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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
[X] For the fiscal year ended December 31, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Transition period from _______________ to ______________
Commission File Number: 1-8351
ROTO-ROOTER, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 31-0791746
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2600 Chemed Center, 255 East Fifth Street, Cincinnati, Ohio 45202-4726
(Address of principal executive offices) (Zip Code)
(513) 762-6900
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -----------------------
Capital Stock - Par Value $1 Per Share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 period 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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the average bid and asked price of said stock on
the New York Stock Exchange - Composite Transaction Listing on June 30, 2003
($38.03 per share), was $375,315,385.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED
-------- ------------------
Proxy Statement for Annual Meeting to be held May 17, 2004 Part III
Form 8K-A filed February 23, 2004 Part II
ROTO-ROOTER, INC.
2003 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business.............................................................................................. 1
Item 2. Properties............................................................................................ 21
Item 3. Legal Proceedings..................................................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders................................................... 22
-- Executive Officers of the Registrant.................................................................. 22
PART II
Item 5. Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities......................................... 23
Item 6. Selected Financial Data............................................................................... 24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................................ 39
Item 8. Financial Statements and Supplementary Data........................................................... 40
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................................................................... 40
Item 9A. Controls & Procedures................................................................................. 40
PART III
Item 10. Directors and Executive Officers of the Registrant.................................................... 41
Item 11. Executive Compensation................................................................................ 41
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters............................................................ 41
Item 13. Certain Relationships and Related Transactions........................................................ 41
Item 14. Principal Accountant Fees and Services................................................................ 41
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K........................................................................................... 43
ITEM 1. BUSINESS
GENERAL
Pursuant to a stockholder vote at the Company's Annual Meeting of
Stockholders held on May 19, 2003, the Company amended its Amended Certificate
of Incorporation and changed its name from Chemed Corporation to Roto-Rooter,
Inc. The Company was incorporated in Delaware in 1970 as a subsidiary of W. R.
Grace & Co. and succeeded to the business of W. R. Grace & Co.'s Specialty
Products Group as of April 30, 1971 and remained a subsidiary of W. R. Grace &
Co. until March 10, 1982. As used herein, "Company" refers to Roto-Rooter, Inc.,
and its subsidiaries and "Grace" refers to W. R. Grace & Co. and its
subsidiaries.
On March 10, 1982, the Company transferred to Dearborn Chemical
Company, a wholly owned subsidiary of the Company, the business and assets of
the Company's Dearborn Group, including the stock of certain subsidiaries within
the Dearborn Group, plus $185 million in cash, and Dearborn Chemical Company
assumed the Dearborn Group's liabilities. Thereafter, on March 10, 1982 the
Company transferred all of the stock of Dearborn Chemical Company to Grace in
exchange for 16,740,802 shares of the capital stock of the Company owned by
Grace with the result that Grace no longer has any ownership interest in the
Company.
On December 31, 1986, the Company completed the sale of substantially
all of the business and assets of Vestal Laboratories, Inc., a wholly owned
subsidiary. The Company received cash payments aggregating approximately $67.4
million over the four-year period following the closing, the substantial portion
of which was received on December 31, 1986.
On April 2, 1991, the Company completed the sale of DuBois Chemicals,
Inc. ("DuBois"), a wholly owned subsidiary, to the Diversey Corporation
("Diversey"), then a subsidiary of The Molson Companies Ltd. Under the terms of
the sale, Diversey agreed to pay the Company net cash payments aggregating
$223,386,000, including deferred payments aggregating $32,432,000.
On December 21, 1992, the Company acquired The Veratex Corporation and
related businesses ("Veratex Group") from Omnicare, Inc. The purchase price was
$62,120,000 in cash paid at closing, plus a post-closing payment of $1,514,000
(paid in April 1993) based on the net assets of Veratex.
Effective January 1, 1994, the Company acquired all the capital stock
of Patient Care, Inc. ("Patient Care"), for cash payments aggregating
$20,582,000, plus 17,500 shares of the Company's Capital Stock. An additional
cash payment of $1,000,000 was made on March 31, 1996 and another payment of
$1,000,000 was made on March 31, 1997.
In July 1995, the Company's Omnia Group (formerly Veratex Group)
completed the sale of the business and assets of its Veratex Retail division to
Henry Schein, Inc. ("HSI") for $10 million in cash plus a $4.1 million note for
which payment was received in December 1995.
Effective September 17, 1996, the Company completed a merger of a
subsidiary of the Company, Chemed Acquisition Corp., and Roto-Rooter, Inc.
pursuant to a Tender Offer commenced on August 8, 1996 to acquire any and all of
the outstanding shares of Common Stock of Roto-Rooter, Inc. for $41.00 per share
in cash.
1
On September 24, 1997, the Company completed the sale of its wholly
owned businesses comprising the Omnia Group to Banta Corporation for $50 million
in cash and $2.3 million in deferred payments.
Effective September 30, 1997, the Company completed a merger between
its 81-percent-owned subsidiary, National Sanitary Supply Company, and a wholly
owned subsidiary of Unisource Worldwide, Inc. for $21.00 per share, with total
payments of $138.3 million.
Effective October 11, 2002, the Company sold its Patient Care, Inc.
subsidiary ("Patient Care") to an investor group that included Schroder Ventures
Life Sciences Group, Oak Investment Partners, Prospect Partners and Salix
Ventures. Patient Care provides home-healthcare services primarily in the New
York-New Jersey-Connecticut area. The cash proceeds to the Company totaled
$57,500,000, of which $5,000,000 was placed in escrow pending settlement of
Patient Care's receivables with third-party payers. Of this amount, $2,500,000
was distributed as of October 2003 and $2,500,000 is expected to be distributed
as of October 2004. Based on the collection history of Patient Care, the Company
expects to collect the funds held in escrow in full. The Company may also be
entitled to additional funds based on the final value of the estimated balance
sheet valuation which is expected to be determined in 2004. In addition, the
Company received a senior subordinated note receivable ("Note") for $12,500,000
and a common stock purchase warrant ("Warrant") for 2% of the outstanding stock
of the purchasing company. The Note is due October 11, 2007, and bears interest
at the annual rate of 7.5% through September 30, 2004, 8.5% from October 1,
2004, through September 30, 2005, and 9.5% thereafter. The Warrant has an
estimated fair value of $1,445,000.
During 2003 the Company conducted its business operations in two
segments: Plumbing and Drain Cleaning Group ("Plumbing and Drain Cleaning")
and Service America Systems, Inc. ("Service America").
Effective February 24, 2004, The Company completed a merger of its
wholly owned indirect subsidiary, Marlin Merger Corp., and Vitas Healthcare
Corporation ("Vitas"). Under the terms of the merger agreement, Vitas
stockholders received cash of $30.00 per share. The transaction, including the
refinancing of existing Vitas debt and other payments made in connection with
the merger, totaled approximately $406 million in cash. In order to complete the
merger the Company sold two million shares of its Capital Stock in a private
placement at a price of $50.00 per share, issued $110 million principal amount
of floating rate senior secured notes due 2010 ("Floating Rate Notes"), issued
$150 million principal amount of 8.75% Senior Notes due 2011 ("Fixed Rate
Notes"), and entered into new $135 million senior secured credit facilities.
More information with respect to the Company's merger with Vitas is set forth in
Item 7 of this Report on page 25 and within Note 23 of the Notes to the
Financial Statements appearing on pages F-31 - F-33 of this Report on Form 10-K.
FORWARD LOOKING STATEMENTS
This Annual Report contains or incorporates by reference certain
forward looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company intends such statements to be subject
to the safe harbors created by that legislation. Such statements involve risks
and uncertainties that could cause actual results of operations to differ
materially from these forward looking statements.
2
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The required segment and geographic data for the Company's continuing
operations (as described below) for the three years ended December 31, 2001,
2002 and 2003 are shown in Note 2 of the Notes to the Financial Statements on
pages F-11 to F-13 of this Report on Form 10-K.
DESCRIPTION OF BUSINESS BY SEGMENT
The information called for by this item with respect to the Plumbing
and Drain Cleaning segment and Service America segment is included within Note 2
of the Notes to Financial Statements appearing on pages F-11 - F-13 of this
Report on Form 10-K.
VITAS
General. Vitas is the nation's largest provider of hospice services for patients
with severe, life-limiting illnesses. This type of care is aimed at making the
terminally ill patient's final days as comfortable and pain free as possible.
Hospice care is typically available to patients who have been initially
certified as terminally ill (i.e. a prognosis of six months or less) by their
attending physician, if any, and the hospice physician.
Vitas' hospice operations began in South Florida in 1978 and were
incorporated as a for-profit corporation in 1983. Today, Vitas provides a
comprehensive range of hospice services through 25 operating programs covering
many of the large population areas in the U.S. including Florida, California,
Texas and Illinois. Vitas has over 6,000 employees, including approximately
2,400 nurses and 1,500 home health aides.
In general, Vitas offers all levels of hospice care in a given market.
In each of its markets, Vitas employs an active community relations effort that
involves relationship building and hospice education activities, the extensive
education of referral sources, and print and radio media initiatives. This
broad-based approach has helped Vitas increase market share and achieve
consistent historical revenue growth. As the largest provider of hospice care in
a highly fragmented industry, Vitas currently believes it has approximately 7%
of the market share in the U.S. hospice market.
Hospice Services Industry Overview
Hospice care is primarily provided under the government's Medicare and
Medicaid programs. In 1982, Congress established the Medicare Hospice Benefit,
which is available to patients who have been certified as terminally ill, with a
prognosis of six months or less, by the patient's attending physician, if any,
and the hospice physician.
Effective in 1997, the Medicare Hospice Benefit was amended to reflect
the following benefit periods: an initial 90-day period; a second 90-day period;
and an unlimited number of subsequent 60-day benefit periods, as long as the
patient is recertified as terminally ill by a physician at the beginning of each
benefit period. The Medicare Hospice Benefit covers care associated with a
patient's terminal illness, which would include prescription drugs for pain and
symptom relief, medical supplies and equipment, inpatient care and bereavement
services for the family for up to one year after death.
3
The variety of services provided by hospice programs include:
Nursing Care: Nurses coordinate care, provide direct patient care, and
check symptoms and medication. Because patient and family education is such an
important part of every care program, the nurse often becomes the link between
the patient and the family and the hospice services.
Social Services: Social workers provide advice and counseling to the
patient and family members and may also act as an advocate for the patient and
the family in utilizing community resources.
Physician Services: A hospice medical director and physician oversee
the plan of care as members of an interdisciplinary team.
