UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (date of earliest event reported):
February 24, 2004
ROTO-ROOTER, INC.
(Exact name of registrant as specified in its charter)
Delaware 1-8351 31-0791746
(State or other jurisdiction (Commission File Number) (I.R.S. Employer
of incorporation) Identification Number)
2600 Chemed Center, 255 East Fifth Street, Cincinnati, OH 45202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(513) 762-6900
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
On December 18, 2003, we and Marlin Merger Corp., a wholly owned indirect
subsidiary of ours ("Marlin"), entered into a merger agreement with Vitas
Healthcare Corporation ("Vitas"). The merger agreement provides for the merger
of Marlin into Vitas, with Vitas surviving the merger as an indirect wholly
owned subsidiary of ours (the "Acquisition"). In connection with the
Acquisition, the following transactions occurred (collectively with the
Acquisition, the "Transactions") on February 24, 2004:
o Pursuant to the merger agreement, we paid to the holders of the 63%
of Vitas common stock that we did not own, merger consideration of
$30.00 in cash per share of common stock. The aggregate amount of
the merger consideration paid by us to the holders of common stock,
options and warrants of Vitas in connection with the Acquisition
was approximately $313.9 million.
o We repaid approximately $67.3 million in existing indebtedness of
Vitas, including accrued interest.
o We repaid approximately $29.4 million of our existing indebtedness
including a $3.0 million make-whole payment on our 7.31% Senior
Notes due 2008-2012 and accrued interest.
o We paid Hugh A. Westbrook, the former Chairman and Chief Executive
Officer of Vitas, $25.0 million pursuant to a non-competition and
consulting agreement and will make severance payments totaling $2.3
million to two other officers of Vitas.
o Mr. Westbrook repaid his $8.0 million note payable to Vitas.
o We entered into new $135.0 million senior secured credit facilities
consisting of a $35.0 million term loan and a $100.0 million
revolving credit facility (the "New Credit Facility"). We borrowed
the entire $35.0 million available under the term loan and $40.0
million under the revolving credit facility. In addition, we
requested the issuance of approximately $26 million in letters of
credit under the revolving credit facility to replace previous
letters of credit in that amount.
o We sold 2,000,000 shares of our capital stock at a price of $50.00
per share, before estimated expenses of $435,000.
o We issued $110 million principal amount of floating rate senior
secured notes due 2010 ("Floating Rate Notes").
o We issued $150 million principal amount of 8 3/4% senior notes due
2011 ("Fixed Rate Notes").
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o Our warrant C providing for the purchase of 1.6 million additional
shares of Vitas common stock was cancelled.
o We incurred estimated transaction fees and expenses of approximately
$20.0 million. Of this amount, we allocated approximately $14.1
million to deferred debt costs, $5.5 million to the purchase price
of Vitas and $435,000 to the cost of issuing our capital stock.
Effective with the closing of the Transactions, Timothy S. O'Toole, one
of our directors and executive officers, replaced Mr. Westbrook as Chief
Executive Officer of Vitas. Kevin J. McNamara, one of our directors and our
Chief Executive Officer, replaced Mr. Westbrook as Chairman of Vitas.
We issued a press release announcing the Transactions, a copy of which is
filed as Exhibit 99.1.
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ITEM 5. OTHER EVENTS AND REQUIRED FD DISCLOSURE
We are filing this Current Report on Form 8-K to disclose certain
information about our business. As used in this Current Report on Form 8-K,
unless otherwise indicated or the context otherwise requires, the terms "Roto-
Rooter," "we," "the Company," "us" and "our" refer to Roto-Rooter, Inc.
together with its subsidiaries including, where applicable, Vitas after the
Transactions, and "Vitas" refers to Vitas Healthcare Corporation together with
its subsidiaries.
FORWARD-LOOKING STATEMENTS
This Current Report on Form 8-K contains forward-looking statements
within the meaning of the federal securities laws. These forward-looking
statements generally can be identified by use of statements that include words
such as "anticipate", "estimate", "expect", "project", "intend", "plan",
"believe" and other words and terms of similar meaning, although not all
forward-looking statements contain such words. Statements that describe our
objectives, plans or goals are also forward-looking statements. These forward-
looking statements are subject to risks and uncertainties which could cause
actual results to differ materially from those currently anticipated. Factors
that could materially affect these forward-looking statements can be found in
our periodic reports filed with the SEC and herein under the heading "Risk
Factors" below. Potential investors and other readers are urged to consider
these factors carefully in evaluating the forward-looking statements and are
cautioned not to place undue reliance on these forward-looking statements. The
forward-looking statements included in this Current Report on Form 8-K are
made only as of the date of this Current Report on Form 8-K, and we undertake
no obligation to publicly update these forward-looking statements to reflect
new information, future events or otherwise. In light of these risks,
uncertainties and assumptions, the forward-looking events might or might not
occur. We cannot assure you that projected results or events will be achieved.
RISK FACTORS
The following are some of the factors that could cause our actual results
to differ materially from the expected results described in our
forward-looking statements.
RISKS RELATED TO OUR BUSINESS
THE AGREEMENTS AND INSTRUMENTS GOVERNING OUR OUTSTANDING DEBT WILL CONTAIN
RESTRICTIONS AND LIMITATIONS THAT COULD SIGNIFICANTLY IMPACT OUR ABILITY TO
OPERATE OUR BUSINESS.
The operating and financial restrictions and covenants in our new credit
facilities and the indentures governing our Floating Rate Notes restrict our
ability to:
o incur additional debt;
o pay dividends, make redemptions and purchases of Capital Stock and
make other restricted payments;
o issue and sell capital stock of subsidiaries;
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o sell assets;
o engage in transactions with affiliates;
o restrict distributions from subsidiaries;
o incur liens;
o engage in businesses other than permitted businesses;
o engage in sale/leaseback transactions;
o engage in mergers or consolidations;
o make capital expenditures;
o make guarantees;
o make investments and acquisitions;
o enter into operating leases;
o hedge interest rates; and
o prepay other debt.
Moreover, if we are unable to meet the terms of the financial covenants
or if we breach any of these covenants, a default could result under one or
more of these agreements. A default, if not waived by our lenders or
noteholders, could accelerate repayment of our outstanding indebtedness. If an
acceleration were to occur, we may not be able to repay our debt and it is
unlikely that we would be able to borrow sufficient additional funds to
refinance such debt on acceptable terms. In the event of any default under our
new credit facilities, the lenders thereunder could elect to declare all
outstanding borrowings, together with accrued and unpaid interest and other
fees, to be due and payable, any of which would be an event of default under
the indentures governing the Floating Rate Notes and the Fixed Rate Notes.
WE DEPEND ON OUR MANAGEMENT TEAM AND THE LOSS OF THEIR SERVICES COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
Our success depends to a large extent upon the continued services of our
executive management team. The loss of key personnel could have a material
adverse effect on our business, financial condition, results of operations and
cash flows. Additionally, we cannot assure you that we will be able to attract
or retain other skilled personnel in the future.
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WE FACE INTENSE COMPETITION FROM NUMEROUS, FRAGMENTED COMPETITORS. IF WE DO
NOT COMPETE EFFECTIVELY, OUR BUSINESS MAY SUFFER.
We face intense competition from numerous competitors, many of whom have
less leverage than we do. The sewer, drain and pipe cleaning, heating/air-
conditioning services and plumbing repair businesses are highly fragmented,
with the bulk of the industries consisting of local and regional competitors.
We compete primarily on the basis of advertising, range of services provided,
name recognition, speed and quality of customer service, service guarantees
and pricing. Our competitors may succeed in developing new or enhanced
products and services more successful than ours and in marketing and selling
existing and new products and services better than us. In addition, new
competitors may emerge. We cannot make any assurances that we will continue to
be able to compete successfully with any of these companies.
OUR OPERATIONS ARE SUBJECT TO NUMEROUS LAWS AND REGULATIONS, EXPOSING US TO
POTENTIAL CLAIMS AND COMPLIANCE COSTS THAT COULD ADVERSELY AFFECT OUR BUSINESS.
We are subject to federal, state and local laws and regulations relating
to franchising, insurance and other aspects of our business. If we fail to
comply with existing or future laws and regulations, we may be subject to
governmental or judicial fines and sanctions. Our 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 us to provide all of our prospective franchisees with
specific information regarding us and our franchise program in the form of a
detailed franchise offering circular. In addition, a number of states require
us to register our franchise offering prior to offering or selling franchises
in such states. Various state laws also provide for certain rights in favor of
franchisees, including (i) 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. The 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. In
addition, 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 as well as additional unencumbered reserves.
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. We cannot predict what legislation or
regulations affecting our business will be enacted in the future, how existing
or future laws or regulations will be enforced, administered or interpreted,
or the amount of future expenditures that may be required to comply with these
laws or regulations. Compliance costs associated with governmental regulations
could have a material adverse effect on our business, financial condition and
results of operations.
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ENVIRONMENTAL COMPLIANCE COSTS AND LIABILITIES COULD INCREASE OUR EXPENSES AND
ADVERSELY AFFECT OUR FINANCIAL CONDITION.
Our operations are subject to numerous environmental, health and safety
laws and regulations that prohibit or restrict the discharge of pollutants
into the environment and regulate employee exposure to hazardous substances in
the workplace. Failure to comply with these laws could subject us to material
costs and liabilities, including civil and criminal fines, costs to cleanup
contamination we cause and, in some circumstances, costs to cleanup
contamination we discover on our own property but did not cause.
Because we use and generate hazardous materials in some of our
operations, we are potentially subject to material liabilities relating to the
cleanup of contamination and personal injury claims. In addition, we have
retained certain environmental liabilities in connection with the sale of
former businesses. We are currently funding the cleanup of historical
contamination at one of our former properties and contributing to the cleanup
of third-party sites as a result of our sale of Dubois Chemicals Inc. Although
we have established a reserve for these liabilities, actual cleanup costs may
exceed our current estimates due to factors beyond our control, such as the
discovery of additional contamination or the enforcement of more stringent
cleanup requirements. New laws and regulations or their stricter enforcement,
the discovery of presently unknown conditions or the receipt of additional
claims for indemnification could require us to incur costs or become the basis
for new or increased liabilities that could have a material adverse effect on
our business, financial condition and results of operations.
AN ADVERSE RULING AGAINST US IN CERTAIN LITIGATION COULD HAVE AN ADVERSE EFFECT
ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
We are involved in litigation incidental to the conduct of our business
currently and from time to time. The damages claimed against us in some of
these cases are substantial.
We are party to a class action lawsuit filed in the Third Judicial
Circuit Court of Madison County, Illinois in June of 2000 alleging that
certain of our plumbing services were performed by unlicensed employees in
violation of state law and that we failed to disclose such information to
customers in violation of state consumer fraud laws. The Plaintiff moved for a
certification of a class of customers in 32 states who allegedly paid for
plumbing work performed by unlicensed employees. The Plaintiff also moved for
partial summary judgment on grounds that 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 a violation of the Illinois
Plumbing License Act and the Illinois Consumer Fraud Act based upon our
representation of a licensed apprentice as a plumber. Due to the complex legal
and other issues involved, we cannot 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 us in the Court of Common Pleas, Cuyahoga County, Ohio,
alleging that the miscellaneous parts charge charged by one of our
subsidiaries, Roto-Rooter Services Company ("Services"), violated the Ohio
Consumer Sales Practices Act. We contend that such miscellaneous parts charge,
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which is included within the estimate approved by Services' customers, is a
fully disclosed component of Services' pricing. On February 25, 2003, the
trial court certified a nationwide class of customers who paid the
miscellaneous parts charge from October 1999 to July 2002. We are appealing
this order and believe the ultimate disposition of this lawsuit will not have
a material effect on our financial position.
We cannot assure you that we will prevail in either of the two cases
described above. Regardless of the outcome, such litigation is costly to
manage, investigate and defend, and the related defense costs, diversion of
management's time and related publicity may adversely affect the conduct of
our business and the results of our operations.
RISKS RELATED TO VITAS' BUSINESS
VITAS IS HIGHLY DEPENDENT ON PAYMENTS FROM MEDICARE AND MEDICAID. IF THERE ARE
CHANGES IN THE RATES OR METHODS GOVERNING THESE PAYMENTS, VITAS' NET PATIENT
SERVICE REVENUE AND PROFITS COULD MATERIALLY DECLINE.
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, subject to an annual
expenditure cap. Because Vitas receives a per diem fee to provide eligible
services to all patients, Vitas' profitability is largely dependent upon its
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, without a compensating increase in Medicare and Medicaid rates,
could have a material adverse effect on Vitas' business in the future.
Medicare and Medicaid currently adjust the various hospice payment rates
annually based on the increase or decrease of the medical care expenditure
category of the Consumer Price Index. However, the increases usually have been
less than actual inflation. Vitas' profitability could be negatively impacted
if this adjustment were eliminated or reduced, or if Vitas' costs of providing
hospice services increased more than the annual adjustment. In addition, cost
pressures resulting from shorter patient lengths of stay and the use of more
expensive forms of palliative care, including drugs and drug delivery systems,
could negatively impact Vitas' profitability. Many payors are increasing
pressure to control health care costs. In addition, both public and private
payors are increasing pressure to decrease, or limit increases in,
reimbursement rates for health care services. Vitas' levels of revenues and
profitability will be subject to the effect of possible reductions in coverage
or payment rates by third-party payors, including payment rates from Medicare
and Medicaid.
Each state that maintains a Medicaid program has the option to provide
reimbursement for hospice services at reimbursement rates generally required
to be at least as much as Medicare rates. All states in which Vitas operates
cover Medicaid hospice services; however, we cannot assure you that the states
in which Vitas is presently operating or states into which Vitas could expand
operations will continue to cover Medicaid hospice services. In addition, the
Medicare and Medicaid programs are subject to statutory and regulatory
changes, 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
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material adverse effect on Vitas' business. We cannot assure you that Medicare
and/or Medicaid payments to hospices will not decrease. Reductions in amounts
paid by government programs for services or changes in methods or regulations
governing payments could cause Vitas' net patient service revenue and profits
to materially decline.
