter of 2005 and again in May 2006, the OIG requested additional information
from us. A qui tam complaint has been filed in U.S. District Court for the
Southern District of Florida. We are conferring with the U.S. Attorney regarding
our defenses to the complaint allegations. The U.S. Attorney has not decided
whether to intervene in the qui tam action. We have incurred pretax expense
related to complying with OIG requests of $344,000 for the quarter ended
September 30, 2006 and $818,000 for the nine months ended September 30, 2006.
The government continues to investigate the complaint's allegations,
against which VITAS is presently defending. We are unable to predict the outcome
of this matter or the impact, if any, that the investigation may have on the
business, results of operations, liquidity or capital resources. Regardless of
outcome, responding to the subpoenas can adversely affect us through defense
costs, diversion of our time and related publicity.
Results of Operations
Third Quarter 2006 versus Third Quarter 2005-Consolidated Results
- -----------------------------------------------------------------
Our service revenues and sales for the third quarter of 2006 increased 8.5%
versus the third quarter of 2005. Of this increase, $14.4 million was
attributable to VITAS and $5.5 million was attributable to Roto-Rooter, as
follows (dollars in thousands):
Increase/(Decrease)
-------------------
Amount Percent
----------- -------
VITAS
Routine Homecare $16,309 14.6%
Continuous Care 3,012 11.1%
General Inpatient 569 2.7%
Less: Medicare Cap (5,503) -
Roto-Rooter
Plumbing 2,556 8.5%
Drain Cleaning 2,722 8.5%
Other 209 1.9%
-----------
Total $19,874 8.5%
===========
20
The increase in VITAS' revenues for the third quarter of 2006 versus the
third quarter of 2005 is attributable to increases in ADC of 9.9% and 7.0%,
respectively, for routine homecare and continuous care. General inpatient ADC
was unchanged between periods. ADC is a key measure we use to monitor volume
growth in our hospice business. Changes in total program admissions and average
length of stay for our patients are the main drivers of changes in ADC. The
remainder of the revenue increase is due primarily to the annual increase in
Medicare reimbursement rates in the fourth quarter of 2005. In excess of 90% of
VITAS' revenues for both periods were from Medicare and Medicaid. The increase
in VITAS revenue was partially offset by a reduction of $5.5 million for
Medicare Cap including $2.9 million for the Phoenix program. The revenue
reduction is the result of three programs reaching the Medicare Cap revenue
limitation during the third quarter of 2006, including the Phoenix program.
The increase in the plumbing revenues for the third quarter of 2006 versus
2005 comprises a 0.4% decrease in the number of jobs performed and an 8.9%
increase in the average price per job. The increase in drain cleaning revenues
for the third quarter of 2006 versus 2005 comprised a 0.4% decrease in the
number of jobs and an 8.9% increase in the average price per job. The increase
in other revenues is attributable primarily to increased revenue from
independent contractor operations.
The consolidated gross margin was 26.1% in the third quarter of 2006 as
compared with 29.1% in the third quarter of 2005. On a segment basis, VITAS'
gross margin was 17.4% in the third quarter of 2006 and 21.7% in the third
quarter of 2005. The decrease in VITAS' gross margin in the third quarter of
2006 is primarily attributable to the $5.5 million reduction in revenue related
to Medicare Cap billing limitations. This represents a decrease in VITAS margin
of 3.1%. The remaining margin decrease is primarily the result of increased
manpower and labor capacity relative to ADC. Given the inherent difficulty in
hiring and retaining qualified healthcare professionals, management continued to
build manpower in anticipation of an increase in admissions and overall census
in the majority of its programs in the fourth quarter of 2006. Roto-Rooter
segment's gross margin was 45.4% in the third quarter of 2006 and 45.7% in the
third quarter of 2005.
Selling, general and administrative expenses ("SG&A") for the third quarter
of 2006 were $39.2 million, an increase of $737,000 (1.9%) versus the third
quarter of 2005. The increase is largely due to higher revenues by both segments
which increase certain variable selling costs.
Other expenses - net, included in income from operations, include an
impairment charge of $2.4 million related to our intention to close or sell
VITAS' Phoenix program by December 31, 2006. As a result of our announcement, we
performed interim impairment tests of our long-lived assets of the Phoenix
operation as of September 30, 2006 in accordance with Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The impairment charge was recorded for the referral network
intangible asset and fixed assets.