Spiritual Support and Counseling: Chaplains are available to visit and
provide spiritual support to the patient.
Home and Health Aide Services: Home care includes personal care for the
patient, such as assistance with bathing, eating and general hygiene. Homemaking
services may also be available for the patient's living area.
Continuous Care: If the patient's condition requires, hospice staff may
provide around the clock care.
Volunteers: Volunteers are intended to be an integral part of any
hospice program. Hospice volunteers may provide compassionate support and
companionship, help with certain everyday tasks such as shopping or babysitting,
and deliver other helpful services.
24-hour On-call Availability: A hospice team member is on-call 24-hours
a day, seven days a week, either for phone consultation or visitation.
Hospice Inpatient Care: Although hospice care may be centered around
the home, it sometimes becomes necessary to move the patient to a hospice
inpatient bed. The hospice team will arrange this care as well as the return to
in-home care when appropriate.
Respite Care: To provide relief for the family members, the hospice may
be able to arrange for a brief period of inpatient care for the patient at a
hospice inpatient bed, depending upon the circumstances of the patient and the
family.
Bereavement Support: The hospice care team works with surviving family
members to help them through the grieving process for up to one year after the
patient's death. The hospice care provider may also suggest medical or
professional care for surviving family members as appropriate.
Vitas' Services
Vitas classifies its services based on the location and type of care
provided. The major classifications are Home Care, Continuous Care and Inpatient
Care.
Home Care: Routine care provided to patients and their families
residing at home or in a nursing facility. The hospice is typically paid the
routine home care rate for each day the patient is under the care of the
hospice. In the year ended December 31,
4
2003, Home Care accounted for 68.3% of Vitas' net revenues and 90.5% of its days
of care. Vitas' average daily reimbursement rate for Home Care in such period
was $122.70.
Inpatient Care: Short term care provided in a participating hospice
inpatient unit, hospital or skilled nursing facility that meets the special
hospice standards. Inpatient care may be required for procedures necessary for
pain control or acute symptom management which cannot be provided in other
settings. Medicare distinguishes two different levels of Inpatient Care: (i)
inpatient respite care and (ii) general inpatient care. The reimbursement rate
for inpatient respite care is paid for each day the patient is in an approved
inpatient facility and is receiving respite care. Payment for respite care may
be made for a maximum of five days. General inpatient care is reimbursed at a
different, higher rate. In the year ended December 31, 2003, Inpatient Care
accounted for 15.5% of Vitas' net revenues and 4.6% of its days of care. Vitas'
average daily reimbursement rate for Inpatient Care in such period was $544.98.
Continuous Care: Care provided to patients while at home, during
periods of crisis when intensive monitoring and care, primarily nursing care, is
required in order to achieve palliation or management of acute medical symptoms.
Reimbursement is calculated by multiplying the applicable continuous care hourly
rate by the number of hours of care provided. A minimum of 8 hours of continuous
care in a 24 hour period is to be provided to receive the continuous home care
rate. In the year ended December 31, 2003, Continuous Care accounted for 16.2%
of Vitas' net revenues and 4.9% of its days of care. Vitas' average daily
reimbursement rate for Continuous Care was $541.88.
Service Delivery and Systems
Vitas delivers its service through local hospice programs that operate
under a standardized organizational structure consisting of a senior management
team and multiple teams of caregivers assisted by volunteers. A senior
management team is typically comprised of a general manager, a patient care
administrator, a medical director and a director of admissions. Patient care
teams typically include a team manager, nurses, home health aides, a chaplain,
team physicians, a patient care secretary and a social worker.
Vitas' standardized model for patient care is complemented by its
internal systems and controls. Vitas has developed an information technology
platform that is designed to enable management to monitor and evaluate various
operating, clinical and employee performance measures in a timely manner.
Vitas' information systems infrastructure supports all its operations,
including clinical operations, billing and collections, accounts payable and
claims processing, financial reporting, human resources and compliance. The
system is built upon a proprietary business enterprise application. At the
corporate level, management uses this application to monitor and evaluate the
various operating, clinical and employee performance measures. At the program
level, it provides detailed information on referral sources, patients and
staffing for patient management, as well as staff scheduling and management.
Compliance and Training
Vitas' compliance and training structure is designed to monitor
conformity to company standards as well as standards mandated by Medicare, state
agencies and private insurance providers. The Compliance Committee, consisting
of members of senior
5
management, oversees Vitas' compliance program, reviews patient surveys and
analyzes the company's performance measurements. Vitas' Department of Clinical
Research, Analysis and Audit performs periodic reviews of each local program,
which are similar to Medicare certification and state licensing surveys. Any
finding documented in the survey report prepared as a part of the periodic
reviews requires a formal written response and corrective action plan. Vitas'
Department of Hospice Education and Training administers compliance training to
each employee on an annual basis. In addition, every patient and family is asked
to complete a satisfaction survey regarding the quality of care delivered to the
patient and the family.
Hospice Programs
Vitas currently operates 25 hospice programs in the following markets:
- California - Inland Empire, Orange County, Coastal
Cities, San Gabriel, San Diego, San Francisco Bay
Area and San Fernando
- Florida - Dade, Broward, Central Florida, Brevard and
Palm Beach
- Texas - Dallas, Ft. Worth, Houston and San Antonio
- Illinois - Chicago Northwest, Chicago Central and
Chicago South
- New Jersey - North, West and Shore
- Ohio - Cincinnati
- Pennsylvania - Philadelphia
- Wisconsin - Milwaukee
Historically, Vitas has expanded its hospice operations through the
acquisition of hospice programs and the opening of new hospice programs in new
geographic locations. In the fiscal year ended September 30, 2003, Vitas
acquired a hospice program in Palm Beach, Florida. Vitas intends to continue to
expand its business by actively pursuing strategic acquisitions of hospices in
new and existing markets throughout the United States. Since 1978, Vitas has
opened 16 new hospice programs throughout the country. In the fiscal year ended
September 30, 2003, Vitas opened three new hospice programs in New Jersey and
Brevard County, Florida. In opening a new program, Vitas assesses, among other
things, the potential Average Daily Census for the area by evaluating factors
such as the region's demographic profile, current hospice providers, mortality
rates by type of disease, and the availability of health care workers. A key
part of Vitas' growth strategy is to open new hospice programs.
Reimbursement Environment
Medicare rates of reimbursement for hospice care, as stipulated in
Section 1814(i)(1)(C)(ii) of the Social Security Act, continue to be adjusted
based on a market basket percentage increase, which for fiscal year 2004 has
already been established at an increase of 3.4%.
6
As with most government programs, the Medicare and Medicaid programs
are subject to statutory and regulatory changes, possible retroactive and
prospective rate adjustments, administrative rulings, freezes and funding
reductions, all of which may adversely affect the level of program payments to
Vitas for its services. Reductions or changes in Medicare or Medicaid funding
could significantly affect Vitas' results of operations. It is not possible to
predict at this time whether any additional health care reform initiatives will
be implemented or whether there will be other changes in the administration of
governmental health care programs or interpretations of governmental policies or
other changes affecting the health care system.
PRODUCT AND MARKET DEVELOPMENT
Each segment of the Company's business engages in a continuing program
for the development and marketing of new services and products. While new
products and services and new market development are important factors for the
growth of each active segment of the Company's business, the Company does not
expect that any new products and services or marketing effort, including those
in the development stage, will require the investment of a material amount of
the Company's assets.
RAW MATERIALS
The principal raw materials needed for the Company's manufacturing
operations are purchased from United States sources. No segment of the Company
experienced any material raw material shortages during 2003, although such
shortages may occur in the future. Products manufactured and sold by the
Company's active business segments generally may be reformulated to avoid the
adverse impact of a specific raw material shortage.
PATENTS, SERVICE MARKS AND LICENSES
The Roto-Rooter trademarks and service marks have been used and
advertised since 1935 by Roto-Rooter Corporation, an indirectly wholly owned
subsidiary of the Company. The Roto-Rooter marks are among the most highly
recognized trademarks and service marks in the United States. The Company
considers the Roto-Rooter marks to be a valuable asset and a significant factor
in the marketing of Roto-Rooter's franchises, products and services and the
products and services provided by its franchisees. "Vitas" is a trademark of
Vitas Healthcare Corporation. The Company and its subsidiaries also own certain
trade secrets including training manuals, pricing information, customer
information, and software source codes.
COMPETITION
ROTO-ROOTER
All aspects of the sewer, drain, and pipe cleaning, HVAC services and
plumbing repair businesses are highly competitive. Competition is, however,
fragmented in most markets with local and regional firms providing the primary
competition. The principal methods of competition are advertising, range of
services provided, name recognition, speed and quality of customer service,
service guarantees, and pricing.
7
No individual customer or market group is critical to the total sales
of this segment.
SERVICE AMERICA
All aspects of the HVAC and appliance repair and maintenance service
industry are highly competitive. Competition is, however, fragmented in most
markets with local and regional firms providing the primary competition. The
principal methods of competition are advertising, range of services provided,
speed and quality of customer service, service guarantees, and pricing.
No individual customer or market group is critical to the total sales
of this segment.
VITAS
Hospice care in the United States is competitive. Because payments for
hospice services are generally fixed, Vitas competes primarily on the basis of
its ability to deliver quality, responsive services. Vitas is the nation's
largest provider of hospice services in a market dominated by small, non-profit,
community-based hospices. More than 72% of all hospices are not-for-profit.
Because the hospice care market is highly fragmented, Vitas competes with a
large number of organizations.
Vitas also competes with a number of national and regional hospice
providers, including Odyssey Healthcare, Inc. and VistaCare, Inc., hospitals,
nursing homes, home health agencies and other health care providers. Many
providers offer home care to patients who are terminally ill, and some actively
market palliative care and hospice-like programs. In addition, various health
care companies have diversified into the hospice market. Some of these health
care companies may have greater financial resources than Vitas.
Relatively few barriers to entry exist in the markets served by Vitas.
Accordingly, other companies that are not currently providing hospice care may
enter these markets and expand the variety of services offered.
RESEARCH AND DEVELOPMENT
The Company engages in a continuous program directed toward the
development of new products and processes, the improvement of existing products
and processes, and the development of new and different uses of existing
products. The research and development expenditures from continuing operations
have not been nor are they expected to be material.