ALMOST 40% OF VITAS' HOSPICE PATIENTS RESIDED IN NURSING HOMES AT DECEMBER 31,
2003. CHANGES IN THE LAWS AND REGULATIONS REGARDING PAYMENTS FOR HOSPICE
SERVICES AND "ROOM AND BOARD" PROVIDED TO VITAS' HOSPICE PATIENTS RESIDING IN
NURSING HOMES COULD REDUCE ITS NET PATIENT SERVICE REVENUE AND PROFITABILITY.
For Vitas' hospice patients receiving nursing home care under certain
state Medicaid programs who elect hospice care under Medicare or Medicaid, the
state generally must pay Vitas, in addition to the applicable Medicare or
Medicaid hospice per diem rate, an amount equal to at least 95% of the
Medicaid per diem nursing home rate for "room and board" furnished to the
patient by the nursing home. Vitas contracts with various nursing homes for
the nursing homes' provision of certain "room and board" services that the
nursing homes would otherwise provide Medicaid nursing home patients. Vitas
bills and collects from the applicable state Medicaid program an amount equal
to approximately 95% of the amount that would otherwise have been paid
directly to the nursing home under the state's Medicaid plan. Under Vitas'
standard nursing home contracts, it pays the nursing home for these "room and
board" services at approximately 100% of the Medicaid per diem nursing home
rate.
The reduction or elimination of Medicare or Medicaid payments for hospice
patients residing in nursing homes would reduce Vitas' net patient service
revenue and profitability. In addition, changes in the way nursing homes are
reimbursed for "room and board" services provided to hospice patients residing
in nursing homes could affect Vitas' ability to serve patients in nursing
homes and would adversely affect Vitas' net patient service revenue and
profitability.
IF VITAS IS UNABLE TO MAINTAIN RELATIONSHIPS WITH EXISTING PATIENT REFERRAL
SOURCES OR TO ESTABLISH NEW REFERRAL SOURCES, VITAS' GROWTH AND PROFITABILITY
COULD BE ADVERSELY AFFECTED.
Vitas' success is heavily dependent on referrals from physicians, long-
term care facilities, hospitals and other institutional health care providers,
managed care companies, insurance companies and other patient referral sources
in the communities that its hospice locations serve, as well as on its ability
to maintain good relations with these referral sources. Vitas' referral
sources may refer their patients to other hospice care providers or not to a
hospice provider at all. Vitas' growth and profitability depend significantly
on its ability to establish and maintain close working relationships with
these patient referral sources and to increase awareness and acceptance of
hospice care by its referral sources and their patients. We cannot assure you
that Vitas will be able to maintain its existing relationships or that it will
be able to develop and maintain new relationships in existing or new markets.
Vitas' loss of existing relationships or its failure to develop new
relationships could adversely affect its ability to expand or maintain its
operations and operate profitably. Moreover, we cannot assure you that
awareness or acceptance of hospice care will increase or remain at current
levels.
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VITAS OPERATES IN AN INDUSTRY THAT IS SUBJECT TO EXTENSIVE GOVERNMENT
REGULATION AND CLAIMS REVIEWS, AND CHANGES IN LAW AND REGULATORY
INTERPRETATIONS COULD REDUCE ITS NET PATIENT SERVICE REVENUE AND PROFITABILITY
AND ADVERSELY AFFECT ITS FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The health care industry is subject to extensive federal, state and local
laws, rules and regulations relating to, among others:
o payment for services;
o conduct of operations, including fraud and abuse, anti-kickback
prohibitions, self-referral prohibitions and false claims;
o privacy and security of medical records;
o employment practices; and
o various state approval requirements, such as facility and
professional licensure, certificate of need, compliance surveys and
other certification or recertification requirements.
Changes in these laws, rules or regulations or in interpretations thereof
could reduce Vitas' net patient service revenue and profitability.
FRAUD AND ABUSE LAWS. As a provider of services under the Medicare and
Medicaid program, Vitas is subject to federal and state health care program
fraud and abuse laws. The fraud and abuse provisions of the Social Security
Act (the "Anti-Kickback Law") prohibit the knowing offer, payment,
solicitation or receipt of any remuneration, directly or indirectly, overtly
or covertly, in cash or in kind, in return for the referral of patients for
items or services, or arranging for the furnishing of items or services, for
which payment may be made under government health care programs. Violations of
these provisions may result in civil and criminal penalties and exclusion from
participation in Medicare and state health programs such as Medicaid. The
broad language of the Anti-Kickback Law has been interpreted by the courts and
governmental enforcement agencies in a manner that could impose liability on
health care providers for engaging in a wide variety of business transactions.
Because the breadth of the law has the potential to sweep into the prohibition
many legitimate business activities, Congress included certain exceptions in
the statute and authorized the Secretary of the Department of Health and Human
Services ("HHS") to promulgate, by regulation, additional "safe harbors." The
"safe harbors" supply additional exceptions to the sweeping prohibitions of
the Anti-Kickback Law. However, the statutory exceptions and regulatory safe-
harbors are narrow and may not cover many common business arrangements between
hospices and other health care providers. Vitas contracts with a significant
number of health care providers and practitioners, including physicians,
hospitals and nursing homes and arranges for these entities to provide
services to Vitas' patients. Some of these health care providers and
practitioners may refer, or be in a position to refer, patients to Vitas (or
Vitas may refer patients to them). 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 the
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Anti-Kickback Law to its programs, and in response thereto, takes such
actions as it deems appropriate. Vitas generally believes that its contracts
and arrangements with providers, practitioners and suppliers should not be
found to violate the Anti-Kickback Law. However, we cannot assure you that
such laws will ultimately be interpreted in a manner consistent with Vitas'
practices.
Several health care reform proposals have included an expansion of the
Anti-Kickback Law to include referrals of any patients regardless of payor
source, which is similar to the scope of certain laws that have been enacted
at the state level. In addition, a number of states in which Vitas operates
have laws, which vary from state to state, prohibiting certain direct or
indirect remuneration or fee-splitting arrangements between health care
providers, regardless of payor source, for the referral of patients to a
particular provider.
The federal Ethics in Patients Referral Act, 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 certain statutory or
regulatory exceptions. We cannot assure you that future statutory or
regulatory changes will not result in hospice services being subject to the
Stark Law's ownership, investment, compensation or referral prohibitions.
Several states in which Vitas operates have similar laws which likewise are
subject to change. Any such changes could adversely affect the business,
financial condition and operating results of Vitas.
Further, under separate statutes, submission of claims for items or
services that are "not provided as claimed" may lead to civil money penalties,
criminal fines and imprisonment and/or exclusion from participation in
Medicare, Medicaid and other federally funded state health care programs.
These false claims statutes include the federal False Claims Act, which allows
any person to bring a suit on behalf of the federal government, known as a qui
tam action, alleging false or fraudulent Medicare or Medicaid claims or other
violations of the statute and to share in any amounts paid by the entity to
the government in fines or settlement. Any entity found to be violating the
False Claims Act may be liable for up to $11,000 per false claim and treble
the amount of damages the federal government is found to have sustained
because of the false claims.
CERTIFICATE OF NEED LAWS. Many states, including Florida, have
certificate of need laws or other 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 a 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
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County, Florida hospice program. Such a challenge, whether or not ultimately
successful, could adversely affect Vitas.
OTHER FEDERAL AND STATE REGULATIONS. The federal government and all
states regulate various aspects of the hospice industry and Vitas' business.
In particular, Vitas' operations are subject to federal and state health
regulatory laws, including those covering professional services, the
dispensing of drugs and certain types of hospice activities. Certain of Vitas'
employees are subject to state laws and regulations governing professional
practice. Vitas' operations are subject to periodic survey by governmental
authorities and private accrediting entities to assure compliance with
applicable state licensing, and Medicare and Medicaid certification and
accreditation standards, as the case may be. From time to time in the ordinary
course of business, Vitas receives survey reports noting deficiencies for
alleged failure to comply with applicable requirements. Vitas reviews such
reports and takes appropriate corrective action. The failure to effect such
action could result in one of Vitas' hospice programs being terminated from
the Medicare hospice program. Any termination of one or more of Vitas' hospice
locations from the Medicare hospice program could adversely affect Vitas' net
patient service revenue and profitability and adversely affect its financial
condition and results of operations. The failure to obtain, renew or maintain
any of the required regulatory approvals, certifications or licenses could
materially adversely affect Vitas' business and could prevent the programs
involved from offering products and services to patients. In addition, laws
and regulations often are adopted to regulate new products, services and
industries. We cannot assure you that either the states or the federal
government will not impose additional regulations on Vitas' activities, which
might materially adversely affect Vitas.
CLAIMS REVIEW. The Medicare and Medicaid programs and their 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. As a result of such reviews or audits, Vitas could be required
to return any amounts found to be overpaid, or amounts found to be overpaid
could be recouped through reductions in future payments. There is pressure
from state and federal governments and other payors to scrutinize health care
claims to determine their validity and appropriateness. During the past
several years, Vitas' claims have been subject to review and audit. We cannot
assure you that reviews and/or similar audits of Vitas' claims will not result
in material recoupments, denials or other actions that could have a material
adverse effect on Vitas' business, financial condition and results of
operations.
REGULATION AND PROVISION OF CONTINUOUS HOME CARE. Vitas provides
continuous home care to patients requiring such 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.
Continuous home care can be challenging for a hospice to provide for a
number of reasons, including the need to have available sufficient skilled and
trained staff to furnish such care, the need to manage the staffing and
provision of such care, and a shortage of nurses that can make it particularly
difficult to attract and retain the nurses that are required to furnish a
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majority of such care. Medicare reimbursement for continuous home care is
calculated by multiplying the applicable continuous home care hourly rate by
the number of hours of care provided.
Medicare reimbursement for continuous home care is subject to a number of
requirements posing further challenges for a hospice providing such care. For
example, if a patient requires skilled interventions for palliation or symptom
management that can be accomplished in less than 8 aggregate hours within the
24-hour period, if the majority of care can be accomplished by someone other
than a registered nurse or a licensed practical nurse (e.g., if a majority of
care is furnished by a home health aide or homemaker), or if for any reason
less than 8 hours of direct care are provided (such as when a patient dies
before 8 AM even if 7 or more hours of care has been provided), the care
rendered cannot be reimbursed by Medicare at the continuous home care rate
(although the care instead may be eligible for Medicare reimbursement as a
routine home care day). As a result of such requirements, Vitas may incur the
costs of providing services intended to be continuous home care services yet
be unable to bill or be reimbursed for such services at the continuous home
care rate. We cannot assure you that challenges in providing continuous home
care will not cause Vitas' net patient service revenue and profits to
materially decline or that reviews and/or similar audits of Vitas' claims will
not result in material recoupments, denials or other actions that could have a
material adverse effect on Vitas' business, financial condition and results of
operations.
COMPLIANCE. 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.
NEW FEDERAL AND STATE LEGISLATIVE AND REGULATORY INITIATIVES RELATING TO
PATIENT PRIVACY COULD REQUIRE VITAS TO EXPEND SUBSTANTIAL SUMS ON ACQUIRING AND
IMPLEMENTING NEW INFORMATION SYSTEMS, WHICH COULD NEGATIVELY IMPACT ITS
PROFITABILITY.
There are currently numerous legislative and regulatory initiatives at
both the state and federal levels that address patient privacy concerns. In
particular, regulations issued under the Health Insurance Portability and
Accountability Act of 1996 ("HIPAA") require Vitas to protect the privacy and
security of patients' individual health information. The 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. 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 benefit authorizations (the
"Transactions Standard"). Vitas was required to comply with the Transactions
Standard by October 16, 2003. 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. Because the final Security Rule has only recently been issued and
compliance is not yet required, we cannot predict the total financial or other
impact of the regulations on Vitas' operations. In addition, although Vitas'
management believes it is in compliance with the requirement of the Privacy
Rule and the Transactions Standard, we cannot
13
assure you that Vitas will not be found to have violated the Privacy Rule or
the Transactions Standard. Compliance with the HIPAA requirements could
require Vitas to make substantial investments, which could negatively impact
its profitability.
VITAS' GROWTH STRATEGIES MAY NOT BE SUCCESSFUL, WHICH COULD ADVERSELY AFFECT
ITS BUSINESS.
A significant element of Vitas' growth strategy is expected to include
expansion of its business by developing new hospice locations in new and
existing markets. This aspect of Vitas' growth strategy may not be successful,
which could adversely impact its growth and profitability. We cannot assure
you that Vitas will be able to:
o identify markets that meet its selection criteria for new hospice
locations;
o hire and retain qualified management teams to operate each of its
new hospice locations;
o manage a large and geographically diverse group of hospice
locations;
o become Medicare and Medicaid certified in new markets;
o generate sufficient hospice admissions in new markets to operate
profitably in these new markets;
o compete effectively with existing hospices in new markets; or
o obtain state licensure and/or a certificate of need from appropriate
state agencies in new markets.
In addition to growing existing locations and developing new hospice
locations, Vitas' growth strategy is expected to include expansion through the
acquisition of other hospices. We cannot assure you that Vitas' acquisition
strategy will be successful. The success of Vitas' acquisition strategy
depends upon a number of factors, including:
o its ability to identify suitable acquisition candidates;
o its ability to negotiate favorable acquisition terms, including
purchase price, which may be adversely affected due to increased
competition with other buyers;
o the availability of financing on favorable terms, or at all;
o its ability to integrate effectively the systems and operations of
acquired hospices;
o its ability to retain key personnel of acquired hospices; and
o its ability to obtain required regulatory approvals.
Acquisitions involve a number of other risks, including diversion of
management's attention from other business concerns and assuming known or
unknown liabilities of acquired
14
hospices, including liabilities for failure to comply with health care laws
and regulations. Integrating acquired hospices may place significant strains
on Vitas' current operating and financial systems and controls. Vitas may not
successfully overcome these risks or any other problems encountered in
connection with its acquisition strategy.
