Chemed - 10-Q quarterly report FY2010 Q3

 

 

 

 

 As used herein, the terms "We," "Company" and "Chemed" refer to Chemed Corporation or Chemed Corporation and its consolidated subsidiaries.

We have prepared the accompanying unaudited consolidated financial statements of Chemed in accordance with Rule 10-01 of SEC Regulation S-X.  Consequently, we have omitted certain disclosures required under generally accepted accounting principles in the United States (“GAAP”) for complete financial statements.  The December 31, 2009 balance sheet data were derived from audited financial statements but do not include all disclosures required by GAAP.  However, in our opinion, the financial statements presented herein contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our financial position, results of operations and cash flows.  These financial statements are prepared on the same basis as and should be read in conjunction with the Consolidated Financial Statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2009.

Both the VITAS segment and the Roto-Rooter segment recognize service revenues and sales when the earnings process has been completed.  Generally, this occurs when services are provided or products are delivered.  VITAS recognizes revenue at the estimated realizable amount due from third-party payers.  Medicare payments are subject to certain limitations, as described below.

As of September 30, 2010, VITAS has approximately $5.6 million in unbilled revenue included in accounts receivable (December 31, 2009 - $9.9 million).  The unbilled revenue at VITAS relates to hospice programs currently undergoing focused medical reviews (“FMR”).  During FMR, surveyors working on behalf of the U.S. Federal government review certain patient files for compliance with Medicare regulations.  During the time the patient file is under review, we are unable to bill for care provided to those patients.  We make appropriate provisions to reduce our accounts receivable balance for potential denials of patient service revenue due to FMR activity.

We actively monitor each of our hospice programs, by provider number, as to their specific admission, discharge rate and median length of stay data in an attempt to determine whether they are likely to exceed the annual per-beneficiary Medicare cap (“Medicare cap”).  Should we determine that revenues for a program are likely to exceed the Medicare cap based on projected trends, we attempt to institute corrective action to influence the patient mix or to increase patient admissions.  However, should we project our corrective action will not prevent that program from exceeding its Medicare cap, we estimate the amount of revenue recognized during the period that will require repayment to the Federal government under the Medicare cap and record the amount as a reduction to patient revenue.  The Medicare cap measurement period is from September 29 through September 28 of the following year for admissions and from November 1 through October 31 of the following year for revenue.  During the three-month period ended September 30, 2010 we recorded $117,000 for one small program’s projected Medicare cap liability for the 2010 measurement period.  For the nine month period ended September 30, 2010, we reversed $1.7 million, net in Medicare cap liability for amounts recorded in the fourth quarter of 2009 for two programs’ projected 2010 measurement period liability.  For the three-month period ended September 30, 2009, we recorded $43,000 in Medicare cap liability related to a retroactive billing for 2006.  For the nine month period ended September 30, 2009, we reversed $235,000 for the 2009 measurement period offset by $43,000 in Medicare cap liability related to a retroactive billing for 2006.

The U.S. government revises hospice reimbursement rates on an annual basis using the Hospice Wage Index (HWI) and the Consumer Price Index plus a phase out of the Budget Neutrality Adjustment Factor (BNAF).  The HWI is geographically adjusted to reflect local differences in wages.  The BNAF is a portion of inflation calculated in prior years that is being phased out over a seven year period.  In August 2008, the U.S. government announced a 25% reduction in the BNAF for its fiscal 2009 (October 2008 through September 2009) pursuant to a three year phase-out of the BNAF.  The February 2009 American Recovery and Reinvestment Act mandated a one year delay in the BNAF phase-out.  In August 2009, the Centers for Medicare and Medicaid Services (CMS) revised the phase-out schedule of the BNAF.  CMS reduced the price increase in hospice reimbursement by 10% of the BNAF effective October 1, 2009.  The remaining 90% of the BNAF will be phased out over the next nine years by revising the October 1 reimbursement adjustment by 15% of the original BNAF inflation factor.  Based upon this revised schedule, 100% of the BNAF will be eliminated on October 1, 2015.  As a result, included in the nine months ended September 30, 2009 results, is $1.95 million of revenue for the retroactive price increase related to services provided by VITAS in the fourth quarter of 2008.