GOVERNMENT REGULATIONS
ROTO-ROOTER
Roto-Rooter's franchising activities are subject to various federal and
state franchising laws and regulations, including the rules and regulations of
the Federal Trade Commission (the "FTC") regarding the offering or sale of
franchises. The rules and regulations of the FTC require that Roto-Rooter
provide all prospective franchisees with specific information regarding the
franchise program and Roto-Rooter in the form of a detailed franchise offering
circular. In addition, a number of states require Roto-Rooter to register its
franchise offering prior to offering or selling franchises in the state. Various
state laws also provide for certain rights in favor of franchisees, including
(i)
8
limitations on the franchisor's ability to terminate a franchise except for good
cause, (ii) restrictions on the franchisor's ability to deny renewal of a
franchise, (iii) circumstances under which the franchisor may be required to
purchase certain inventory of franchisees when a franchise is terminated or not
renewed in violation of such laws, and (iv) provisions relating to arbitration.
Roto-Rooter's ability to engage in the plumbing repair business is also subject
to certain limitations and restrictions imposed by state and local licensing
laws and regulations.
SERVICE AMERICA
Service America's home and service warranty operations are regulated by
the Florida and Arizona Departments of Insurance. In accordance with certain
Florida regulatory requirements, Service America maintains cash with the
Department of Insurance and is also required to maintain additional unencumbered
reserves. In addition, Service America's air conditioning and appliance repair
and maintenance business is also subject to certain limitations imposed by state
and local licensing laws and regulations.
VITAS
General. The health care industry and Vitas' hospice programs are
subject to extensive federal and state regulation. Vitas' hospices are licensed
as required under state law as either hospices or home health agencies, or both,
depending on the regulatory requirements of each particular state. In addition,
Vitas' hospices are required to meet certain conditions of participation to be
eligible to receive payments as hospices under the Medicare and Medicaid
programs. All of Vitas' hospices, other than those currently in development, are
certified for participation as hospices in the Medicare program, and are also
eligible to receive payments as hospices from the Medicaid program in each of
the states in which Vitas operates. Vitas' hospices are subject to periodic
survey by governmental authorities or private accrediting entities to assure
compliance with state licensing, certification and accreditation requirements,
as the case may be.
Medicare Conditions of Participation. Federal regulations require that
a hospice program satisfy certain conditions of participation to be certified
and receive Medicare payment for the services it provides. Failure to comply
with the conditions of participation may result in sanctions, up to and
including decertification from the Medicare program. See "Surveys and Audits"
below.
The Medicare conditions of participation for hospice programs include
the following:
Governing Body. Each hospice must have a governing body that
assumes full responsibility for the policies and the overall operation
of the hospice and for ensuring that all services are provided in a
manner consistent with accepted standards of practice. The governing
body must designate one individual who is responsible for the
day-to-day management of the hospice.
Medical Director. Each hospice must have a medical director
who is a physician and who assumes responsibility for overseeing the
medical component of the hospice's patient care program.
Direct Provision of Core Services. Medicare limits those
services for which the hospice may use individual independent
contractors or contract agencies to provide care to patients.
Specifically, substantially all nursing, social work, and
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counseling services must be provided directly by hospice employees
meeting specific educational and professional standards. During periods
of peak patient loads or under extraordinary circumstances, the hospice
may be permitted to use contract workers, but the hospice must agree in
writing to maintain professional, financial and administrative
responsibility for the services provided by those individuals or
entities.
Professional Management of Non-Core Services. A hospice may
arrange to have non-core services such as therapy services, home health
aide services, medical supplies or drugs provided by a non-employee or
outside entity. If the hospice elects to use an independent contractor
to provide non-core services, however, the hospice must retain
professional management responsibility for the arranged services and
ensure that the services are furnished in a safe and effective manner
by qualified personnel, and in accordance with the patient's plan of
care.
Plan of Care. The patient's attending physician, the medical
director or designated hospice physician, and the interdisciplinary
team must establish an individualized written plan of care prior to
providing care to any hospice patient. The plan must assess the
patient's needs and identify services to be provided to meet those
needs and must be reviewed and updated at specified intervals.
Continuation of Care. A hospice may not discontinue or reduce
care provided to a Medicare beneficiary if the individual becomes
unable to pay for that care.
Informed Consent. The hospice must obtain the informed consent
of the hospice patient, or the patient's representative, that specifies
the type of care services that may be provided as hospice care.
Training. A hospice must provide ongoing training for its
employees.
Quality Assurance. A hospice must conduct ongoing and
comprehensive self-assessments of the quality and appropriateness of
care it provides and that its contractors provide under arrangements to
hospice patients.
Interdisciplinary Team. A hospice must designate an
interdisciplinary team to provide or supervise hospice care services.
The interdisciplinary team develops and updates plans of care, and
establishes policies governing the day-to-day provision of hospice
services. The team must include at least a physician, registered nurse,
social worker and spiritual or other counselor. A registered nurse must
be designated to coordinate the plan of care.
Volunteers. Hospice programs are required to recruit and train
volunteers to provide patient care services or administrative services.
Volunteer services must be provided in an amount equal to at least five
percent of the total patient care hours provided by all paid hospice
employees and contract staff.
Licensure. Each hospice and all hospice personnel must be
licensed, certified or registered in accordance with applicable
federal, state and local laws and regulations.
Central Clinical Records. Hospice programs must maintain
clinical records for each hospice patient that are organized in such a
way that they may be easily
10
retrieved. The clinical records must be complete and accurate and
protected against loss, destruction, and unauthorized use.
Surveys and Audits. Hospice programs are subject to periodic survey by
federal and state regulatory authorities and private accrediting entities to
ensure compliance with applicable licensing and certification requirements and
accreditation standards. Regulators conduct periodic surveys of hospice programs
and provide reports containing statements of deficiencies for alleged failure to
comply with various regulatory requirements. Survey reports and statements of
deficiencies are common in the healthcare industry. In most cases, the hospice
program and regulatory authorities will agree upon any steps to be taken to
bring the hospice into compliance with applicable regulatory requirements. In
some cases, however, a state or federal regulatory authority may take a number
of adverse actions against a hospice program, including the imposition of fines,
temporary suspension of admission of new patients to the hospice's service or,
in extreme circumstances, de-certification from participation in the Medicare or
Medicaid programs or revocation of the hospice's license.
From time to time Vitas receives survey reports containing statements
of deficiencies. Vitas reviews such reports and takes appropriate corrective
action. Vitas believes that its hospices are in material compliance with
applicable licensure and certification requirements. If a Vitas hospice were
found to be out of compliance and actions were taken against a Vitas hospice,
they could materially adversely affect the hospice's ability to continue to
operate, to provide certain services and to participate in the Medicare and
Medicaid programs, which could materially adversely affect Vitas.
Billing Audits/ Claims Reviews. The Medicare program and its fiscal
intermediaries and other payors periodically conduct pre-payment or post-payment
reviews and other reviews and audits of health care claims, including hospice
claims. There is pressure from state and federal governments and other payors to
scrutinize health care claims to determine their validity and appropriateness.
In order to conduct these reviews, the payor requests documentation from Vitas
and then reviews that documentation to determine compliance with applicable
rules and regulations, including the eligibility of patients to receive hospice
benefits, the appropriateness of the care provided to those patients and the
documentation of that care. During the past several years, Vitas' claims have
been subject to review and audit.
Certificate of Need Laws and Other Restrictions. Some states, including
Florida, have certificate of need or similar health planning laws that apply to
hospice care providers. These states may require some form of state agency
review or approval prior to opening a new hospice program, to adding or
expanding hospice services, to undertaking significant capital expenditures or
under other specified circumstances. Approval under these certificate of need
laws is generally conditioned on the showing of a demonstrable need for services
in the community. Vitas may seek to develop, acquire or expand hospice programs
in states having certificate of need laws. To the extent that state agencies
require Vitas to obtain a certificate of need or other similar approvals to
expand services at existing hospice programs or to make acquisitions or develop
hospice programs in new or existing geographic markets, Vitas' plans could be
adversely affected by a failure to obtain such certificate or approval. In
addition, competitors may seek administratively or judicially to challenge such
an approval or proposed approval by the state agency, and Vitas has been
defending against such a challenge in connection with the development of its
Palm Beach County, Florida hospice program. Such a challenge, whether or not
ultimately successful, could adversely affect Vitas.
11
Limitations on For-Profit Ownership. A few states have laws that
restrict the development and expansion of for-profit hospice programs. For
example, Florida law does not permit the operation of a hospice by a for-profit
corporation unless it was operated in that capacity on or before July 1, 1978,
although under certain circumstances a for-profit corporation may be permitted
to purchase a grandfathered hospice program and continue to operate it. In New
York, a hospice generally cannot be owned by a corporation that has another
corporation as a stockholder. These types of restrictions could affect Vitas'
ability to expand in Florida or into New York, or in other jurisdictions with
similar restrictions.
Limits on the Acquisition or Conversion of Non-Profit Health Care
Organizations. An increasing number of states have enacted laws that restrict
the ability of for-profit entities to acquire or otherwise assume the operations
of a non-profit health care provider. Some states may require government review,
public hearings, and/or government approval of transactions in which a
for-profit entity proposes to purchase certain non-profit healthcare
organizations. Heightened scrutiny of these transactions may significantly
increase the costs associated with future acquisitions of non-profit hospice
programs in some states, otherwise increase the difficulty in completing those
acquisitions or prevent them entirely. Vitas cannot assure that it will not
encounter regulatory or governmental obstacles in connection with any proposed
acquisition of non-profit hospice programs in the future.
Professional Licensure and Participation Agreements. Many hospice
employees are subject to federal and state laws and regulations governing the
ethics and practice of their profession, including physicians, physical, speech
and occupational therapists, social workers, home health aides, pharmacists and
nurses. In addition, those professionals who are eligible to participate in the
Medicare, Medicaid or other federal health care programs as individuals must not
have been excluded from participation in those programs at any time.
State Licensure of Hospice. Each of Vitas' hospices must be licensed in
the state in which it operates. State licensure rules and regulations require
that Vitas' hospices maintain certain standards and meet certain requirements,
which may vary from state to state. Vitas believes that its hospices are in
material compliance with applicable licensure requirements. If a Vitas hospice
were found to be out of compliance and actions were taken against a Vitas
hospice, they could materially adversely affect the hospice's ability to
continue to operate, to provide certain services and to participate in the
Medicare and Medicaid programs, which could materially adversely affect Vitas.