Income from operations decreased $6.0 million from $24.5 million in the
third quarter of 2005 to $18.5 million in the third quarter of 2006. The
decrease is attributable to the decrease in gross margin and the Phoenix
impairment charge.
Interest expense, substantially all of which is incurred at Corporate,
declined from $5.1 million in the third quarter of 2005 to $4.1 million in the
third quarter of 2006. This decline is due primarily to the reduction of
outstanding debt balances.
As part of our Patient Care settlement, we determined that the value of the
warrant has been permanently impaired and have recorded a pretax impairment
charge of $1.4 million. This charge is included in income from continuing
operations on the statement of income.
Our effective income tax rate decreased from 29.1% in the third quarter of
2005 to 25.8% in the third quarter of 2006. The decrease relates to adjustments
made upon expiration of certain statutes of limitations.
21
Income from continuing operations decreased $4.4 million or 30% in the
third quarter of 2006 as compared to the third quarter of 2005. Income from
continuing operations for both periods included the following aftertax special
items/adjustments that increased/(reduced) aftertax earnings (in thousands):
Three Months Ended
September 30,
---------------------
2006 2005
---------- --------
Asset impairment charges related to selling or closing VITAS' Phoenix
operation $(1,355) $ -
Loss from impairment of investment (918) -
Stock option expense (379) -
Legal expenses of OIG investigation (213) (192)
Costs related to class action litigation (169) -
Tax adjustments upon expiration of certain statutes 1,791 1,787
Adjustments to transaction costs - 130
---------- --------
$(1,243) $1,725
========== ========
In addition, VITAS' Phoenix program recorded an aftertax operating loss of
$2.7 million in the third quarter of 2006 including the impairment charge, as
compared to aftertax operating income of $337,000 for the comparable period of
2005.
Discontinued operations in the third quarter of 2006 include aftertax
charges related to the settlement of certain items related to our sale of
Patient Care in 2002 and additional charges related to environmental costs in
connection with DuBois Chemical which we sold in 1991.
Third quarter 2006 versus Third quarter 2005-Segment Results
- ------------------------------------------------------------
The change in net income for the third quarter of 2006 versus the third
quarter of 2005 is due to (dollars in thousands):
Net Income
Increase/(Decrease)
-------------------------
Amount Percent
------------ -----------
VITAS $(3,865) -33.1%
Roto-Rooter 1,429 20.2%
Corporate (2,009) -48.9%
Discontinued operations (2,226) -
------------
$(6,671) -45.6%
============
22
First Nine Months of 2006 versus First Nine Months of 2005-Consolidated Results
- -------------------------------------------------------------------------------
Our service revenues and sales for the first nine months of 2006 increased
10.5% versus the first nine months of 2005. Of this increase, $55.2 million was
attributable to VITAS and $15.7 million was attributable to Roto-Rooter, as
follows (dollars in thousands):
Increase/(Decrease)
--------------------
Amount Percent
--------- -------
VITAS
Routine Homecare $47,447 14.9%
Continuous Care 12,182 15.7%
General Inpatient 3,479 5.5%
Less: Medicare Cap (7,843) -
Roto-Rooter
Plumbing 5,784 6.6%
Drain Cleaning 8,671 8.9%
Other 1,229 3.7%
---------
Total $70,949 10.5%
=========
The increase in VITAS' revenues for the first nine months of 2006 versus
the first nine months of 2005 is attributable to increases in ADC of 10.1%,
10.2% and 2.2%, respectively, for routine homecare, continuous care and general
inpatient. ADC is a key measure we use to monitor volume growth in our hospice
business. Changes in total program admissions and average length of stay for our
patients are the main drivers of changes in ADC. The remainder of the revenue
increase is due primarily to the annual increase in Medicare reimbursement rates
in the fourth quarter of 2005. In excess of 90% of VITAS' revenues for both
periods were from Medicare and Medicaid. The increase in VITAS revenue was
partially offset by a reduction of $7.8 million for Medicare Cap including $4.6
million for the Phoenix program. The revenue reduction is the result of three
programs reaching the Medicare Cap revenue limitation during the first nine
months of 2006.