In addition, since 1990, Vitas has acquired hospice programs in Florida,
California and Ohio, some of which involved acquisitions of hospice programs
from not-for-profit entities. Vitas believes that acquisitions of not-for-
profit programs are generally more complex than acquisitions from for-profit
entities and that a substantial number of acquisition opportunities are likely
to involve acquisitions from not-for-profit entities. Such acquisitions are
subject to provisions of the Internal Revenue Code and, in certain states,
state attorney general powers, which have been interpreted to require that the
consideration paid for the assets purchased be at fair market value and, where
applicable, that any fees paid for services be reasonable. In many states
there is no mechanism for state attorney general pre-clearance of transactions
to assure that applicable standards have been met. Entities that acquire not-
for-profit hospices could face potential liability if the acquisition
transaction is not structured to comply with Internal Revenue Code and state
law requirements, and in some cases the transaction could be enjoined or
subject to rescission. Recently, the acquisition of not-for-profit businesses,
including the fairness of the purchase price paid, has received increasing
regulatory scrutiny by state attorneys general and other regulatory
authorities. Although Vitas believes that reasonable actions have been taken
to date to establish the fair market value of assets purchased in prior
acquisitions of hospice operations from not-for-profit entities and the
reasonableness of fees paid for services, we cannot assure you that such
transactions or any future similar transactions will not be challenged or
that, if challenged, the results of such challenge would not have a material
adverse effect on Vitas' business.
VITAS' LOSS OF KEY MANAGEMENT PERSONNEL OR ITS INABILITY TO HIRE AND RETAIN
SKILLED EMPLOYEES COULD ADVERSELY AFFECT ITS BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Vitas' future success significantly depends upon the continued service of
its senior management personnel. The loss of one or more of Vitas' key senior
management personnel or its inability to hire and retain new skilled employees
could negatively impact Vitas' ability to maintain or increase patient
referrals, a key aspect of its growth strategy, and could adversely affect its
future operating results. See "Risks Relating to our Acquisition of Vitas -
Key Vitas employees are party to severance agreements that are triggered by
the consummation of the Transactions. Loss of such employees could adversely
affect our combined business."
Upon the closing of the Transactions, Hugh A. Westbrook, one of Vitas'
founders, will cease to be Chief Executive Officer and Chairman of Vitas.
Timothy S. O'Toole, one of our directors and our Executive Vice President and
Treasurer, will replace Mr. Westbrook as Chief Executive Officer of Vitas, and
Kevin J. McNamara, one of our directors and our Chief Executive Officer, will
replace Mr. Westbrook as Chairman of Vitas. Mr. O'Toole also is a current
director of Vitas. In addition, two other senior executives of Vitas are
expected to retire upon the closing of the Transactions.
Competition for skilled employees is intense, and the process of locating
and recruiting skilled employees with the combination of qualifications and
attributes required to care
15
effectively for terminally ill patients and their families can be difficult
and lengthy. We cannot assure you that Vitas will be successful in attracting,
retaining or training highly skilled nursing, management, community education,
operations, admissions and other personnel. Vitas' business could be disrupted
and its growth and profitability negatively impacted if it is unable to
attract and retain skilled employees.
A NATIONWIDE SHORTAGE OF QUALIFIED NURSES COULD ADVERSELY AFFECT VITAS'
PROFITABILITY, GROWTH AND ABILITY TO CONTINUE TO PROVIDE QUALITY, RESPONSIVE
HOSPICE SERVICES TO ITS PATIENTS AS NURSING WAGES AND BENEFITS INCREASE.
Vitas currently employs approximately 2,400 nurses on a full-time and
part-time basis. Vitas depends on qualified nurses to provide quality,
responsive hospice services to its patients. The current nationwide shortage
of qualified nurses impacts some of the markets in which Vitas provides
hospice services. In response to this shortage, Vitas has adjusted its wages
and benefits to recruit and retain nurses and to engage contract nurses.
Vitas' inability to attract and retain qualified nurses could adversely affect
its ability to provide quality, responsive hospice services to its patients
and its ability to increase or maintain patient census in those markets.
Increases in the wages and benefits required to attract and retain qualified
nurses or an increase in reliance on contract nurses could negatively impact
profitability.
VITAS MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST OTHER HOSPICE PROVIDERS,
AND COMPETITIVE PRESSURES MAY LIMIT ITS ABILITY TO MAINTAIN OR INCREASE ITS
MARKET POSITION AND ADVERSELY AFFECT ITS PROFITABILITY, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Hospice care in the United States is highly competitive. In many areas in
which Vitas' hospices are located, they compete with a large number of
organizations, including:
o community-based hospice providers;
o national and regional companies;
o hospital-based hospice and palliative care programs;
o physician groups;
o nursing homes;
o home health agencies;
o infusion therapy companies; and
o nursing agencies.
Various health care companies have diversified into the hospice market.
For example, several large long-term care providers and other health care
providers have entered into the hospice business directly or through
affiliates. Accordingly, other companies, including hospitals and health care
organizations that are not currently providing hospice care, may enter the
markets Vitas serves and expand the variety of services offered to include
hospice care. We
16
cannot assure you that Vitas will not encounter increased competition in the
future that could limit its ability to maintain or increase its market
position, including competition from parties in a position to impact referrals
to Vitas. Such increased competition could have a material adverse effect on
Vitas' business, financial condition and results of operations.
CHANGES IN RATES OR METHODS OF PAYMENT FOR VITAS' SERVICES COULD ADVERSELY
AFFECT ITS REVENUES AND PROFITS.
Managed care organizations have grown substantially in terms of the
percentage of the population that is covered by such organizations and in
terms of their control over an increasing portion of the health care economy.
Managed care organizations have continued to consolidate to enhance their
ability to influence the delivery of health care services and to exert
pressure to control health care costs. Vitas has a number of contractual
arrangements with managed care organizations and other similar parties.
Vitas provides hospice care to many Medicare beneficiaries who receive
their non-hospice health care services from health maintenance organizations
("HMOs") under Medicare risk contracts. Under such contracts between HMOs and
the federal Department of Health and Human Services, the Medicare payments for
hospice services are excluded from the per-member, per-month payment from
Medicare to HMOs and instead are paid directly by Medicare to the hospices. As
a result, Vitas' payments for Medicare beneficiaries enrolled in Medicare risk
HMOs are processed in the same way with the same rates as other Medicare
beneficiaries. The federal Balanced Budget Act codified that reimbursement for
hospice services provided to beneficiaries enrolled in Medicare HMOs and the
Medicare + Choice plans be paid by Medicare directly to hospice programs
rather than to Medicare managed care plans. We cannot assure you, however,
that payment for hospice services will continue to be excluded from HMO
payment under Medicare risk contracts and similar Medicare managed care plans
or that if not excluded, managed care organizations or other large third-party
payors would not use their power to influence and exert pressure on health
care providers to reduce costs in a manner that could have a material adverse
effect on Vitas' business, financial condition and results of operations.
LIABILITY CLAIMS MAY HAVE AN ADVERSE EFFECT ON VITAS, AND ITS INSURANCE
COVERAGE MAY BE INADEQUATE.
Participants in the hospice industry are subject to lawsuits alleging
negligence, product liability or other similar legal theories, many of which
involve large claims and significant defense costs. From time to time, Vitas
is subject to such lawsuits. The ultimate liability for claims, if any, could
have a material adverse effect on its financial condition or operating
results. Although Vitas currently maintains liability insurance intended to
cover the claims, we cannot assure you that the coverage limits of such
insurance policies will be adequate or that all such claims will be covered by
the insurance. In addition, Vitas' insurance policies must be renewed annually
and may be subject to cancelation during the policy period. While Vitas has
been able to obtain liability insurance in the past, such insurance varies in
cost, is difficult to obtain and may not be available in the future on terms
acceptable to Vitas, if at all.
A successful claim in excess of the insurance coverage could have a
material adverse effect on Vitas. Claims, regardless of their merit or
eventual outcome, also may have a material
17
adverse effect on Vitas' business and reputation due to the costs of
litigation, diversion of management's time and related publicity.
Vitas procures professional liability coverage on a claims-made basis.
The insurance contracts specify that coverage is available only during the
term of each insurance contract. Vitas' management intends to renew or replace
the existing claims-made policy annually but such coverage is difficult to
obtain, may be subject to cancelation and may be written by carriers that are
unable, or unwilling to pay claims. During fiscal 2001, Vitas was notified
that one of its prior carriers was ordered into rehabilitation, and in early
fiscal 2002, into liquidation, creating the possibility that certain prior
year claims could be underinsured or uninsured. Certain claims have been
asserted where the coverage would be the responsibility of this prior carrier
and/or other carriers that may not have the financial wherewithal to satisfy
the claims. Additionally, some risks and liabilities, including claims for
punitive damages, are not covered by insurance.
A SIGNIFICANT REDUCTION IN THE CARRYING VALUE OF VITAS' GOODWILL COULD HAVE A
MATERIAL ADVERSE EFFECT ON ITS TOTAL ASSETS AND RESULTS OF OPERATIONS.
A substantial portion of Vitas' total assets consists of intangible
assets, including goodwill. Goodwill accounted for approximately 28% of Vitas'
total assets as of December 31, 2003. Any event that results in a significant
reduction in the carrying value of Vitas' goodwill could have a material
adverse effect on its total assets and results of operations.
RISKS RELATING TO OUR ACQUISITION OF VITAS
COMBINING OUR BUSINESS WITH THAT OF VITAS MAY PROVE TO BE DISRUPTIVE AND COULD
RESULT IN THE COMBINED BUSINESSES FAILING TO MEET OUR EXPECTATIONS.
We cannot be sure that we will realize the anticipated benefits of the
Acquisition. Vitas is in a different line of business than we are, and the
combined company following the Transactions will be significantly larger. The
future operation of the combined company may pose different and greater
challenges than our management has experienced in the past and may require
substantial attention from our management, which may limit the amount of time
available to be devoted to our day-to-day operations or to the execution of
our business strategy. Changes in our senior management and that of Vitas
following consummation of the Transactions could impair relationships with
employees and parties with which we have business relationships. We may not
adequately anticipate all the demands that our growth will impose on our
personnel, procedures and structures, including our financial and reporting
control systems, data processing systems and management structure. If we
cannot adequately anticipate and respond to these demands, the performance of
the combined businesses may not meet our expectations.
In addition, under the agreement governing the Acquisition, we have
agreed to assume certain Vitas liabilities. If Vitas' known liabilities are
greater than projected, or if there are obligations of Vitas of which we are
not aware at the time the Acquisition is completed, we will not receive
indemnification from any party to cover costs associated with those
liabilities. As a result, we could incur liabilities that could adversely
affect our business, financial condition and operating results.
18
KEY VITAS EMPLOYEES ARE PARTY TO SEVERANCE AGREEMENTS THAT ARE TRIGGERED BY THE
CONSUMMATION OF THE TRANSACTIONS. LOSS OF SUCH EMPLOYEES COULD ADVERSELY
AFFECT OUR COMBINED BUSINESS.
Twenty-three senior employees of Vitas are party to special severance
agreements. Under the terms of those agreements, if such employee leaves Vitas
within the two year period after a change of control of Vitas, the employee is
entitled to a severance payment equal to two times his or her current base
salary plus an average of his or her annual bonus for the previous two years.
We have not yet discussed the signing of new employment agreements with these
employees, and do not know what the costs of signing new employment agreements
with such employees will be. If all 23 such employees opted not to sign new
employment agreements with us, and instead opted to resign and take the
special severance payments, the cost to the combined company would be
approximately $12 million. While we will attempt to sign new employment
agreements with such employees, there can be no assurance that such employees
will sign new employment agreements and remain employed at the Company
following the consummation of the Transactions. Loss of one or more of such
key employees of Vitas could adversely affect our future operating results.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF VITAS
The following is a discussion of Vitas' results of operations and current
financial position. This discussion should be read in conjunction with, and is
qualified in its entirety by reference to, Vitas' consolidated financial
statements and related notes previously filed by us on our Current Report on
Form 8-K/A dated February 23, 2004. The discussion of Vitas' results of
operations and financial condition includes various forward-looking statements
about Vitas' markets, the demand for its products and services and its future
results. Vitas' actual results may differ materially from those discussed in
the forward-looking statements as a result of various factors, including but
not limited to those described under "Risk Factors."
OVERVIEW
Vitas is the largest provider of hospice services in the United States in
terms of both average daily census and net revenue from patient services.
Vitas began operations in South Florida in 1978. Through the growth of
existing programs, the development of new programs and acquisitions, it now
provides service through 25 hospice programs serving patients in eight states.
In the five years ended September 30, 2003, Vitas increased its patient census
by 51% primarily as a result of growth of existing programs. Patient census at
September 30, 2003, was approximately 7,862 patients. In 2003, Vitas' net
patient revenue was $420.1 million, which represents a 17% increase over
fiscal 2002 net patient revenue of $359.2 million and a 31.5% increase over
fiscal 2001 net patient revenue of $319.5 million. For the fiscal years ended
September 30, 2003, 2002 and 2001, Vitas recorded net income of $13.7 million,
$13.8 million and $12.3 million, respectively. Net income for the year ended
September 30, 2003, included a pretax charge of $4.1 million ($2.5 million on
an after-tax basis) due to a loss from early extinguishment of debt.
19
NET REVENUE FROM PATIENT SERVICES
Net revenue from patient services is recognized as services are rendered
and is reported at the estimated net realizable amounts due from third-party
payors, primarily Medicare and Medicaid. Medicare and Medicaid payments are
calculated using daily or hourly rates for each of the three levels of care
that Vitas delivers and are adjusted based on geographic location. Payors may
deny payment for services in whole or in part on the basis that such services
are not eligible for coverage and do not qualify for reimbursement. Vitas
adjusts gross revenue from patient services for contractual adjustments based
on historical experience.