Overview of Government Payments -- General. A substantial portion of
Vitas' revenues are derived from payments received from the Medicare and
Medicaid programs. 95.2%, 95.4% and 95.4% of Vitas' net patient service revenue
for the years ended September 30, 2001, 2002 and 2003, respectively, and 95.8%
of Vitas' net patient service revenue for the three months ended December 31,
2003, consisted of payments from the Medicare and Medicaid programs. Such
payments are made primarily on a "per diem" basis. Under the per diem
reimbursement methodology, Vitas is essentially at risk for the cost of eligible
services provided to hospice patients. Profitability is therefore largely
dependent upon Vitas' ability to manage the costs of providing hospice services
to patients. Increases in operating costs, such as labor and supply costs that
are subject to inflation and other increases, without a compensating increase in
Medicare and Medicaid rates, could have a material adverse effect on Vitas'
business in the future. The Medicare and Medicaid programs are increasing
pressure to control health care costs and to decrease or limit increases in
reimbursement rates for health care services. As with most government
12
programs, the Medicare and Medicaid programs are subject to statutory and
regulatory changes, possible retroactive and prospective rate and payment
adjustments, administrative rulings, freezes and funding reductions, all of
which may adversely affect the level of program payments and could have a
material adverse effect on Vitas' business. Vitas' levels of revenues and
profitability will be subject to the effect of legislative and regulatory
changes, including possible reductions in coverage or payment rates, or changes
in methods of payment, by the Medicare and Medicaid programs.
Overview of Government Payments -- Medicare
Medicare Eligibility Criteria. To receive Medicare payment for hospice
services, the hospice medical director and, if the patient has one, the
patient's attending physician, must certify that the patient has a life
expectancy of six months or less if the illness runs its normal course. This
determination is made based on the physician's clinical judgment. Due to the
uncertainty of such prognoses, however, it is likely and expected that some
percentage of hospice patients will not die within six months of entering a
hospice program. The Medicare program (among other third-party payors)
recognizes that terminal illnesses often do not follow an entirely predictable
course, and therefore the hospice benefit remains available to beneficiaries so
long as the hospice physician or the patient's attending physician continues to
certify that the patient's life expectancy remains six months or less.
Specifically, the Medicare hospice benefit provides for two initial 90-day
benefit periods followed by an unlimited number of 60-day periods. In order to
qualify for hospice care, a Medicare beneficiary also must elect hospice care
and waive any right to other Medicare benefits related to his or her terminal
illness. A Medicare beneficiary may revoke his or her election of the Medicare
hospice benefit at any time and resume receiving regular Medicare benefits. The
patient may elect the hospice benefit again at a later date so long as he or she
remains eligible. Increased regulatory scrutiny of compliance with the Medicare
six-month eligibility rule has impacted the hospice industry. The Medicare
program, however, has recently reaffirmed that Medicare hospice beneficiaries
are not limited to six months of coverage and that there is no limit on how long
a Medicare beneficiary can continue to receive hospice benefits and services,
provided that the beneficiary continues to meet the eligibility criteria under
the Medicare hospice program. In addition, the Medicare, Medicaid and SCHIP
Benefits Improvement and Protection Act of 2000 requires HHS to conduct a study
to examine the appropriateness of the current physician certification
requirement required before a Medicare beneficiary is eligible to receive the
Medicare hospice benefit.
Levels of Care. Medicare pays for hospice services on a prospective
payment system basis under which Vitas receives an established payment rate for
each day that it provides hospice services to a Medicare beneficiary. These
rates are subject to annual adjustments for inflation and may also be adjusted
based upon the geographic location where the services are provided. The rate
Vitas receives will vary depending on which of the following four levels of care
is being provided to the beneficiary:
Routine Home Care. The routine home care rate is paid for each day that
a patient is in a hospice program and is not receiving one of the other
categories of hospice care. This rate is also paid when a patient is
receiving hospital care for a condition that is not related to his or
her terminal illness. The routine home care rate does not vary based
upon the volume or intensity of services provided by the hospice
program.
General Inpatient Care. The general inpatient care rate is paid when a
patient requires inpatient services for a short period for pain control
or symptom management
13
which cannot be managed in other settings. General inpatient care
services must be provided in a Medicare or Medicaid certified hospital
or long-term care facility or at a freestanding inpatient hospice
facility with the required registered nurse staffing.
Continuous Home Care. Continuous home care is provided to patients
while at home, during periods of crisis when intensive monitoring and
care, primarily nursing care, is required in order to achieve
palliation or management of acute medical symptoms. Continuous home
care requires a minimum of 8 hours of care within a 24-hour day, which
begins and ends at midnight. The care must be predominantly nursing
care provided by either a registered nurse or licensed practical nurse.
While the published Medicare continuous home care rates are daily
rates, Medicare actually pays for continuous home care services on an
hourly basis. This hourly rate is calculated by dividing the daily rate
by 24.
Respite Care. Respite care permits a hospice patient to receive
services on an inpatient basis for a short period of time in order to
provide relief for the patient's family or other caregivers from the
demands of caring for the patient. A hospice can receive payment for
respite care for a given patient for up to five consecutive days at a
time, after which respite care is reimbursed at the routine home care
rate.
Medicare Payment for Physician Services. Payment for direct patient
care physician services delivered by hospice physicians is billed separately by
the hospice to the Medicare intermediary and paid at the lesser of the actual
charge or the Medicare allowable charge for these services. This payment is in
addition to the daily rates Vitas receives for hospice care. Payment for hospice
physicians' administrative and general supervisory activities is included in the
daily rates discussed above. Payments for attending physician professional
services (other than services furnished by hospice physicians) are not paid to
the hospice, but rather are paid directly to the attending physician by the
Medicare carrier. For fiscal 2003, 1.9% of Vitas' net revenue was attributable
to physician services.
Medicare Limits on Hospice Care Payments. Medicare payments for hospice
services are subject to two additional limits or "caps." Each of Vitas' hospice
programs is separately subject to both of these "caps." Both of these "caps" are
determined on an annual basis for the period running from November 1 through
October 31 of each year.
First, under a Medicare rule known as the "80-20" rule applicable to
Medicare inpatient services, if the number of inpatient care days furnished by a
hospice to Medicare beneficiaries exceeds 20% of the total days of hospice care
furnished by such hospice to Medicare beneficiaries, Medicare payments to the
hospice for inpatient care days exceeding the inpatient cap are reduced to the
routine home care rate. During its history, Vitas has never exceeded the
inpatient cap.
Second, overall Medicare payments to a hospice are also subject to a
separate cap based on overall average payments per admission. Any payments
exceeding this overall hospice cap must be refunded by the hospice. This cap was
set at $18,661.29 per admission through the twelve-month period ended on October
31, 2003, and is adjusted annually to account for inflation. While historically
Vitas' revenues per admission generally have not exceeded the applicable cap,
there can be no assurance that Vitas' hospices will not be subject to future
payment reductions or recoupments as the result of this cap.
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Medicare Managed Care Programs. The Medicare program has entered into
contracts with managed care companies to provide a managed care benefit to
Medicare beneficiaries who elect to participate in managed care programs. These
managed care programs are commonly referred to as Medicare HMOs, Medicare +
Choice or Medicare risk products. Vitas provides hospice care to Medicare
beneficiaries who participate in these managed care programs, and Vitas is paid
for services provided to these beneficiaries in the same way and at the same
rates as those of other Medicare beneficiaries who are not in a Medicare managed
care program. Under current Medicare policy, Medicare pays the hospice directly
for services provided to these managed care program participants and then
reduces the standard per-member, per-month payment that the managed care program
otherwise receives.
Overview of Government Payments -- Medicaid
Medicaid Coverage and Reimbursement. State Medicaid programs are
another source of Vitas' net patient revenue. Medicaid is a state-administered
program financed by state funds and matching federal funds to provide medical
assistance to the indigent and certain other eligible persons. In 1986, hospice
services became an optional state Medicaid benefit. For those states that elect
to provide a hospice benefit, the Medicaid program is required to pay the
hospice at rates at least equal to the rates provided under Medicare and
calculated using the same methodology. States maintain flexibility to establish
their own hospice election procedures and to limit the number and duration of
benefit periods for which they will pay for hospice services.
Nursing Home Residents. For Vitas' patients who receive nursing home
care under a state Medicaid program and who elect hospice care under Medicare or
Medicaid, Vitas generally contracts with nursing homes for the nursing homes'
provision to patients of room and board services. In addition to the applicable
Medicare or Medicaid hospice daily or hourly rate, the state generally must pay
Vitas an amount equal to at least 95% of the Medicaid daily nursing home rate
for room and board services furnished to the patient by the nursing home. Under
Vitas' standard nursing home contracts, Vitas pays the nursing home for these
room and board services at the Medicaid daily nursing home rate.
Adjustments to Medicare and Medicaid Payment Rates. Payment rates under
the Medicare and Medicaid programs are generally indexed for inflation annually;
however, the increases have historically been less than actual inflation. On
October 1, 2001, the base Medicare payment rates for hospice care increased by
approximately 3.2% over the base rates previously in effect. On October 1, 2002
and on October 1, 2003, the base Medicare payment rates for hospice care
increased by approximately 3.4% each year over the base rates in effect in the
prior year. These rates were further adjusted by the hospice wage index. It is
possible that there will be further modifications to the rate structure under
which the Medicare or Medicaid programs pay for hospice care services. Any
future reductions in the rate of increase in Medicare and Medicaid payments may
have an adverse impact on Vitas' net patient service revenue and profitability.
OTHER HEALTHCARE REGULATIONS
Federal and State Anti-Kickback Laws and Safe Harbor Provisions. The
federal Anti-Kickback Law makes it a felony to knowingly and willfully offer,
pay, solicit or receive any form of remuneration in exchange for referring,
recommending, arranging, purchasing, leasing or ordering items or services
covered by a federal health care program including Medicare or Medicaid. The
Anti-Kickback Law applies regardless of whether the remuneration is provided
directly or indirectly, in cash or in kind. Although the anti-kickback statute
does not prohibit all financial transactions or relationships that providers of
healthcare
15
items or services may have with each other, interpretations of the law have been
very broad. Under current law, courts and federal regulatory authorities have
stated that this law is violated if even one purpose (as opposed to the sole or
primary purpose) of the arrangement is to induce referrals.
Violations of the Anti-Kickback Law carry potentially severe penalties
including imprisonment of up to five years, criminal fines of up to $25,000 per
act, civil money penalties of up to $50,000 per act, and additional damages of
up to three times the amounts claimed or remuneration offered or paid. Federal
law also authorizes exclusion from the Medicare and Medicaid programs for
violations of the Anti-Kickback Law.