 

 

Service revenues and sales and after-tax earnings by business segment are as follows (in thousands):

We report corporate administrative expenses and unallocated investing and financing income and expense not directly related to either segment as “Corporate”.  Historically, we have recorded stock award amortization as a corporate expense.  In the first quarter of 2010, our chief decision maker determined that this was an on-going expense and should be reported within the appropriate business segment.  Accordingly, stock award amortization has been reclassified to the corresponding business segment for all periods presented.

For the three and nine-month periods ended September 30, 2010, 990,000 and 986,000 stock options, respectively were excluded from the computation of diluted earnings per share as their exercise prices were greater than the average market price for most of the period. For the three and nine-month periods ended September 30, 2009, 1.3 million and 1.7 million stock options were excluded from the computation of diluted earnings per share.

Diluted earnings per share may be impacted in future periods as the result of the issuance of our 1.875% Senior Convertible Notes (the “Notes”) and related purchased call options and sold warrants.  Per FASB’s authoritative guidance on the effect of contingently convertible instruments on diluted earnings per share and convertible bonds with an issuer option to settle for cash upon conversion, we will not include any shares related to the Notes in our calculation of diluted earnings per share until our average stock price for a quarter exceeds the current conversion price.  We would then include in our diluted earnings per share calculation those shares issuable using the treasury stock method.  The amount of shares issuable is based upon the amount by which the average stock price for the quarter exceeds the conversion price.  The purchased call option does not impact the calculation of diluted earnings per share as it is always anti-dilutive. The sold warrants become dilutive when our average stock price for a quarter exceeds the strike price of the warrant.

The following table provides examples of how changes in our stock price impact the number of shares that would be included in our diluted earnings per share calculation.  It also shows the impact on the number of shares issuable upon conversion of the Notes and settlement of the purchased call options and sold warrants:

We are in compliance with all debt covenants as of September 30, 2010.  We have issued $28.2 million in standby letters of credit as of September 30, 2010 for insurance purposes.  Issued letters of credit reduce our available credit under the revolving credit agreement.  As of September 30, 2010, we have approximately $146.8 million of unused lines of credit available and eligible to be drawn down under our revolving credit facility, excluding the $100 million expansion feature.

In May 2008, the FASB issued authoritative guidance for accounting for convertible debt instruments that may be settled in cash upon conversion including partial cash settlement.  This guidance requires all convertible debentures classified as Instruments B or C to separately account for the debt and equity pieces of the instrument.   Convertible debentures classified as Instruments B may be settled in either stock or cash equivalent to the conversion value and convertible debentures classified as Instruments C must settle the accreted value of the obligation in cash and may satisfy the excess conversion value in either cash or stock.  At inception of the convertible instrument, cash flows related to the convertible instrument are to be discounted using a market rate of interest.  We adopt ed the provisions of the guidance on January 1, 2009 and applied the guidance retrospectively.  Upon adoption, the Notes had a discount of approximately $55.1 million.

The following amounts are included in our consolidated balance sheet related to the Notes:

 

The following amounts comprise interest expense included in our consolidated income statement (in thousands):

The unamortized debt discount will be amortized using the effective interest method over the remaining life of the Notes.  The effective rate on the Notes after adoption of the standard is approximately 6.875%.

For the nine-month period of 2009, we recorded pretax expenses of $4.0 million related to the costs of a contested proxy solicitation.  There were no other operating expenses for any other period presented.

 

 

 

Other income -- net comprises the following (in thousands):

On May 17, 2010 the stockholders approved the adoption of the Company’s 2010 Stock Incentive Plan.  The Stock Incentive Plan authorizes the issuance or transfer of a maximum of 1,750,000 shares of capital stock pursuant to stock incentives granted to key employees of the Company.  Stock incentives granted under the Stock Plan may be in the form of options to purchase capital stock or in the form of capital stock awards.