The increase in the plumbing revenues for the first nine months of 2006
versus 2005 comprises a 0.4% increase in the number of jobs performed and a 6.2%
increase in the average price per job. The increase in drain cleaning revenues
for the first nine months of 2006 versus 2005 comprised a 0.9% increase in the
number of jobs and a 8.0% increase in the average price per job. The average
price per job for both plumbing and drain cleaning was positively impacted by
the continued shift to commercial jobs. Overall, the number of commercial jobs
increased 1.3% while the number of residential jobs increased 0.5%. This is a
favorable shift in job mix since a commercial job averaged approximately 33%
more revenue per job through the first nine months of 2006 than a residential
job. The increase in other revenues is attributable primarily to increased
revenue from the independent contractor operations.
The consolidated gross margin was 27.1% in the first nine months of 2006 as
compared with 29.3% in the first nine months of 2005. On a segment basis, VITAS'
gross margin was 18.8% in the first nine months of 2006 and 21.4% in the first
nine months of 2005. The decrease in VITAS' gross margin in 2006 is primarily
attributable to the $7.8 million reduction in revenue for the Medicare Cap
billing limitation and excess patient care capacity experienced in the first and
third quarter of 2006. Roto-Rooter segment's gross margin was 45.4% in the first
nine months of 2006 and 46.1% in the first nine months of 2005. The decrease in
Roto-Rooter's gross margin in 2006 is primarily attributable to a benefit
realized in the first quarter of 2005 of $1.6 million (pretax) related to prior
period casualty insurance claims.
Selling, general and administrative expenses ("SG&A") for the first nine
months of 2006 were $116.3 million, an increase of $1.3 million (1.1%) versus
the first nine months of 2005. The increase is largely due to higher revenues by
both segments which increase certain variable selling costs, such as
commissions.
Other expenses - net, included income from operations, include an
impairment charge of $2.4 million related to our intention to close or sell
VITAS' Phoenix program by December 31, 2006. As a result of our announcement, we
performed interim impairment tests of our long-lived assets of the Phoenix
operation as of September 30, 2006 in accordance with Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The impairment charge was recorded for the referral network
intangible asset and fixed assets.
23
Income from operations decreased $1.7 million from $69.2 million in the
first nine months of 2005 to $67.5 million in the first nine months of 2006. The
decrease in the consolidated gross margin and the Phoenix impairment charge
caused the decrease.
Interest expense, substantially all of which is incurred at Corporate,
declined from $16.0 million in the first nine months of 2005 to $13.7 million in
the first nine months of 2006. This decline is due primarily to the reduction in
debt outstanding that occurred as a result of the February 2005 and 2006
refinancings, as well as subsequent debt payments.
We tentatively settled our litigation with Patient Care in the third
quarter of 2006. As part of the settlement, we determined that the value of the
warrant has been permanently impaired and recorded a pretax impairment charge of
$1.4 million. This charge is included in income from continuing operations on
the statement of income.
Loss on extinguishment of debt decreased from $4.0 million in the first
nine months of 2005 to $430,000 in the first nine months of 2006. The 2005 loss
on extinguishment relates to the refinancing in February 2005. The loss on
extinguishment in 2006 relates to the early repayment of our $84.4 million term
loan in March 2006.
Our effective income tax rate increased from 35.1% in the first nine months
of 2005 to 35.5% in the first nine months of 2006.
Income from continuing operations increased $1.6 million or 4.7% in the
first nine months of 2006 as compared to the first nine months of 2005. Income
from continuing operations for both periods included the following aftertax
special items/adjustments that increased/(reduced) aftertax earnings (in
thousands):
Nine Months Ended
September 30,
-----------------
2006 2005
-------- --------
Asset impairment charges related to selling or closing VITAS' Phoenix
operation $ (1,355) $ -
Loss from impairment of investment (918) -
Legal expenses of OIG investigation (507) (352)
Stock option expense (391) (137)
Loss on extinguishment of debt (273) (2,523)
Costs related to class action litigation (169) -
Tax adjustments upon expiration of certain statutes 1,791 1,787
LTIP - (1,847)
Adjustments to transaction costs - 801
Favorable adjustment for insurance - 1,014
-------- --------
$(1,822) $(1,257)
======== ========
In addition, VITAS' Phoenix program recorded an aftertax operating loss of
$3.2 million in the first nine months of 2006 including the impairment charge,
as compared to aftertax operating income of $1.4 million for the comparable
period of 2005.