The Anti-Kickback Law contains several statutory exceptions to the
broad prohibition. In addition, Congress authorized the Office of Inspector
General ("OIG") to publish numerous "safe harbors" that exempt some practices
from enforcement action under the Anti-Kickback Law and related laws. These
statutory exceptions and regulatory safe harbors protect various bona fide
employment relationships, contracts for the rental of space or equipment,
personal service arrangements, and management contracts, among other things,
provided that certain conditions set forth in the statute or regulations are
satisfied. The safe harbor regulations, however, do not comprehensively describe
all lawful relationships between healthcare providers and referral sources, and
the failure of an arrangement to satisfy all of the requirements of a particular
safe harbor does not mean that the arrangement is unlawful. Failure to comply
with the safe harbor provisions, however, may mean that the arrangement will be
subject to scrutiny. It is possible for healthcare providers to request an
advisory opinion from the OIG regarding an existing or proposed business
arrangement and the possible anti-kickback concerns raised by that arrangement.
Many states, including states where Vitas does business, have adopted
similar prohibitions against payments that are intended to induce referrals of
patients, regardless of the source of payment. Some of these state laws lack
explicit "safe harbors" that may be available under federal law. Sanctions under
these state anti-kickback laws may include civil money penalties, license
suspension or revocation, exclusion from Medicare or Medicaid, and criminal
fines or imprisonment. Little precedent exists regarding the interpretation or
enforcement of these statutes.
Vitas is required under the Medicare conditions of participation and
some state licensing laws to contract with numerous healthcare providers and
practitioners, including physicians, hospitals and nursing homes, and to arrange
for these individuals or entities to provide services to Vitas' patients. In
addition, Vitas has contracts with other suppliers, including pharmacies,
ambulance services and medical equipment companies. Some of these individuals or
entities may refer, or be in a position to refer, patients to Vitas, and Vitas
may refer, or be in a position to refer, patients to these individuals or
entities. These arrangements may not qualify for a safe harbor. Vitas from time
to time seeks guidance from regulatory counsel as to the changing and evolving
interpretations and the potential applicability of these anti-kickback laws to
its programs, and in response thereto, takes such actions as it deems
appropriate. We generally believe that Vitas' contracts and arrangements with
providers, practitioners and suppliers do not violate applicable anti-kickback
laws. However, we cannot assure you that such laws will ultimately be
interpreted in a manner consistent with Vitas' practices.
HIPAA Anti-Fraud Provisions. HIPAA includes several revisions to
existing health care fraud laws by permitting the imposition of civil monetary
penalties in cases involving violations of the anti-kickback statute or
contracting with excluded providers. In
16
addition, HIPAA created new statutes making it a federal felony to engage in
fraud, theft, embezzlement, or the making of false statements with respect to
healthcare benefit programs, which include private, as well as government
programs. In addition, for the first time, federal enforcement officials have
the ability to exclude from the Medicare and Medicaid programs any investors,
officers and managing employees associated with business entities that have
committed healthcare fraud, even if the investor, officer or employee had no
actual knowledge of the fraud.
OIG Fraud Alerts, Advisory Opinions and Other Program Guidance. In
1976, Congress established the OIG to, among other things, identify and
eliminate fraud, abuse and waste in HHS programs. To identify and resolve such
problems, the OIG conducts audits, investigations and inspections across the
country and issues public pronouncements identifying practices that may be
subject to heightened scrutiny. In the last several years, there have been a
number of hospice related audits and reviews conducted. These reviews and
recommendations have included the following:
- better ensuring that Medicare hospice eligibility
determinations are made in accordance with the Medicare
regulations; and
- revising the annual cap on hospice benefits to better reflect
the cost of care provided.
From time to time, various federal and state agencies, such as HHS and
the OIG, issue a variety of pronouncements, including fraud alerts, the OIG's
Annual Work Plan and other reports, identifying practices that may be subject to
heightened governmental scrutiny. For example, the OIG in 2002 specifically
called for a review of hospice plans of care to examine the variance among
hospice plans of care and the extent to which services are provided in
accordance with plans of care, and to determine whether there should be uniform
standards or minimum requirements for their completion. In addition, the OIG
called for a review of payments for the care of hospice patients residing in
nursing homes and the level of services they receive. We cannot predict what, if
any changes may be implemented in coverage, reimbursement, or enforcement
policies as a result of these OIG reviews and recommendations.
Additionally, in March 1998, the OIG issued a special fraud alert
titled "Fraud and Abuse in Nursing Home Arrangements with Hospices." This
special fraud alert focused on payments received by nursing homes from hospices.
Federal False Claims Acts. The federal law includes several criminal
and civil false claims provisions, which provide that knowingly submitting
claims for items or services that were not provided as represented may result in
the imposition of multiple damages, administrative civil money penalties,
criminal fines, imprisonment, and/or exclusion from participation in federally
funded healthcare programs, including Medicare and Medicaid. In addition, the
OIG may impose extensive and costly corporate integrity requirements upon a
healthcare provider that is the subject of a false claims judgment or
settlement. These requirements may include the creation of a formal compliance
program, the appointment of a government monitor, and the imposition of annual
reporting requirements and audits conducted by an independent review
organization to monitor compliance with the terms of the agreement and relevant
laws and regulations.
The Civil False Claims Act prohibits the known filing of a false claim
or the known use of false statements to obtain payments. Penalties for
violations include fines ranging
17
from $5,500 to $11,000, plus treble damages, for each claim filed. Provisions in
the Civil False Claims Act also permit individuals to bring actions against
individuals or businesses in the name of the government as so called "qui tam"
relators. If a qui tam relator's claim is successful, he or she is entitled to
share in the government's recovery.
Both direct enforcement activity by the government and qui tam actions
have increased significantly in recent years and have increased the risk that a
healthcare company may have to defend a false claims action, pay fines or be
excluded from the Medicare and/or Medicaid programs as a result of an
investigation arising out of this type of an action. Because of the complexity
of the government regulations applicable to the healthcare industry, we cannot
assure you that Vitas will not be the subject of an action under the False
Claims Act.
State False Claims Laws. At least 10 states and the District of
Columbia, including states in which Vitas currently operates, have adopted state
false claims laws that mirror to some degree the federal false claims laws.
While these statutes vary in scope and effect, the penalties for violating these
false claims laws include administrative, civil and/or criminal fines and
penalties, imprisonment, and the imposition of multiple damages.
The Stark Law and State Physician Self-Referral Laws. Section 1877 of
the Social Security Act, commonly known as the "Stark Law," prohibits physicians
from referring Medicare or Medicaid patients for "designated health services" to
entities in which they hold an ownership or investment interest or with whom
they have a compensation arrangement, subject to a number of statutory and
regulatory exceptions. Penalties for violating the Stark Law are severe and
include:
- denial of payment;
- civil monetary penalties of $15,000 per referral or $1,000,000
for "circumvention schemes;"
- assessments equal to 200% of the dollar value of each such
service provided; and
- exclusion from the Medicare and Medicaid programs.
Hospice care itself is not specifically listed as a designated health
service; however, certain services that Vitas provides, or in the future may
provide, are among the services identified as designated health services for
purposes of the self-referral laws. We cannot assure you that future regulatory
changes will not result in hospice services becoming subject to the Stark Law's
ownership, investment or compensation prohibitions in the future.
Many states where Vitas operates have laws similar to the Stark Law,
but with broader effect because they apply regardless of the source of payment
for care. Penalties similar to those listed above as well the loss of state
licensure may be imposed in the event of a violation of these state
self-referral laws. Little precedent exists regarding the interpretation or
enforcement of these statutes.
Civil Monetary Penalties. The Civil Monetary Penalties Statute provides
that civil penalties ranging between $10,000 and $50,000 per claim or act may be
imposed on any person
18
or entity that knowingly submits improperly filed claims for federal health
benefits or that offers or makes payments to induce a beneficiary or provider to
reduce or limit the use of health care services or to use a particular provider
or supplier. Civil monetary penalties may be imposed for violations of the
anti-kickback statute and for the failure to return known overpayments, among
other things.
Prohibition on Employing or Contracting with Excluded Providers. The
Social Security Act and federal regulations state that individuals or entities
that have been convicted of a criminal offense related to the delivery of an
item or service under the Medicare or Medicaid programs or that have been
convicted, under state or federal law, of a criminal offense relating to neglect
or abuse of residents in connection with the delivery of a healthcare item or
service cannot participate in any federal health care programs, including
Medicare and Medicaid. Additionally, individuals and entities convicted of
fraud, that have had their licenses revoked or suspended, or that have failed to
provide services of adequate quality also may be excluded from the Medicare and
Medicaid programs. Federal regulations prohibit Medicare providers, including
hospice programs, from submitting claims for items or services or their related
costs if an excluded provider furnished those items or services. The OIG
maintains a list of excluded persons and entities. Nonetheless, it is possible
that Vitas might unknowingly bill for services provided by an excluded person or
entity with whom it contracts. The penalty for contracting with an excluded
provider may range from civil monetary penalties of $50,000 and damages of up to
three times the amount of payment that was inappropriately received.
Corporate Practice of Medicine and Fee Splitting. Most states have laws
that restrict or prohibit anyone other than a licensed physician, including
business entities such as corporations, from employing physicians and/or
prohibit payments or fee-splitting arrangements between physicians and
corporations or unlicensed individuals. Violations of corporate practice of
medicine and fee-splitting laws vary from state to state, but may include civil
or criminal penalties, the restructuring or termination of the business
arrangements between the physician and unlicensed individual or business entity,
or even the loss of the physician's license to practice medicine. These laws
vary widely from state to state both in scope and origin (e.g. statute,
regulation, Attorney General opinion, court ruling, agency policy) and in most
instances have been subject to only limited interpretation by the courts or
regulatory bodies.
Vitas employs or contracts with physicians to provide medical direction
and patient care services to its patients. Vitas has made efforts in those
states where certain contracting or fee arrangements are restricted or
prohibited to structure those arrangements in compliance with the applicable
laws and regulations. Despite these efforts, however, we cannot assure you that
agency officials charged with enforcing these laws will not interpret Vitas'
contracts with employed or independent contractor physicians as violating the
relevant laws or regulations. Future determinations or interpretations by
individual states with corporate practice of medicine or fee splitting
restrictions may force Vitas to restructure its arrangements with physicians in
those locations.
Health Information Practices. There currently are numerous legislative
and regulatory initiatives at both the state and federal levels that address
patient privacy concerns. In particular, federal regulations issued under the
HIPAA Act of 1996 ("HIPAA") require Vitas to protect the privacy and security of
patients' individual health information. HHS published final regulations
addressing patient privacy on December 28, 2000, which were modified on August
14, 2002 (the "Privacy Rule"). Vitas was required to comply with the Privacy
Rule by April 14, 2003, and Vitas believes that it is in material compliance.
Additionally, HIPAA does not automatically preempt applicable state laws and
regulations
19
concerning Vitas' use, disclosure and maintenance of patient health information,
which means that Vitas is subject to a complex regulatory scheme that, in many
instances, requires Vitas to comply both with federal and state laws and
regulations.