 

In April 2010, we met the stock price target of our Long-Term Incentive Plan.  The stock price hurdle of $54.00 was achieved during 30 trading days out of a 60 day trading day period. On April 16, 2010, the Compensation/Incentive Committee of the Board of Directors (“CIC”) approved a stock grant of 27,900 shares and the related allocation to participants.  The pretax cost of the stock grant was $1.8 million.

On February 18, 2010, the CIC approved a grant of 47,896 shares of restricted stock to certain key employees.  The restricted shares cliff vest four years from the date of issuance.  The cumulative compensation expense related to the restricted stock award is $2.5 million and will be recognized ratably over the four-year vesting period.  We assumed no forfeitures in determining the cumulative compensation expense of the grant.

On February 18, 2010, the CIC approved a grant of 515,100 stock options to certain employees.  The stock options vest ratably over three years from the date of issuance.  The cumulative compensation expense related to the stock option grant is $7.8 million and will be recognized over the three-year vesting period.  We used the Black-Scholes option valuation method to determine the cumulative compensation expense of the grant.

The Roto-Rooter segment sublicenses with sixty-one independent contractors to operate certain plumbing repair and drain cleaning businesses in lesser-populated areas of the United States and Canada.  We had notes receivable from our independent contractors as of September 30, 2010 totaling $1.2 million (December 31, 2009 -$1.3 million).  In most cases these loans are fully or partially secured by equipment owned by the contractor.  The interest rates on the loans range from zero to 8% per annum and the remaining terms of the loans range from two months to 5 years at September 30, 2010.  During the three months ended September 30, 2010, we recorded revenues of $5.5 million (2009 - $5.3 million) and pretax profits of $2.5 milli on (2009 - $2.4 million) from our independent contractors.  During the nine months ended September 30, 2010, we recorded revenues of $16.7 million (2009 - $16.0 million) and pretax profits of $7.6 million (2009 - $7.1 million) from our independent contractors.

All of the Company’s plans that provide retirement and similar benefits are defined contribution plans.  Expenses for the Company’s pension and profit-sharing plans, excess benefit plans and other similar plans were $2.3 million and $4.3 million for the three months ended September 30, 2010 and 2009, respectively. Expenses for the Company’s pension and profit-sharing plans, excess benefit plans and other similar plans were $7.0 million and $11.3 million for the nine months ended September 30, 2010 and 2009, respectively.

 

 

 

Litigation

On March 1, 2010 Anthony Morangelli and Frank Ercole filed a class action lawsuit in federal district court for the Eastern District of New York seeking unpaid minimum wages and overtime service technician compensation from     Roto-Rooter and Chemed.  They also seek payment of penalties, interest and plaintiffs’ attorney fees.  We contest these allegations.  In September 2010, the Court conditionally certified a nationwide class of service technicians, excluding those who signed dispute resolution agreements in which they agreed to arbitrate claims arising out of their employment.  There has been no final determination of the merits of collective treatment of the case.  The lawsuit is in its early stage an d we are unable to estimate our potential liability, if any, with respect to these allegations.

VITAS is party to a class action lawsuit filed in the Superior Court of California, Los Angeles County, in September 2006 by Bernadette Santos, Keith Knoche and Joyce White.  This case alleges failure to pay overtime and failure to provide meal and rest periods to a purported class of California admissions nurses, chaplains and sales representatives.  The case seeks payment of penalties, interest and Plaintiffs’ attorney fees.  VITAS contests these allegations.  In December 2009, the trial court denied Plaintiffs’ motion for class certification. The lawsuit is in its early stages and we are unable to estimate our potential liability, if any, with respect to these allegations.

Regardless of outcome, defense of litigation adversely affects us through defense costs, diversion of our time and related publicity.  In the normal course of business, we are a party to various claims and legal proceedings.  We record a reserve for these matters when an adverse outcome is probable and the amount of the potential liability is reasonably estimable.