24
First Nine Months of 2006 versus First Nine Months of 2005-Segment Results
- --------------------------------------------------------------------------
The change in net income for the first nine months of 2006 versus the first
nine months of 2005 is due to (dollars in thousands):
Net Income
Increase/(Decrease)
--------------------
Amount Percent
------------ -------
VITAS $(1,822) -5.7%
Roto-Rooter 2,448 12.1%
Corporate 970 5.2%
Discontinued operations (211) -10.5%
------------
$1,385 4.4%
============
The following chart updates historical unaudited financial and operating
data of VITAS, acquired in February 2004 (dollars in thousands, except dollars
per patient day):
25
CHEMED CORPORATION AND SUBSIDIARY COMPANIES
OPERATING STATISTICS FOR VITAS SEGMENT
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2006 2005 2006 2005
---- ---- ---- ----
OPERATING STATISTICS
Net revenue ($000) (a)
Homecare $128,268 $111,959 $366,888 $319,441
Inpatient 21,890 21,321 66,779 63,300
Continuous care 30,140 27,128 89,587 77,405
-------- -------- -------- --------
Total before Medicare cap allowance $180,298 $160,408 $523,254 $460,146
Medicare cap allowance (5,503) - (7,843) -
-------- -------- -------- --------
Total $174,795 $160,408 $515,411 $460,146
======== ======== ======== ========
Net revenue as a percent of total before
Medicare cap allowance
Homecare 71.2 % 69.8 % 70.1 % 69.4 %
Inpatient 12.1 13.3 12.8 13.8
Continuous care 16.7 16.9 17.1 16.8
-------- -------- -------- --------
Total before Medicare cap allowance 100.0 100.0 100.0 100.0
Medicare cap allowance (3.1) - (1.5) -
-------- -------- -------- --------
Total 96.9 % 100.0 % 98.5 % 100.0 %
======== ======== ======== ========
Average daily census ("ADC") (days)
Homecare 6,670 5,972 6,419 5,719
Nursing home 3,590 3,366 3,484 3,276
-------- -------- -------- --------
Routine homecare 10,260 9,338 9,903 8,995
Inpatient 401 404 413 404
Continuous care 552 517 553 502
-------- -------- -------- --------
Total 11,213 10,259 10,869 9,901
======== ======== ======== ========
Total Admissions 12,753 12,375 39,718 37,969
Total Discharges 12,621 12,025 38,640 36,766
Average length of stay (days) 71.0 66.5 70.5 66.8
Median length of stay (days) 14.0 13.0 13.0 12.0
ADC by major diagnosis
Neurological 33.6 % 32.1 % 33.4 % 32.0 %
Cancer 20.1 21.3 20.1 21.4
Cardio 14.7 14.9 14.9 15.1
Respiratory 6.9 7.1 7.1 7.1
Other 24.7 24.6 24.5 24.4
-------- -------- -------- --------
Total 100.0 % 100.0 % 100.0 % 100.0 %
======== ======== ======== ========
Admissions by major diagnosis
Neurological 19.3 % 18.0 % 19.9 % 18.8 %
Cancer 37.0 38.3 35.4 36.6
Cardio 12.4 12.4 13.2 13.5
Respiratory 6.7 6.3 7.2 7.2
Other 24.6 25.0 24.3 23.9
-------- -------- -------- --------
Total 100.0 % 100.0 % 100.0 % 100.0 %
======== ======== ======== ========
Direct patient care margins (b)
Routine homecare 49.1 % 50.4 % 48.8 % 49.9 %
Inpatient 16.5 21.3 20.2 22.4
Continuous care 17.5 18.1 18.7 18.4
Homecare margin drivers
(dollars per patient day)
Labor costs $ 48.21 $45.04 $ 49.15 $45.58
Drug costs 8.46 7.66 8.12 7.71
Home medical equipment 5.66 5.45 5.58 5.48
Medical supplies 2.21 2.23 2.15 2.18
Inpatient margin drivers
(dollars per patient day)
Labor costs $ 269.72 $242.70 $ 257.82 $240.61
Continuous care margin drivers
(dollars per patient day)
Labor costs $ 467.65 $447.99 $ 461.89 $441.83
Bad debt expense as a percent of revenues 0.9 % 0.9 % 0.9 % 0.9 %
Accounts receivable --
days of revenue outstanding 42.1 42.1 N/A N/A
- ------------------------------------------------------------------------------
(a) VITAS has 6 large (greater than 450 ADC), 15 medium (greater than 200 but
less than 450 ADC) and 21 small (less than 200 ADC) hospice programs. There
are three programs with estimated Medicare Cap billing limitations for the
2006 measurement period. There is one other program with Medicare Cap
cushion of less than 10% for the 2006 measurement period. No other programs
have an estimated Medicare Cap cushion of less than 10% for the 2006
measurement period
(b) Amounts exclude indirect patient care and administrative costs, as well as
Medicare Cap billing limitation.