In August of 2000, HHS published final regulations establishing health
care transaction standards and code sets for the electronic transmission of
health care information in connection with certain transactions, such as billing
or health plan eligibility (the "Transactions Standard"). The official deadline
for compliance with the Transactions Standard for covered entities such as Vitas
was October 16, 2003. The Centers for Medicare and Medicaid Services ("CMS") is
the division of HHS that is responsible for interpreting and enforcing the
Transactions Standard. Failure to comply with the Transactions Standard may
subject covered entities, including Vitas, to civil monetary penalties and
possibly to criminal penalties. Vitas believes that it has made significant and
appropriate good faith efforts to comply with the Transactions Standard and to
develop an appropriate contingency plan as encouraged by CMS. It is unclear,
however, how CMS will regulate providers in general or Vitas in particular with
respect to compliance with the Transactions Standard. Consequently, it also is
unclear whether Vitas would be found to be in material compliance with the
Transactions Standard if CMS were to review Vitas' electronic claims submissions
and assess Vitas' electronic transactions, or whether Vitas would be required to
expend substantial sums on acquiring and implementing new information systems,
or would otherwise be affected in a manner that would negatively impact its
profitability.
On May 31, 2002, HHS published its final rule regarding the HIPAA
Unique Employer Identifier Standard, which establishes a standard for
identifying employers in healthcare transactions where information about the
employer is transmitted electronically, as well as requirements concerning its
use by HIPAA covered entities. The deadline for compliance with the Unique
Employer Identifier Standard rule is July 30, 2004. Additionally, HHS published
final regulations addressing the security of such health information on February
20, 2003 (the "Security Rule"), and Vitas will be required to comply with the
Security Rule by April 21, 2005. Also, HHS published its final rule adopting the
HIPAA Standard Unique Health Identifier for health care providers on January 23,
2004, and Vitas' compliance deadline for that rule is May 23, 2007. Because
compliance with the final rules regarding the HIPAA Unique Employer Identifier
Standard and the Standard Unique Health Identifier, and the Security Rule is not
yet required, we cannot predict the total financial or other impact of any of
these final regulations on Vitas' operations, including any need for Vitas to
expend financial resources on acquiring and implementing new information systems
or any other negative impact on Vitas' profitability.
Additional Federal and State Regulation. Federal and state governments
also regulate various aspects of the hospice industry. In particular, Vitas'
operations are subject to federal and state health regulatory laws covering
professional services, the dispensing of drugs and certain types of hospice
activities. Some of Vitas' employees are subject to state laws and regulations
governing the ethics and professional practice of medicine, respiratory therapy,
pharmacy and nursing.
Compliance with Health Regulatory Laws. Vitas maintains an internal
regulatory compliance review program and from time to time retains regulatory
counsel for guidance on compliance matters. We cannot assure you, however, that
Vitas' practices, if reviewed, would be found to be in compliance with
applicable health regulatory laws, as such laws ultimately may be interpreted,
or that any non-compliance with such laws would not have a material adverse
effect on Vitas.
20
ENVIRONMENTAL MATTERS
Roto-Rooter's operations are subject to various federal, state, and
local laws and regulations regarding environmental matters and other aspects of
the operation of a sewer and drain cleaning, HVAC and plumbing services
business. For certain other activities, such as septic tank and grease trap
pumping, Roto-Rooter is subject to state and local environmental health and
sanitation regulations. Service America's operations are also subject to various
federal, state and local laws and regulations regarding environmental matters
and other aspects of the operation of a HVAC and appliance repair and
maintenance service industry.
At December 31, 2003, the Company's accrual for its estimated liability
for potential environmental cleanup and related costs arising from the sale of
DuBois Chemcials Inc. ("Dubois") amounted to $2,070,000. Of this balance,
$870,000 is included in other liabilities and $1,200,000 is included in other
current liabilities. The Company is contingently liable for additional
DuBois-related environmental cleanup and related costs up to a maximum of
$18,036,000. On the basis of a continuing evaluation of the Company's potential
liability, management believes that it is not probable this additional liability
will be paid. Accordingly, no provision for this contingent liability has been
recorded. Although it is not presently possible to reliably project the timing
of payments related to the Company's potential liability for environmental
costs, management believes that any adjustments to its recorded liability will
not materially adversely affect its financial position or results of operations.
The Company, to the best of its knowledge, is currently in compliance
in all material respects with the environmental laws and regulations affecting
its operations. Such environmental laws, regulations and enforcement proceedings
have not required the Company to make material increases in or modifications to
its capital expenditures and they have not had a material adverse effect on
sales or net income. Capital expenditures for the purposes of complying with
environmental laws and regulations during 2004 and 2005 with respect to
continuing operations are not expected to be material in amount; there can be no
assurance, however, that presently unforeseen legislative or enforcement actions
will not require additional expenditures.
SEASONALITY
Advertising costs for Roto-Rooter inordinately impact the Company's
fourth-quarter results. Roto-Rooter recognizes telephone directory costs
immediately upon distribution of a directory by its publisher into the
community. Since a large number of directories are distributed in the fourth
quarter, this direct expense accounting policy results in fourth-quarter
earnings including a disproportionately large share of Roto-Rooter's full-year
telephone directory advertising expense. In the fourth quarter 2003, Roto-Rooter
expensed $7.1 million of total advertising costs that represented 42% of the
aggregate advertising costs for the full-year 2003.
EMPLOYEES
On December 31, 2003, Roto-Rooter, Inc. had a total of 3,357 employees.
21
AVAILABLE INFORMATION
The Company's internet address is www.rotorooterinc.com. The Company's
annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports
on Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Exchange Act are electronically available through
the Company's website as soon as reasonably practicable after such reports are
filed with, or furnished to, the SEC.
Annual and quarterly reports, press releases, and other printed
materials may also be obtained from Roto-Rooter Investor Relations without
charge by writing or by calling 800-224-3633 or 513-762-6463.
ITEM 2. PROPERTIES
The Company's corporate offices and the headquarters for the
Roto-Rooter Group are located in Cincinnati, Ohio. Roto-Rooter has manufacturing
and distribution center facilities in West Des Moines, Iowa and has 61 office
and service facilities in 26 states. The headquarters for Service America is
located in Ft. Lauderdale, Florida and Service America has 8 office and service
facilities in Florida and Arizona. Vitas operates 25 programs from 41 leased
facilities in 8 states, including Florida, California, Texas and Illinois.
All "owned" property is held in fee and is subject to the security
interests of the Company's new senior secured credit facilities and of the
holders of the Floating Rate Notes issued in connection of the Company's merger
with Vitas. The leased property have lease terms ranging from one year to
fifteen years. Management does not foresee any difficulty in renewing or
replacing the remainder of its current leases. The Company considers all of its
major operating properties to be maintained in good operating condition and to
be generally adequate for present and anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is 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. The Company contests these allegations and believes 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
has not yet ruled on certification of a class in the remaining 31 states. Due to
the complex legal and other issues involved, it is not presently possible to
estimate the amount of liability, if any, related to this matter.
On April 5, 2002 Michael Linn, an attorney, filed a class action
complaint against the Company in the Court of Common Pleas, Cuyahoga County,
Ohio. He alleges Roto-Rooter Services Company's miscellaneous parts charge,
ranging from $4.95 to $12.95 per job, violates the Ohio Consumer Sales Practices
Act. The Company contends that the charge,
22
which is included within the estimate approved by its customers, is a fully
disclosed component of its pricing. On February 25, 2003 the trial court
certified a class of customers who paid the charge from October 1999 to July
2002. The Company is appealing this order and believes the ultimate disposition
of this lawsuit will not have a material effect on its financial position.
However, management cannot provide assurance the Company will ultimately prevail
in either of the above two cases. Regardless of outcome, such litigation can
adversely affect the Company through defense costs, diversion of management's
time, and related publicity.
The District Attorney of Suffolk County, New York is contemplating
legal proceedings against Roto-Rooter Services Company, an indirect subsidiary
of the Company, arising out of the disposal of restaurant grease trap waste,
originating in adjacent Nassau County, in Suffolk County disposal sites. The
Company believes the disposition of this matter will not have a material effect
on its financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE COMPANY
Name Age Office First Elected
- ------------------ --- ------------------------------------ ---------------
Edward L. Hutton 84 Chairman November 3, 1993 (1)
Kevin J. McNamara 50 President and Chief Executive Officer August 2, 1994 (2)
Timothy S. O'Toole 48 Executive Vice President May 18, 1992 (3)
Spencer S. Lee 48 Executive Vice President May 15, 2000 (4)
David P. Williams 43 Vice President and Chief Financial March 5, 2004 (5)
Officer
Arthur V. Tucker, 54 Vice President and Controller May 20, 1991 (6)
Jr.
(1) Mr. E. L. Hutton is the Chairman of the Company and has held this
position since November 1993. Previously, from April 1970 to May 2001,
Mr. E. L. Hutton also served as Chief Executive Officer and from April
1970 to November 1993, he held the position of President of the
Company. Mr. E. L. Hutton is the father of Mr. T. C. Hutton, a director
and a Vice President of the Company.
(2) Mr. K. J. McNamara is President and Chief Executive Officer of the
Company and has held these positions since August 1994 and May 2001,
respectively. Previously, he served as an Executive Vice President,
Secretary and General Counsel of the Company, since November 1993,
August 1986 and August 1986, respectively. He previously held the
position of Vice President of the Company, from August 1986 to May
1992.
(3) Mr. T. S. O'Toole is an Executive Vice President of the Company and has
held this position since May 1992. He is also President and Chief
Executive Officer of Vitas, a wholly owned subsidiary of the Company,
and has held this position since February 24, 2004. Previously, from
May 1992 to February 24, 2004, he also served the Company as Treasurer.
23
(4) Mr. Lee is an Executive Vice President of the Company and has held this
position since May 15, 2000. Mr. Lee is also Chairman and Chief
Executive Officer of Roto-Rooter Management Company, a wholly owned
subsidiary of the Company, and has held this position since January
1999. Previously, he served as a Senior Vice President of Roto-Rooter
Services Company from May 1997 to January 1999.
(5) Mr. Williams is Vice President and Chief Financial Officer of the
Company and has held these positions since March 5, 2004. Mr. Williams
is also Senior Vice President and Chief Financial Officer of
Roto-Rooter Management Company and has held these positions since
January 1999.
(6) Mr. A. V. Tucker, Jr. is a Vice President and Controller of the Company
and has held these positions since February 1989. From May 1983 to
February 1989, he held the position of Assistant Controller of the
Company.