YEAR ENDED SEPTEMBER 30,
------------------------------
% OF SERVICES PROVIDED UNDER: 2001 2002 2003
----- ----- -----
Medicare 89.0 89.4 89.9
Medicaid 6.2 6.0 5.5
Vitas classifies its services based on the location and type of care
delivery. The major classifications are Home Care, Continuous Care and
Inpatient Care. Home Care is routine care provided to patients and their
families residing at home or in a nursing facility. Inpatient Care is short-
term care provided in a participating hospice unit, hospital or skilled
nursing facility that meets hospice standards. Continuous Care is care
provided to patients at home, during periods of crisis when intensive
monitoring and care, primarily nursing care, is required to achieve palliation
or management of acute medical symptoms. The tables below show the percent of
revenues and percentage days of care for each classification for the fiscal
years ended September 30, 2003, 2002 and 2001 and the three months ended
December 31, 2003:
THREE MONTHS ENDED DECEMBER 31, 2003
Type of Service % of Revenues % Days of Care
--------------- ------------- --------------
Home Care 68.8 90.7
Continuous Care 16.9 5.0
Inpatient Care 14.3 4.3
FISCAL YEAR 2003
Type of Service % of Revenues % Days of Care
--------------- ------------- --------------
Home Care 68.0 90.4
Continuous Care 15.9 4.8
Inpatient Care 16.1 4.8
20
FISCAL YEAR 2002
Type of Service % of Revenues % Days of Care
--------------- ------------- --------------
Home Care 68.2 90.5
Continuous Care 14.8 4.5
Inpatient Care 17.0 5.0
FISCAL YEAR 2001
Type of Service % of Revenues % Days of Care
--------------- ------------- --------------
Home Care 68.4 90.6
Continuous Care 13.1 4.0
Inpatient Care 18.5 5.4
The principal factors that impact net patient service annual revenue are
Vitas' average daily census, levels of care provided to its patients and
changes in Medicare and Medicaid payment rates. Average daily census is
affected by the number of patients referred by new and existing referral
sources, and admitted into Vitas' hospice programs, and average length of stay
of those patients once admitted. Average length of stay is impacted by
patients' decisions of when to enroll in hospice care after diagnoses of
terminal illnesses and, once enrolled, the length of the terminal illnesses.
Vitas' average hospice length of stay has increased from 52 days in fiscal
2002 to 55 days in fiscal 2003.
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, 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 previously in effect in the prior year. These
rates were further adjusted by the hospice wage index. 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.
EXPENSES
Because Vitas generally receives fixed payments for its hospice services,
its profitability is largely dependent on its ability to manage the expenses
of providing hospice services. Vitas recognizes expenses as incurred and
classifies expenses as either hospice program expenses or central support
services expenses. Hospice program expenses primarily include salaries for
direct patient care, local hospice non-patient care salaries, related employee
fringe benefits, pharmaceuticals, medical equipment and supplies, inpatient
costs, nursing home room and board expenses, net of Medicaid payments and
local hospice administrative expenses. Central support services includes
centralized corporate executive management, financial, information
21
technology, human resources, clinical research, legal, strategic planning,
development, operations support, training and other services supporting Vitas'
hospice programs from Vitas' corporate headquarters in Miami, Florida. Length
of stay impacts Vitas' direct hospice care expenses as a percentage of net
patient service revenue because, if lengths of stay decline, direct hospice
care expenses, which are often highest during the latter days of care for a
patient, are spread over fewer days of care. Expenses are normally higher
during the latter days of care because patients generally require greater
hospice services, including drugs, medical equipment and nursing care at that
time due to their deteriorating medical condition. These increased expenses
reduce Vitas' profitability because Vitas generally receives fixed payments
for its hospice services. In addition, cost pressures resulting from the use
of more expensive forms of palliative care, including drugs and drug delivery
systems, could negatively impact Vitas' profitability.
For the patients receiving nursing home care under a state Medicaid
program who elect hospice care under Medicare or Medicaid, Vitas 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 must pay Vitas an amount equal to at least 95%
of the Medicaid daily nursing home rate for room and board 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. These costs, net of Medicaid payments, are included
in hospice program expenses.
RESULTS OF OPERATIONS
The following table sets forth selected consolidated income statement
data as a percentage of net patient revenue for the periods indicated:
YEAR ENDED SEPTEMBER 30,
------------------------------
2001 2002 2003
------- ------- -------
Net revenue from patient services 100.0% 100.0% 100.0%
Operating expenses:
Hospice program expenses 78.1 78.3 79.0
Central support services 10.9 11.0 10.9
Provision for bad debts 1.6 1.5 1.3
Depreciation and amortization 2.0 1.4 1.2
------ ------ ------
Income from operations 7.5 7.8 7.6
Interest and other income 0.2 0.2 0.2
Interest expense (1.1) (1.6) (1.4)
Loss from early extinguishment of debt -- -- (1.0)
------ ------ ------
Income before income taxes 6.5 6.4 5.4
Provision for income taxes 2.7 2.6 2.2
Net income 3.9% 3.8% 3.3%
====== ====== ======
22
Year Ended September 30, 2003 Compared to Year Ended September 30, 2002
Net revenue from patient services increased $60.9 million, or 16.9%, from
$359.2 million in 2002 to $420.1 million in 2003 due primarily to an increase
in average daily census of 797, or 12.6%, from 6,320 in 2002 to 7,117 in 2003.
Increases in patient referrals from existing and new referral sources,
resulting in increased billable days, provided approximately $45.8 million, or
75.2% of this increase in net revenue, including $4.8 million from development
of new hospices. The remaining increase of $15.1 million, or 24.7%, came from
increases in billable days related to inpatient and continuous care levels of
service and, to a lesser extent, increases in payment rates. Net revenue from
patient services per day of care was $155.72 and $161.72 in 2002 and 2003,
respectively. This increase was primarily due to overall increases in Medicare
payment rates for hospice services. Medicare and Medicaid payments represented
approximately 95% of Vitas' net revenue from patient services in 2002 and
2003.
Hospice program expenses include direct patient care costs and general
and administrative expenses incurred at the hospice program locations. Hospice
program expenses increased $50.4 million, or 17.9%, from $281.4 million in
2002 to $331.8 million in 2003. This increase was primarily due to the growth
of Vitas' operations, as discussed above. As a percentage of net revenue from
patient services, hospice program expenses increased from 78.3% in 2002 to
79.0% in 2003.
Central support services expenses increased $6.2 million, or 15.7%, from
$39.5 million in 2002 to $45.7 million in 2003. This increase was primarily
due to investments in information technology, including an electronic patient
record, increased staffing in Vitas' human resources department and the
establishment of a strategic development division dedicated to new business
development. As a percentage of net revenue from patient services, central
support services expenses decreased from 11.0% in 2002 to 10.9% in 2003 due
primarily to costs being spread over increased patient census volume and, to a
lesser extent, increases in Medicare payment rates.
The provision for bad debts decreased $0.1 million, or 1.8%, from $5.5
million in 2002 to $5.4 million in 2003, due primarily to improved collection
efforts. As a percentage of net revenue from patient services, the provision
for bad debts decreased from 1.5% in 2002 to 1.3% in 2003.
Depreciation and amortization expense increased from $4.9 million in 2002
to $5.1 million in 2003, or 4.1%, primarily due to investment in Vitas'
electronic patient record and expansion of its in-sourced home medical
equipment service. As a percentage of net revenue from patient services,
depreciation and amortization decreased from 1.4% in 2002 to 1.2% in 2003.
On August 6, 2003 Vitas refinanced its then existing credit facility (the
"2001 Credit Facility") and as a result $4.1 million of deferred debt issuance
costs related to the 2001 Credit Facility were written off and included in
loss from early extinguishment of debt representing 1.0% of net revenue from
patient services.
Interest and other income remained constant at $0.7 million in 2002 and
2003.
23
Interest expense increased from $5.7 million in 2002 to $5.9 million in
2003, or 3.5%, primarily due to an increase in outstanding debt from the
August 6, 2003 recapitalization of Vitas. As a percentage of net revenue from
patient services, interest expense decreased from 1.6% in 2002 to 1.4% in
2003.
The provision for income taxes was $9.2 million in 2002 and $9.1 million
in 2003. The effective income tax rate was 40.0% in 2002 and 39.8% in 2003.
Net income was $13.8 million in 2002 and $13.7 million in 2003, including
after-tax expenses of $2.5 million in connection with the write-off of
deferred debt issuance costs related to the refinancing of Vitas' 2001 Credit
Facility on August 6, 2003.
Year Ended September 30, 2002 Compared to Year Ended September 30, 2001
Net revenue from patient services increased $39.7 million, or 12.4%, from
$319.5 million in 2001 to $359.2 million in 2002 due primarily to an increase
in average daily census of 369, or 6.2%, from 5,951 in 2001 to 6,320 in 2002.
Increases in patient referrals from existing and new referral sources,
resulting in increased billable days, provided approximately $21.1 million, or
53.1% of this increase in net revenue, including $1.0 million from development
of new hospices. The remaining increase of $18.6 million, or 46.9% resulted
from increases in billable hours related to the continuous care level of
service and, to a lesser extent, increases in payment rates. Net revenue from
patient services per day of care was $147.09 and $155.72 in 2001 and 2002,
respectively. This increase was primarily due to overall increases in Medicare
payment rates for Vitas' hospice services and to increases in billable hours
related to the continuous care level of service. Medicare and Medicaid
payments represented approximately 95% of our net revenue from patient
services in 2001 and 2002.
Hospice program expenses increased $31.9 million, or 12.8%, from $249.5
million in 2001 to $281.4 million in 2002. This increase was primarily due to
the growth of Vitas' operations, as discussed above. As a percentage of net
revenue from patient services, hospice program expenses increased slightly
from 78.1% in 2001 to 78.3% in 2002.
Central support services expenses increased $4.8 million, or 13.8%, from
$34.7 million in 2001 to $39.5 million in 2002. This increase was primarily
due to investments in information technology, including an electronic patient
record. As a percentage of net revenue from patient services, central support
services expenses increased from 10.9% in 2001 to 11.0% in 2002.
The provision for bad debts increased $0.3 million, or 5.8%, from $5.2
million in 2001 to $5.5 million in 2002, due primarily to increases in net
revenue from patient services. As a percentage of net revenue from patient
services, the provision for bad debts decreased from 1.6% in 2001 to 1.5% in
2002.
Depreciation and amortization expense decreased from $6.2 million in 2001
to $4.9 million in 2002, or 21.0%. The decrease was due to the adoption of
SFAS 142 effective October 1, 2001, under which goodwill is no longer
amortized but assessed for impairment on an annual basis. Amortization of
goodwill for 2001 was $1.7 million.
Interest and other income was $0.6 million in 2001 and $0.7 million in
2002.
24
Interest expense increased $2.1 million, or 58.3%, from $3.6 million in
2001 to $5.7 million in 2002, primarily due to the April 27, 2001,
recapitalization and refinancing of Vitas which included the repurchase of
$26.3 million of Series B Convertible Preferred Stock financed by a portion of
the proceeds. As a percentage of net revenue from patient services, interest
expense increased from 1.1% in 2001 to 1.6% in 2002.
The provision for income taxes was $8.6 million in 2001 and $9.2 million
in 2002, respectively. Vitas had an effective income tax rate of 41.0% in 2001
and 40.0% in 2002.
Net income was $12.3 million in 2001 and $13.8 million in 2002. Excluding
aftertax goodwill amortization, net income in 2001 was $13.3 million.
LIQUIDITY AND CAPITAL RESOURCES
Vitas' principal liquidity requirements have been for working capital,
debt service, new program development, acquisitions and other capital
expenditures. Vitas has financed these requirements primarily with cash flows
from operations, proceeds from the issuance of preferred stock and borrowings
under Vitas' credit facility. At September 30, 2003, Vitas had cash and cash
equivalents of $9.1 million, working capital of $15.8 million and an available
borrowing capacity of $21.7 million under its credit agreement.
In August 2003, Vitas refinanced the 2001 Credit Facility with a new $120
million credit facility ("2003 Credit Facility") in connection with a
recapitalization and refinancing transaction of which $27.3 million was used
for the redemption of all of the outstanding shares of 9% Preferred Stock.
Net cash provided by operating activities was $19.7 million, $13.3
million and $12.2 million for the years ended September 30, 2003, 2002, and
2001, respectively. The increases in cash provided by operating activities in
2003, 2002, and 2001 were primarily attributable to increases in net income
during those periods including a non-cash charge for $4.1 million in
connection with the write-off of deferred debt issuance costs related to the
refinancing of the 2001 Credit Facility in August 2003, partially offset by
increases in non-cash working capital requirements due to the growth of Vitas'
business.
Net cash used in investing activities, consisting primarily of capital
expenditures, was $9.6 million, $6.9 million and $6.0 million for the years
ended September 30, 2003, 2002, and 2001, respectively, and for the
acquisition of a hospice for $2.1 million in 2003.
Net cash used in financing activities was $6.5 million, $9.3 million and
$2.9 million for the years ended September 30, 2003, 2002, and 2001,
respectively, and included payments on long-term debt and dividends on 9%
preferred stock. Net cash used in financing activities in 2003 also included
$95.0 million in proceeds from the 2003 Credit Facility, repayment of $24.8
million in subordinated notes plus interest, repayment of a $30.7 million
remaining balance on the 2001 Credit Facility, debt issuance costs of $5.3
million relating to the 2003 Credit Facility and $1.1 million for common stock
purchased by Vitas and retired.
The 2003 Credit Facility consists of a $60 million senior secured term
loan ("Senior Term Loan"), a $35 million second lien term loan ("Second Lien
Term Loan") and a $25 million
25
senior secured revolving loan commitment ("Revolving Loan"). Borrowings under
the Revolving Loan are limited to an amount equal to 85% of the book value of
Vitas' eligible accounts receivable, as defined in the agreement governing the
2003 Credit Facility. The 2003 Credit Facility also provides for the periodic
issuance, at the request of Vitas and subject to limitations based on
outstanding indebtedness and other factors, of letters of credit of up to $5.0
million of which $3.3 million had been issued as of September 30, 2003.
Under the 2003 Credit Facility, the Senior Term Loan requires quarterly
amortization payments ranging from $1,500,000 to $4,500,000 plus interest
beginning November 1, 2003 through August 1, 2008. The Senior Term Loan and
Revolving Loan accrue interest, at Vitas' option, at either LIBOR or the Base
Rate, as defined, plus a margin ranging from 2.25% to 3.00% for base rate
loans and 3.25% to 4.00% for LIBOR rate loans based on the Senior Leverage
Ratio of Vitas. At September 30, 2003, the interest rate based on Vitas'
Senior Leverage Ratio was LIBOR plus 4% or Base Rate plus 3%. The base rate is
equal to the higher of the Prime Rate or the Federal Funds Rate plus .5%.