26
Recent Accounting Statements
- ----------------------------
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in the Current Year Financial Statements" ("SAB 108").
Traditionally, there have been two widely recognized methods for quantifying the
effects of financial statement misstatements. The first, called the "roll-over"
method, focuses primarily on the income statement effect of a misstatement but
its use can lead to the accumulation of misstatements on the balance sheet. The
other method, referred to as the "iron curtain" method, focuses primarily on the
balance sheet effect of a misstatement but its use can cause out-of-period
adjustments in the income statement. We currently use the roll-over method.
SAB 108 requires companies to evaluate financial statement misstatements
using both methods, referred to as the "dual approach." An issuer may either
restate all periods presented as if the dual approach had always been used or
record the cumulative effect of using the dual approach to assets and
liabilities with an offsetting adjustment to the opening balance of retained
earnings as of January 1, 2006. We believe there will be no material impact on
our financial statements as a result of adopting SAB 108.
In September 2006, the FASB issued Statement No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans" ("SFAS
158"). The new standard will require employers to fully recognize the
obligations associated with single-employer defined benefit pension, retiree
healthcare and other postretirement plans in their financial statements. Under
past accounting standards, the funded status of an employer's postretirement
benefit plan (i.e., the difference between the plan assets and obligations) was
not always completely reported in the balance sheet. Employers reported an asset
or liability that almost always differed from the plan's funded status because
previous accounting standards allowed employers to delay recognition of certain
changes in plan assets and obligations that affected the costs of providing such
benefits. The requirement to recognize the funded status of a benefit plan and
the disclosure requirements are effective as of the end of the fiscal year
ending after December 15, 2006. We believe there will be no material impact on
our financial statements as a result of adopting SFAS 158.
In September 2006, the FASB issued Statement No. 157, "Fair Value
Measurements" ("SFAS 157"), which addresses how companies should measure fair
value when they are required to use a fair value measure for recognition or
disclosure purposes under generally accepted accounting principles (GAAP). It
sets a common definition of fair value to be used throughout GAAP. The new
standard is designed to make the measurement of fair value more consistent and
comparable and improve disclosures about those measures. This statement is
effective for financial statements issued for fiscal years beginning after
November 15, 2007. We are currently evaluating the impact that SFAS 157 will
have on our financial condition and results of operations.
In September 2006, the FASB issued a staff position related to the
accounting for planned major maintenance activities. The staff position sets
forth four alternative methods of accounting for planned major maintenance
activities but disallowed the accrue-in-advance method. The accrue-in-advance
method provides for estimating the cost of major maintenance activities and
accruing that cost in advance of the maintenance being performed. The guidance
is effective for the first fiscal year beginning after December 15, 2006. We are
currently evaluating the impact that this staff position will have on accounting
related to our transportation equipment.
In July 2006, the FASB issued Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109",
which prescribes a comprehensive model for how a company should recognize,
measure, present and disclose in its financial statements uncertain tax
positions that it has taken or expects to take on a tax return. Upon adoption of
FIN 48, the financial statements will reflect expected future tax consequences
of such uncertain positions assuming the taxing authorities' full knowledge of
the position and all relevant facts. FIN 48 also revises disclosure requirements
and introduces an annual, tabular roll-forward of the unrecognized tax benefits.
This interpretation is effective as of the beginning of fiscal years starting
after December 15, 2006. We are currently evaluating the impact FIN 48 will have
on our financial condition and results of operations.
In February 2006, the FASB issued Statement No. 155, "Accounting for
Certain Hybrid Financial Instruments", which nullifies and amends various
accounting guidance relating to accounting for derivative instruments and
securitization transactions. In general, these changes will reduce the
operational complexity associated with bifurcating embedded derivatives, and
increase the number of beneficial interests in securitization transactions. This
statement is effective for all financial instruments acquired or issued after
the beginning of our first fiscal year that begins after September 15, 2006.
Because we do not have any material derivative instruments or securitization
transactions, we believe there will be no material impact on our financial
condition, results of operations or cash flows upon adoption.