Each executive officer holds office until the annual election at the
next annual organizational meeting of the Board of Directors of the Company
which is scheduled to be held on May 17, 2004.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Capital Stock (par value $1 per share) is traded on the
New York Stock Exchange under the symbol RRR. The range of the high and low sale
prices on the New York Stock Exchange and dividends paid per share for each
quarter of 2002 and 2003 are set forth below.
Closing
------------------------- Dividends Paid
High Low Per Share
- -------------------------------------------------------------------------------------
2003
First Quarter $36.51 $31.55 $.12
Second Quarter 40.20 32.98 .12
Third Quarter 40.35 34.42 .12
Fourth Quarter 51.78 33.69 .12
2002
First Quarter $38.30 $33.52 $.11
Second Quarter 39.35 33.60 .11
Third Quarter 37.04 29.85 .11
Fourth Quarter 37.84 29.65 .12
Future dividends are necessarily dependent upon the Company's earnings
and financial condition, compliance with certain debt covenants and other
factors not presently determinable.
24
As of March 5, 2004, there were approximately 3,382 stockholders of
record of the Company's Capital Stock. This number only includes stockholders of
record and does not include stockholders with shares beneficially held in
nominee name or within clearinghouse positions of brokers, banks or other
institutions.
Information with respect to securities authorized for issuance under
the Company's equity compensation plans is included within Note 18 of the Notes
to Financial Statements appearing on page F-29 of this Report on Form 10-K.
25
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data for Roto-Rooter, Inc. and subsidiary companies
("Company") as of and for each of the five years ended December 31, 1999 through
December 31, 2003 are presented below (in thousands, except per share and
footnote data, ratios and employee data):
2003 2002 2001 2000 1999
-------- --------- --------- --------- ---------
SUMMARY OF OPERATIONS
Continuing operations (a)
Service revenues and sales $ 308,871 $ 314,176 $ 337,908 $ 355,307 $ 316,719
Gross profit (excluding depreciation) 126,061 127,891 132,292 146,329 127,042
Depreciation 12,054 13,587 14,395 13,374 11,285
Amortization of goodwill - - 4,102 4,090 3,770
Income/ (loss) from operations (b) (7,720) (2,678) (11,561) 28,548 21,227
Income/ (loss) from continuing operations (c) (3,499) (8,854) (10,738) 18,030 16,195
Net income/ (loss) (c) (3,435) (2,545) (12,185) 19,971 19,481
Earnings/ (loss) per share
Income/ (loss) from continuing operations $ (0.35) $ (0.90) $ (1.11) $ 1.83 $ 1.55
Net income/ (loss) (0.35) (0.26) (1.25) 2.03 1.86
Average number of shares outstanding 9,924 9,858 9,714 9,833 10,470
Diluted earnings/ (loss) per share
Income/ (loss) from continuing operations $ (0.35) $ (0.90) $ (1.11) $ 1.82 $ 1.54
Net income/ (loss) (0.35) (0.26) (1.25) 2.01 1.85
Average number of shares outstanding 9,924 9,858 9,714 9,927 10,514
Cash dividends per share $ 0.48 $ 0.45 $ 0.44 $ 0.40 $ 2.12
Net income/(loss) excluding goodwill amortization (e)
Net income/(loss) $ (3,435) $ (2,545) $ (7,564) $ 24,579 $ 23,789
Earnings/(loss) per share (0.35) (0.26) (0.78) 2.50 2.27
Diluted earnings/(loss) per share (0.35) (0.26) (0.78) 2.48 2.26
FINANCIAL POSITION--YEAR END
Cash and cash equivalents $ 50,587 $ 37,731 $ 8,725 $ 9,978 $ 17,043
Working capital 42,993 29,269 19,200 6,911 21,478
Current ratio 1.73 1.45 1.23 1.07 1.23
Properties and equipment, at cost less
accumulated depreciation $ 41,004 $ 48,361 $ 54,549 $ 60,343 $ 56,913
Total assets 329,069 338,144 401,457 419,932 422,674
Long-term debt 25,931 25,603 61,037 58,391 78,580
Mandatorily redeemable convertible preferred
securities of the Chemed Capital Trust $ 14,126 $ 14,186 $ 14,239 $ 14,641 $ -
Stockholders' equity 192,693 198,422 204,160 211,451 210,344
OTHER STATISTICS--CONTINUING OPERATIONS
Net cash provided by continuing operations $ 22,590 $ 26,894 $ 27,123 $ 45,981 $ 28,582
Capital expenditures 11,178 11,855 14,457 17,586 16,696
Number of employees (d) 3,357 3,335 3,764 3,784 3,949
Number of service and sales representatives 2,529 2,514 2,623 2,586 2,699
- ------------------
(a) Continuing operations exclude Patient Care, discontinued in 2002, and Cadre
Computer, discontinued in 2001.
(b) Income/(loss) from operations includes asset impairment charges of
$15,828,000 and severance charges of $3,627,000 in 2003, a goodwill
impairment charge of $20,342,000 in 2002 and restructuring and similar
expenses and other charges of $27,211,000 in 2001.
(c) Income/(loss) from continuing operations and net income/(loss) include
aftertax asset impairment charges of $14,363,000 in 2003, an aftertax
goodwill impairment charge of $20,342,000 in 2002 and aftertax
restructuring and similar expenses and other charges of $16,943,000 and an
aftertax loss on the early extinguishment of debt of $1,701,000 in 2001.
Aftertax capital gains on the sales and redemption of investments for the
years 2003 through 1999 amounted to $3,351,000, $775,000, $703,000,
$2,261,000 and $2,960,000, respectively. In accordance with FASB Statement
No. 142, amortization of goodwill ceased December 31, 2001. Aftertax
amortization of goodwill for continuing operations for the years 2001
through 1999 was $3,888,000, $3,875,000 and $3,580,000, respectively.
(d) Employee numbers reflect full-time-equivalent employees.
(e) In accordance with FASB Statement No. 142, amortization of goodwill ceased
December 31, 2001. Aftertax amortization of goodwill for for all operations
for the years 2001 through 1999 was $4,621,000, $4,608,000 and $4,308,000,
respectively.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
Significant factors affecting the Company's consolidated cash flows
during 2003 and financial position at December 31, 2003, include the following:
- Continuing operations generated cash of $22.6 million;
- Proceeds from the redemption of Vitas' redeemable preferred stock
totaled $27.3 million;
- The Company invested $18.0 million in Vitas' common stock (37%
ownership interest);
- Capital expenditures totaled $11.2 million; and,
- The Company placed $10.0 million in escrow to secure its offer to
purchase the shares of Vitas it did not own.
The ratio of total debt (excluding the Preferred Securities) to total
capital was 12.0% at December 31, 2003, as compared with 10.9% at December 31,
2002. The Company's current ratio at December 31, 2003, was 1.7 as compared with
1.5 at December 31, 2002.
The Company had $51.4 million of unused lines of credit with various
banks at December 31, 2003.
CASH FLOW
The Company's cash flows for 2003, 2002 and 2001 are summarized as
follows (in millions):
For the Years Ended December 31,
-----------------------------------
2003 2002 2001
------- ------- -------
Net cash provided by operating activities $ 22.6 $ 29.5 $ 34.4
Capital expenditures (11.2) (11.9) (14.5)
------- ------- -------
Operating cash excess after capital expenditures 11.4 17.6 19.9
Proceeds from redemption of Vitas' preferred stock 27.3 - -
Investment in Vitas' common stock (18.0) - -
Deposit to secure Vitas merger offer (10.0) - -
Dividends paid (4.8) (4.4) (4.4)
Proceeds from sales of available for sale securities 4.5 1.9 1.4
Net proceeds/(uses) from sale of
discontinued operations 1.1 50.7 (6.3)
Net decrease in long-term debt (0.4) (35.4) (11.4)
Other--net 1.8 (1.4) (0.5)
------- ------- -------
Increase/(decrease) in cash and cash equivalents $ 12.9 $ 29.0 $ (1.3)
======= ======= =======
For 2003, the operating cash excess after capital expenditures was
$11.4 million as compared with $17.6 million in 2002 and $19.9 million in 2001.
This excess, along with the proceeds from the redemption of Vitas' preferred
stock, was used to purchase 37% of Vitas common stock, to place a deposit of
$10.0 million to secure the Company's merger offer for Vitas' remaining common
stock, to pay cash dividends and to increase the Company's available cash and
cash equivalents. For 2002, the operating excess after capital expenditures and
the proceeds from the sale of Patient Care were used to retire funded debt, to
pay cash dividends and to increase the Company's available cash and cash
equivalents. For 2001, the operating cash excess after capital expenditures was
used to fund debt repayment, pay costs related to discontinued operations and to
pay cash dividends.
COMMITMENTS AND CONTINGENCIES
In connection with the sale of DuBois Chemicals, Inc. ("DuBois") in
1991, the Company provided allowances and accruals relating to several long-term
costs, including income tax matters, lease commitments and environmental costs.
Also, in conjunction with the sales of The Omnia Group ("Omnia") and National
Sanitary Supply Company in 1997 and the sale of Cadre Computer Resources, Inc.
("Cadre Computer") in 2001, the Company provided long-term allowances and
accruals relating to costs of severance arrangements,
27
lease commitments and income tax matters. In the aggregate, the Company believes
these allowances and accruals are adequate as of December 31, 2003.
Based on reviews of its environmental-related liabilities under the
DuBois sale agreement, the Company has estimated its remaining liability to be
$2.1 million. As of December 31, 2003, the Company is contingently liable for
additional cleanup and related costs up to a maximum of $18.0 million, for which
no provision has been recorded.
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. Of this
amount, $2.5 million was returned to the Company in October 2003. Based on
Patient Care's collection history, the Company believes that the specified
receivables will be collected and that the remaining balance of the escrow funds
will be paid to Roto-Rooter, Inc. The remaining $2.5 million of these escrow
funds will be evaluated and distributed as of October 2004.
The Company's various loan agreements and guarantees of indebtedness as
of December 31, 2003, contained certain restrictive covenants. The Company was
in compliance with all of the covenants at that time. Effective with the
acquisition of Vitas on February 24, 2004, the Company's revolving credit
agreement with Bank One, N.A. ("Bank One") was cancelled. In addition, the
Company retired its $25 million senior notes due 2005 - 2009, incurring a
prepayment penalty of $3.3 million.