LIBOR was 1.13% at September 30, 2003. Interest on the Revolving Loan is
payable monthly with any outstanding principal due in full August 1, 2008.
Vitas is required to pay 0.5% annually on the unused portion of the Revolving
Loan. Interest on the Second Lien Term Loan is LIBOR plus 10% or Base Rate
plus 9%.
Vitas can prepay outstanding amounts on the Senior Term Loan and
Revolving Loan under the 2003 Credit Facility at its discretion and without
penalty. As part of the Transactions, Roto-Rooter will repay the 2003 Credit
Facility, and the 2003 Credit Facility will be cancelled.
At December 31, 2003, Vitas did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would
have been established to facilitate off-balance sheet arrangements or for
other contractually narrow or limited purposes.
PRO FORMA LIQUIDITY AND CAPITAL RESOURCES FOR THE COMPANY AND VITAS
All of our existing debt and Vitas' existing debt was repaid in
connection with the Transactions. Following the Transactions, our operating
requirements will be funded by cash flows provided by our existing businesses,
by Vitas' businesses and by financing provided under the Fixed Rate Notes and
Floating Rate Notes and our new credit facilities. Management believes that
these funds will be sufficient to meet our working capital needs for the
foreseeable future. As of December 31, 2003, on a pro forma basis after giving
effect to the Transactions, we would have had aggregate indebtedness of $349.1
million, and would have approximately $25.0 million available for borrowing
under our new revolving credit facility, subject to certain restrictions
contained therein and in the Notes.
On March 15, 2004 and thereafter, the outstanding mandatorily redeemable
convertible preferred securities (the "Trust Securities"), of Chemed Capital
Trust, a trust wholly-owned by us, are callable without premium at a price of
$27.00 per Trust Security. The Trust Securities are convertible into our
Capital Stock at $37.00 per Trust Security. We intend to call all of the Trust
Securities following the closing of the Transactions. We anticipate that the
majority of the Trust
26
Securities will be redeemed for Capital Stock rather than cash. However, were
all of the Trust Securities redeemed for cash, we would be obligated to pay
approximately $14 million in cash.
We believe that our Incentive and Compensation Committee will meet to
authorize certain awards under our 2002 Executive Long-Term Incentive Plan
prior to the closing of the Transactions. We believe that these awards will be
made to key employees and aggregate approximately $8.0 million, comprising
approximately $2.8 million in cash and $5.2 million in restricted stock. We
believe these awards will be triggered primarily as a result of our Capital
Stock attaining an average price of $50.00 for ten consecutive trading days.
CONTRACTUAL OBLIGATIONS
Summarized below are Vitas' long-term obligations as of September 30,
2003 (in thousands):
PAYMENTS DUE BY PERIOD
-----------------------------------------------
LESS THAN MORE THAN
1 YEAR 1 TO 3 YEARS 4 TO 5 YEARS 5 YEARS TOTAL
----------- -------------- -------------- ----------- ----------
LONG-TERM DEBT $ 6,000 $ 36,000 $ 18,000 $ 35,000 $ 95,000
OPERATING LEASES 6,331 14,635 5,750 - 26,716
CAPITAL LEASE
OBLIGATIONS 426 243 - - 669
----------- -------------- -------------- ----------- ----------
TOTAL $ 12,757 $ 50,878 $ 23,750 $ 35,000 $122,385
=========== ============== ============== =========== ==========
All long-term debt will be repaid in connection with the Transactions.
Vitas expects that its principal liquidity requirements will be for working
capital, the development of new hospice programs, the acquisition of other
hospice programs and other capital expenditures. Vitas expects that its
existing funds and cash flows from operations will be sufficient to fund its
principal liquidity requirements for at least the next twelve months. Vitas'
future liquidity requirements and the adequacy of its available funds will
depend on many factors, including payment for its services, regulatory changes
and compliance with new regulations, expense levels, capital expenditures and
future development of new hospice locations and acquisitions.
CRITICAL ACCOUNTING POLICIES
Certain of Vitas' accounting policies are particularly important to
understanding Vitas' financial position and results of operations and require
the application of significant judgment. As a result, they are subject to an
inherent degree of uncertainty. In applying those policies, Vitas uses its
judgment to determine the appropriate assumptions to be used in the
determination of certain estimates. Those estimates are based on Vitas'
historical experience, observance of trends in the industry and information
available from other outside sources, as appropriate.
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
Net revenue is reported at the estimated net realizable amounts due from
third-party payors, primarily Medicare and Medicaid. Payors may deny payment
for services in whole or in part on the basis that such services are not
eligible for coverage and do not qualify for
27
reimbursement. Vitas' management estimates denials each period and makes
adequate provision for them in its financial statements. Due to the complexity
of the laws and regulations affecting the Medicare and Medicaid programs,
there is a reasonable possibility that recorded estimates could change by a
material amount in the future.
Vitas receives biweekly payments for patient services from the Medicare
program under the Prospective Interim Payment (PIP) System. These payments are
subsequently applied against specific Medicare accounts as claims are
processed by the fiscal intermediary. The unapplied portion of these biweekly
PIP payments is recorded as a reduction to patient accounts receivable.
Vitas maintains a policy of providing an allowance for uncollectible
accounts. Vitas calculates this allowance based on a formula tied to the aging
of accounts receivable by payor class and historical write-off rates. Vitas
provides allowances for specific accounts determined to be uncollectible when
such determinations are made. Accounts are written off when all collection
efforts are exhausted.
ACCRUAL FOR INSURANCE RISKS
General and professional liability costs for the health care industry
have increased and become more difficult to estimate. In addition,
insurance
coverage for patient care liabilities and other risks has become more difficult
to obtain. Insurance carriers often require companies to increase their
liability retention levels and pay higher policy premiums for reduced coverage.
In Vitas' consolidated financial statements, Vitas accrues for estimated
liabilities associated with the uninsured portion of its general and
professional liability risks, based on the company's experience, consultation
with its attorneys and insurers, and its existing insurance coverage.
GOODWILL
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 141, Business Combinations and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001. SFAS No. 141 also specifies the criteria that
must be met for intangible assets acquired in a purchase method business
combination to be recognized and reported apart from goodwill. The
requirements of SFAS No. 141 are effective for any business combination
accounted for by the purchase method that is completed after June 30, 2001.
Under SFAS No. 142, goodwill and intangible assets with indefinite useful
lives are no longer amortized, but are reviewed at least annually for
impairment. The amortization provisions of SFAS No. 142 apply to goodwill and
intangible assets acquired after June 30, 2001. Vitas elected to early adopt
the provisions of SFAS No. 142, effective October 1, 2001 with respect to
goodwill and intangible assets acquired prior to July 1, 2001. Accordingly,
the amortization of all of Vitas' goodwill ceased September 30, 2001. During
the fiscal years ended September 30, 2002 and 2003, Vitas tested goodwill for
impairment pursuant to the guidance of SFAS No. 142 and concluded that there
was no impairment.
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BUSINESS
BUSINESS OF THE COMPANY
GENERAL
We are a leading provider of plumbing and drain cleaning and residential
appliance and air-conditioning repair services to both the residential and
commercial markets. We also manufacture and sell equipment used to provide
such services. We conduct our business operations in two segments, Roto-Rooter
Group and Service America Systems, Inc. ("Service America").
ROTO-ROOTER GROUP
We believe we are the largest provider of plumbing and drain cleaning
services in North America, providing repair and maintenance services to
residential and commercial accounts. We operate through more than 100 company-
owned branches and independent contractors and 500 franchisees. We offer
services to more than 90% of the U.S. population and approximately 55% of the
Canadian population. We also have licensed master franchisees in Australia,
China, Indonesia, Japan, Mexico, the Philippines and the United Kingdom.
SERVICE AMERICA
Service America provides residential and commercial appliance and
heating/air-conditioning repair, maintenance and replacement services. It also
sells air-conditioning equipment and duct cleaning services. Service America
enters into service agreements with home and business owners for repairs to
their air-conditioning systems and major appliances. In addition, Service
America offers retail sales and services not covered by an agreement.
BUSINESS OF 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.
Vitas believes it is crucial to establish and maintain close working
relationships with managed care organizations, private and governmental third-
party payers, hospitals, physicians, physician groups, home
29
health agencies, long-term care facilities and other institutional health care
providers, and large self-insured employers. 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. By providing a government funding mechanism
for hospice, Congress was responding to the desire of many patients to leave
the hospital setting and spend the remainder of their life at home if
terminally ill. Further, proponents of hospice believed that a home-based
focus would prove more cost-effective than hospitalization, thus making good
use of the nation's limited health care resources.
Since the passage of this legislation, hospice has experienced
significant growth in terms of patients and hospice providers. Specifically,
the number of Medicare-certified hospices grew from 31 in 1984 to 2,283 in
2002. Meanwhile, the number of hospice patients climbed from approximately
60,000 in 1989 to approximately 885,000 in 2002. Hospice has also grown in
terms of the diversity of diagnoses. Originally geared for cancer patients,
hospice care is now utilized almost equally between cancer and non-cancer
patients.
The historical growth rates of the hospice industry are projected to
accelerate in coming years. This expectation is primarily predicated on the
aging of the U.S. population as well as the currently underserved nature of
hospice. The elderly segment of the U.S. population, which constitutes the
primary recipients of hospice care, is expected to experience significant
growth into the foreseeable future. The U.S. Census Bureau estimates that the
elderly population (age 65 and over) will grow from 34.8 million persons, or
approximately 12.6% of the population, as of August 2000, to 53.7 million
persons, or approximately 16.5% of the population, by the year 2020.
Furthermore, while hospice care has experienced strong growth over the
last two decades, industry analysts generally believe that only 40% of dying
patients who are eligible for hospice care actually elect to receive hospice
care. The remaining 60% of terminally ill patients not utilizing hospice
suggests a substantial market opportunity for hospice care.
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.
30
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.
31
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, 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.
32
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 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.
COMPETITION
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.
HOSPICE PROGRAMS
Vitas currently operates 24 hospice programs in the following markets:
o California - Inland Empire, Orange County, Coastal Cities, San
Gabriel, San Diego, San Francisco Bay Area and San Fernando
o Florida - Dade, Broward, Central Florida, Brevard and Palm Beach
o Texas - Dallas, Ft. Worth, Houston and San Antonio
o Illinois - Chicago Northwest, Chicago Central and Chicago South
o New Jersey - North, West and Shore
33
o Ohio - Cincinnati
o Pennsylvania - Philadelphia
o 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
Hospice care remains cost-effective as compared with other Medicare
benefits. Although we believe that the Medicare program accounts for
approximately 90% of hospice market expenditures, we believe that hospice
represents only 1% of Medicare spending. Further, 28% of Medicare dollars are
spent in the last year of life, which provides significant incentive to find
lower cost alternatives to the current treatment regime.
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%.
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.
GOVERNMENT REGULATION
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
34
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 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.
35
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 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
36
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.
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
37
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 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
38
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 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
39
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.
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
40
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 items or services may have with each other, interpretations of the
law have been very broad. Under current law, courts and
42
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.
42
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 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:
o better ensuring that Medicare hospice eligibility determinations are
made in accordance with the Medicare regulations; and
o 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
43
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 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:
o denial of payment;
o civil monetary penalties of $15,000 per referral or $1,000,000 for
"circumvention schemes;"
o assessments equal to 200% of the dollar value of each such service
provided; and
o 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
44
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 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
45
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 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.
46
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.
47
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) Financial statements of business acquired. The consolidated
financial statements for Vitas Healthcare Corporation and
Subsidiaries as of September 30, 2003 and 2002, and for each of the
three years in the period ending September 30, 2003 have been
previously filed as an Exhibit to our Current Report on Form 8-K/A,
dated February 23, 2004.
The unaudited consolidated financial statements for Vitas Healthcare
Corporation and Subsidiaries as of December 31, 2003 and for the
three months ended December 31, 2003 and 2002, are included in this
Report on Form 8-K:
Unaudited Consolidated Balance Sheet F-1
Unaudited Consolidated Statement of Income F-2
Unaudited Consolidated Statements of Cash Flow F-3
Notes to Unaudited Consolidated Financial Statements F-4
48
(b) Pro forma financial information.
The unaudited pro forma combined financial statements have been
derived from our historical consolidated financial statements and
those of Vitas, adjusted to give pro forma effect to the
transactions summarized in Item 2 ("Transactions").
The unaudited pro forma combined statement of operations of
Roto-Rooter, Inc. and subsidiary companies ("Roto-Rooter") for the
year ended December 31, 2003 gives effect to the Transactions as if
they had occurred on January 1, 2003, and the unaudited pro forma
combined balance sheet as of December 31, 2003 gives effect to the
Transactions as if they had occurred on December 31, 2003.
The following summarizes the assumed sources and uses of funds for
the Transactions in preparing the pro forma financial statements (in
millions):
SOURCES:
Cash $ 31.1
New Credit Facility 75.0
Floating Rate Notes 110.0
Fixed Rate Notes 150.0
Sale of capital stock 100.0
-----------
TOTAL SOURCES $ 466.1
===========
USES:
Purchase price of Vitas shares $ 313.9
Repayment of our existing debt 29.9
Repayment of Vitas existing debt 75.0
Payments under non-competition and consulting
agreement and severance arrangements 27.3
Transaction fees and expenses 20.0
-----------
TOTAL USES $ 466.1
===========
The Acquisition is being accounted for using the purchase method of
accounting. The fair value of Vitas' assets and related liabilities
are based on preliminary estimates. Additional analysis will be
required to determine the fair value of Vitas' assets and
liabilities, including the identification and valuation of
intangible assets acquired. Additional intangible assets acquired
may include customer contracts and related customer relationships
and other contract-based intangibles such as lease agreements and
service contracts. Should we identify and value additional
intangible assets, everything else being equal, goodwill will be
reduced. In addition, such additional intangible assets
49
may have finite lives and be subject to amortization. The final
allocation of the Acquisition consideration may result in
significant differences from the pro forma amounts reflected in the
unaudited pro forma financial information.