27
Safe Harbor Statement under the Private Securities Litigation Reform Act of
- ---------------------------------------------------------------------------
1995 Regarding Forward-Looking Information
- ------------------------------------------
In addition to historical information, this report contains forward-looking
statements and performance trends that are based upon assumptions subject to
certain known and unknown risks, uncertainties, contingencies and other factors.
Variances in any or all of the risks, uncertainties, contingencies, and other
factors from our assumptions could cause actual results to differ materially
from these forward-looking statements and trends. Our ability to deal with the
unknown outcomes of these events, many of which are beyond our control, may
affect the reliability of projections and other financial matters.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our primary market risk exposure relates to interest rate risk exposure
through variable interest rate borrowings. At September 30, 2006, we had a total
of $15.4 million of variable rate debt outstanding. Should the interest rate on
this debt increase 100 basis points, our annual interest expense would increase
$154,000. The quoted market value of our 8.75% fixed rate senior notes on
September 30, 2006 is $156 million (carrying value is $150 million). We estimate
that the fair value of the remainder of our long-term debt approximates its book
value at September 30, 2006.
Item 4. Controls and Procedures
We carried out an evaluation, under the supervision of our President and
Chief Executive Officer and with the participation of the Vice President and
Chief Financial Officer and the Vice President and Controller, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this report. Based on that
evaluation, the President and Chief Executive Officer, Vice President and Chief
Financial Officer and Vice President and Controller have concluded that our
disclosure controls and procedures were effective as of the end of the period
covered by this report. There has been no change in our internal control over
financial reporting that occurred during the quarter covered by this report that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
PART II OTHER INFORMATION
Item 2(e). Purchases of Equity Securities by the Issuer and Affiliated
Purchasers
In July 2006, we announced a $50 million on-going stock repurchase program.
Our previous stock repurchase program authorized in February 2000 had remaining
authorization of $8.5 million. The following table shows the repurchase activity
related to the programs for the three months ended September 30, 2006:
Weighted Cumulative Dollar
Average Shares Amount
Total Number Price Repurchased Remaining
of Shares Paid Per Under Under
Repurchased Share the Program The Program
------------ --------- ------------ -----------
February 2000 Program (a)
- -------------------------
July 1 through July 31, 2006 - $ - 42,349 $8,498,717
August 1 through August 31, 2006 111,380 $37.30 153,729 $4,344,488
September 1 through September 30, 2006 - $ - 153,729 $4,344,488
------------ --------- ============ ===========
Third Quarter Total - February 2000 Program 111,380 $37.30
============ =========
(a) No shares had been purchased under the February 2000 program since June
2001. $10 million was originally authorized under this program with no
expiration date.
July 2006 Program
- ----------------------------------------------------------------------
We have not repurchased any shares to date under this program. $50 million
remains authorized under this program with no expiration date.
28
Item 6. Exhibits
Exhibit No. Description
------------- ----------------------------------------------------------------
18.1 PricewaterhouseCoopers LLP preferability letter regarding
change in accounting principle
31.1 Certification by Kevin J. McNamara pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act of 1934.
31.2 Certification by David P. Williams pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act of 1934.
31.3 Certification by Arthur V. Tucker, Jr. pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act of 1934.
32.1 Certification by Kevin J. McNamara pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification by David P. Williams pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.3 Certification by Arthur V. Tucker, Jr. pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
29
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Chemed Corporation
---------------------------------------
(Registrant)
Dated: November 1, 2006 By: Kevin J. McNamara
--------------------------- ---------------------------------------
Kevin J. McNamara
(President and Chief Executive Officer)
Dated: November 1, 2006 By: David P. Williams
--------------------------- ---------------------------------------
David P. Williams
(Vice President and Chief Financial
Officer)
Dated: November 1, 2006 By: Arthur V. Tucker, Jr.
--------------------------- ---------------------------------------
Arthur V. Tucker, Jr.
(Vice President and Controller)
30
Exhibit 18.1
Board of Directors
Chemed Corporation
2600 Chemed Center
255 East Fifth Street
Cincinnati, OH 45202
Dear Directors:
We are providing this letter to you for inclusion as an exhibit to your Form
10-Q filing pursuant to Item 601 of Regulation S-K.
