Chemed - 10-Q quarterly report FY

 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 b asis 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 March 31, 2010, VITAS has approximately $9.1 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 March 31, 2010, we  reversed $1.8 million of Medicare cap liability recorded during the fourth quarter of 2009 for two programs’ projected liability for the 2010 measurement period.  This reversal was offset by a $35,000 pretax charge related to one program’s projected liability for the 2010 measurement period.  During the period ended March 31, 2009 we recorded $270,000 in Medicare cap liability for one program’s projected liability for the 2009 measurement period.  This amount was subsequently reversed due to improved admission trends during the second quarter of 2009.

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 eliminated or 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 six 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 three months ended March 31, 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.

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-month period ended March 31, 2010, 1.3 million stock options 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-month period ended March 31, 2009, 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 u pon 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.

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.

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 F lorida 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 from the state of Texas Attorney General’s Office, seeking related documents. Based on the early stage of the investigation 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 two 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 written notice at least 90 days prior to the end of said term.  VITAS made purchases from OCR of $8.6 million and $7.9 million for the three months ended March 31, 2010 and 2009, respectively.

 Mr. Joel F. Gemunder, President and Chief Executive Officer of OCR and Ms. Andrea Lindell are directors 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 these agreements are no less favorable to VITAS than we could negotiate with an unrelated party.

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.  There was no impact on our financial position or results of operations upon adoption of this authoritative guidance.

 

For the three months ended March 31, 2010, the increase in consolidated service revenues and sales was driven by a 7.0% increase at VITAS while Roto-Rooter revenues decreased by 0.7%.  The increase in service revenues at VITAS was a result of increased average daily census (“ADC”) of 5.1%, driven by an increase in admissions of 4.8%, combined with Medicare price increases of approximately 1.3%.  Roto-Rooter was driven by a 7.0% decrease in job count offset by an approximate 6.3% price and mix shift increase. The Roto-Rooter changes include the impact of acquisitions in 2009, offset by the conversion of one company-owned branch to an independent contractor in 2009.  The impact of these transactions is not material.  Consolidated net income is essentially flat over prior year.  Diluted EPS decreased as the result of the increased number of average shares outstanding. Adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) increased 2.0% from the first quarter of 2009 to the first quarter of 2010.

EBITDA and Adjusted EBITDA are not measures derived in accordance with GAAP and exclude components that are important to understanding our financial performance.  We use Adjusted EBITDA as a measure of earnings for our LTIP awards.  We provide EBITDA and Adjusted EBITDA to help readers evaluate our operating results, compare our operating performance with that of similar companies that have different capital structures and help evaluate our ability to meet future debt service, capital expenditure and working capital requirements.  Our EBITDA and Adjusted EBITDA should not be considered in isolation or as a substitute for comparable measures presented in accordance with GAAP.  A reconciliation of our net income to our Adjusted EBITDA is presente d on page 21.

VITAS expects to achieve full-year 2010 revenue growth, prior to Medicare cap, of 5.0% to 6.0%.  Admissions are estimated to increase 2.0% to 4.0%.  Adjusted EBITDA margin, prior to Medicare cap is estimated to be 15.0% to 15.5%.  Roto-Rooter expects full-year 2010 revenue growth of 1.0% to 3.0%.  The revenue estimate is a result of increased pricing of 3.0%, a favorable mix shift to higher revenue jobs, offset by a job count decline estimated at 2.0% to 4.0%.  Adjusted EBITDA margin for 2010 is estimated to be in the range of 17.5% to 18.0%.  We anticipate that our operating income and cash flows will be sufficient to operate our businesses and meet any commitments for the foreseeable future.

We have issued $28.0 million in standby letters of credit as of March 31, 2010, for insurance purposes.  Issued letters of credit reduce our available credit under the revolving credit agreement.  As of March 31, 2010, we have approximately $147.0 million of unused lines of credit available and eligible to be drawn down under our revolving credit facility, excluding the expansion feature. Management believes its liquidity and sources of capital are satisfactory for the Company’s needs in the foreseeable future.

Collectively, the terms of our credit agreements require us to meet various financial covenants, to be tested quarterly.  In connection therewith, we are in compliance with all financial and other debt covenants as of March 31, 2010 and anticipate remaining in compliance throughout 2010.

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 Plantiffs’ 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.

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 Fl orida 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 from the state of Texas Attorney General’s office, seeking related documents. Based on the early stage of the investigation and the limited information we have at this time, we cannot predict the outcome of this investigation.  We believe that we are in mat erial compliance with Medicare and Medicaid rules and regulations applicable to hospice providers.

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.

The increase in VITAS’ revenues for the first quarter of 2010 versus the first quarter of 2009 was a result of increased ADC of 5.1% driven by an increase in admissions of 4.8%, combined with Medicare reimbursement rate increases of approximately 1.3%.  In excess of 90% of VITAS’ service revenues for the period were from Medicare and Medicaid.

The increase in plumbing revenues for the first quarter of 2010 versus 2009 is attributable to a 9.0% increase in the average price per job and a 5.2% decrease in the number of jobs performed.  The increase in the plumbing price per job was a combination of increased pricing and favorable job mix shift to more expensive jobs such as excavation.  Our excavation job count increased by 12.6% compared to 2009.  Drain cleaning revenues for the first quarter of 2010 versus 2009 reflect an 8.1% decline in the number of jobs, while the average price per job increased 2.9%.  The increase in other revenues is attributable primarily to an increase in our independent contractor operations offset by lower sales in our HVAC operation.

The consolidated gross margin was 29.0% in the first quarter of 2010 as compared with 29.8% in the first quarter of 2009.  On a segment basis, VITAS’ gross margin was 22.8% in the first quarter of 2010 and 23.4% in the first quarter of 2009.  The Roto-Rooter segment’s gross margin was 45.2% for the first quarter of 2010 essentially flat with the first quarter of 2009.  The decrease in VITAS’ gross margin is attributable to higher labor costs for admissions and Medicare compliance personnel, the opening of inpatient units which carry significant one time start-up costs as capacity begins to ramp-up and a slight mix shift towards higher acuity care which has a lower gross margin than routine homecare.

Selling, general and administrative expenses (“SG&A”) for the first quarter of 2010 were $48.5 million, an increase of $2.7 million (6.0%) versus the first quarter of 2009.  Included in SG&A is a $1.6 million increase related to the increase in our deferred compensation liability due to improved stock market performance.  The offset to the increased liability is recorded in other (non-operating) income and expense. Also in included in the SG&A increase is $147,000 related to OIG expenses.  The remaining change in SG&A is the result of typical cost of living increases for salaries and benefits plus increases in certain selling expenses which vary based on change in revenue.

 Other income increased $462,000 in the first quarter of 2010 to $186,000 due to a $1.8 million gain in the investments of deferred compensation plans which offsets the related expense in SG&A.  This was offset by a $1.2 million decrease related to the settlement of company-owned life insurance that occurred in 2009 but did not recur in 2010.

Our effective income tax rate of 38.9% in the first quarter of 2010 was essentially flat with the first quarter of 2009.