LIQUIDITY AND COMMITMENTS AFTER THE VITAS ACQUISITION
In connection with the acquisition of Vitas on February 24, 2004, the
Company entered into a secured revolving credit/term loan facility ("New Credit
Facility") with Bank One. The revolving credit facility provides for borrowings
of up to $100 million, including up to $40 million in letters of credit.
Interest payments for the revolving line of credit are based on LIBOR plus
3.25%. The term loan facility provides for a $35 million term loan and requires
quarterly principal payments of $1,250,000 with interest based on LIBOR plus
3.50%. All unpaid borrowings under the New Credit Facility, along with accrued
interest, are due February 24, 2009. Initially, the Company drew down $40
million under the revolving credit portion of the New Credit Facility and $35
million under the term loan portion. The Company intends to draw down
approximately $26 million of letters of credit under the New Credit Facility in
March 2004.
The Company also issued $110 million principal amount of floating rate
senior secured notes due 2010 ("Floating Rate Notes") and $150 million of 8.75%
senior notes due 2011 ("Fixed Rate Notes") in a private placement with various
institutional investors on February 24, 2004. Interest on the Floating Rate
Notes is computed at LIBOR plus 3.75% and is payable quarterly beginning May 15,
2004. Interest payments on the Fixed Rate notes are due quarterly beginning May
15, 2004. No principal payments are due on either the Floating Rate Notes or the
Fixed Rate Notes until their dates of maturity (February 24, 2010, and February
24, 2011, respectively).
As of February 24, 2004, the Company had $60 million of available
borrowings under the New Credit Facility. After the anticipated draw down of
approximately $26 million of letters of credit in March 2004, the Company will
have $34 million in borrowings available under the New Credit Facility.
The table below summarizes the Company's debt and contractual
obligations, giving effect to the transactions described above (in thousands):
Long-Term Minimum
Debt Preferred Lease Severance
Payments Securities Payments Payments Total
--------- ---------- -------- --------- --------
2004 $ 4,198 $ - $ 12,395 $ 1,559 $ 18,152
2005 5,190 - 11,237 1,356 17,783
2006 5,200 - 7,552 1,356 14,108
2007 5,210 - 4,740 265 10,215
2008 5,162 - 5,771 - 10,933
After 2008 311,419 14,126 205 - 325,750
-------- -------- -------- -------- --------
Total $336,379 $ 14,126 $ 41,900 $ 4,536 $396,941
======== ======== ======== ======== ========
28
Collectively, the credit agreements provide that the Company will be
required to meet the following financial covenants, to be tested quarterly,
beginning with the quarter ending June 30, 2004:
- a minimum net worth requirement, which requires a net worth of at
least (i) $232 million plus (ii) 50% of consolidated net income (if
positive) beginning with the quarter ending June 30, 2004, plus (iii)
the net cash proceeds from issuance of the Company's capital stock or
the capital stock of the Company's subsidiaries;
- a maximum leverage ratio, calculated quarterly, based upon the ratio
of consolidated funded debt to consolidated EBITDA which will require
maintenance of a ratio of 5.5 to 1.00 through December 31, 2004, a
ratio of 4.75 to 1.00 from January 1 through December 31, 2005, and
4.25 to 1.00 thereafter;
- a maximum senior leverage ratio, calculated quarterly, based upon the
ratio of senior consolidated funded debt to consolidated EBITDA (which
ratio excludes indebtedness in respect of the Fixed Rate Notes), which
will require maintenance of a ratio of 3.375 to 1.00 through December
31, 2004, a ratio of 2.875 to 1.00 from January 1 through December 31,
2005, and 2.625 to 1.00 thereafter; and
- a minimum fixed charge coverage ratio, based upon the ratio of
consolidated EBITDA minus capital expenditures to consolidated
interest expense plus consolidated current maturities (including
capitalized lease obligations) plus cash dividends paid on equity
securities plus expenses for taxes, which will require maintenance of
a ratio of 1.15 to 1.00 through December 31, 2004, 1.375 to 1.00 from
January 1 through December 31, 2005, and 1.50 to 1.00 thereafter.
In addition, the New Credit Facility, the Floating Rate Notes and the
Fixed Rate Notes provide for affirmative and restrictive covenants including
without limitation, requirements or restrictions (subject to exceptions) related
to the following:
- use of proceeds of loans,
- restricted payments, including payments of dividends and retirement of
stock (permitting $.48 per share dividends so long as the aggregate
amount of dividends in any fiscal year does not exceed $7.0 million
and providing for additional principal prepayments to the extent
dividends exceed $5.0 million in any fiscal year), with exceptions for
existing employee benefit plans and stock option plans,
- mergers and dissolutions,
- sales of assets,
- investments and acquisitions,
- liens,
- transactions with affiliates,
- hedging and other financial contracts,
- restrictions on subsidiaries,
- contingent obligations,
- operating leases,
- guarantors,
- collateral,
- sale and leaseback transactions,
- prepayments of indebtedness, and
- maximum annual capital expenditures of $20 million subject to one-year
carry-forwards on amounts not used during the previous year.
It is management's opinion that the Company has no long-range
commitments that would have a significant impact on its liquidity, financial
condition or the results of its operations. Due to the nature of the
environmental liabilities, it is not possible to forecast the timing of the cash
payments for these potential liabilities. Based on the Company's available
credit lines, sources of borrowing and cash and cash equivalents, management
believes its sources of capital and liquidity are satisfactory for the Company's
needs for the foreseeable future.
INTENTION TO CALL CONVERTIBLE SECURITIES
On March 15, 2004, and thereafter, the outstanding mandatorily
redeemable convertible preferred securities ("Preferred Securities") of the
Chemed Capital Trust are callable without premium at a price of $27.00 per
Preferred Security. The Preferred Securities are convertible into the Company's
capital stock at the ratio of .73 share of capital stock per Preferred Security.
The Company intends to call all of the Preferred Securities as soon after March
15, 2004, as practicable. Management anticipates that most of the
29
securities will be redeemed for capital stock rather than cash. However, were
all the Preferred Securities redeemed for cash, the Company would be obligated
to pay approximately $14.1 million in cash.
RESULTS OF OPERATIONS
Set forth below are the year-to-year changes in the components of the
statement of operations relating to continuing operations:
Percent
Increase/(Decrease)
---------------------
2003 vs. 2002 vs.
2002 2001
-------- --------
Service revenues and sales
Plumbing and Drain Cleaning 3% (6)%
Service America (20) (12)
Total (2) (7)
Cost of services provided and goods
sold (excluding depreciation) (2) (9)
General and administrative expenses 18 (10)
Selling and marketing expenses - (5)
Depreciation (11) (6)
Impairment, restructuring and similar expenses (22) (18)
Loss from operations 188 (77)
Interest expense (27) (46)
Distributions on preferred securities (1) (3)
Loss on extinguishment of debt n.a. 100
Other income--net 163 (14)
Income/(loss) before income taxes n.a. (85)
Income taxes (26) (229)
Equity in earnings of affiliate n.a. n.a.
Loss from continuing operations 35 (18)
2003 VERSUS 2002 - CONSOLIDATED RESULTS
The Company's service revenues and sales for 2003 declined 2% versus
revenues for 2002. This $5.3 million decline was attributable to the $12.4
million, or 20%, decline in Service America's revenues, partially offset by a
$7.1 million, or 3%, increase in the Plumbing and Drain Cleaning segment's total
revenues. Within this segment, plumbing repair and maintenance revenues
increased $2.8 million, or 3%, drain cleaning revenues were even with the prior
year, contractor revenues increased $1.8 million, or 14%, and industrial and
municipal revenues increased $1.2 million, or 8%. Service America's revenues
from repair services under contracts declined $8.8 million, or 19%, and its
revenues from demand repair services declined $3.6 million, or 23%.
Of the increase in plumbing revenues, 2.4 percentage points are
attributable to an increase in the number of jobs completed during the year. The
remainder is attributable to an increase in the average price per job. The drain
cleaning business experienced a 2.8% decline in the number of jobs completed
during 2003 and a 3% increase in the average price per job. The decline in
Plumbing and Drain Cleaning's HVAC repair and maintenance business was
attributable to the Company's decision in 2001 to exit this line of business.
Units divested in 2002 contributed $403,000 in revenues during 2002, prior to
their divestment. Of the 14% increase in contractor revenues, 5 percentage
points are attributable to locations acquired in 2003. The gross margin of the
Plumbing and Drain Cleaning segment declined from 44.4% in 2002 to 43.7% in
2003, primarily as a result of higher training wages in 2003. The increase in
training wages was directly attributable to hiring more service technicians in
2003.
The decline in Service America's service contract revenues is
attributable to insufficient sales of new service contracts to replace service
contracts that were not renewed either by Service America or the customer.
During 2003, the average number of service contracts outstanding declined 23%
versus the average for 2002. The year-to-year decline in service contract
revenues is anticipated to continue during 2004 at approximately the same rate
as experienced in 2003.
Consolidated cost of services provided and goods sold (excluding
depreciation) for 2003 declined 2% versus such costs in 2002, primarily due to
the decline in service revenues and sales.
General and administrative ("G&A") expenses for 2003 increased $9.2
million, or 18%, versus 2002 within the following operations (in millions):
30
Plumbing and Drain Cleaning $ 9.0
Service America .2
------
Total $ 9.2
======
The increase in Plumbing and Drain Cleaning G&A is largely due to incurring
severance charges of $3.6 million in the first quarter of 2003 for a corporate
officer and to unfavorable market-value adjustments to the deferred compensation
liability in 2003 (a $1.6 million charge to G&A) versus a favorable adjustment
in 2002 (a $1.4 million reduction in G&A). These market adjustments are offset
entirely by equal, but opposite, gains and losses on trading assets used to fund
the liabilities and included in other income. Higher employee recruiting costs
in 2003 (an increase of $542,000), related largely to recruiting and hiring
service technicians and higher legal fees (an increase of $485,000), due
primarily to increased costs of defending against class actions, also
contributed to the higher G&A costs in 2003.
Depreciation expense for 2003 declined $1.5 million, or 11%, versus
2002. Of this decline, $905,000 was attributable to the decline in depreciation
expense in the Plumbing and Drain Cleaning segment, and the remaining $628,000
occurred at Service America. Both declines are attributable to reduced capital
expenditures over the past several years, largely related to service vans.
Impairment charges for both 2003 and 2002 relate entirely to the
Service America segment. As of December 31, 2003, all of Service America's
intangibles have been written down to nil. In addition, Service America recorded
an impairment charge of approximately $4.0 million to reduce the value of its
internally developed software to its estimated fair value.
The Company's loss from operations increased from $2.7 million in 2002
to $7.7 million in 2003. Operating expenses for 2003 included severance charges