We have been provided a copy of the Company's Quarterly Report on Form 10-Q for
the period ended September 30, 2006. Note 20 therein describes a change in
accounting principle for the date of the Company's annual impairment test
required under Statement of Financial Accounting Standards No. 142, Goodwill and
Other Intangible Assets from December 31st to October 1st. It should be
understood that the preferability of one acceptable method of accounting over
another for the date a company uses for its annual goodwill impairment test has
not been addressed in any authoritative accounting literature, and in expressing
our concurrence below we have relied on management's determination that this
change in accounting principle is preferable. Based on our reading of
management's stated reasons and justification for this change in accounting
principle in the Form 10-Q, and our discussions with management as to their
judgment about the relevant business planning factors relating to the change, we
concur with management that such change represents, in the Company's
circumstances, the adoption of a preferable accounting principle in conformity
with Statement of Financial Accounting Standards No. 154, Accounting Changes and
Error Corrections.
We have not audited any financial statements of the Company as of any date or
for any period subsequent to December 31, 2005. Accordingly, our comments are
subject to change upon completion of an audit of the financial statements
covering the period of the accounting change.
/s/ PricewaterhouseCoopers LLP
Cincinnati, OH
October 30, 2006
E-1
EXHIBIT 31.1
CERTIFICATION PURSUANT TO RULES 13a-14(a)/15d-14(a) OF THE EXCHANGE ACT OF 1934
I, Kevin J. McNamara, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Chemed
Corporation ("registrant");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations, and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rule
13a-15(f) and 15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or
caused such internal control over financial report to be
designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles;
c) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting.
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal control over financial reporting.
Date: November 1, 2006 /s/ Kevin J. McNamara
------------------------- ------------------------
Kevin J. McNamara
(President and Chief
Executive Officer)
E-2
Exhibit 31.2
CERTIFICATION PURSUANT TO RULES 13a-14(a)/15d-14(a) OF THE EXCHANGE ACT OF 1934
I, David P. Williams, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Chemed
Corporation ("registrant");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations, and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rule
13a-15(f) and 15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or
caused such internal control over financial report to be
designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles;
c) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting.
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors:
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal control over financial reporting.
Date: November 1, 2006 /s/ David P. Williams
-------------------- ------------------------
David P. Williams
(Vice President and
Chief Financial Officer)
E-3
EXHIBIT 31.3
CERTIFICATION PURSUANT TO RULES 13a-14(a)/15d-14(a) OF THE EXCHANGE ACT OF 1934
I, Arthur V. Tucker, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Chemed
Corporation ("registrant");
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations, and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rule
13a-15(f) and 15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) designed such internal control over financial reporting, or
caused such internal control over financial report to be
designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles,
c) evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting.
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors:
a) all significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal control over financial reporting.
Date: November 1, 2006 /s/ Arthur V. Tucker, Jr.
------------------- -------------------------
Arthur V. Tucker, Jr.
(Vice President and
Controller)
E-4
EXHIBIT 32.1
CERTIFICATION BY KEVIN J. MCNAMARA
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002.
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as
President and Chief Executive Officer of Chemed Corporation ("Company"), does
hereby certify that:
1) the Company's Quarterly Report of Form 10-Q for the quarter
ending September 30, 2006 ("Report"), fully complies with the
requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934; and
2) the information contained in the Report fairly presents, in
all material respects, the financial condition and results of
operations of the Company.
Dated: November 1, 2006 /s/ Kevin J. McNamara
------------------- -------------------------
Kevin J. McNamara
(President and Chief
Executive Officer)
E-5
EXHIBIT 32.2
CERTIFICATION BY DAVID P. WILLIAMS
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002.
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as
Vice President and Chief Financial Officer of Chemed Corporation ("Company"),
does hereby certify that:
1) the Company's Quarterly Report of Form 10-Q for the quarter
ending September 30, 2006 ("Report"), fully complies with the
requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934; and
2) the information contained in the Report fairly presents, in
all material respects, the financial condition and results of
operations of the Company.
Dated: November 1, 2006 /s/ David P. Williams
------------------ -------------------------
David P. Williams
(Vice President and
Chief Financial Officer)
E-6
EXHIBIT 32.3 CERTIFICATION BY ARTHUR V. TUCKER, JR. PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002. Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as Vice President and Controller of Chemed Corporation ("Company"), does hereby certify that: 1) the Company's Quarterly Report of Form 10-Q for the quarter ending September 30, 2006 ("Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: November 1, 2006 /s/ Arthur V. Tucker, Jr. ------------------- ------------------------- Arthur V. Tucker, Jr. (Vice President and Controller) E-7