The unaudited pro forma financial information is for informational
purposes only and does not purport to represent what our financial
position or results of operations would actually have been had the
Transactions occurred as of the dates indicated, nor does the
unaudited pro forma financial information purport to project our
results for any future date or any future period. The unaudited pro
forma financial information reflects pro forma adjustments that are
described in the accompanying notes and are based on available
information and certain assumptions we believe are reasonable, but
are subject to change. We have made, in our opinion, all adjustments
that are necessary to present fairly the pro forma information.
The unaudited pro forma financial information should be read in
conjunction with our annual reports on Form 10-K and quarterly
reports on Form 10-Q that are filed with the Securities and Exchange
Commission, and with Vitas' consolidated financial statements
contained in this Report on Form 8-K.
Our unaudited pro forma combined financial statements are listed
below:
Page No.
--------
Unaudited Pro Forma Combined Statement of Operations
for the Year Ended December 31, 2003 F-6
Unaudited Pro Forma Combined Balance Sheet
as of December 31, 2003 F-8
50
(c) Exhibits
Exhibit SK 601 Page
No. Ref. No. Description No.
------- -------- ----------- ----
1* (10) Amended and Restated Investor Agreement E-1 to
as of April 27, 2001, between Vitas Healthcare E-39
Corporation and Chemed Corporation.
99.1 (99) Press Release
*Incorporated by reference from Current Report on Form 8-K
filed with the S.E.C. on October 29, 2003.
ITEM 9. REGULATION FD DISCLOSURE
We are furnishing the following information reagarding our and Vitas'
operating results for the periods presented below.
SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
OF ROTO-ROOTER AND OTHER DATA
The following table sets forth our selected historical and pro forma
consolidated financial information for the periods indicated. The historical
statement of operations and balance sheet data at and for the years ended
December 31, 1999, 2000, 2001 and 2002 (which amounts have been reclassified
to conform to our 2003 presentation) is derived from our financial statements
audited by PricewaterhouseCoopers LLP, independent auditors. The financial
information for and as of the year ended December 31, 2003 is unaudited and
includes all adjustments, consisting of normal recurring accruals, which we
consider necessary for a fair presentation of the financial position and the
results of operations for such period.
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1999 2000 2001 2002 2003
------------- ------------- ------------- ------------- -------------
(IN THOUSANDS EXCEPT PER SHARE AND RATIO DATA) (UNAUDITED)
STATEMENT OF OPERATIONS DATA
Continuing operations (a)
Service revenues and sales............. $ 316,719 $ 355,307 $ 337,908 $ 314,176 $ 308,871
Gross profit (excluding 127,042 146,329 132,292 127,891 126,061
depreciation)........................
Depreciation........................... 11,285 13,374 14,395 13,587 12,054
Amortization of goodwill............... 3,770 4,090 4,102 - -
Amortization of other intangibles...... 917 902 680 621 560
Income/(loss) from operations (b)...... 21,227 28,548 (11,561) (2,678) (7,720)
Income/(loss) from continuing 16,195 18,030 (10,738) (8,854) (3,499)
operations (c)(d)....................
Net income/(loss) (d).................. 19,481 19,971 (12,185) (2,545) (3,435)
Earnings/(loss) per share
Income/(loss) from continuing $ 1.55 $ 1.83 $ (1.11) $ (0.90) $ (0.35)
operations...........................
Net income/(loss)...................... 1.86 2.03 (1.25) (0.26) (0.35)
Average number of shares outstanding... 10,470 9,833 9,714 9,858 9,924
Diluted earnings/(loss) per share
Income/(loss) from continuing $ 1.54 $ 1.82 $ (1.11) $ (0.90) $ (0.35)
operations...........................
51
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1999 2000 2001 2002 2003
------------- ------------- ------------- ------------- -------------
(IN THOUSANDS EXCEPT PER SHARE AND RATIO DATA) (UNAUDITED)
Net income/(loss)...................... 1.85 2.01 (1.25) (0.26) (0.35)
Average number of shares 10,514 9,927 9,714 9,858 9,924
outstanding..........................
Cash dividends per share................ $ 2.12 $ 0.40 $ 0.44 $ 0.45 $ 0.48
OTHER FINANCIAL DATA
EBITDA (e).............................. $ 54,163 $ 60,649 $ 10,635 $ 22,269 $ 17,334
Adjusted EBITDA (e) .................... 40,631 49,206 33,034 30,207 25,902
Net cash provided by continuing 28,582 45,981 27,123 26,894 22,590
operations...........................
Capital expenditures.................... 16,696 17,586 14,457 11,855 11,178
52
AS OF DECEMBER 31,
-------------------------------------------------------------------------
1999 2000 2001 2002 2003
------------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
BALANCE SHEET DATA
Cash and cash equivalents $ 17,043 $ 9,978 $ 8,725 $ 37,731 $ 50,587
Working capital......................... 21,478 6,911 19,200 29,269 42,993
Properties and equipment, at cost less
accumulated depreciation.............. $ 56,913 $ 60,343 $ 54,549 $ 48,361 $ 41,004
Total assets............................ 422,674 419,932 401,457 338,144 329,069
Long-term debt.......................... 78,580 58,391 61,037 25,603 25,931
Mandatorily redeemable convertible
preferred securities of the Chemed - 14,641 14,239 14,186 14,126
Capital Trust Stockholders' equity.... 210,344 211,451 204,160 198,422 192,693
PRO FORMA
AS OF DECEMBER 31,
2003
------------------------------------------------------------------
(UNAUDITED)
------------------------------------------------------------------
PRO FORMA FINANCIAL DATA
EBITDA (e)(f).......................... $51,659
Adjusted EBITDA (e)(f)................. 68,239
Ratio of Debt to Adjusted EBITDA (g)... 4.91x
Ratio of Adjusted EBITDA to interest
expense (h).......................... 3.06x
--------------
(a) Continuing operations exclude Cadre Computer Resources, discontinued in
2001, and Patient Care, discontinued in 2002.
(b) Income/(loss) from operations includes restructuring and similar expenses
and other charges of $27.2 million in 2001, a goodwill impairment charge
of $20.3 million in 2002 and asset impairment charges of $15.8 million
and severance charges of $3.6 million in 2003.
(c) Income/(loss) from continuing operations includes the following: (i)
aftertax restructuring and similar expenses and other charges of $16.9
million in 2001, (ii) an aftertax goodwill impairment charge of $20.3
million in 2002, (iii) an aftertax severance charge of $2.4 million in
2003, (iv) aftertax asset impairment charges of $14.4 million in 2003 and
(v) aftertax gains on the sales of investment for the years 1999 through
2003 of $3.0 million, $2.3 million, $703,000, $775,000 and $3.4 million,
respectively. In accordance with FASB Statement No. 142, amortization of
goodwill ceased January 1, 2002. Aftertax amortization of goodwill for
continuing operations for the years 1999 through 2001 was $3.6 million,
$3.9 million and $3.9 million, respectively.
(d) Income/(loss) from continuing operations includes a $1.7 million aftertax
loss on extinguishment of debt in 2001 ($0.18 per share).
(e) We define EBITDA as net income/(loss) plus interest expense,
distributions on trust preferred securities, income taxes and
depreciation and amortization. We define Adjusted EBITDA as EBITDA (1)
plus (i) impairment, restructuring and similar expenses, (ii) severance
charges, (iii) loss on extinguishment of debt and (iv) fees for pending
sale of business (2) minus (i) interest income, (ii) gains on sales or
redemption of investments, (iii) dividend income from Vitas, (iv) equity
in earnings of Vitas and (v) income from discontinued operations. We use
EBITDA and Adjusted EBITDA, in addition to net income, operating income
and cash flows from operating activities, to assess our performance and
believe it is important for investors to be able to evaluate us using the
same measures used by management. We believe that EBITDA and Adjusted
EBITDA are important supplemental measures of operating performance
because they provide investors with an indication of our ability to fund
our operating capital expenditures and debt service
53
requirements through earnings. In addition, we use Adjusted EBITDA
because we believe Adjusted EBITDA adds back and subtracts items to and
from net income/(loss) which we believe are generally not indicative of
core operating performance of our continuing operations. We also believe
that EBITDA and Adjusted EBITDA are supplemental measurement tools used
by analysts and investors to help evaluate a company's overall operating
performance by including only transactions related to core cash operating
business activities.
A number of the items included in Adjusted EBITDA, such as impairment,
restructuring and similar expenses, severance charges, loss on
extinguishment of debt, gains on sales or redemption of investments and
dividend income from Vitas represent charges, expenses or gains which
have occurred or are likely to recur within two years of the date such
item is reported. We believe that two of these items (impairment,
restructuring and similar expenses and loss on extinguishment of debt)
are not expected to be repetitive in nature over the long-term and that
it is therefore meaningful to compare operating performance using
adjusted, non-GAAP measures. In addition, we also believe that our
severance charges taken to date are not routine in nature and not
indicative of our core operating performance. Further, we believe that it
is appropriate to adjust for interest income as such income does not
result directly from our core business activities. We believe that it is
informative to adjust for these items so that our core operating
performance can be easily compared to that of other companies that have
not incurred such charges or income. In addition, we believe that two of
the items (gains on sales or redemption of investments and dividend
income from Vitas) are unique to our performance prior to giving effect
to the Transactions. Finally, we believe it is appropriate to deduct
discontinued operations in calculating Adjusted EBITDA to indicate our
earnings from operations that will be a continuing part of the
enterprise.
EBITDA and Adjusted EBITDA as calculated by us are not necessarily
comparable to similarly titled measures reported by other companies. In
addition, EBITDA and Adjusted EBITDA are not prepared in accordance with
accounting principles generally accepted in the United States ("GAAP"),
and should not be considered as alternatives for net income, operating
income, net cash provided by continuing operations or our other financial
information determined under GAAP, and should not be considered as
measures of our profitability or liquidity.
We believe the line on our consolidated statement of operations entitled
net income/(loss) is the most directly comparable GAAP measure to EBITDA
and Adjusted EBITDA. The following table reconciles EBITDA and Adjusted
EBITDA to net income/(loss) for each of the respective periods:
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1999 2000 2001 2002 2003
----------- ----------- ---------- ----------- ------------
(DOLLARS IN THOUSANDS)
Net income/(loss)............................... $ 19,481 $ 19,971 $(12,185) $ (2,545) $ (3,435)
Add/(deduct)....................................
Interest expense.............................. 7,680 7,211 5,423 2,928 2,140
Distributions on trust preferred securities - 1,197 1,113 1,079 1,071
Income taxes.................................. 9,955 11,956 (4,989) 6,451 4,749
Depreciation and amortization 17,047 20,314 21,273 14,356 12,809
----------- ----------- ---------- ----------- ------------
EBITDA.................................... 54,163 60,649 10,635 22,269 17,334
Add/(deduct):
Impairment, restructuring and similar expenses - - 24,734 21,542 15,828
Severance charges............................. - - - - 3,627
Loss on extinguishment of debt - - 2,617 - -
Interest income............................... (3,155) (3,673) (2,872) (3,308) (2,717)
Gains on sales or redemption of investments (4,661) (3,399) (993) (1,141) (5,390)
Dividend income from Vitas.................... (2,430) (2,430) (2,534) (2,846) (1,794)
Equity in earnings of Vitas - - - - (922)
Discontinued operations....................... (3,286) (1,941) 1,447 (6,309) (64)
----------- ----------- ---------- ----------- ------------
Adjusted EBITDA........................... $ 40,631 $ 49,206 $ 33,034 $ 30,207 $ 25,902
=========== =========== ========== =========== ============
54
(f) Represents EBITDA and Adjusted EBITDA after giving pro forma effect to
the Transactions as if they had occurred as of January 1, 2003. We
believe the line on our pro forma combined statement of operations
entitled income/(loss) from continuing operations is the most directly
comparable GAAP measure to EBITDA and Adjusted EBITDA. The following
tables reconcile EBITDA and Adjusted EBITDA to the line on our pro forma
combined statement of operations entitled income/(loss) from continuing
operations. Supplementally, we have also provided a reconciliation of our
pro forma income/(loss) from continuing operations to our pro forma net
loss. See note (e) above for a further discussion of EBITDA and Adjusted
EBITDA. See "Unaudited Pro Forma Financial Information of Roto-Rooter"
contained herein for descriptions of the adjustments for the
Transactions.
YEAR ENDED DECEMBER 31, 2003
----------------------------------------------------------
HISTORICAL HISTORICAL TRANSACTIONS PRO FORMA
ROTO-ROOTER VITAS AND ADJUSTMENTS
----------------------------------------------------------
(IN THOUSANDS)
----------------------------------------------------------
Income/(loss) from continuing operations.......... $ (3,499) $ 15,574 $ (16,209) $ (4,134)
Discontinued operations........................... 64 - - 64
---------- ---------- ----------- ----------
Net income/(loss)................................. (3,435) 15,574 (16,209) (4,070)
Add/(deduct):
Interest expense, including amortization of debt
costs......................................... 2,140 6,253 16,853 25,246
Distributions on trust preferred securities 1,071 - - 1,071
Income taxes.................................... 4,749 10,455 (8,931) 6,273
Depreciation and amortization 12,809 5,080 5,250 23,139
========== ========== =========== ==========
EBITDA...................................... 17,334 37,362 (3,037) 51,659
Add/(deduct):
Impairment charges.............................. 15,828 - - 15,828
Severance charges............................... 3,627 - - 3,627
Loss on extinguishment of debt - 4,117 - 4,117
Interest income................................. (2,717) (683) 321 (3,079)
Fees for pending sale of business - 1,541 - 1,541
Gains on sales or redemption of investments (5,390) - - (5,390)
Dividend income from Vitas...................... (1,794) - 1,794 -
Equity in earnings of Vitas..................... (922) - 922 -
Discontinued operations......................... (64) - - (64)
---------- ---------- ----------- ----------
Adjusted EBITDA.............................. $ 25,902 $ 42,337 - $ 68,239
========== ========== =========== ==========
(g) Represents pro forma combined long-term debt, including current portion
of long-term debt, excluding trust preferred securities, divided by
Adjusted EBITDA.
(h) Represents pro forma combined Adjusted EBITDA divided by pro forma
interest expense excluding distributions on trust preferred securities
and amortization of debt costs.