Regulatory Matters

In April 2005, the Office of Inspector General (“OIG”) for the Department of Health and Human Services served VITAS with civil subpoenas relating to VITAS’ alleged failure to appropriately bill Medicare and Medicaid for hospice services.  As part of this investigation, the OIG selected medical records for 320 past and current patients from VITAS’ three largest programs for review.  It also sought policies and procedures dating back to 1998 covering admissions, certifications, recertifications and discharges.  During the third quarter of 2005 and again in May 2006, the OIG requested additional information from us.  The Court dismissed a related qui tam complaint filed in U.S. District Court for the Southern District of Flori da with prejudice in July 2007.  The plaintiffs appealed this dismissal, which the Court of Appeals affirmed.  The government continues to investigate the complaint’s allegations.  In March 2009, we received a letter from the government reiterating the basis of their investigation.

In May 2009, VITAS received an administrative subpoena from the U.S. Department of Justice requesting VITAS deliver to the OIG documents, patient records, and policy and procedure manuals for headquarters and its Texas programs concerning hospice services provided for the period January 1, 2003 to the date of the letter.  In August 2009, the OIG selected medical records for 59 past and current patients from a Texas program for review.   In February 2010, VITAS received a companion civil investigative demand (“CID”) from the state of Texas Attorney General’s Office, seeking related documents. In September 2010, it received a second CID and a second administrative subpoena seeking related documents.  Based on the early stage of the inve stigation and the limited information we have at this time, we cannot predict the outcome of this investigation.  We believe that we are in material compliance with Medicare and Medicaid rules and regulations applicable to hospice providers.

The costs to comply with either of these investigations were not material for any period presented.  We are unable to predict the outcome of these matters or the impact, if any, that the investigation may have on our business, results of operations, liquidity or capital resources.  Regardless of outcome, responding to the subpoenas can adversely affect us through defense costs, diversion of our time and related publicity.

VITAS has pharmacy services agreements ("Agreements") with Omnicare, Inc. and its subsidiaries (“OCR”) whereby OCR provides specified pharmacy services for VITAS and its hospice patients in geographical areas served by both VITAS and OCR.  The Agreements renew automatically for one-year terms.  Either party may cancel the Agreements at the end of any term by giving 90 days prior written notice.  VITAS made purchases from OCR of $9.0 million and $8.5 million for the three months ended September 30, 2010 and 2009, respectively.  VITAS made purchases from OCR of $26.5 million and $24.6 million for the nine months ended September 30, 2010 and 2009, respectively.

 

 

Mr. Joel Gemunder retired as President and CEO of OCR during the third quarter of 2010 and is a director of the Company.  Ms. Andrea Lindell is a director of both OCR and the Company. Mr. Kevin J. McNamara, President, Chief Executive Officer and a director of the Company, is a director emeritus of OCR.  We believe that the terms of the Agreements are no less favorable to VITAS than we could negotiate with an unrelated party.

Included in accounts payable at September 30, 2010 is cash overdrafts payable of $11.5 million (December 31, 2009 - $11.7 million).

We adopted the provisions of the FASB’s authoritative guidance on fair value measurements.  This statement defines a hierarchy which prioritizes the inputs in fair value measurements.  Level 1 measurements are measurements using quoted prices in active markets for identical assets or liabilities.  Level 2 measurements use significant other observable inputs.  Level 3 measurements are measurements using significant unobservable inputs which require a company to develop its own assumptions.  In recording the fair value of assets and liabilities, companies must use the most reliable measurement available.

 

For cash and cash equivalents, accounts receivable and accounts payable, the carrying amount is a reasonable estimate of fair value because of the liquidity and short-term nature of these instruments.

On April 26, 2007, our Board of Directors authorized a $150 million stock repurchase program.  On May 19, 2008, our Board of Directors authorized an additional $56 million to the April 2007 stock repurchase program.  For the quarter ended September 30, 2010, there were no shares repurchased.  For the nine months ended September 30, 2010, we repurchased 146,275 shares at a weighted average cost per share of $53.32. For the quarter and nine months ended September 30, 2009 we repurchased no stock.