55
SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
OF VITAS
The following table sets forth Vitas' selected historical consolidated
financial information for the periods indicated. The selected consolidated
summary of operations data for the years ended September 30, 1999, 2000, 2001,
2002 and 2003 and the financial position data as of September 30, 2003, 2002,
2001, 2000 and 1999 set forth below are derived from Vitas' financial
statements audited by Ernst & Young LLP, independent auditors. The financial
information for and as of the year ended December 31, 2003 is unaudited and
includes all adjustments, consisting of normal recurring accruals, which Vitas
considers necessary for a fair presentation of the financial position and the
results of operations for such period.
FOR THE YEAR ENDED
FOR THE YEARS ENDED SEPTEMBER 30, DECEMBER 31,
1999 2000 2001 2002 2003 2003
----------- ---------- ----------- ----------- ----------- -----------------
(DOLLARS IN THOUSANDS, EXCEPT NET REVENUE PER DAY) (UNAUDITED)
STATEMENT OF OPERATIONS DATA
Service revenues................................ $ 239,812 $272,595 $ 319,517 $ 359,200 $ 420,074 $ 441,017
Service revenues less hospice
program expenses
(excluding depreciation)...................... 49,175 57,540 69,973 77,841 88,254 95,342
Depreciation and amortization (a)............... 7,052 6,425 6,238 4,876 5,084 5,080
Income from operations.......................... 14,196 17,512 23,814 28,019 32,022 35,716
Net income (a).................................. 7,416 9,883 12,311 13,789(b) 13,689 15,574
OTHER FINANCIAL DATA
EBITDA (c)...................................... 21,789 24,516 30,656 33,575 33,705 37,362(d)
Adjusted EBITDA (c)............................. 21,248 23,937 30,052 32,895 37,106 42,337(d)
Net cash from operating activities.............. $ 7,431 $ 12,138 $ 12,248 $ 13,291 $ 19,747 $ 23,270
Capital expenditures............................ 3,444 5,242 4,670 5,368 7,007 7,652
Average daily census............................ 4,922 5,439 5,951 6,320 7,117 7,428
Number of hospice
locations..................................... 19 19 19 20 24 25
Admissions...................................... 32,873 36,818 39,562 40,753 43,105 43,652
Total days of care.............................. 1,796,525 1,990,842 2,172,243 2,306,767 2,597,589 2,711,296
Net revenue per patient day..................... $ 133 $ 137 $ 147 $ 156 $ 162 $ 163
Working capital/(deficit)....................... (8,575) (7,636) 2,144 4,899 15,845 16,656
56
AS OF
AS OF SEPTEMBER 30, DECEMBER 31,
1999 2000 2001 2002 2003 2003
--------- ---------- ---------- --------- ---------- ---------------
(IN THOUSANDS) (UNAUDITED)
BALANCE SHEET DATA
Cash and cash equivalents.............. $ 9,831 $ 9,883 $ 8,381 $ 5,466 $ 9,103 $ 17,062
Properties and equipment, at cost
less accumulated depreciation........ 8,681 9,184 9,549 10,845 12,355 12,613
Total assets........................... 85,888 84,469 102,250 111,467 132,551 143,365
Long-term debt......................... 20,650 14,750 65,508 58,282 89,243 67,625
Redeemable preferred stock............. 69,261 72,677 20,374 22,006 - -
Stockholders' equity (deficit)......... (45,478) (42,734) (26,650) (16,426) (11,548) 11,849
(a) In accordance with FASB Statement No. 142, amortization of goodwill
ceased October 1, 2001. Pretax amortization of goodwill was $1.7 million
per year in fiscal years 1999 through 2001. Aftertax amortization of
goodwill for the fiscal years 1999 through 2001 was approximately $1.0
million in each such fiscal year.
(b) Amount includes aftertax loss of $2.5 million on early extinguishment of
debt in fiscal year 2003.
(c) Vitas defines EBITDA as net income plus (i) interest expense, (ii) income
taxes and (iii) depreciation and amortization expense. Vitas defines
Adjusted EBITDA as EBITDA plus (i) interest income, (ii) fees for pending
sale of business and (iii) noncash loss from early extinguishment of
debt. Vitas has historically used EBITDA and Adjusted EBITDA, in addition
to net income, operating income and cash flows from operating activities,
to assess performance and we believe it is important for investors to be
able to evaluate Vitas using the same measures used by management. We
believe that EBITDA and Adjusted EBITDA are important supplemental
measures of operating performance because they provide investors with an
indication of a company's ability to fund operating capital expenditures
and debt service requirements through earnings. In addition, we have
included Adjusted EBITDA because Adjusted EBITDA adjusts for items which
Vitas believes are generally not operational in nature and not indicative
of core operating performance of its continuing operations. We also
believe that EBITDA and Adjusted EBITDA are supplemental measurement
tools used by analysts and investors to help evaluate a company's overall
operating performance by including only transactions related to core cash
operating business activities.
Adjusted EBITDA as calculated by Vitas is not necessarily comparable to
similarly titled measures reported by other companies. In addition,
Adjusted EBITDA is not prepared in accordance with GAAP, and should not
be considered as an alternative for net income, operating income, net
cash provided by continuing operations or Vitas' other financial
information determined under GAAP, and should not be considered as a
measure of profitability or liquidity of Vitas.
Vitas believes the line on its consolidated statement of operations
entitled net income is the most directly comparable GAAP measure to
EBITDA and Adjusted EBITDA. The following table reconciles EBITDA and
Adjusted EBITDA to net income for each of the respective periods:
FOR THE YEAR
ENDED
FOR THE YEARS ENDED SEPTEMBER 30, DECEMBER 31,
1999 2000 2001 2002 2003 2003
--------- ---------- ---------- --------- ---------- ---------------
(IN THOUSANDS) (UNAUDITED)
Net income............................... $ 7,416 $ 9,883 $ 12,311 $ 13,789 $ 13,689 $ 15,574
Add/(deduct):
Interest expense....................... 2,477 1,756 3,552 5,717 5,886 6,253
Income taxes........................... 4,844 6,452 8,555 9,193 9,046 10,455
Depreciation and amortization 7,052 6,425 6,238 4,876 5,084 5,080
--------- ---------- ---------- --------- ---------- ---------------
EBITDA............................... 21,789 24,516 30,656 33,575 33,705 37,362
Add/(deduct):
Interest income....................... (541) (579) (604) (680) (716) (683)
Fees for pending sale of business - - - - 1,541
Noncash loss from early
extinguishment of debt............... - - - - 4,117 4,117
--------- ---------- ---------- --------- ---------- ---------------
Adjusted EBITDA...................... $ 21,248 $ 23,937 $ 30,052 $ 32,895 $ 37,106 $ 42,337
========= ========== ========== ========= ========== ===============
(d) Includes $5.0 million of compensation for three executives of Vitas
expected to retire upon the closing of the Transactions, and $1.5 million
in fees and expenses relating to the Transactions.
57
CERTIFICATION AND SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Roto-Rooter, Inc.
(Registrant)
Dated: February 24, 2004 By /s/ Arthur V. Tucker, Jr.
--------------------------------
Arthur V. Tucker, Jr.
(Vice President and Controller)
58
VITAS HEALTHCARE CORPORATION
UNAUDITED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2003 AND SEPTEMBER 30, 2003
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31, SEPTEMBER 30,
2003 2003
--------------- --------------
ASSETS
Current assets
Cash and cash equivalents $ 17,062 $ 9,103
Restricted cash 8,490 6,000
Accounts receivable less allowances of $7,211 (September 30 - $6,455) 45,796 52,311
Prepaid expenses and other current assets 8,271 2,477
--------------- --------------
Total current assets 79,619 69,891
Properties and equipment, at cost, less accumulated depreciation
of $39,666 (September 30 - $38,366) 12,613 12,355
Intangiible assets less accumulated amortization of $11,168 (September 30 - $11,162) 40,437 40,443
Other assets 10,696 9,862
--------------- --------------
Total Assets $ 143,365 $ 132,551
=============== ==============
LIABILITIES
Current liabilities
Accounts payable $ 22,164 $ 18,203
Current portion of long-term debt 6,750 6,426
Income taxes 3,314 107
Accrued compensation 16,049 17,195
Current deferred income taxes 1,634 1,634
Other current liabilities 13,052 10,481
--------------- --------------
Total current liabilities 62,963 54,046
Long-term debt 67,625 89,243
Other liabilities 928 810
--------------- --------------
Total liabilities 131,516 144,099
--------------- --------------
STOCKHOLDERS' EQUITY
Capital stock $.001 par value, 40,000,000 shares authorized,
11,138,569 (September 30 - 6,980,326) shares issued and outstanding 11 7
Paid-in capital (6,989) (24,986)
Retained earnings 26,880 21,484
Stock subscription receivable from shareholder (8,053) (8,053)
--------------- --------------
Total Stockholders' Equity 11,849 (11,548)
--------------- --------------
Total Liabilities and Stockholders' Equity $ 143,365 $ 132,551
=============== ==============
The Notes to Unaudited Financial Statements are an integral part of this statement
F - 1
VITAS HEALTHCARE CORPORATION
UNAUDITED CONSOLIDATED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED DECEMBER 31, 2003 AND 2002
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------- --------------
2003 2002
--------------- --------------
Net revenue from patient services $ 121,062 $ 100,119
Hospice program services 93,547 79,692
Central support services 12,515 10,883
Provision for bad debts 1,481 1,256
Depreciation and amortization 1,251 1,255
Fees for pending sale of business 1,541 -
--------------- --------------
Total costs and expenses 110,335 93,086
--------------- --------------
Income from operations 10,727 7,033
Interest expense (1,744) (1,377)
Interest and other income 162 195
--------------- --------------
Income before income taxes 9,145 5,851
Provision for income taxes (3,749) (2,340)
--------------- --------------
Net income 5,396 3,511
Preferred stock dividends and accretion of
preferred stock to redemption value - (857)
--------------- --------------
Net income available to common stockholders $ 5,396 $ 2,654
=============== ==============
The Notes to Unaudited Financial Statements are an integral part of this
statement
F - 2
VITAS HEALTHCARE CORPORATION
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2003 AND 2002
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
----------------------------
2003 2002
-------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,396 $ 3,511
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,756 1,677
Provision for uncollectible accounts receivable 1,481 1,256
Changes in operating assets and liabilities:
Increase in restricted cash (2,490) -
Decrease in accounts receivable 5,034 1,641
Decrease in other current assets (5,597) (3,923)
Increase in accounts payable and accrued expenses 4,960 2,647
Increase in income taxes 3,207 2,970
Decrease/(increase) in other assets (1,120) 85
Increase/(decrease) in other liabilities (15) 429
Other sources - 1
-------------- ------------
Net cash provided by operating activities 12,612 10,294
-------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (1,720) (1,075)
Cash paid for hospice acquisition - (2,044)
-------------- ------------
Net cash used by investing activities (1,720) (3,119)
-------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of warrants 17,999 -
Repayment of long-term debt (20,624) -
Dividends on preferred stock - (608)
Other uses (308) (113)
-------------- ------------
Net cash used by financing activities (2,933) (721)
-------------- ------------
INCREASE IN CASH AND CASH EQUIVALENTS 7,959 6,454
Cash and cash equivalents at beginning of year 9,103 5,466
-------------- ------------
Cash and cash equivalents at end of year $ 17,062 $ 11,920
============== ============
The Notes to Unaudited Financial Statements are an integral part of this statement
F - 3
VITAS HEALTHCARE CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
1. The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles
except that they do not include all the disclosures required under
generally accepted accounting principles for complete financial
statements. However, in the opinion of management of Vitas Healthcare
Corporation ("Vitas"), the financial statements presented herein contain
all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly the financial position, results of operations
and cash flows of Vitas. For further information regarding Vitas'
accounting policies, refer to the consolidated financial statements and
notes included in Vitas' annual financial statements for the year ended
September 30, 2003, included in this Report on Form 8-K.
Vitas uses Accounting Principles Board Opinion No. 25 ("APB No. 25),
Accounting for Stock Issued to Employees, to account for stock-based
compensation. Since the Company's stock options qualify as fixed options
under APB No. 25 and since the option price equals the fair value of the
stock on the date of grant, there is no compensation expense for stock
options.
The following table illustrates the effect on net income if Vitas had
applied the fair-value-recognition provisions of Financial Accounting
Standards Board Statement No. 123, Accounting for Stock-Based
Compensation (in thousands):
THREE MONTHS ENDED DECEMBER 31,
2003 2002
--------- ---------
Net income as reported $ 5,396 $ 3,511
Deduct: fair value of stock-based employee
compensation expense, net of income tax (157) (142)
--------- ---------
Pro forma net income $ 5,239 $ 3,369
========= =========
Because Vitas' employee stock options have characteristics significantly
different from those of traded options, for which option valuation models
were developed, the values calculated above do not necessarily provide a
reliable measure of the fair value of Vitas' employee stock options.
2. On October 14, 2003, Roto-Rooter exercised two of its three warrants
(Warrants A and B) to purchase 4,158,000 common shares of Vitas for $18.0
million in cash. At December 31, 2003, Roto-Rooter owns 37% of Vitas'
outstanding common stock.
3. During the quarter ended December 31, 2003, Vitas incurred approximately
$1,541,000 of fees and expenses related to the sale of the business to
Roto-Rooter, Inc. ("Roto-
F - 4
Rooter"). On February 24, 2004, Roto-Rooter acquired the portion of Vitas
it did not own for approximately $313.9 million in cash.
F - 5
ROTO-ROOTER INC. AND SUBSIDIARY COMPANIES
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2003
(IN THOUSANDS EXCEPT PER SHARE AND PERCENTAGE DATA)
ADD/(DEDUCT)
-------------------------------
HISTORICAL HISTORICAL PRO FORMA
ROTO-ROOTER VITAS (A) ADJUSTMENTS PRO FORMA (H)
------------- ------------ ------------ ------------
Service revenues and sales $ 308,871 $ 441,017 $ - $ 749,888
------------- ------------ ------------ ------------
Cost of services provided and goods sold
(excluding depreciation) 182,810 345,675 - 528,485
Selling, general and administrative expenses 105,899 53,005 158,904
Depreciation 12,054 5,080 2,000 (b) 19,134
Amortization of purchased intangibles - - 3,250 (b) 3,250
Fees for pending sale of business - 1,541 - 1,541
Impairment expenses 15,828 - - 15,828
------------- ------------ ------------ ------------
Total costs and expenses 316,591 405,301 5,250 727,142
------------- ------------ ------------ ------------
Income/(loss) from operations (7,720) 35,716 (5,250) 22,746
Interest expense, including amortization of debt
costs (2,140) (6,253) (16,853) (c) (25,246)
Distributions on preferred securities (1,071) - - (1,071)
Loss on extinguishment of debt - (4,117) - (4,117)
Other income--net 11,259 683 (2,115) (d) 9,827
------------- ------------ ------------ ------------
Income before income taxes 328 26,029 (24,218) 2,139
Income taxes (4,749) (10,455) 8,931 (e) (6,273)
Equity in earnings of Vitas 922 - (922) (f) -
------------- ------------ ------------ ------------
Loss from continuing operations $ (3,499) $ 15,574 $ (16,209) $ (4,134)
============= ============ ============ ============
LOSS PER SHARE AND DILUTED LOSS PER SHARE
Loss from continuing operations $ (0.35) $ (0.35)
============= ============
Average number of shares outstanding 9,924 2,000 (g) 11,924
============= ============ ============
-------------------------------------------------
(a) Amounts represent the historical results of Vitas for the year ended
December 31, 2003:
ADD/(DEDUCT)--
YEAR ENDED THREE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31,
-------------- ---------------------------- -------------
2003 2003 2002 2003
Service revenues and sales $ 420,074 $ 121,062 $ (100,119) $ 441,017
Cost of services provided and goods sold
(excluding depreciation) 331,820 93,547 (79,692) 345,675
Selling, general and administrative expenses 51,148 13,996 (12,139) 53,005
Depreciation 5,084 1,251 (1,255) 5,080
Fees for pending sale of business - 1,541 - 1,541
------------- ------------- ------------- ------------
Total costs and expenses 388,052 110,335 (93,086) 405,301
------------- ------------- ------------- ------------
Income from operations 32,022 10,727 (7,033) 35,716
Interest expense (5,886) (1,744) 1,377 (6,253)
Loss on extinguishment of debt (4,117) - - (4,117)
Other income--net 716 162 (195) 683
------------- ------------- ------------- ------------
Income before income taxes 22,735 9,145 (5,851) 26,029
Income taxes (9,046) (3,749) 2,340 (10,455)
------------- ------------- ------------- ------------
Net Income $ 13,689 $ 5,396 $ (3,511) $ 15,574
============= ============= ============= ============
F - 6
(b) Amounts represent the additional depreciation and
amortization expenses the Company will record as a
result of recording the assets and liabilities of
Vitas' at their fair market value on the date of
the Acquisition. This additional depreciation and
amortization includes the following:
Computer software (estimated value of $10,000
and useful life of 5 years) $ 2,000
==========
Covenant not to compete with Vitas' retiring CEO
(value of $18,000; contractual and estimated
useful life of 8 years) $ 2,250
==========
Consulting agreement with Vitas' retiring CEO
(value of $7,000; contractual and useful life
of 7 years) 1,000
----------
Total amortization $ 3,250
==========
(c) Interest adjustments include the following:
Elimination of interest on Vitas' existing debt $ 6,253
Elimination of interest on our existing debt 2,140
Interest on New Credit Facility:
$40,000 term loan at 4.38% (LIBOR + 3.25%) (1,752)
$35,000 term loan at 4.63% (LIBOR + 3.50%) (1,621)
Interest on $110,000 Floating Rate Notes at
4.88% (LIBOR + 3.75%) (5,368)
Interest on $150,000 Fixed Rate Notes at 8.75% (13,125)
Credit facility fees for New Facility (400)
----------
Net additional interest expense (13,873)
Amortization of debt costs (2,980)
----------
Total additional interest costs, including
amortization of debt costs $ (16,853)
==========
The above computations are based on LIBOR of 1.13%
at February 11, 2004. If LIBOR fluctuates by by 1/8%,
then interest expense for the Company's variable
interest rate debt (a total of $185,000) would
increase or decrease by $231 per annum.
The amortization of debt amount represents
amortization of $14,065 of transaction costs to be
classified as long-term financing costs using the
effective interest method over the lives of the
respective debt issues.
(d) Amount represents the total of the following:
Estimated lost interest on cash used for Acquisition
based on average pretax investment rate of
approximately 1% and average balance of $31,140. $ (321)
Elimination of our dividend income from Vitas'
preferred stock (redeemed by Vitas in August 2003) (1,794)
----------
Total $ (2,115)
==========
(e) Amount represents tax benefit of net additional
interest expense, based on statutory income tax
rates and giving effect to the corporate dividend
exclusion.
(f) Amount represents the elimination of our equity in
Vitas' earnings.
(g) Amount assumes that 2,000 shares of our capital stock
are issued in the Transactions.
(h) The pro forma results do not include the effects of the
loss arising from the write-off of Vitas' existing
deferred financing costs ($4,622) or the loss arising
from the make whole payment on our debt ($3,000)
which will occur in connection with the Transactions.
F - 7
ROTO-ROOTER INC. AND SUBSIDIARY COMPANIES
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
DECEMBER 31, 2003
(IN THOUSANDS EXCEPT PER SHARE AND PERCENTAGE DATA)
ADD/(DEDUCT)
---------------------------------
HISTORICAL HISTORICAL PRO FORMA
ROTO-ROOTER VITAS(A) ADJUSTMENTS PRO FORMA(Q)
-------------- --------------- ---------------- --------------
ASSETS
Current assets
Cash and cash equivalents $ 50,587 $ 17,062 $ (4,597) (b) $ 63,052
Restricted cash - 8,490 (8,490) (c) -
Accounts receivable less allowances 13,592 45,796 - 59,388
Inventories 8,256 - - 8,256
Statutory deposits 9,358 - - 9,358
Prepaid expenses and other current assets 20,292 8,271 - 28,563
-------------- --------------- ---------------- --------------
Total current assets 102,085 79,619 (13,087) 168,617
Investments of deferred compensation plans held in
trust 17,743 - - 17,743
Other investments 25,081 - (23,636) (d) 1,445
Note receivable 12,500 - - 12,500
Properties and equipment, at cost, less accumulated
depreciation 41,004 12,613 10,000 (e) 63,617
Identifiable intangible assets less accumulated
amortization 592 - 25,000 (e) 25,592
Goodwill less accumulated amortization 105,335 40,437 320,791 (e) 466,563
Deferred financing costs - 4,622 9,443 (f) 14,065
Cash held in escrow for Acquisition 10,000 - (10,000) (g) -
Other assets 14,729 6,074 - 20,803
-------------- --------------- ---------------- --------------
Total Assets $ 329,069 $ 143,365 $ 318,511 $ 790,945
============== =============== ================ ==============
LIABILITIES
Current liabilities
Accounts payable $ 7,120 22,164 - 29,284
Current portion of long-term debt 448 6,750 (2,198) (h) 5,000
Income taxes 26 3,314 (3,822) (i) (482)
Deferred contract revenue 14,362 - - 14,362
Other current liabilities 37,136 30,735 (1,179) (j) 66,692
-------------- --------------- ---------------- --------------
Total current liabilities 59,092 62,963 (7,199) 114,856
Existing long-term debt 25,931 67,625 (93,556) (k) -
New Credit Facility, less current portion - - 70,000 (l) 70,000
Floating Rate Notes - - 110,000 (m) 110,000
Fixed Rate Notes - - 150,000 (m) 150,000
Mandatorily redeemable convertible preferred securities
of the Chemed Capital Trust 14,126 - - 14,126
-------------- --------------- ---------------- --------------
Total long-term debt 40,057 67,625 236,444 344,126
Deferred compensation liabilities 17,733 - - 17,733
Other liabilities 19,494 928 3,500 (n) 23,922
-------------- --------------- ---------------- --------------
Total liabilities 136,376 131,516 232,745 500,637
-------------- --------------- ---------------- --------------
STOCKHOLDERS' EQUITY
Capital stock 13,453 11 (11) (o) 13,453
Paid-in capital 170,501 (6,989) 44,609 (o) 208,121
Retained earnings 119,746 26,880 (28,830) (o) 117,796
Treasury stock at cost (109,427) - 61,945 (o) (47,482)
Unearned compensation (2,954) - - (2,954)
Deferred compensation payable in Company stock 2,308 - - 2,308
Notes receivable for shares sold (934) - - (934)
Stock subscription receivable from shareholder - (8,053) 8,053 (p) -
-------------- --------------- ---------------- --------------
Total Stockholders' Equity 192,693 11,849 85,766 290,308
-------------- --------------- ---------------- --------------
Total Liabilities and Stockholders' $ 329,069 $ 143,365 $ 318,511 $ 790,945
_____________________________________________
F - 8
(a) Amounts represent the historical balance sheet of Vitas at December 31,
2003.
(b) Amount represents the net of the following transactions:
Roto-Rooter cash used in Acquisition $ (31,140)
Reclassification of Vitas cash, restricted by the terms of its existing debt
agreement that is to be retired with the proceeds from the Transactions 8,490
Release of our cash held in escrow, pending completion of the
Acquisition 10,000
Repayment of shareholder note upon completion of the Acquisition 8,053
-------------
Total $ (4,597)
=============
(c) Reclassification of Vitas cash, restricted by the terms of its existing debt
agreement that is to be retired with the proceeds from the Transactions.
(d) Amount represents elimination of the Company's current investment in
Vitas.
(e) Amounts represent the elimination of Vitas' goodwill ($40,437) and
allocation of the excess of the purchase price of Vitas over its recorded
assets and liabilities as required under purchase accounting rules.
For the purpose of these pro forma statements, we have assumed that the fair
values of Vitas' tangible assets and liabilities are equal to their book
values on the date of acquisition and that we identified the following
intangible assets of Vitas:
Computer systems and software (average useful life of 5 years) $ 10,000
=============
Covenant not to compete with Vitas' retiring CEO (contractual and useful
life of 8 years) $ 18,000
Consulting agreement with Vitas' retiring CEO (contractual and useful life
of 7 years) 7,000
-------------
Total identifiable intangible assets $ 25,000
=============
Unallocated residual asset (goodwill) with an indefinite life $ 361,228
=============
We have assumed that the remainder of the unallocated excess purchase
price ($361,228) is goodwill with an indefinite life. During the next
several months, we will perform a thorough valuation of all tangible and
intangible assets and liabilities as required under purchase accounting
rules. It is possible that our valuation will identify additional and/or
different intangible assets with different useful lives and the final purchase
price allocation could differ materially from the estimated allocation used for
pro forma purposes.
The purchase price of Vitas is assumed to have been allocated to the following
assets and liabilities:
Current assets, including note due from stockholder $ 87,672
Property and equipment, including computer software 22,613
Identifiable intangible assets 25,000
Goodwill 361,228
Other assets 6,074
Current liabilities (60,191)
Long-term debt (67,625)
Other liabilities (4,428)
----------
Subtotal 370,343
Elimination of our existing investment in Vitas (23,636)
----------
Total purchase price 346,707
Less: cash and cash equivalents (25,115)
----------
Net cash outlay $321,592
==========
(f) Amount represents the net of the following transactions:
Write-off of Vitas' existing deferred financing costs $ (4,622)
Capitalize the portion of financing costs related to debt
incurred to fund the Acquisition 14,065
----------
Total $ 9,443
==========
(g) Amount represents release of our cash held in escrow, pending
completion of the Acquisition.
(h) Amount represents the net of the following transactions:
Repayment of current maturities of existing long-term debt $ (7,198)
Proceeds of New Credit Facility (current portion) 5,000
Total $ (2,198)
==========
(i) Amount represents the tax benefits of the following transactions,
computed at the statutory rates:
Tax benefit for the write-off of Vitas' existing deferred $ (1,849)
financing costs
Tax benefit for severance payments (923)
Tax benefit for the make whole payment for the retirement of
our 7.31% Senior Notes (1,050)
----------
Total $ (3,822)
==========
(j) Amount represents payment of accrued interest on existing
debt.
(k) Amount represents the retirement of Noncurrent maturities of existing long-
term debt.
(l) Amount represents proceeds from our New Credit Facility, less current
portion.
(m) Amounts represent principal amount of Floating Rate and Fixed Rate Notes.
(n) Amount represents the deferred tax liability arising from the book/ tax
basis difference of acquired software.
F-9
------------ --------- ---------- ----------- ----------
(o) Amount represents the net of the following
transactions:
CAPITAL PAID IN RETAINED TREASURY
STOCK CAPITAL EARNINGS STOCK TOTAL
Issuance of 2,000 new shares of capital stock
from treasury stock at a price of $50 per
share $ - $ 37,620 $ - $ 62,380 $ 100,000
Transaction costs allocated to issuance of Capital
Stock - - - (435) (435)
Aftertax loss from the make whole payment on our
debt - - (1,950) - (1,950)
Elimination of Vitas' shareholders' equity (11) 6,989 (26,880) - (19,902)
------------ --------- ---------- ----------- ----------
Total $ (11) $ 44,609 $(28,830) $ 61,945 $ 77,713
============ ========= ========== =========== ==========
(p) Amount represents repayment of stockholder note upon
completion of the Acquisition.
(q) Twenty-three key employees of Vitas have severance arrangements
which they may invoke upon change in control of Vitas. If all of these
employees elected to leave Vitas during the two-year period following
the completion of the Acquisition, an aggregate payout of approximately
$12,200 will be required. Although we will make reasonable efforts to
retain all of these employees, it is not possible at this time to
predict how many, if any, will choose to leave. Because it is not
possible to estimate the liability that may be incurred in connection with
the possible departure of these key employees, no liability for such
severance payments is included on this pro forma balance sheet.
F-10
INDEX TO EXHIBITS
Exhibit No. Exhibit
----------- -------
99.1 Press release, dated February 24, 2004, issued by Roto-Rooter,
Inc.
F - 11